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What makes Amazon.com, Inc. (NASDAQ: AMZN) such a formidable competitor, and sometimes a ruthless partner, is that just when the rest of American retailing and logistics thinks they have caught up with its strategy and execution, it has already moved miles down the road.
The 800-pound gorilla of U.S. commerce threw down the gauntlet in a major way late on April 25. It disclosed plans to cut delivery windows for its wildly-popular Prime service from two days to one, and make one-day deliveries the standard for the service, which has about 102 million worldwide members. Amazon also said it plans to launch a similar initiative internationally.
Amazon currently offers deliveries more rapidly than two days, and it will continue to do so. However, the one-day service will become the "default" Prime window, meaning it will be included for free to subscribers with their paid monthly or annual subscription. In the past month, the company has made certain products and markets eligible for one-day deliveries, the first step in what is expected to be a major ramp-up starting this quarter and building momentum as the year progresses.
The implications are profound for all companies affected by Amazon, which in the retail and logistics sectors is pretty much all of those companies. It also poses an immense challenge for Amazon itself. The company will bear enormous cost to change an infrastructure that CFO Brian Olsavsky said yesterday is "attuned to two-day delivery." Amazon will spend about $800 million in the second quarter alone, Olsavsky said. It will spend a great deal more before Chairman and CEO Jeff Bezos is satisfied with the program's progress.
Hitting such ambitious delivery targets with regularity could mean doubling the number of air freighter deliveries from Amazon's two flying partners, Atlas Air Worldwide Holdings (NASDAQ: AAWW) and Air Transport Services Group (NASDAQ: ATSG) to as many as 87 aircraft, according to Kevin Sterling, transport analyst for Seaport Global Securities. It could spawn a major expansion of its ground network, both in physical structures and automation. Neither investment will come cheap.
Amazon will eventually need between 350 and 400 U.S. delivery stations to support one-day delivery in markets with populations of more than 100,000, according to Marc Wulfraat, whose consultancy, MWPVL International, tracks Amazon's physical network activities. Amazon currently operates 115 U.S. delivery stations, with 10 more in the works, according to MWPVL data. Currently, Amazon focuses on U.S. markets with more than 250,000 people, but it will push harder into markets with populations of 100,000 or more, Wulfraat said.
Amazon faces another potential obstacle in that it will have less opportunity to build high route density because it will have a shorter time span to harness volumes needed to optimize routes and create efficiencies, Wulfraat said.
For manufacturers and competing retailers, Amazon's plans are a nightmare of epic proportions. If UPS Inc.'s (NYSE: UPS) 8 percent year-over-gain in domestic air volumes during its first quarter are any indication, companies are being forced to upshift to higher-priced air deliveries to meet elevated customer expectations, set primarily by Amazon. Pushing – or shrinking – the delivery envelope from two days to one presents an exponential challenge for businesses already squeezed by higher shipping costs for faster deliveries on one end and a consumer base that's obsessed with free shipping on the other.
For UPS, Amazon's initiative could pose a seminal test of its multi-year "transformation" initiative, the centerpiece of which is multiple, highly automated hubs being built to increase throughput by as much as 35 percent over hubs that aren't as highly automated. UPS delivers 20 million parcels and letters a day across a worldwide network, so a 35 percent throughput increase would be massive.
The ability to drive more parcels through its network is of paramount importance to UPS, especially in its dealings with Amazon. According to data published Friday by investment firm Baird, UPS' domestic operating margins, measured as earnings before interest and taxes, have eroded from 15.7 percent in 2005 to 8.9 percent in 2018. Coincidentally or not, Amazon Prime was launched in 2005, even though it didn't become a major force until early in the next decade.
The post-2005 period has been one in which Amazon, which effectively created modern-day business-to-consumer fulfillment, has pushed more density at UPS and other carriers, but at lower rates for the carriers. UPS has found it difficult to consistently price those shipments at levels acceptable to Amazon; hence the margin erosion according to Baird data. Yet UPS cannot abandon a customer that contributes billions of dollars in revenue, and which tenders it between 21 percent and 26 percent of its traffic. "It's a delicate balance," said Benjamin J. Hartford, the Baird analyst who wrote the report.
Amazon's migration to one-day delivery will make it harder for UPS to stem the margin erosion, the Baird data implied. What's also implied in the data is that density without adequate pricing to accompany it is a pyrrhic victory at best, and a losing proposition at worst.
The difference between 2005 and today, though, is the new hubs, which could go a long way to offset and perhaps reverse the pressure that UPS has felt, largely at Amazon's hands, for the past 13 years.
Image sourced from Pixabay
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