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Amazon could face logistical obstacles as it rolls out 1-day delivery


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Amazon could face logistical obstacles as it rolls out 1-day delivery Inc. could face logistical and workforce obstacles in the coming years as it builds out shipping capacity for its ambitious one-day delivery program across North America and abroad, experts say.

It could be difficult and costly for Amazon to build out its current infrastructure programmed for two-day deliveries, according to analysts speaking to S&P Global Market Intelligence. Also problematical is the e-commerce giant's reliance on a somewhat risky, unpredictable system of third-party carriers.

"Will there be hiccups? Absolutely," said Charlie O’Shea, a Moody’s analyst covering Amazon. "This is a gargantuan effort. You’re trying to change a two-day shipping standard to one day. [Amazon is] literally throwing everything but the kitchen sink at this."

Amazon announced April 25 that it was spending $800 million on the free one-day Prime delivery program, up from the free two-day standard available to Prime members since 2005. In a conference call July 25, the company said it already spent more than the $800 million it forecast for one-day Prime delivery costs in the second quarter, due largely to shipping and warehouse expenses and moving its network closer to customers.

The company did not disclose exact figures. But Amazon officials expect to spend more in the second half of the year to build out shipping capacity for the program, which began in April and currently varies in terms of selection, threshold and country.

A costly bet on delivery

Higher delivery costs negatively impacted Amazon's second-quarter EPS and net income that missed analysts' estimates.

The transition to a one-day window has not been easy. Amazon Senior Vice President and CFO Brian Olsavsky described it as a "shock to the system" in the July 25 call and said it would take a "number of quarters" to regain cost efficiency.

Greg Buzek, president of Franklin, Tenn.-based research firm IHL Group, said in an interview that it could take "five years" before the company turns a profit on the free delivery program to Prime members, who pay $119 annually in the U.S.

He said Amazon is trying to make up for losses associated with one-day delivery from an increasing number of orders made by Prime members. The problem is that the cost of transporting the items is currently greater than the value of those paid orders.

"Each one of those things is a loss to Amazon right now," Buzek said. "I don't think they have a huge concern on that, mainly because they have such a profitable business in other places [including its on-demand cloud computing unit Amazon Web Services Inc. and online advertising operations]."

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Challenging Walmart

Amazon is ratcheting up spending for its one-day delivery program as part of its battle against brick-and-mortar rival Walmart Inc.

The e-commerce company has tinkered with various shipping initiatives over the years, including one- and two-hour delivery. But the shift to a one-day standard in April was an indication that Amazon was taking its delivery strategy to the next level. Free one-day shipping is available to Prime members with no minimum purchase amount in the U.S. It is offered seven days a week, with limited availability on certain holidays and major shopping days such as Black Friday.

About a month after Amazon said its one-day delivery program, Walmart responded with a May 14 announcement that it would provide free no-membership next day shipping for minimum orders of $35 and reach approximately 75% of the U.S population in 2019.

Amazon upped the ante in June with plans to make more than 10 million items available for one-day delivery. Walmart, by comparison, offers one-day shipping for about 200,000 products.

The retail companies also went head-to-head with major discount shopping events in July. Amazon held Prime Day, a two-day "global shopping event" for Prime members, which began July 16. Walmart ran its own sales event from July 14 to July 17.

In-house vs. third party

Walmart has a big advantage in the delivery realm because it is a brick-and-mortar operation with a network of more than 5,000 stores and has control over delivery to the final consumer destination, said O'Shea of Moody's. Furthermore, it and other big-box retailers also have huge loading docks that can quickly become impromptu distribution centers.

Amazon's network is largely made up of individual contractors driving Penske and Enterprise rental vans, which can be prone to breakdowns, to deliver hundreds of packages a day. Also, entrepreneurs have started their own Amazon delivery businesses, O'Shea said.

"Distribution is what the brick-and-mortar guys have because they have stores, and they stock those stores and they control the last mile for 90% of their sales," O'Shea said. "Amazon has outsourced the last mile. ... You're relying a lot on a lot of other people who do not work for you."

Amazon declined to provide a breakdown of how much it relies on FedEx Corp., the U.S. Postal Service and individual contractors, but a company spokesman said in an emailed statement that the company has "strategically grown our network in the U.S. to include 110 fulfillment centers, 40 package sortation centers, 100 delivery stations and 20 air gateways."

"This allows Amazon to work smarter based on decades of process improvement and innovation, and to deliver orders faster and more efficiently," the spokesman stated.

Amazon's delivery ambitions could be further challenged by FedEx's announcement Aug. 7 to end a ground-delivery contract with it that expires at the end of August. And in June, FedEx said it would not renew its U.S. contract with Amazon to transport packages on its air cargo service FedEx Express.

Potential employee strain

Amazon's promise to meet one-day shipping deadlines could increase the workloads of fulfillment employees who need to find items and place them in boxes even faster, said Brandon Fletcher, an analyst at Sanford C. Bernstein & Co.

"The only way to go faster is to either up the standards, which is tempting and you have to be careful, because if you do that, you can hurt people or create a backlash, or you have to automate parts of the process," Fletcher said.

Buzek, of IHL Group, noted that Amazon is working on "multiple fronts" to mitigate against any employee backlash with hopes of eventual drone deliveries and incorporating more and more automation into its fulfillment centers.

In the meantime, "there's going to be pressure and tighter deadlines" for human workers, he said.

"I think one of the biggest issues they have right now is a shortage of labor," Buzek said. "The number of packages that need to be delivered keeps going up, and that's a squeeze that they've got to manage."

Amazon officials said in an emailed statement Aug. 8 that "increasing delivery speeds for customers did not change any individual performance expectations for associates in our fulfillment and delivery operations."

Forgiving customers?

Fletcher of Sanford C. Bernstein believes Prime consumers will give Amazon the benefit of the doubt as the company works on the one-day shipping program, at least at first.

"People are tolerating it because it's not like they said you pay more for the one-day promise," he said. "So people will be like, 'Amazon is a good partner to me, and makes my household run easier. Yeah, it didn't come on time, but I'm sure they will figure out.' That's what Amazon has built, this brand promise that even if they over-promise today, they will deliver with enough frequency and get better at it every time, that you'll still stay loyal and keep your membership."

He added that Amazon only needs to hit the one-day window threshold about 60% of the time to earn initial credibility.

"Then customers rely on it, and once you've got the customer demanding it, then you've won the game because now you've moved the customer expectation to a level that pretty much just Amazon or Walmart over time can deliver on," he said.