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E-comm Recon: Amazon's vision for a new retail model unfolds

Amazon.com Inc. is carving out a niche in a business long dominated by companies like UPS and FedEx.

The company is in the process of building out its shipping and logistics business to outstrip the competition, requiring more innovation, more investment and slimmer margins. Being first to the fastest shipping has long been an advantage for the legacy e-commerce giant, but lately the company has targeted direct investments in the underlying infrastructure.

Recently, the company has made numerous infrastructure investments and it is rumored to be making even more. The year opened with reports that Amazon would build a $1.5 billion air hub in Kentucky, for instance. When asked about this on the company’s fourth-quarter 2016 earnings call, CFO Brian Olsavsky compared it to air cargo partnerships it made in the prior year.

Subsequently, reports indicated that Amazon is now directly managing transoceanic shipping from Asia on products in its network. Most recently, the company set up a meeting with large consumer products companies, reportedly to cut some fat from the traditional retail supply chain and do more direct business with brands.

Amazon had also reportedly been interested in making a bid for the office supply retailer Staples. Jim Barnes, CEO of logistics consulting company enVista and B2B platform-as-a-service company Enspire Commerce, in an interview said the play was not only for its stores, but "also because Staples has one of the largest carrier networks in the B2B business that no one knows about."

At the end of 2015, Amazon operated 69.9 million square feet of domestic data center and fulfillment space. In 2016, that number swelled 40% to 97.2 million, according to SEC filings. The company’s executives have repeatedly discussed infrastructure investment as a way to serve its customers better, and its customer base is increasingly comprised of merchants contracting logistics services.

Amazon services a shipping network called Fulfillment by Amazon that gets items to a customer quickly and supports returns and exchanges. If brands use the service, they are invited to become a Prime seller and benefit from Amazon’s additional support of Prime. As Olsavsky put it: "FBA reinforces Prime. Prime reinforces FBA. It's a good flywheel."

Amazon's Fulfillment by Amazon sellers grew 70% in 2016, Olsavsky said. As more sellers use FBA, Amazon's shipping costs shrink and it can pass that savings to the customer, squeezing retail competition more tightly. The company is expanding its international FBA capacity, building out a global fulfillment network that if decoupled from its e-commerce business could challenge some of the world's most staid shipping companies.

"They could definitely disrupt some of the other logistics companies, or at least become a competitive option for retailers," Linda Bustos, co-founder and managing partner of e-commerce advisory firm Edgacent, said in an interview.

E-commerce websites are not particularly hard to build, said Barnes, so Amazon is not competing too much on technology. Rather, it is competing on capacity, he said. Just as disruptors in other sectors like Uber and Lyft compete on capacity of drivers filling the local demand at reasonable prices, Amazon competes on positioning its inventory as close to the demand signal as possible, supported by a logistics network that it can optimize in real time.

The executive argued that longstanding shipping companies like UPS and FedEx should launch their own e-commerce marketplaces. The supply chain is by far the most complicated and expensive component to Amazon’s business, and the one that has allowed it to maintain its advantage, he said. FedEx and UPS already have that all-important piece.

"It took UPS and FedEx 30-plus years to build out their infrastructure around physical distribution and transportation," he said. "So why ... aren't FedEx and UPS in this marketplace?"

Traditional shipping companies likely have been distracted by record top-line earnings as they service the broader secular boom in e-commerce. For example, UPS in 2016 collected record earnings and revenue, and its executives credited much of the growth to "the e-commerce opportunity." But Barnes warned that Amazon's growth in fulfillment still represents missed opportunities for those shipping companies.

Whether traditional shipping companies could compete effectively in the e-commerce space is far from certain though. Bustos suggested that those companies are already too far behind to pivot quickly enough.

"What is baffling is they don’t have better online experiences with their digital platforms," she said. While the technology piece of e-commerce may be much less overhead compared to the supply chain, UPS, FedEx and other longstanding shipping companies are still woefully behind, including in the collection and application of valuable customer data, Bustos said.

But she agreed with Barnes that fulfillment infrastructure is increasingly a defining part of the e-commerce business. Other retailers are trying to compete by using existing infrastructure and carving out an omnichannel space, most predominantly by providing an in-store pickup option on online orders. Wal-Mart, for example, with its integration of Jet.com, seems poised to provide both a pure e-commerce experience and an omnichannel experience, with Jet.com competing with a dynamic pricing model.

But even with these, catching up to Amazon's digital experience, backed by an ever-growing fulfillment network, may not be easy.