Market Overview

When Dealing With Amazon, It Pays To Not Whistle Past The Graveyard

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When Dealing With Amazon, It Pays To Not Whistle Past The Graveyard

FedEx Corp. (NYSE: FDX) has been consistent in its views of Amazon.com, Inc. (NASDAQ: AMZN) becoming a threat to FedEx's delivery business. To wit, a delivery startup like Amazon can't compete with FedEx's network, technologies and portfolio built up over nearly 50 years and at a cost of billions of dollars. Amazon is not a FedEx competitor but is instead a valuable customer. Finally, no single FedEx customer accounts more than 3 percent of its total revenue. Fred Smith, FedEx's founder, chairman and CEO, last month labelled the notion of Amazon's encroachment on FedEx's share "fantastical."

Here's another view: A survey of 85 parcel shippers conducted in October 2017 last by Shipware, LLC, a consultancy, found that more than 65 percent expect Amazon to be competing with FedEx and its chief rival, UPS Inc. (NYSE: UPS) within 2 to 5 years. More than 68 percent would "definitely" or "likely" explore a competing service from Amazon if all the costs were similar, the survey found. More than two-thirds of respondents said they were most focused on reducing transit times in response to Amazon's growing presence. The shipper respondents accounted for more than $2 billion in annual parcel spend at the time, according to Rob Martinez, Shipware's founder.

Though he hasn't sampled shipper responses on the issue since then, Martinez said today that the results would likely favor Amazon even more because it has expanded its capabilities in the past 15 months.

Here's still another: According to estimates from ShipMatrix, a consultancy, Amazon's 2018 average daily package volume will hit about 8.5 million. FedEx Ground, FedEx's ground parcel unit and a $17 billion a year business in its own right, had average daily volumes in 2018 of 8.336 million, based on Shipware data. That includes the core ground parcel business, its home delivery operation and "SmartPost," a service with the U.S. Postal Service where FedEx inducts parcels deep into the USPS pipeline for letter carriers to deliver to residences.

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The big caveat in the Amazon volume story is that it delivers only about 10 percent of its traffic, most of that through its network of independent drivers. The rest of the pie is divvied up among USPS at between 40 and 62 percent, depending on the source of the estimates, UPS at 21 to 35 percent, and FedEx at 6 to 15 percent. Those figures aren't likely to change much in the near future. Amazon's volumes are growing by double-digit amounts per quarter--ShipMatrix pegs it at a staggering 20 percent quarterly clip. Facing such an avalanche, Amazon recognizes it would be folly right now to cut the cord with its partners if it hopes to balance its growth with its delivery commitments.

Yet Amazon has an unerring way of moving the cheese. What can't be imagined today ends up becoming reality several years later. Two consistent patterns, though, have emerged: Amazon likes to keep control of its operations, and it is obsessed with calibrating low cost and reliable service.

Extrapolate those two objectives to the delivery business, and one can hear the thunder rumbling in the distance. Amazon owns thousands of truck trailers, and it is rapidly signing up independent drivers to transport goods ordered under its Prime service, which guarantees deliveries in a range of 2 hours to 2 days for flat monthly or annual fees. Prime has about 102 million worldwide members, and research has shown that Prime members order twice as much on Amazon's site as non-Prime members. Amazon is piloting a program in southern California where it picks up goods at customers' locations and delivers them to one of its fulfillment centers, services currently handled by other providers. It has acquired 20,000 Mercedes-Benz sprinter vans to make local deliveries of Prime orders. Its "Amazon Air' fleet has 40 Boeing 767 aircraft, and it recently announced plans to acquire 10 more.

Amazon has repeatedly said it is not in a battle with the incumbents over parcel market share. Yet Amazon need not seek out FedEx, UPS, and USPS traffic in order to inflict damage. Business is already coming Amazon's way in the form of massive volumes from its website and its "Fulfillment by Amazon" (FBA) service, which functions as a combination virtual storefront-distribution service and today accounts for 58 percent of the company's total sales. Any business that Amazon chooses to move itself would either be share diverted from the incumbents, or traffic which they would never have a chance to bid on, according to Satish Jindel, head of ShipMatrix.It then becomes a matter of how much traffic Amazon calculates it can more cost-effectively handle in-house than through outsourcing. Amazon's FBA customers don't determine who handles their deliveries, according to Mark S. Schoeman, president of The Colography Group, Inc., a consultancy. Amazon typically makes those decisions at the package sort facilities, Schoeman said.

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Though much of the focus has been on the final-mile segment, Amazon's air service poses a strong challenge to FedEx and UPS on the line-haul portion as well. In what may turn out to be a watershed report given the vast amount of data in it, analysts at Morgan Stanley (NYSE: MS) late last year calculated that it would cost Amazon about $6 a package to ship goods on its own planes, versus paying between $8 per-package to use UPS and $10 to use FedEx Express, FedEx's air operation. (The figures are all net of applicable discounts). Under this scenario, Amazon stands to save $1 to $2 billion in 2019, equal to 3 to 6 percent of its global shipping costs, Morgan Stanley reckoned.

Even with only 27 of the 40 freighters in service as of mid-2018, Amazon Air still has the capacity to transport up to a quarter of its North American packages, Morgan Stanley estimated. Amazon's Cincinnati air hub, which is scheduled to partially open in 2020, will eventually be able to accommodate up to 100 planes. In addition, volumes flown by FedEx and UPS into airports not served by Amazon Air but are within a 50-mile radius of an Amazon warehouse represent 14 and 19 percent, respectively, of their total air volumes, Morgan Stanley estimated.

Not surprisingly given what Morgan Stanley believes are secular threats posed by increased in-sourcing by Amazon and by a "resurgent" USPS with its expanded emphasis on parcels, the investment firm reduced its price targets on FedEx and UPS shares. UPS is more exposed because it handles more Amazon traffic and more B2C commerce, has a higher cost structure because of its unionized status, and its integrated business model-- where one driver picks up and delivers all packages regardless of service line--may make it harder to quickly respond to changing business conditions, the analysts wrote.

In the long run, what may tip the scales in Amazon's favor has less to do with the company than with macro trends in the parcel market. According to Martinez of Shipware, shippers weary of the long-running FedEx and UPS duopoly on business-to-business traffic, as well as their strong combined position in B2C, are eager for an alternative. "After years of rate hikes, arrogant sales reps, and `take it or leave it' approaches to customer requests, shippers are wide-open to trying new services" as long as they are high quality, he said.

A decade ago this month, DHL Express ended its financially disastrous six-year quest to be the third private U.S. parcel player when it ceased domestic operations. DHL's problem was not its rates, which were actually quite competitive, but its inconsistent service and oftentimes shoddy service. By contrast, Amazon has the market capitalization to make a serious, sustained run, and it has a reputation for doing things right, Martinez said. FedEx and UPS, he added, "should be a little worried" about Amazon's future capabilities..

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