Why Amazon Shipping Costs Are Becoming an Increasing Problem

Amazon's  (NASDAQ: AMZN  ) cost of shipping in the first quarter of 2014 increased to an all-time high for a non-holiday period, according to an SEC filing from the company.  The online retailer spent almost $1 billion in shipping during the quarter, an increase of 28% from the same period in 2012. 

Shipping expenses have grown as a percentage of sales each year since 2009, according to securities filings.

That sheds some light on why the company raised the price of its Amazon Prime service, which includes free two-day shipping on millions of items, from $79 to $99 earlier this year. It also explains why Amazon has been pursuing a number of ways to lower its shipping costs, including creating its own trucking network and using drones to deliver items.

Amazon walks a tightrope when it comes to shipping costs -- the company already operates on very narrow retail margins so an increase in shipping costs directly hits the bottom line, but passing that expense on to customers might lead to them buying less often from Amazon.

Amazon still had a good quarter

In the first quarter of 2014 Amazon's net sales increased 23% to $19.74 billion compared with $16.07 billion in first quarter 2013. Despite the large increase in shipping costs the company made slightly more money in the quarter than it did during the same period last year with net income increasing to $108 million in the first quarter of 2014 compared to  $82 million in the first quarter of 2013.

The early returns for the Prime price increase also appear positive. Amazon CFO Tom Szkutak said on Thursday's earnings conference call that Prime subscriptions continue to grow week over week even after the price increase, GeekWire reported. That statement needs to be taken with a bit of a grain of salt, however, as Amazon does not release subscriber counts for Prime so it's impossible to know if growth has grown, slowed, or maintained the same pace since the price went up in March.

Searching for solutions

Amazon's efforts to develop drones -- which sounds like a sci-fi concept that's unlikely to ever be deployed -- actually seems closer to reality. In a letter to shareholders that accompanied Amazon's 2013 annual report CEO Jeff Bezos avoided using the word drones but he did write that "the Prime Air team is already flight testing our 5th and 6th generation aerial vehicles, and we are in the design phase on generations 7 and 8." 

The drones, if they ever come into reality, would likely be used to offer same-delivery from Amazon fulfillment centers, though it's unclear if using drones would lower costs or would be a premium offering customers pay for.

One service the company has launched nationally is Prime Pantry, which offers Prime members the ability to order grocery items, a list that "includes popular soft drinks and bottled water, a new range of paper and laundry products in popular pack sizes, single boxes of breakfast cereal, potato chips, convenience-sized personal care products, and more," for a flat $5.99 delivery fee per box, according to a press release. 

Prime Pantry allows the company to offer odd-sized and difficult-to-ship items that are not included in the regular Prime service to its customers while recouping some (if not all) of the shipping cost.

Amazon is also testing using its own trucks to deliver the so-called "last mile," which has the potential to lower costs while also allowing the company to deliver on its own schedule. Theoretically, having its own trucks would allow Amazon to offer same-day delivery, deliveries in the middle of the night, or at noon on Christmas Day -- all things it might be able to charge a premium for. 

Starting a delivery network is no simple task and it might only make sense for Amazon to attempt it in densely populated areas. 

"UPS (NYSE: UPS  ) , founded in 1907, has a head start of more than a century," the Wall Street Journal reported. "Industry observers say it will be difficult for Amazon to match the efficiency of UPS or FedEx  (NYSE: FDX  ) in more than a handful of U.S. markets, simply because it will be delivering fewer packages over a wider area."

That may be true on its own, but the company is also rolling out its Amazon Fresh grocery service in select markets using its own trucks. The company could increase its delivery load and make having its own trucking fleet a viable plan.
 
Amazon showed that it is in fact targeting UPS and FedEx in a recent job posting on its website.

Amazon is growing at a faster speed than UPS and FedEx, who are responsible for shipping the majority of our packages. At this rate Amazon cannot continue to rely solely on the solutions provided through traditional logistics providers. To do so will limit our growth, increase costs and impede innovation in delivery capabilities. Last Mile is the solution to this. It is a program which is going to revolutionize how shipments are delivered to millions of customers.

The company may not have all the answers yet but it has had some success with "last mile" trucking in the United Kingdom where it tested delivering its own shipments in areas where the commercial carriers could not keep up with peak volumes (a problem the company faced in the U.S. last Christmas).

Amazon needs to do something

"What happened during Christmas cost a huge amount of money" for Amazon, UPS, and FedEx, Marc Wulfraat, president of logistics consulting firm MWPVL International, which tracks Amazon closely, told The Journal.

Add shipping problems to years of rising delivery costs and the potential that existing carriers won't be able to meet demand as Amazon grows, and it's clear that the company's prospects rest heavily on finding a way to control shipping costs without simply passing the expense on to customers.

Amazon does not have its answer yet but the company will find a mix that lowers its expenses while making shipping more efficient. If Amazon can tuck that pair of earbuds and copy of Moby Dick you ordered in with your regularly scheduled grocery shipment, it can save money while getting customers to buy more.

Similarly if the company can market same-day delivery or even odd-time deliveries as a premium, it should become a more nimble competitor that can steal business from physical stores whose chief advantage is often that customers can have the product when they want it. 

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