Amazon's Going the Extra Mile to Deliver Your Packages

Amazon.com (NASDAQ: AMZN  ) is testing its own in-house delivery service in a few key cities like San Francisco, Los Angeles, and New York. According to The Wall Street Journal, the company hopes to save money and reduce delivery times by cutting out package delivery companies like United Parcel Service (NYSE: UPS  ) and FedEx (NYSE: FDX  ) .

Amazon.com is starting to handle some of its own deliveries

At first glance, the prospect of having Amazon.com go its own way might seem like a big problem for UPS and FedEx. In reality, while Amazon may "insource" some deliveries, most of its packages will continue to be delivered by other companies for the foreseeable future. Moreover, other retailers will become ever more reliant on UPS and FedEx to compete with Amazon.

Amazon's next grand plan
Amazon's top priority is ensuring that delivery capacity issues do not impede its growth. In the company's recent investor letter, CEO Jeff Bezos wrote that Amazon was building its own delivery network in the U.K. because existing delivery companies couldn't handle Amazon's peak package volume.

Amazon's experience during the 2013 holiday season was probably an eye-opener. Because of higher-than-expected e-commerce growth and bad weather, UPS (and to a lesser extent, FedEx) were overwhelmed with last-minute package deliveries. As a result, some Amazon customers didn't receive their packages in time for Christmas, as promised.

Amazon refunded shipping charges and gave $20 gift cards as compensation for some customers who experienced delivery issues. Still, that can't quite make up for getting Christmas gifts after Christmas! If Amazon wants to ensure better service, it may need to take a more active role in package delivery.

Amazon and the delivery kings
Fortunately for UPS and FedEx, while Amazon.com is a big customer, it's not so big that the loss of Amazon's business would hurt either one very much. In total, Amazon spent $6.6 billion on shipping costs last year. However, not all of that was in the U.S., and not all of the U.S. shipping costs went to UPS and FedEx.

Amazon represents a tiny fraction of revenue for UPS and FedEx.

That means Amazon represents just a tiny fraction of revenue for UPS and FedEx. (Combined, the two have annual revenue of more than $100 billion.) This isn't high-margin revenue, either. As a major shipper, Amazon naturally gets very favorable pricing already.

Additionally, Amazon would have a lot of trouble trying to make a clean break from UPS and FedEx. Delivering packages to consumers' homes is a very challenging and capital-intensive business. Some customers who have received packages through Amazon's in-house delivery service have found it to be very unreliable compared with UPS, FedEx, or the U.S. Postal Service.

Assuming that Amazon can work out the kinks over time in its test markets, it might be able to expand its delivery network. That said, only in big cities would Amazon have enough deliveries in each neighborhood to support the fixed costs of operating delivery trucks.

In most of the country, Amazon would still need to rely on UPS and FedEx. With broad customer bases, UPS and FedEx carry far more package and envelope traffic than Amazon alone would generate. For example, last year UPS delivered 4.3 billion items.

Better service for customers
UPS has already admitted that it wasn't prepared for the growth in e-commerce shipments that it saw last December. Back in January, UPS executives laid out a four-point plan that they will use in the future to better predict demand and ensure that the company delivers all packages in a timely fashion.

UPS is implementing a 4-point plan to improve delivery performance for the 2014 holiday season.

For Amazon, one of the biggest benefits of operating its own fleet of delivery trucks is that doing so would put more pressure on UPS and FedEx to live up to their promises. An in-house delivery service could also help Amazon offer free next-day or even same-day delivery on some items.

However, even this wouldn't be so bad for the delivery companies. If Amazon popularizes next-day or same-day delivery, its competitors would probably have to follow. That will make other retailers rely upon UPS and FedEx even more heavily. That's one of the big reasons both companies are excited about the long-term growth of e-commerce.

Foolish final thoughts
Even if Amazon.com begins handling some of its own deliveries, you will still see more and more UPS or FedEx delivery trucks in your neighborhood as other retailers race to grow their own e-commerce operations. In that sense, Amazon's frustration could turn out to benefit UPS and FedEx in the long run.

There's one big caveat, though. Just as Amazon currently sells other merchants' goods on its website and fulfills some merchants' orders from its own warehouses, Amazon could ultimately try to compete with UPS and FedEx to win business delivering other retailers' e-commerce shipments.

If Amazon succeeded in this kind of effort, it would obviously be a big problem for UPS and FedEx. On the other hand, most major retailers would probably be wary of outsourcing their deliveries to a direct competitor.

Amazon would need to offer dramatically lower prices -- and fix its reliability problems -- to overcome these concerns. The day when Amazon can bring UPS and FedEx to their knees is still far in the future, if it even exists. In the meantime, UPS and FedEx just need to focus on keeping costs down and keeping their customers happy. As long as they do, they will continue to ride the rising tide of e-commerce.

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