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Package delivery companies are finding servicing e-commerce growth to be more costly and difficult than originally expected. Online merchants need to take note.
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What's Amazon (AMZN +0.01%) planning with its delivery and logistics network? It's well known that the e-commerce company is expanding its delivery services -- but is it merely to complement the existing services it gets from FedEx Corporation (FDX +0.00%) and United Parcel Service (UPS 0.01%), or will Amazon end up directly competing with the package delivery giants? The question of the threat from Amazon comes up on almost every investor presentation given by FedEx and UPS.
However, what's less discussed is that e-commerce growth is creating challenges for both companies. If Jeff Bezos thinks Amazon could compete with FedEx and UPS, the evidence from their latest results suggests he might be in for a rude awakening. Here's why.
It's well known that servicing e-commerce deliveries requires investment, but the amount of investment needed has surprised UPS and FedEx in recent years. Consequently, both companies -- whose management teams have decades of experience between them -- have had to increase capital expenditures in order to service growth.
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For example, at its investor conference in November 2014, UPS predicted that capital expenditures would be just 4.5%-5% of revenue in the 2015-2019 period. More than two years on, the reality is significantly different. UPS' capital expenditure was $2.965 billion in 2016, representing 4.8% of its reported revenue of $60.9 billion -- but that's set to increase to more than 6% in 2017 in order to expand network capacity for e-commerce deliveries. In addition, the traditional increase in U.S. domestic package profitability from the third to fourth quarter has been impacted by the strains of e-commerce delivery during peak season.
It's a similar story at FedEx, where increased capital expenditures are impacting profitability. In reality, FedEx has dealt better with the burgeoning e-commerce growth than UPS -- possibly because it operates separate air and ground networks, while UPS' integrated network has trouble dealing with peak delivery surges -- but on the flip side, its capital expenditures tend to be relatively higher, and its return on invested capital tends to be lower than that of UPS.
FDX CAPEX to Revenue (Annual) data by YCharts.
All told, the warning is clear: If Amazon really plans to compete, it could find itself making significantly higher capital expenditures than management may want to make right now.
UPS and FedEx are both facing the issue of margin compression as e-commerce customers increasingly want the delivery of less profitable and inefficiently packed items. A trampoline, for example, may be an ideal Christmas present, but it's not a particularly profitable one for delivery companies. In addition, oversize but relatively light packages also put pressure on profitability. In response, UPS and FedEx have hiked prices and taken a raft of measures in order to influence customer behavior.
The key point is that it's not just about chasing e-commerce delivery growth: It's about chasing profitable e-commerce delivery growth, something Amazon might not find it so easy to do. In addition, UPS and FedEx make money from deliveries, while Amazon also has the goal of retaining customers. In other words, making less profitable deliveries might make sense to Amazon, so Bezos might find his company making increasingly less-profitable deliveries in the future -- particularly as UPS and FedEx price such deliveries away from their networks.
Finally, Amazon is in direct competition with other e-commerce companies, and they may not want to use delivery services from Amazon as a consequence. If Bezos wants the company to become a package delivery company in its own right, it will have to build scale, and for that it would need to deliver for competitors -- even competitors from markets Amazon enters in the future.
Putting all of this together, the evidence from UPS and FedEx suggests that new entrants into the market -- Amazon being the most likely candidate -- might find servicing e-commerce growth to be problematic.
In reality, Amazon's network expansion plans are likely to be more about trying to cut some shipping costs and move its inventory around more efficiently. This doesn't mean the company is a future existential threat to the incumbent delivery companies, but rather a customer looking to build a complementary delivery service.