Amazon (NASDAQ:AMZN) CFO Brian Olsavsky made waves earlier this year when he told analysts the online retail giant would "evolve" Prime shipping from its standard two-day delivery into just one-day delivery. He also mentioned the company would invest an extra $800 million in its fulfillment network in the second quarter in order to reach that goal. He reiterated a continued level of heightened investment during the company's second-quarter earnings call.
Those efforts to speed up its shipping operations have already had a noticeable impact on Amazon's top line. North American retail revenue growth accelerated in Q2 thanks, in large part, to the one-day shipping available on 10 million products.
But those orders came at a cost. Indeed, Olsavsky disappointed analysts with his third-quarter operating income outlook. Analyst Brian Nowak from J.P. Morgan recently released an estimate that one-day shipping costs per unit were 2.2 times higher than average shipping costs, leading to total fulfillment costs two times higher.
Why one-day costs so much more than two-day
Just because packages are getting to customers twice as fast doesn't mean it should cost twice as much. In fact, Walmart (NYSE:WMT) said its version of one-day shipping, called NextDay, will actually reduce shipping expenses for the company.
The difference between Walmart and Amazon's strategy becomes quite clear when you take a look behind the scenes.
Walmart offers one-day shipping on far fewer items, and depending on where you live, you'll see different things available or sometimes none at all. That's because Walmart is often shipping items directly from its stores, perhaps using FedEx's Extra Hours service, or shipping items from one of its seven e-commerce warehouses, which head of e-commerce Marc Lore says can reach 75% of the population with overnight shipping. If you're not in that 75%, your one-day shipping options will be extremely limited.
There are other restrictions on Walmart's NextDay service, among them a $35 minimum order value. Additionally, shoppers cannot combine items that will ship from a Walmart store with those from its warehouse, nor with those that aren't covered under NextDay, to meet that minimum. That's because the deal only works for the company if it can ship all the items together from the same location.
By comparison, Amazon places far fewer restrictions on its customers. It offers one-day shipping coast-to-coast in the U.S. on over 10 million items, with plans to expand further. There's no value minimum either, which often means it's processing orders with just one or two items. Those small orders can have a huge impact on per-unit shipping costs. Nowak estimates the average order value for one-day shipping is just about one-third of that of Amazon's other orders.
The big difference between Walmart and Amazon's strategy is how they use their distribution networks. Walmart replicates its entire inventory in all of its warehouses, while Amazon stocks relatively unique items in each of its warehouses, with minimal overlap. As a result, preparing an Amazon package often means shipping items from multiple warehouses to one hub, where they are gathered into the box that gets sent out to the customer. That's more expensive than Walmart's strategy, but it allows Amazon to rapidly ship far more items to far more shoppers.
Will Amazon's costs come down?
Amazon is constantly building out new warehouses and fulfillment centers in order to accommodate its growing business. But simply adding warehouses and putting new unique inventory in 90% of the available space won't reduce shipping expenses.
Increasing the amount of inventory replication in its warehouses would likely reduce efficiency, and could require it to put similar restrictions to Walmart's in place on what products it will offer one-day shipping for. Adding complexity to an already-complex logistics network probably won't help reduce costs.
The best way for Amazon to trim its shipping expenses would be by taking more ownership of its logistics network -- leasing more planes, building more hubs, and controlling more of the last-mile fulfillment operation. The company has traveled far down that path already, and investors should expect most of Amazon's investments in one-day shipping to keep pushing it forward.
If Amazon can cut the profit margins required by its logistics and fulfillment partners out of the equation, it can reduce costs. Ultimately, it may even offer a competing shipping service, using its own fulfillment demand to subsidize prices for other businesses, and offsetting its fulfillment costs for its own packages.
The strong demand for one-day shipping gives Amazon a reason to invest more in its logistics capabilities. The relatively high cost of fulfillment today should come down as Amazon makes investments in a long-term opportunity to at least reduce costs, if not create a new source of revenue.