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Free One-Day Shipping Is Costing Amazon a Fortune

By James Brumley – May 5, 2020 at 7:22AM

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Delivery spending has soared compared to product sales growth, putting profit pressure on Amazon Web Services and underscoring the need for a homegrown shipping network.

Amazon (AMZN -0.54%) decided last year to offer Prime members free next-day shipping on much of what the company sells through its online marketplace. Has the decision actually paid off? The global coronavirus pandemic deprioritized the question earlier this year, and the response to COVID-19 itself has been anything except "business as usual."

On the other hand, Amazon's shift in focus to only essential consumer items hasn't altered its typical delivery costs. It's simply scaled them up, in step with heightened demand for online ordering options.

Once the coronavirus contagion makes its way toward the rearview mirror and things (more or less) get back to normal, investors will find the monarch of e-commerce is still spending a relative fortune on its free shipping strategy.

Now and then

While this is one of the last things on many investors' minds right now, it's better to know and prepare now than before it's too late -- when the distraction of COVID-19 eventually fades. Since last year's launch of a very generous delivery scheme, Amazon's delivery spending has challenged the company's bottom line. During the quarter ending in March, product sales grew an impressive 22% year over year, but shipping (or fulfillment) costs grew 34%.

Man receiving a cash payment from a businessman at a desk

Image source: Getty Images.

And that's not exactly new. While increases in shipping costs have outpaced product revenue growth for the better part of the past three years, growth for this expense has significantly outpaced product sales increases for four straight quarters now. That big change coincides with the point in time Amazon decided to offer Prime members a one-day shipping option on a huge selection of goods. shipping expense growth compared to product sales growth.

Data source: Amazon Investor Relations. Chart by author. YOY = year over year.

Put in different but just as telling terms, worldwide shipping costs were 14.5% of the top line in the first quarter of 2020. That's down slightly from the fourth-quarter 2019 figure of 14.7% but still notably higher than it has been at any point in the past few years. That's a shift since late 2018, just when it looked like the company was finally interested in and capable of growing the bottom line. net income margins versus shipping costs, as a percentage of revenue.

Data source: Amazon Investor Relations. Chart by author.

It's not the end of the world. While last quarter was an anomaly, Amazon had been spending relatively less on its cost of sales. The growth of Amazon Web Services has also been generating more profit than product sales have, and that arm grows more consistently. In other words, there's more and more money left over to cover swelling shipping costs, even after paying for more product inventory and Amazon Web Services' necessary infrastructure.

Still, even before the advent of COVID-19, that "more and more money" was quietly starting to shrink again, at the same time it was increasingly being consumed by shipping and delivery costs. So in terms of a bottom-line benefit, it remains to be seen whether this grand experiment will actually drive the profit growth that matters most.

Get comfortable, and inquisitive

It's too soon to jump to sweeping conclusions about Amazon's fairly new and expanded one-day shipping offer -- the new program was only unveiled around the middle of last year. The company may be able to squeeze out some of the unnecessary spending on this front. It will also, once the coronavirus pandemic abates, continue building its own delivery service; that will at least partially free it from delivery markups imposed by shipping partners like FedEx or UPS. Pressure to make that happen sooner than later is mounting, though, particularly now that product margins are sinking.

The "X factor" is of course the lingering effect of COVID-19. With the release of the company's first-quarter numbers, CEO Jeff Bezos commented:

Under normal circumstances, in this coming Q2, we'd expect to make some $4 billion or more in operating profit. But these aren't normal circumstances. Instead, we expect to spend the entirety of that $4 billion, and perhaps a bit more, on COVID-related expenses getting products to customers and keeping employees safe.

Translation: Even if the coronavirus helps more than it hurts business during the three-month stretch under way, the company won't have anything left to continue building its in-house shipping operation. That will leave it at least somewhat reliant on logistics names like FedEx and UPS a while longer, and contributing to their top and bottom lines. It also means that one-day delivery will continue to cost Amazon a great deal for the foreseeable future with no real clarity as to when or if those costs will eventually start to pare back.

The main benefit of all this heavy spending on shipping is the potential to bring more consumers into the Amazon ecosystem, who can then be monetized in several ways. But it's difficult to determine if the e-commerce powerhouse is even doing this right now.

It's time to start asking how an expanded one-day shipping apparatus benefits the bottom line that shareholders are ultimately trying to plug into.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. James Brumley has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and FedEx and recommends the following options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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