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The Latest Sign Amazon's Expecting a Big Holiday Season

By Adam Levy – Jul 15, 2020 at 11:30AM

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Amazon's trying to make the most of its fulfillment capacity while demand is surging. (AMZN -1.90%) saw an unprecedented surge in demand starting in mid-March as consumers started to stay at home and practice social distancing. It had to suspend its "Fulfilled by Amazon" service for certain products from third-party merchants for about a month as it worked to get essential items to customers' doors.

But as it prepares for what's likely to be another record-setting holiday season, it's putting quantity restrictions in place again for third-party sellers. It's restricting warehousing to about three months' worth of sales for most items. In effect, it's dedicating most of its warehouse space to items it expects to sell during the holidays and restricting space for items that it may have to hold onto until next summer. Amazon will waive removal fees for merchants that reclaim their inventory to make room for faster selling items.

The move is another strong indication that Amazon expects to remain capacity constrained through the end of the year as it experiences surging sales. It previously announced it's making 125,000 of the new positions it added earlier this year permanent for anyone who wants to keep their job -- another sign of strength.

A man placing an Amazon box on a conveyor belt.

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A quality problem

Amazon is adding capacity to its fulfillment network as quickly as it can. The company notes it's on track to open 33 new fulfillment centers in the U.S. by the end of the year, but it still won't have enough capacity for all of its own inventory as well as its merchants'. Not only is it asking merchants to cut back on sending slower-selling inventory, it's cut back on orders itself.

It's certainly asking a lot from its sellers, though, especially those that may have been planning to release new products for the holiday season. With no track record of sales, Amazon will provide its own quantity restrictions. But Amazon can't spare warehouse space on speculative inventory.

Prime Day will be the next big test of Amazon's new restrictions. The shopping holiday is reportedly slated for the first week of October, which gives it only a few weeks to assess the results and restock inventory for the start of the holiday shopping season in November. That's a tight turnaround, especially for small sellers that might only be ordering inventory as Amazon opens capacity.

Amazon is risking upsetting a lot of third-party sellers, which make up more than 50% of its gross merchandise volume. But with a massive market share of online retail, many third-party sellers might not have a better option than to take what Amazon gives them.

Is Amazon setting itself up for a New Year's hangover?

While Amazon should see strong sales in the fourth quarter, its restrictions on third-party sellers could set it up for a kind of hangover in 2021. As mentioned, it's practically discouraging sellers from trying to introduce new products in the second half of the year. It's also actively encouraging merchants to remove inventory from Amazon's warehouses (making it potentially less expensive to sell on other marketplaces).

It's unlikely Amazon will have much trouble filling its warehouse shelves with inventory as it continues to ramp up capacity in 2021. But there is still some risk of stronger-than-usual seasonality in the first quarter as third-party merchants could face delays in restocking once capacity constraints are lifted after the holidays.

How the new restrictions impact Amazon's bottom line

Amazon is looking to use its warehouse capacity as efficiently as possible. Investors should expect that to have a positive impact on its profit margin. Counteracting that is the additional spending Amazon has had to do in order to slow the spread of COVID-19. Additionally, it's working with added restrictions to reduce the spread of the virus, which means its warehouse employees likely won't be as efficient as they've been in the past.

Meanwhile, strong expected demand likely means a continued reduction in marketing spend for Amazon. Amazon started pulling back on ad spend earlier this year as a way to reduce demand for non-essential items. That should support a higher profit margin.

Amazon has the potential to turn a big profit in the fourth quarter. The move to restrict third-party inventory is another sign Amazon expects strong consumer demand to persist through the end of the year. Whether management lets most of that potential profit fall to the bottom line or reinvests most of it in the company's future remains to be seen.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon 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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