Amazon's (AMZN -1.64%) e-commerce sales are skyrocketing, but they are still being held back by fulfillment constraints. As the company ramps up capacity, it's likely to report a further acceleration in e-commerce growth. Here's why.

Amazon's e-commerce business continued to hum along in 2019, growing about 15%. Growth picked up in the latter half thanks to the company's investments upgrading the free shipping that comes with Amazon Prime from two-day delivery to one day. As Prime members noticed that they could receive more of their orders the very next day, they naturally ordered more items more frequently.

A shock to the system

But things really began to heat up last March when the coronavirus struck in a big way in the U.S. As communities shut down and more people sheltered at home, they turned online for more of their needs. Amazon was so overwhelmed by the sudden surge in demand, it prioritized only essential items. It hired 175,000 workers to help keep up, and actively tried to discourage demand by dialing back advertising. What normally took one or two days to arrive often took longer than a week during this time.

An Amazon Prime Air plane flying through the blue sky.

Image source: Amazon.

Amazon's e-commerce sales grew 24% in the first quarter (25% when excluding changes in foreign exchange rates). But that only included about one month of the coronavirus pandemic. If e-commerce sales grew an estimated 17% year over year in January and February, which is the same pace in the second half of 2019, March sales would have had to grow by around 39% in order for the whole quarter to have grown 24%.

An acceleration of that sort in March is impressive, but it is even more so since it was achieved while prioritizing only essential items, actively discouraging demand, and not even remotely fulfilling all the demand it was seeing. The big question was, how fast would Amazon grow its e-commerce business if it could fulfill all the demand it was seeing at normal speeds?

Ramping up capacity

Amazon scrambled to hire those 175,000 additional workers, raised base pay from $15 per hour to $17, and raised its overtime pay from 1.5 times base pay to 2 times. That meant Amazon fulfillment personnel were making $34 per hour during overtime hours. 

In the first quarter, the company also increased its grocery delivery capacity by over 60% and expanded in-store pickup at Whole Foods stores from 80 stores to more than 150. It was also able to open up additional fulfillment capacity in the second quarter.

The company's efforts have started to work. E-commerce sales growth accelerated to 48% in the second quarter (49% when excluding changes in foreign exchange rates). That's incredible for a company of Amazon's size.

Accelerating growth

The remarkable thing is that Amazon achieved that 48% e-commerce growth while still not being back to pre-coronavirus fulfillment performance. On the company's second-quarter conference call, CFO Brian Olsavsky said the company has "seen the one-day and two-day [Prime shipping] recover through the quarter, but it's still probably considerably behind the going in rate before any of this happened." 

While management does not know when the company will fully return to pre-coronavirus fulfillment levels, it says it is getting "progressively better." And the company is planning a significant increase in fulfillment capacity in the third and fourth quarters of this year. For the full year, Amazon is increasing fulfillment-network square footage by 50%, a massive expansion compared with the 15% increase seen last year.

That makes sense given the demand surge that caused e-commerce sales in the second quarter to be even greater than in last year's fourth quarter. That's unheard of for a retailer, which typically sees outsize fourth-quarter holiday demand. Management added that the current third quarter would also be larger than last year's fourth quarter.

Given the second-half increase in fulfillment capacity and the still-below-normal one-day and two-day fulfillment seen in the second quarter, investors shouldn't be surprised if Amazon's already torrid e-commerce growth accelerates further in the months to come.