By the looks of it, Amazon.com (NASDAQ:AMZN) had another good holiday season. In fact, e-commerce growth was so strong that package delivery leader United Parcel Service (NYSE:UPS) was overwhelmed by demand and couldn't deliver all of its holiday packages by Christmas Eve. FedEx (NYSE:FDX) also had trouble keeping up, but missed deliveries were not quite as widespread.
These delivery delays represent a significant problem that Amazon needs to solve ASAP. While the delivery companies were at fault for the delays, Amazon still risks losing business in the future if it cannot ensure that holiday gifts arrive speedily.
For now, the company is giving away $20 gift certificates and refunding shipping charges to placate people whose holiday gifts did not arrive on time. Longer-term, Amazon will need to reduce its reliance on UPS and FedEx -- potentially by investing in its own delivery capabilities.
United Parcel Service dominates the package delivery market in the U.S., and it bore the brunt of this year's spike in demand. UPS expected to deliver 132 million packages last week, but demand was higher than that -- just how much higher, it wouldn't say. Bad weather earlier in the holiday season also left UPS scrambling to catch up.
FedEx appears to have done better, but it too was unable to get every package to its destination by Christmas. FedEx said it processed 275 million deliveries between Thanksgiving and Christmas, almost all of which arrived on time. For shipments that did not arrive on time, FedEx allowed some customers to pick up their packages at local FedEx depots on Christmas Day itself.
A structural problem
The strain on package delivery companies this year highlights a bigger structural problem for e-commerce retailers. Holiday season package volume greatly exceeds normal levels, and delivery companies like UPS and FedEx do not want to invest billions of dollars to buy extra planes and delivery vehicles that are only needed for one month a year. Indeed, UPS was already using some rental trucks -- and even golf carts! -- to supplement its regular truck fleet this month.
While the package delivery companies will certainly try to do better next year, Amazon doesn't have much bargaining power right now. UPS, FedEx, and USPS are the only options. Since Amazon can't credibly threaten to take its business elsewhere, the package delivery companies are unlikely to invest enough to guarantee timely deliveries during the busy holiday season.
Time for more investment?
As the largest e-commerce player, Amazon.com needs customers to feel comfortable that time-sensitive packages will arrive as scheduled during the holiday season. Otherwise, customers will patronize brick-and-mortar retailers instead in order to avoid worrying about whether their gifts will arrive on time.
As the company that has the most to lose from persistent holiday shipping delays, Amazon may need to "in-source" more of its deliveries. The company already has a small fleet of delivery trucks in certain markets where it operates the Amazon Fresh grocery business. Amazon.com is also developing drones, which it hopes to eventually use for deliveries. However, this is at best a long-term option.
In the near-term, Amazon has a few options. It could try to pay extra for special treatment from the package delivery companies. Alternatively, it could try to rent trucks and hire temporary workers for the holiday season in order to ease the burden on UPS, FedEx, and the post office.
Lastly, it could invest in building a fleet of Amazon-branded delivery vehicles in order to maintain greater control of shipments from the time they leave the warehouse until they arrive in customers' hands. This would also put more pressure on the package delivery companies to improve their holiday-season reliability.
In the last few years, heavy investment has driven Amazon's profitability toward zero. Many bulls believe that earnings will quickly rebound as the company's investments start to pay off.
However, for Amazon to maintain its high growth rate, much more investment will be necessary. The need for more reliable holiday deliveries is just one area where Amazon's growth into a megacorporation will require massive investment. This will keep Amazon's profit margin in the low single digits for the foreseeable future, and will also limit Amazon's free cash flow.
This does not mean that Amazon is wrong to make these investments. However, with the company's market cap approaching $200 billion, I do not think its long-term profit potential can justify its current valuation, let alone allow a continuation of its market-crushing stock performance.