This content is from: Portfolio
It Dominates Everything It Touches. But Can Amazon Compete With . . . Walmart?
Jeff Bezos’ ultimate bet
You can purchase an electronic safe for your handgun on Amazon and get free delivery a day later.
For more trusting souls, Walmart employees will begin this fall to enter homes and stuff groceries into pantries and refrigerators when the owners aren’t around.
And Target — a favorite of young families — can deliver diapers within an hour after they have been ordered online.
The last mile of a marathon is always the toughest — and Amazon, the capitalist colossus intent on owning much of the world’s wallet share, is in the closing sprint alongside increasingly web-savvy brick-and-mortar rivals like Walmart and Target. The victor will be the firm that can most rapidly deliver online orders to customers’ homes, within a day or less.
Amazon, with its online prowess, is undeniably ahead. Yet worryingly for the Seattle company and its enigmatic CEO and founder, Jeff Bezos, it cannot match the thousands of stores that Walmart and Target have in close proximity to consumers and that are being used to warehouse and quickly distribute products ordered online. It is these warehouses that pose a serious threat to Amazon — perhaps the most serious threat it has faced in decades.
Bezos brags that his company has never feared failure, no matter how costly. “The good news for shareowners is that a single big winning bet can more than cover the cost of many losers,” Bezos wrote in his latest annual letter to investors.
But the last-mile race is proving to be the most expensive bet Bezos has ever made. Amazon will have to spend tens of billions of dollars year after year to ship the hundreds of millions of products bought online by consumers who are increasingly demanding next-day delivery.
If Amazon emerges the victor in this race, it could ensure its trillion-dollar stature as the world’s most valuable company for years to come. For investors, Amazon’s last-mile strategy is also having a wide impact on a range of collateral businesses, from transportation services to industrial real estate to financial services.
Much of Amazon’s generous valuation draws on impressive growth beyond the core online retail business. In the U.S. market, Amazon is now the leader in cloud computing, is the third-largest digital advertiser, and has a flourishing entertainment company. But retail still generates most of Amazon’s overall revenue — and it is slowing down. After a couple of gravity-defying decades of high-double-digit- and even triple-digit-percent annual hikes, revenue growth this year will strain to reach 20 percent. According to analysts, that figure could fall to 15 percent over the next three years.
That is, unless Amazon regains momentum over the last mile. This means building more fulfillment centers in closer proximity to consumers; delivering the goods from those warehouses just a day after online purchase; and signing up more Prime members beyond the current 100 million, who will be eligible for free one-day deliveries and help compensate Amazon by paying a $119 annual fee. And all this while navigating between regulatory shoals on both sides of the Atlantic.
Will Bezos’ big bet pay off?
The good news for Amazon is that it starts the last mile with a far larger online presence than those of its rivals. According to market researcher eMarketer, Amazon accounted for 36.5 percent of U.S. online sales last year, compared with only 4.0 percent for Walmart.
To build this internet lead, Amazon swallowed losses for years while convincing investors that market share was more important than profits. It gained credibility with consumers by offering big-name brands — Sony and Samsung large-screen television sets, for example — at cut-rate prices. Soon third-party sellers — of clothing, cosmetics, electronic goods, and products of every other kind — were eager to use the Amazon platform. And to help maintain low prices, Amazon launched its own, often unprofitable brands.
“The name of the game is to keep customers on the Amazon channel so they don’t go shopping elsewhere,” says James Thomson, who helped run the third-party business at Amazon and is now a partner at Buy Box Experts, a Utah-based firm that advises companies on how to build their Amazon presence.
The best way to keep consumers eyeballing Amazon.com is to make sure the trendiest items are available at the most competitive prices. If parents don’t find the Nickelodeon Ultimate Unicorn Slime Kit for their 8-year-old daughter on Amazon for Christmas and buy it instead on Walmart.com, that becomes a potential problem for Amazon the next holiday season.
Prime membership is another advantage Amazon enjoys in the competition to keep customers on its platform. Goods get delivered more quickly and for free to Prime members, who also are automatically enrolled in Prime video, with free access to Amazon productions and a lengthy list of other films and television series. Prime members get discounts at Amazon-owned Whole Foods. And an Amazon credit card co-branded with JPMorgan Chase gives Prime members up to 5 percent cash back on purchases.
[II Deep Dive: Jamie Dimon Is Not Messing Around]
These aren’t giveaways. Last year, Prime members spent an average of $1,400 online, compared with $600 for non-Prime shoppers. And Prime member purchases are rising on average by about $100 annually, according to Consumer Intelligence Research Partners, which conducts surveys for brands.
But there are downsides to Prime that dissuade rivals like Walmart and Target from offering similar programs. “Prime incentivizes consumers to order a single toothbrush because everything is shipped for free,” says Beth Davis-Sramek, a professor of supply chain management at Auburn University in Alabama. And Amazon’s efforts to convince consumers to fill up a basket of purchases for a single delivery haven’t yet proved effective.
Keeping third-party sellers on board goes hand in hand with consumer loyalty. Those sellers account for more than half of Amazon’s online retail revenues. Or as Bezos put it in his most recent annual letter to shareholders: “Third-party sellers are kicking our first-party butt. Badly.”
But many third-party businesses might argue that it’s their butts that are getting kicked. Even if they have successful websites of their own, they draw only a fraction of the customers flocking to Amazon. So they must pay commissions to Amazon to get on its platform — and if they want a greater presence for their products on the Amazon site, they pay advertising fees as well.
“I’m not saying it’s fair,” says Thomson. “And I suspect this is one of the issues that the antitrust people will look at.” Indeed, they already are: In July, the European Union’s top antitrust regulator announced a formal investigation into Amazon’s use of third-party businesses to promote its own products and services. And the Federal Trade Commission is interviewing third-party businesses about their reliance on Amazon.
The next stage in the last-mile campaign is moving all those online orders into the best-located warehouses, whether a robot-staffed fulfillment center the size of a dozen football fields or a smaller forward deployment center near a city.
“It’s all about placing the inventory closest to the right customers,” says Kimberly Reuter, who used to design solutions for Amazon’s international logistical problems and now heads Seattle-based CSG Consulting, which offers logistics and delivery advice to e-commerce firms. That’s why furry, warm slippers get shipped to fulfillment and forward deployment centers in Minnesota rather than to warehouses in Georgia.
Only Prime members receive free one- and-two-day deliveries. So if you’re a third-party seller, your products have to be Prime-eligible to use Amazon’s fulfillment centers and qualify for fast delivery. Otherwise, third-party sellers must provide their own warehousing. In that way Amazon avoids the inventory risk of carrying hundreds of millions of unsold products.
All this warehousing is creating a boom in industrial real estate assets. Amazon is famous for its own mammoth fulfillment centers — more than 160 of them in the U.S. alone. But the company must lease millions of square feet of warehouse space closer to its customers. Led by Amazon, such e-commerce warehousing now accounts for 20 percent of new leasing of industrial real estate, according to the Urban Land Institute, a Washington, D.C.–based nonprofit research group. (This so-called “Amazon effect” helped induce Blackstone to purchase the U.S. warehouse assets of Singapore’s GLP for $18.7 billion in June, then spend an additional $5.9 billion in September for the industrial real estate assets of Colony Capital, a Los Angeles–based private equity company. Amazon is a leading lessee of these properties.)
Because of its thousands of big-box stores, Walmart potentially has an advantage over Amazon in placing goods closer to consumers. Walmart’s huge fleet of trucks already undertakes multiple daily deliveries from warehouses to stores. This makes last-mile shipping from stores to residences more efficient.
After years of heavy investment in its online operations, the brick-and-mortar behemoth seems to have found the right combination of web purchases, store pickups, and home deliveries. Its second-quarter results — following a two-year upward trend — beat analyst expectations. And Walmart’s share price has surged 26 percent since the beginning of 2019, doubling Amazon’s stock gains.
“Customers are responding to the improvements we’re making, the productivity loop is working, and we’re gaining market share,” Walmart CEO Doug McMillon said in a statement accompanying the results.
The challenge for both Walmart and Target is that their marketplaces — the online platforms for third-party sellers — are far smaller than Amazon’s.
Amazon doesn’t make it any easier for its brick-and-mortar rivals by repeatedly shifting the goalposts of consumer behavior. Only five years ago consumers were satisfied to receive products a week or more after ordering them online. Then Amazon inaugurated two-day delivery for Prime members. “Now they are conditioning people to expect deliveries in a single day,” says Brian Nowak, a New York City–based Morgan Stanley analyst. “That’s upping the ante again for the investments traditional retailers require to compete with Amazon.”
Amazon already makes available 10 million different products for next-day delivery, versus 200,000 for Walmart. But this faster-paced strategy is putting a heavy strain on Amazon as well. “It does create a shock to the system,” Amazon chief financial officer Brian Olsavsky told analysts in July. “We’re working through that now.”
The extra costs linked to one-day shipping were more than $800 million in the second quarter alone and will rise further in the remainder of 2019. According to Olsavsky, the spending helped generate better-than-expected 20 percent growth in sales over the same period last year.
The retail business — whether online or brick-and-mortar — is known for its low- to mid-single-digit margins. In the past two years, Amazon has been able to demonstrate to investors that it can achieve the same modestly profitable margins as Walmart and Target. “Now Amazon is going back into an investment cycle with its spending on one-day delivery,” notes Mark Mahaney, a San Francisco–based analyst with investment bank RBC Capital Markets.
But will investors continue to respond positively to the mind-boggling outlays ahead? In 2018, Amazon spent $28 billion on shipping. According to Morgan Stanley projections, that figure is rising at a 25 percent compound annual rate. It is projected to reach more than $80 billion by 2023 and explode to $150 billion four years later.
Even with these massive investments, Amazon won’t have the planes and trucks to single-handedly meet its last-mile requirements. It depends on long-established transport companies for about half of annual deliveries, and up to 70 percent during the Christmas season. But these are alliances with “frenemies” — firms that must figure out the tipping point between partnership and rivalry with Amazon.
The very public falling-out between Federal Express and Amazon is one dramatic example. A decade ago, FedEx and Amazon seemed a natural fit. With its growth slowing, FedEx had to embrace e-commerce. And Amazon needed partners — like FedEx, UPS, and the United States Postal Service — to deliver its burgeoning online orders. Amazon became one of FedEx’s largest customers, accounting for 1.3 percent of the delivery services company’s 2018 revenues.
The arrangement unraveled for several reasons. Because of Amazon, consumers expect free shipping. But getting deliveries to doorsteps is costly for traditional retailers and transport companies. FedEx’s extensive fleet of airplanes and trucks was profitable when clients — most of them businesses — willingly paid premiums for next-day deliveries. FedEx much preferred having its trucks unload all their packages at a single corporate address rather than drop them off piecemeal at numerous smaller locations.
But with e-commerce, residences became the destinations for most packages. And truck deliveries — either from airports or directly from Amazon fulfillment centers — left FedEx with ballooning expenses and ever-smaller margins.
FedEx couldn’t raise the fees it charged Amazon, which was large enough to insist on discounts. Worse still, Amazon’s own growing transportation network of airplanes and same-day couriers forced FedEx to compete against its big client at a disadvantage. “Amazon cherry-picked the best full-load routes and left FedEx with less lucrative routes,” recalls Thomson, the former Amazon executive.
So in July, FedEx announced it would not renew its domestic service contract with Amazon. It continues to handle Amazon international deliveries — for now. FedEx also intends to increase its shipments from Walmart and other big brick-and-mortar retailers, though it’s unclear whether their business will prove any more profitable than Amazon’s.
Amazon issued a sour response. “Nothing but respect for FedEx, but they were [a] very small piece of our network,” tweeted David Clark, who runs Amazon’s global supply chain and logistics operation. “We have great strategic partners who are part of our long term plan.”
Amazon will lean more than ever on UPS and the postal service to deliver the bulk of the packages it can’t handle itself. It is also subsidizing former employees to start their own businesses to deliver last-mile shipments. And as part of the gig economy, Amazon has recruited an army of delivery drivers — many of them ex-Amazonians — who use their own vehicles in their off-hours to drop off packages, especially at suburban and rural homes.
This mushrooming transportation network has spawned fears that Amazon intends to become the world’s leading shipping company. That may well happen. But it’s doubtful Amazon could spare any planes, drones, and ground vehicles for transporting anything besides products bought by its customers. “Amazon doesn’t focus on making a profit in transportation,” explains Reuter.
The race often doesn’t end when a delivery vehicle arrives at the doorstep. Too many times there is nobody to receive a package. And customers return up to 15 percent of online orders, according to AMZsecrets, a firm that helps sellers use the Amazon platform. To solve these massive headaches, Amazon has turned to other unlikely partners, who also qualify as frenemies.
Kohl’s, the venerable department store chain, is a case in point. Like other brick-and-mortar retailers, it saw rising numbers of customers opt for the convenience and lower prices offered by Amazon online. On the other hand, Amazon was struggling with all those returns and failed deliveries.
So in May, Kohl’s agreed to pack, label, and ship for free Amazon returns at many of its 1,150 stores. Quid pro quo, Kohl’s gets a sharp increase in foot traffic — and hopefully a rise in sales.
Amazon reached a similar agreement with Rite Aid, another erstwhile rival, in June. Rite Aid’s stock plummeted when Amazon muscled into the drug business by purchasing online pharmacy PillPack last year. But with Rite Aid’s operating losses soaring because of online competition, it has opened its 1,500 drugstores to Amazon customers who missed their package deliveries at home. In return, Rite Aid is betting they will also purchase personal accessories and medicines when they pick up their Amazon packages.
But these are unstable arrangements. If revenue and share prices at Kohl’s and Rite Aid continue to fall, Amazon will look more like a fox in the henhouse.
The costs and risks of the last-mile effort have rekindled an issue that has plagued Amazon over its quarter-century existence: not enough financial transparency.
“Providing more disclosure and segment analysis is never a bad thing,” says Eric Sheridan, an analyst with UBS, which has constructed an Amazon financial model based on company disclosures, its own research, and chats with former Amazon executives. “Investors have applauded whenever Amazon does that.” In fact, since Amazon began giving segment analysis five years ago, its share price has risen more than 400 percent.
But there has been little progress with transparency since then. Consider, for example, Amazon’s most recent earnings results. Net income for first-half 2019 was $6.2 billion, up from $4.2 billion in the same period of 2018. But there is no mention of how much online retail — by far the greatest revenue source — contributed to earnings.
The most profitable business unit — Amazon Web Services, the cloud computing division — discloses only operating income, which accounted for 57 percent of Amazon’s total.
Online advertising, known as Amazon Marketing Services, is presumably the second-largest source of net income. But it isn’t even listed as a distinct business unit. Instead it appears under the “other” category, which doesn’t disclose net or operating income, just sales. “Other” sales amounted to $5.7 billion for the first half of 2019, up from $4.2 billion for the same period last year. And analysts must take Amazon at its word that AMS accounts for 85 to 90 percent of those totals.
AWS and AMS have become the fastest-growing parts of Amazon and its highest-margin businesses. Their profitability has helped convince investors to remain patient as Amazon reinvests most of the gross income from its online retail operations into megabillion-dollar efforts like the last-mile campaign. “Amazon was aggressive in its retail strategy even before it had AWS and AMS,” notes Mahaney, the RBC analyst. “They make it easier for Amazon to stay aggressive.”
Other analysts go further. “Amazon is cross-subsidizing its businesses,” says Allen Gillespie, president of FinTrust Investment Advisory Services, based in Greenville, South Carolina. “AWS absolutely helps them sustain those low margins in online retail.”
The race to claim the last mile in the delivery wars is taking place against a backdrop of regulatory threats aimed at Amazon from both sides of the Atlantic. Like other tech giants, the company has aroused political opponents, ranging from President Donald Trump to Senator Elizabeth Warren and Congressmembers from both parties. EU Commissioner for Competition Margrethe Vestager says a full probe of Amazon will be launched later this year. The FTC is also expected to announce a broad investigation of Amazon soon.
Whether or not Amazon pays enough taxes is a constant complaint. Much of the regulatory interest also centers on how Amazon’s e-commerce prowess provides it with lucrative fees and free data from third-party merchants.
But Amazon’s growing clout is testing accepted antitrust law, which has in recent decades shifted its focus to consumer welfare rather than mere harm to competitors. It’s difficult for regulators to claim that consumers are being injured by Amazon’s growth. The company has helped keep consumer prices in check while forcing competitors to also improve their delivery time for customers.
And regulators would have to figure out how to reel in Amazon without damaging the third-party sellers whose fortunes have become linked to those of the e-commerce colossus. “For many of them Amazon has been a lifeline to a very large marketplace,” says Herb Hovenkamp, an antitrust professor at the University of Pennsylvania Law School and the Wharton School.
Amazon’s last-mile strategy fits nicely with its defense against antitrust threats. Who can argue that consumers won’t benefit from free same-day delivery to their homes — not only from Amazon, but from its brick-and-mortar rivals?
Consumers may well prove to be Amazon’s ace up the sleeve. Davis-Sramek, the Auburn professor, often reminds her students that, besides antitrust issues, Amazon poses mounting environmental threats linked to cardboard and plastic packaging and energy emissions from its shipping network and data centers. “But when I ask students how many of you like Amazon, they all raise their hands,” she says.