Analysis: Shipping expenses take toll on Amazon’s bottom line
Amazon’s growth accelerated this quarter, especially in terms of product sales where revenue increased by a respectable 12.5% over the prior year. Pleasingly, this ends the trend of single digit growth the company has posted for the past two quarters, which is especially impressive as it comes off the back of a 29% rise in product sales last year.
Some of the growth has been driven by the move to one-day delivery for Prime. Our data show that this has been popular, and Amazon has picked up some new Prime members as a result and has captured greater share of those shoppers seeking convenience or needing a product urgently. In our view, neither of these constituencies is temporary so Amazon has effectively succeeded in boosting its long-term share of the market.
That said, the additional shipping expenses have taken their toll on the bottom line. Worldwide shipping expenses leapt by almost 36% over the prior year and now account for a relatively high 12.8% of total sales. This dynamic is one of the contributory factors to the 14.8% decline in operating income within Amazon’s North American segment. As uncomfortable as offering one-day delivery might be, we would argue that the competitive dynamics in the market have compelled Amazon to make this move. Traditional retailers like Walmart and Target are ramping up their e-commerce efforts and have the advantage of being able to offer collection from stores for shoppers wanting to obtain products quickly. By and large, Amazon has no such benefit, so it had to neutralize it by offering faster shipping for free.
Over the longer term, we believe that Amazon will counterbalance the additional shipping expense with bringing more fulfilment in house and via further automation of the delivery chain. In this respect, Amazon is playing the long game where short term pain is eventually turned into long-term advantage. Moreover, Amazon’s delivery promise has forced other retailers to match, at least in part, its service levels. This will also cost them, but unlike Amazon many do not have the luxury of lucrative divisions, such as Amazon’s cloud computing group, to offset margin erosion. We also believe that Wall Street will give Amazon a much easier ride on reduced profitability than it will for traditional retailers.
Despite the gains from shipping, Amazon continues to lose traction with some core customers and is now sharing more than ever with rivals like Target and Walmart. Although the company still has a clear advantage when it comes to having a wide range and low prices, it is less successful in delivering satisfaction for browsing or site engagement. This means that it performs less well in discretionary categories such as apparel. Over the medium-term this is an area Amazon needs to focus on if it is to maintain and build its share. In our opinion, it is also a route to higher margins.
That Amazon is working hard and investing in its customer proposition at the expense of its profitability puts pay to the lie that it is monopolistic or an uncompetitive force in retail. Monopolistic firms can increase prices and reduce service with little consequence. Amazon cannot do that because it is part of a very cutthroat market where many players have the advantage of physical stores in the way it does not.
Away from Amazon’s core business, there is more work to be done at Whole Foods where sales remain virtually flat. Although some progress is being made, we maintain our view that a more radical approach is needed. Physical stores are key to Amazon’s future and getting the Whole Foods division on a growth trajectory is a key part of unlocking the potential of the whole group.
Some of the growth has been driven by the move to one-day delivery for Prime. Our data show that this has been popular, and Amazon has picked up some new Prime members as a result and has captured greater share of those shoppers seeking convenience or needing a product urgently. In our view, neither of these constituencies is temporary so Amazon has effectively succeeded in boosting its long-term share of the market.
That said, the additional shipping expenses have taken their toll on the bottom line. Worldwide shipping expenses leapt by almost 36% over the prior year and now account for a relatively high 12.8% of total sales. This dynamic is one of the contributory factors to the 14.8% decline in operating income within Amazon’s North American segment. As uncomfortable as offering one-day delivery might be, we would argue that the competitive dynamics in the market have compelled Amazon to make this move. Traditional retailers like Walmart and Target are ramping up their e-commerce efforts and have the advantage of being able to offer collection from stores for shoppers wanting to obtain products quickly. By and large, Amazon has no such benefit, so it had to neutralize it by offering faster shipping for free.
Over the longer term, we believe that Amazon will counterbalance the additional shipping expense with bringing more fulfilment in house and via further automation of the delivery chain. In this respect, Amazon is playing the long game where short term pain is eventually turned into long-term advantage. Moreover, Amazon’s delivery promise has forced other retailers to match, at least in part, its service levels. This will also cost them, but unlike Amazon many do not have the luxury of lucrative divisions, such as Amazon’s cloud computing group, to offset margin erosion. We also believe that Wall Street will give Amazon a much easier ride on reduced profitability than it will for traditional retailers.
Despite the gains from shipping, Amazon continues to lose traction with some core customers and is now sharing more than ever with rivals like Target and Walmart. Although the company still has a clear advantage when it comes to having a wide range and low prices, it is less successful in delivering satisfaction for browsing or site engagement. This means that it performs less well in discretionary categories such as apparel. Over the medium-term this is an area Amazon needs to focus on if it is to maintain and build its share. In our opinion, it is also a route to higher margins.
That Amazon is working hard and investing in its customer proposition at the expense of its profitability puts pay to the lie that it is monopolistic or an uncompetitive force in retail. Monopolistic firms can increase prices and reduce service with little consequence. Amazon cannot do that because it is part of a very cutthroat market where many players have the advantage of physical stores in the way it does not.
Away from Amazon’s core business, there is more work to be done at Whole Foods where sales remain virtually flat. Although some progress is being made, we maintain our view that a more radical approach is needed. Physical stores are key to Amazon’s future and getting the Whole Foods division on a growth trajectory is a key part of unlocking the potential of the whole group.