Amazon Takes One Step Forward, Two Steps Back

After Amazon reported its year end revenues, their stock tumbled despite comparable quarter revenue growth of 20 percent. The company did end the year with a narrow profit, something they did not accomplish last year, but investors have tired of the promise of future profits.

Profits would have been bigger except for widespread failures to deliver holiday presents in a timely manner. This led Amazon to issue $20 gift cards and refund shipping costs to unhappy customers.


After Christmas, there were a number of articles speculating on the cause of Amazon’s key parcel partner, UPS, to deliver in a timely manner. I speculated that it involved a failure of strategic planning; subsequent events shows that to be partly true – UPS has said they will “make appropriate investments such as facility expansions, process automation, job simplification, and acceleration of technology implementations” to avoid this next year. And Amazon certainly blamed the parcel carriers, noting that its own distribution centers were able to meet the surge in demand.

But it is becoming clear that Amazon played a role in these delivery failures. There was interesting coverage in USA Today about how Amazon Prime, a program that promises “free” two day shipping to customers that pay an annual fee of $79, contributed to this mess.

In a typical December, parcel carriers see their volumes peak mid-December. Last Christmas, however, more shoppers waited to the last-minute. Amazon Prime customers, for example, believed they had no reason to order early. In short, the December peak happened as forecast, but within this multi-week peak was a much bigger spike in activity concentrated in the last few days before Christmas that was just too big for UPS, in particular, to handle.

While all this was occurring, Amazon issued a congratulatory press release that lauded the fact that they had signed up 1 million Amazon Prime members in the third week of December and that demand was so great that it had to suspend enrollment.

But while delivery failures contributed to the profit hit, which the Amazon Prime program played a role in, the bigger hit comes from the Amazon Prime program itself. Amazon Prime is a loss leader that enables Amazon to steal market share from traditional retailers.

Amazon’s 10-K demonstrated just how big a drag on profits this program really is. Supplemental information about outbound shipping results showed that for every one dollar in shipping fees Amazon collected, they spent more than two, for a total shipping loss of more than 3.5 billion dollars.

Following their earnings call, and the stock tumble, Amazon’s CFO had an ad hoc call with financial analysts where he said that Amazon would look at raising the price of Amazon Prime by $20 to $40. But even with a $40 increase, the 10-K shows that Prime would still be causing shipping losses.

So for Amazon, the two steps backward are the Christmas delivery failures and Amazon’s diminished capacity to use Prime to subsidize unprofitable growth.

But Amazon implicitly reported in October they have made a step forward in warehouse productivity when they announced they had deployed more than 1,300 Kiva robots. The 10-K shows that the premium Amazon paid to acquire Kiva Systems was far higher than was understood at the time. In May 2012, when they acquired Kiva for $678 million, it was widely thought that Kiva had about $100 million in revenues. In short, Amazon was thought to be paying about seven times revenue for Kiva, a high price. But in the 10-K we learned that Kiva’s revenues in the year prior to the acquisition were only $48 million, so they were really paying 13 times revenues!

But this is not an astronomical price if Amazon can automate their warehouses at a lower price, and greater risk mitigation, than buying these bots from an independent Kiva. For that to be the case, Amazon would need to be buying tens of thousands of these robots. And indeed there are reports that Amazon has ordered 18,000 bots. It has taken longer than I expected for Amazon to figure out exactly how they wanted to deploy Kiva, but the shakeout period appears to be over. What I would love to know, but remains unclear, is whether they have changed the layout and flow of their warehouses to better accommodate these bots. This is bad news for existing customers of Kiva who are clearly greatly concerned about recent developments.

In conclusion, with the loss of patience among investors for Amazon’s profit integrity, traditional retailers have gained more time to better compete with Amazon based on omni-channel initiatives.

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