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First Thoughts
  By Dan Gilmore - Editor-in-Chief  
     
   
  - Oct. 29, 2015 -  
     
 

Supply Chain News: Amazon's Stock Price and the Fate of Omnichannel Commerce

 
 

A couple of weeks ago I had the chance to speak to Penn State University's Supply Chain Leaders Forum, and at the event there was a very interesting group discussion on "free shipping" in ecommerce.

I'll be back on that topic in just a bit, but first just a quick note on the tensions between the US and China over artificial islands in the South China Sea that I wrote about last week. (See Pacific Islands and the Supply Chain.). China claims sovereignty over the artificial island it has created there as well as nearby tiny rocks and outcroppings that are far, far from the Chinese mainland.

Gilmore Says:

My main point is that if Amazon's stock did take a plunge over lack of profits, it just might be forced to ease up on free shipping to shore up the bottom line. But that simply is not happening.


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As I predicted last week, the US did sail some naval ships just within the 12 nautical mile range of the fake island on Tuesday. As also predicted there was no shooting, but instead of "escorting" the US ships, as I expected, Chinese naval ships were said to have trailed the US Destroyer from a distance.

Is this over? Hardly.

The Chinese government called the action an "illegal entry" into its waters that has "threatened China's sovereignty and security interests." A senior Chinese official later said the country will need to make it clear that this area of the China Sea is not open international waters, a position obviously the US and the rest of the world vehemently oppose.

The US will test China there again and again. Eventually, something is going to happen. Where it goes from there no one knows. If your supply chain or market plans are heavily China centric, I again strongly suggest you keep close tabs on what is happening and begin contemplating contingency plans.

OK, back to ecommerce. After my opening keynote at Penn State, one executive from one retailer gave an interesting presentation about his company's views and activities on omnichannel, which included this emphatic statement: "There is no free shipping!"

He added: "The last time I negotiated with UPS or FedEx or the United States Post Office, none of them were talking about shipping our orders for free."

The situation of etailers giving away shipping simply can't last, he argued, It has to end or no one will make any money. That's when another supply chain executive said (paraphrasing) that "Our board and our shareholders expect a given rate of return and profitability, and it will be difficult or impossible to hit those objectives if free shipping continues," at least in terms of ecommerce.

My question back to to the speakers: "Is that viewpoint a prediction or just a hope?"

In the world we used to know, this viewpoint would certainly be correct, the financials would push etailers away from free shipping eventually. Heck, it wasn't all that long ago that many companies, certainly catalogers selling to consumers direct, used shipping fees as a clear profit center. What a quaint notion in 2015.

I will note there was also a brief discussion on how many etailers often pay for the shipping for customers that order several items to try on, and then keep one and send the rest back. Of course, that return shipping is free too - a double whammy - and maybe the consumer puts the return in a large box that is subject to dimensional weighing add-ons charges from the parcel carriers.

Ouch! Omnichannel madness indeed. This perspective must be right, it just can't last. There is just one problem - Amazon.com.

Let's face it, Amazon is the "prime" (pun intended) driver of the current shipping scenario. It offers free ground shipping on all orders over $35, free two-day shipping for Amazon Prime members, free two hour shipping for Amazon Prime members in markets served by Amazon Prime Now, free shipping on small orders that weigh 8 ounces or less and cost no more than $10, etc.

The operative word here would seem to be FREE.

But of course it isn't free to Amazon either. In the just ended third quarter, Amazon had shipping revenues (regular shipping charges plus Prime Now revenues) of $1.49 billion (that's an amazing number on its own, isn't it?), but it had shipping costs of $2.72 billion. Its net loss on shipping just in Q3: $1.22 billion.

Amazon reports its shipping loss is a hefty 5.3% of net sales - but that isn't the real story. Net sales includes web services, Amazon Marketplace, electronic media, and other buckets that have little or no physical shipping. As we have done before, if you divide Amazon's net shipping costs into just its merchandise sales of $17.7 billion, now the percentage climbs to an even heftier 6.8%.

By the way, fulfillment costs (which do not include shipping) were $3.23 billion in Q3, or an incredible 18% of merchandise sales. That means shipping and fulfillment costs combined are 24.8% of merchandise sales. That for a company that had gross margins in Q3 of 34% - before those logistics cost and a whole bunch of other administrative costs.

Is it any wonder then that Amazon can't make any money?

It did eke out a small profit of a puny $79 million, just 0.3% of its $25 billion in quarterly sales, so basically break even. But its stock price shot up anyways because Wall Street was expecting another loss.

In its latest quarter, Walmart was solidly profitable and said it will be again next year, but said earnings could decline 6-12% due to heavy spending on ecommerce (just like Amazon) and costs from increasing store associate pay. Its stock was hammered, down 10% in a single day, continuing a downward trend for all of 2015.

Here is the chart that says it all: Walmart and Amazon's stock price histories over the past 10 years. In this case, a picture truly is worth 1000 words.

 

In a normal world, Amazon's lack of profitability would lead to the stock also getting hammered. But of course it still has incredible growth on its side, and investors continue to believe that all this investment will eventually pay off in big profits some day. And it just may - though they have been saying that for at least a decade. Maybe in 2025.

And my main point is that if Amazon's stock did take a plunge over lack of profits, it just might be forced to ease up on free shipping to shore up the bottom line. But that simply is not happening.

So in the end, it simply may be that for quite some time that Amazon will force free shipping for all no matter how irrational it seems to its competitors (though I will note Amazon has lots of data showing the sale uplift it gets from Prime customers).

And just like the airline sector for decades, it could just mean that profits in ecommerce will be very difficult to achieve for many etailers in the country and maybe the world no matter what they do - regardless of what boards or retailer shareholders expect.

So those companies should probably be rooting for an Amazon stock price collapse, and indeed many analysts continue to believe the company is way overvalued.

But they have been saying that almost since the company first went public - and just look at the graphic above. I, for one, would hardly be a short seller.

I am pretty pleased with this column, if I do say so myself. I would welcome your thoughts on this matter.

Is Amazon's free shipping ruining profits for all etailers? Is the impact likely to be felt for many years? What can etailers do, if anything? Let us know your thoughts at the Feedback button (email) or section (web form) below.

 
 
 
     

Recent Feedback

Excellent article.  On both the China warnings, and the free freight myth.

Amazon defies logic.  However, as long as they are driving the issue of free freight, others will feel compelled to follow suit.

 I spent eleven years with BlueStar (Barcode equipment distribution - Now in Hebron, KY), as one of their original employees.  In 2001-2, when free freight became a selling point, our large customers who were buying at ever declining margins, took our shipping department from being a profit center (as you so correctly pointed out), to an expense. 

In the distribution B2B world, our big customers, CDW and Insight to name just two, would place automated EDI orders, that would be filled by the warehouse automatically.  Often, if product configurations were incorrect, we would ship everything out with free freight, pay for the return freight to us, and then also pay for the re-shipment of the correct product.  This was particularly expensive when heavy low dollar items were incorrectly ordered. There were two ways the company tried to offset these costs.  First, they passed the costs on to other smaller customers with inflated shipping rates, and 'handling charges'.  Next, they drastically cut salesperson's commissions.  There was no way they were going to let this affect their competitiveness against others offering the same perk.  Smaller (higher margin) customers soon caught on, and insisted we ship against their shipper numbers, which further reduced our ability to recoup these enormous 'free freight' losses.


Bob McIntyre
National Account Executive
DBK Concepts, Inc.
Oct, 29 2015

Excellent article. Wish I you had an icon allowing me to share it with my LinkedIn network.

More people need to realize the e-tailer dilemma and the longer term consequences. I was at 2015 CSCMP listening to Amazon boast about partnering with USPS for Sunday deliveries and all I could think about is how U.S. tax payers already subsidize an inefficient USPS. Are we further subsidizing Amazon via the USPS? Good work, again!


Ross Corthell
Director, Transportation
PCA
Oct, 29 2015

 

Great article.  It would be great to see that Amazon / Walmart data that also shows profit correlated to stock price.


Editor's Note:

Well, Amazon basically has no profit, so the correlation would be zero. Tied to revenue growth.

Walmart yes, very correlated to Eps and to a lesser extent same store sales growth.

 

Walmart execs must be going mad.

 



Ron Berg
NA
NA
Oct, 29 2015

Just read your piece on this. Very nice job. You have come the closest of anyone I have yet seen (in print, you'll understand why I say that in a minute) to saying "free shipping is here to stay."

We both know how the Web has disintermediated publishing. Well, free shipping (and returns) is the manifestation of the influence of the Web on retailing. The retailers can't charge for shipping and can't walk away from e-commerce. Those are just the facts of where retailing finds itself today. And will find itself going forward. It has nothing to do with Amazon’s stock price or whether the notion of free shipping should ever have been introduced.

Fact is free shipping became the catalyst early on to get people to buy online. E-tailers found that no sales tax was insufficient motivation for consumers to make the change to the brave new world. So the long and short  of it for me is free shipping is here to stay and retailers need to find other ways to generate historical brick and mortar margins online.

I also sent this along to the editor of another industry publication and we just got off the phone. He thinks you did a great job of taking his verbal rantings to me about e-commerce (his wife has a children's store) and turned them into a well said, productive story. And he has been ranting for a very long time now. We both think your follow up piece is on the movement of retailers to becoming closer to wholesalers when it comes to e-margins. Either they are going to have to find other ways to keep margins where they have been or they are going to have to operate from another set of assumptions  (wholesaler margins aren't so bad after all).

Good job. Keep it up.


Gary Forger
Managing Director of Professional Development
MHI
Oct, 29 2015

I totally agree with Dan Gilmore assessment of the Amazon operations. 

What is more astounding is that those companies who manufacture and are serviced by the Amazon structure ultimately own the cost to serve their customers. 

When are the manufactures going to wake up and realize the lowest possible cost to serve their customers is directly off the manufacturing line directly to order not to inventory? 

Shipping overnight would still provide the manufacture as well as the retailer a much better profits and the customer gets served in roughly the same amount of time!

 


Tom French
NA
Supply Chain Coach Inc.
Oct, 29 2015

Amazon is staking out its next new frontier with the "Flex" delivery option.  An Uber like option that will employ individuals (1099 contractors) to make local deliveries in an effort to both reduce delivery cost an provide for virtually immediate delivery to the customer.

This may be Amazon's sword to fall on.  Retailers like Target, Walmart, etc. can easily offer the same option, and they have 1,000’s of physical locations to make deliveries from.  Amazon has lots of DC’s admittedly, but they can in no way claim the territory that the brick and mortar retailers can.

 Free next hours delivery?  Amazon loses.  Stock prices drop.  Drones start crashing into buildings and injuring people.  Stock prices drop more.

Playing field levels.


Steve Murray
Consultant
Supply Chain Visions
Oct, 30 2015

Just wanted to say that I really enjoyed your article today, especially the financial analysis about Amazon. 

My colleague Jarrod Goentzel and I just finished a Supply Chain Finance workshop (built from our Supply Chain Finance grad course) and it’s uncommon to see this kind of financial analysis on supply chain matters. 

Kudos to you for digging in!


James B. Rice, Jr.
Deputy Director - Center for Transportation and Logistics
Massachusetts Institute of Technology
Oct, 30 2015

You have every reason to be proud. As you know, my wife and I are retailers and we learned a couple of years ago, as free shipping proliferated, that we just couldn't play in the online game. I had two eye-openers. One was an article about the impact of e-commerce on retailers margins in the Wall Street Journal. I looked up the same comparison as did you in your column - I sent Gary Walmart's financial results and Amazon's financial results but did it blindly, and said, based on these two cases, which company would you rather invest in? The second eye-opener was a conversation I had off the record with the supply chain manager for shoe retailer, who told me how his company was losing its shirt on its ecommerce operations despite growing sales because of fulfillment costs.

Brian Gibson, from Auburn, gave a presentation at a small conference I was at, on research he's done for RILA that came to the same conclusion. You did a great job of bringing all of those different strands together in one place. Nice job.

Actually, third bullet was reading a Q&A in the Harvard Business Review with the founder of Zappos after he'd sold the company to Amazon. The revelation - his model revolutionized online shoe sales, but he told HBR that he could never figure out how to turn a profit.

In a discussion I've had with Gary Forger of MHI tat question is whether the retail industry can change - and will the investment community accept the change - from retail to wholesale margins to compete with etailers. Many etailers operate like distributors on 5 to 10% gross margins (they pay $1 for the item and sell it for $1.05 or $1.10) versus the traditional keystone that retailers operate on, where they buy it for $1 and sell it for $2 before discounts for sales, close-outs, etc. (Penney, for instance, has a gross margin of about 37% after markdowns), or even the 25% that Walmart, Target, and other Big Box retailers work on. Heck, Amazon margins makes grocer margins look like robber barons.

I'm pretty convinced that free shipping is here to stay, along with low margins. The question is how the retail industry evolves in that reality.

 


Bob Trebilcock
Editorial director
Supply Chain Management Review
Oct, 30 2015


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