Supply Chain Digest editorial staff

The News: Blaming high transportation expense, Amazon.com misses profit targets, sending its stock price tumbling by more than 10%.

The Impact: The chief factor in the company’s financial miss was the high cost of its free shipping program for frequent customers. Amazon and others need to examine whether the benefit is worth the cost.

The Story: This week, Internet retailer Amazon.com announced financial results for the quarter that disappointed investors and sent the stock tumbling. Rising shipping costs, largely from a new program that offers free 2-day shipping for frequent customers, was cited as a key factor in rising fulfillment expense relative to sales.

The program, Amazon Prime, was introduced in February 2005. For a flat membership fee of $79 per year, Amazon Prime members get unlimited, express two-day shipping for free, with no minimum purchase requirement, on over a million eligible items sold by Amazon.com. Alternatively, members can order as late as 6:30 p.m. ET and still get next-day shipping for only $3.99 per item.

"Subscriptions to Amazon Prime more than doubled from November to December," said CEO Jeff Bezos. "Amazon Prime members get 'all-you-can-eat' two-day shipping for free."

No doubt good for the top line – but is it good ultimately for the bottom line as well?

Outbound shipping-related costs totaled rose 20% in the quarter to $280 million. Net shipping loss expanded 17% to $91 million because of Amazon Prime and other free shipping orders. This basically means the transportation element of the business is subsidizing product sales. In many companies, both traditional and on-line, it’s the reverse – shipping charges exceed actual freight costs, turning transportation into a profit center.

Amazon's chief financial officer Tom Szkutak said it was not clear when investments in the Amazon Prime discount shipping program would pay off for investors. The cost of the program is one of Wall Street's chief worries.

Szkutak said the company's various free shipping offers had saved customers more than $475 million during 2005 – or read another way, costs the company something like the equivalent in potential revenue. Szkutak noted that Amazon Prime is "very expensive" for the company, but he said Amazon.com also is seeing customers order more items as a result. He wouldn't say when the program might be profitable.

As virtually every company already has or will consider an on-line sales channel, how shipping charges should be handled continues to present a tricky business and logistics issue.

Do you think Amazon’s Prime program makes good business sense?  How you you think on-line merchants should deal with shipping charges: profit center, break even, or loss leader? Let us know your thoughts.  

Article key words: Logistics, transportation, e-fulfillment, parcel shipping