Satisfactory Returns on Massive Investment are Needed, Smith Says, Doubts Amazon can Get Needed Density

Free or heavily discounted shipping is of course weighing heavily on the bottom line of many etailers, noticeably Amazon.com, which continues to struggle each quarter with profitability. Many other etailers have to follow Amazon's lead, impacting their own margins.

Now legendary FedEx founder and CEO Fred Smith has weighed in, implying that rates at the company and rival UPS need to head higher due to all the investment needed.

Supply Chain Digest Says... Amazon's network of fulfillment center to support its retail operations doesn't mean that could translate to something akin to FedEx's massive network for deliveries, Smith said. What do you say? Click here to send us your comments Click here to see reader feedback

"There's an enormous interest in people having things delivered to themselves. It does not change, one iota, the input costs of the delivery,” Smith said during an interview with the Wall Street Journal last week.

FedEx CFO Alan Graf added that it is important for the price of shipping an ecommerce parcel to reflect the investment make to be able to efficiently deliver it. "We can't build these networks and spend this kind of capital and not get a return on it,” Graf said.

FedEx is increasing its capital spending to $4.8 billion in 2016, with the largest increase in its ground division, which handles most of its ecommerce deliveries, and the company plans to continue the increases in the following two years.

FedEx share price has been down almost 20% over the past year, impacted by unexpected legal costs relative to suits trying to force employee status on many of its contract drivers, the higher spending for network expansion, worries about Amazon.com becoming a competitor (see Amazon - The Most Audacious Logistics Plan in History?), and more.

Put together, the comments of Smith and Graf certainly seem to presage another series of rate hikes from FedEx, increases that presumably would be matched by UPS.

Smith did say that the company will increase its fees for shipping large or irregular items that can't be moved through its normal ground network, and said that the USPS is partially to blame for the general state of affairs because it has for encourared customers' expectations for low-cost shipping rates.

"The postal service's rates, which are the primary driver of ecommerce, they're going to have to go up as mail service goes down,” Smith said.

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FedEx Downplays Risk of Amazon Building Own Parcel Network

There has been much speculation that Amazon will build out is own delivery network, and indeed in recent weeks it fully acquired a large French parcel carrier named Colis Privé that is had previously held a minority interest in.

It also recently confirmed it has leased 20 Boeing 767 freighter aircraft from Air Transport Services (ATS).

ATS operates out of the Wilmington, OH Air Park that was previously DHL's US parcel hub before it shut down its US domestic service, and before that the hub for Airborne Express before it was acquired by DHL.

ATS had been flying a few air cargo flights per day for some months for a mystery customer most assumed was Amazon, with ATS recently confirming that speculation.

Details on Amazon's exact plans are of course few, though it seems clear it wants to end its reliance in part on UPS and FedEx. Amazon said on the news that it expects the agreement to support one and two-day deliveries.

But FedEx think it is unlikely Amazon will turn into a true parcel carrier.

Amazon's network of fulfillment center to support its retail operations doesn't mean that could translate to something akin to FedEx's massive network for deliveries, Smith told the Wall Street Journal, saying that "The key driver of any delivery system is route density and revenue per delivery stop,” something Amazon is a long way from matching versus FedEx and UPS.

A few weeks prior, FedEx executive Mike Glenn had stated that "While recent stories and reports of a new entity [Amazon] competing with the three major carriers in the United States [UPS, FedEx and the USPS] grabs headlines, the reality is it will be a daunting task requiring tens of billions of dollars in capital and years to build sufficient scale and density to replicate existing networks like FedEx."

In other words, it is unlikely to happen, Glenn thinks, and even if Amazon does have such ambitions, the journey would be a very long and expensive one, so no real worries for FedEx in the short term (meaning this shouldn't impact our stock price right now).

Glenn added that "Amazon is a valuable customer that we worked with for many years and we expect to work with them for many years to come. We've been in constant dialogue with them to understand their transportation needs as they've experienced significant growth. We've been aware of Amazon's need for supplemental capacity related to inventory management, which is driving some of the investments they are making in transportation."

There is no doubt it would take massive investment for Amazon to get to the scale of a FedEx or UPS, but we wouldn't count Amazon out quite yet. It may not even know now what its long term strategy will be, but wants as usual to keep its options open.

Do you think rates at UPS and FedEx will rise sharply to drive sufficent returns from their big investments? Is Amazon capable of building its own network? Let us know your thoughts at the Feedback section below.

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