To hear FedEx Corp. (NYSE:FDX) describe it, ending its domestic U.S. ground-delivery contract with Amazon.com. Inc. (NASDAQ:AMZN) is part of a grand strategy to make its offerings available to a broader range of e-commerce businesses. But that’s down the proverbial road. The immediate reality is that FedEx no longer wants to put its network through the parcel delivery version of football’s two-a-day drills to accommodate Amazon’s demands and the low yields accompanying them.
The break will occur at the end of August and apply to all of Amazon’s national account business with FedEx, which is effectively everything. FedEx’s small international business with Amazon will continue, but given the ebbing of the overall relationship, that also may be living on borrowed time. Two months ago, FedEx said it would end its U.S. air services agreement with Amazon, citing the same rationale of seeking to expose its air network to other e-commerce firms.
According to estimates from consultant IDrive, FedEx Ground, which is the FedEx unit handling the Amazon ground-delivery work, carries less than 40 million Amazon parcels a year. This is a pittance considering the unit shipped, on average, 8.9 million parcels a day in its most recent fiscal quarter, based on FedEx data. The dollar value of the ground business is a matter of speculation, as is whether most of the revenue to FedEx came from Amazon’s air or ground business. FedEx is believed to transport 4 percent of Amazon’s ground traffic.
What is clear, at least to Matthew White, an IDrive consultant, is that FedEx has tired of demands placed on its ground network by Amazon, a not-so-big customer that insists on pricing that virtually guarantees FedEx low-yielding hauls. What’s more, nearly all of Amazon’s ground business came to FedEx during peak season, making the annual traffic flow lumpy at best, White said.
White, who pegged the value to FedEx of Amazon’s ground business at $300 million a year, said there are other businesses with a similar spending size that have more stable volume flow and would not leverage their traffic to squeeze FedEx in the manner in which Amazon has.
According to industry watchers, Amazon is using its network to deliver parcels on short-haul, high-density routes while giving its third-party partners volumes moving over longer distances to low-density destinations. Amit Mehrotra, an analyst at Deutsche Bank, said a senior transportation and logistics executive told him an anecdote of a FedEx truck driving 75 miles to make one Amazon package delivery to a rural destination. Mehrotra previously has urged FedEx and rival UPS Inc., which handles far more Amazon traffic than FedEx, to draw lines in the sand with Amazon over its practices. He lauded FedEx in a note Wednesday for “taking a tougher stance, something that is needed in light of recent developments and overtures.”
Benjamin Hartford, an analyst for investment firm Baird, noted Wednesday that the bulk of Amazon’s business left the FedEx Ground network years ago after Amazon diverted its parcels from FedEx’s SmartPost service, in which FedEx tenders parcels to the U.S. Postal Service for final deliveries to residences. Before FedEx terminated the U.S. air relationship, Amazon accounted for 1.3 percent of FedEx’s total revenue, according to FedEx’s year-end 2018 figures. FedEx, which reports financial results on a fiscal year schedule that starts each June 1, generates about $70 billion in annual revenue.
The symbolism of FedEx’s move, however, is undeniable. “One of the two largest e-commerce parcel delivery companies in the U.S. is not doing any business with the dominant e-commerce player in the country,” said Ravi Shanker, analyst for Morgan Stanley & Co., in a Wednesday note. Shanker noted that such a scenario “would have been unthinkable five to seven years ago when e-commerce growth was the main investment thesis” for FedEx and rival UPS Inc. (NYSE:UPS).
Shanker also questioned FedEx’s strategy of jettisoning Amazon to “grow with others,” saying the approach isn’t viable because most non-giant e-tailers are much smaller and because Amazon and others are building platforms that could compete with FedEx for the so-called other volumes. The proliferation of ship-from-store fulfillment programs could further cut into the “other” business that FedEx covets, Shanker said.
For Amazon, which issued a statement thanking FedEx for its service, the loss of the ground capacity is unlikely to be material. Amazon, which is building out its delivery network ostensibly to compliment its partners’ efforts, can move its parcels on its own infrastructure cheaper than if it contracted out the work. According to data from consultancy ShipMatrix, it cost Amazon $3 to deliver a parcel using its network. As a comparison, it costs Amazon $6 per parcel to use UPS’ ground network, ShipMatrix said.
The caveat, said ShipMatrix Founder Satish Jindel, is that Amazon can charge itself less because it mostly operates over the high-density, short-haul routes. By contrast, UPS delivers for Amazon across longer distances and covering less-dense markets, which justify higher unit prices.
If there is a risk for Amazon, it’s that it loses a highly reliable shipping partner as the delivery world turns its attention to the upcoming peak season. White of iDrive said FedEx’s absence will put pressure on UPS, USPS – the biggest Amazon delivery partner – and Amazon’s own network, though as a last resort Amazon could use FedEx if it is willing to pay the non-discounted rates available to non-national accounts.
As for UPS, which counts on Amazon for 5 to 8 percent of its $70 billion-plus in annual revenue, it is likely to see a cascade of ground business, if it hasn’t already. Unlike FedEx, UPS relies on Amazon’s density as leverage to operate more cost-effectively in the business-to-consumer delivery segment. Amazon, in turn, would find life a nightmare without UPS, especially now that Amazon has gone national with its guarantee of one-day delivery on 10 million items eligible for its “Prime” subscription program.
UPS’ second-quarter domestic air volumes surged an eye-popping 30 percent year-over-year, an Amazon effect if there ever was one. Mehrotra of Deutsche Bank said UPS needs to be careful in how it manages Amazon’s peak-season surges, especially with FedEx is no longer in the picture. During the 2013 peak season, Amazon dropped a torrent of parcels on UPS at the last minute and with no visibility to the carrier. The result was a gumming-up of UPS’ network, a lot of late holiday shipments, and a reputational black eye for UPS that has taken five years for it to fully wipe away.
The development itself was marred by confusing communication. FedEx issued a one-sentence statement that did not mention Amazon by name, nor described what it planned to do. Other news outlets, however, said that FedEx issued a statement saying it was severing ties with Amazon. A source close to FedEx confirmed late Wednesday morning that the relationship will indeed end.
The move comes on the heels of FedEx’s announcement in June that it would end its U.S. air services contract with Amazon. FedEx’s domestic ground relationship with Amazon is much larger than its air agreement. Still, it is not large enough, and certainly not compensatory enough, for FedEx to stick around.
One source, who has worked with both companies, estimated the size of the ground business to be about $300 million a year. However, the traffic flows are not stable, and the rates that Amazon demands do not justify the cost of the operational demands and pressures imposed on the FedEx network, the source said.
At the same time, Amazon has concluded that it can move its packages on its own network at much lower unit prices than FedEx could possibly match. As a result, it is unlikely to impact its business either. The one company likely to gain is UPS Inc. (NYSE:UPS), which handles far more Amazon freight and relies on Amazon’s density to achieve desired operational efficiencies in its business-to-consumer traffic.