For all its symbolism, FedEx Corp.’s (NYSE:FDX) June 7 announcement that it would not renew its U.S. air delivery contract with Amazon.com, Inc. (NASDAQ:AMZN) was relatively small potatoes. The decision only affects $150 to $200 million in annual revenue for Memphis-based FedEx, whose fiscal year 2019 top-line will approach, if not exceed, $70 billion.
The real story, instead, may percolate some 400 miles to the southeast in Atlanta, home of UPS Inc. (NYSE:UPS). Unlike FedEx, which had little to lose by dumping the domestic flying portion of its Amazon business, UPS has much more at stake. Amazon tendered 397 million parcels to UPS last year, the vast majority of which were delivered by UPS’ ground network, according to data from ShipMatrix, Inc., a consultancy. By some estimates, Amazon accounts for 5 to 8 percent of UPS’ $72 billion in annual revenue, compared with 1.3 percent for FedEx prior to its recent move. UPS is more deeply involved in e-commerce than is its rival, elevating the importance of its arrangement with Seattle-based Amazon, which, depending on the source of the data, has around a 40 to 50 percent share of U.S. e-commerce.
Perhaps most important, UPS relies on Amazon’s package density to help it “bend the cost curve” in business-to-consumer delivery in order to wring profits out of the challenging segment, according to Rob Martinez, co-founder and CEO of consultancy Shipware, LLC.
There is a lot on the line for Amazon as well. UPS handles about 21 to 26 percent of Amazon’s volumes, according to ShipMatrix. Amazon’s traffic is spiking by double-digit amounts each quarter with no end in sight. Amazon’s air and ground delivery network, although it is rapidly expanding, is incapable of transporting all of its volumes in time to meet its delivery commitments. Amazon faces heightened pressures now that it has made one-day delivery the standard for orders placed through its popular “Prime” service. As a result, UPS remains an important cog in Amazon’s delivery wheel. “Both parties are getting what they want out of the relationship,” said Martinez. “FedEx picking up its marbles and leaving the sandbox doesn’t change that.”
At the same time, the UPS-Amazon relationship is conflicted, and will likely get more so as Amazon continues to gain strength as a transport and logistics provider. UPS and Amazon compete to provide fulfillment and delivery services for small- to mid-size e-merchants. Amazon’s “Fulfillment by Amazon” service, in which third-party merchants use it for storefront, fulfillment and delivery and which now accounts for more than half of the company’s revenue, threatens to poach business from UPS – if it hasn’t done so already – as merchants that may have used UPS for deliveries in the past now bundle fulfillment and delivery with Amazon. Amazon chooses how to move FBA packages based on a series of criteria, according to a company spokeswoman.
UPS Spokesman Steve Gaut said the company is sanguine about the “co-opetition” that exists between the two. UPS, Gaut said, has “mutually beneficial business relationships and competitive relationships with companies in our industry. We closely monitor the behavior of our customers and competitors. We work to optimize the relationship so that it serves the interests of UPS while also delivering value to our customers.”
As Amazon builds out its shipping network, it will face the same question more frequently – whether to make deliveries with its in-house operation, or continue to outsource. According to ShipMatrix, it costs Amazon $3 per parcel to deliver via its own network, and $6 to use UPS’ ground-delivery service. However, Satish Jindel, head of ShipMatrix, said the comparisons are skewed by distance and density. Amazon uses its drivers on short-haul, densely populated routes. Parcels tendered to UPS cover less-dense, longer-haul markets, thus accounting for the higher unit charges, Jindel said.
In the long run, Amazon will conclude the in-house option is the way to proceed, and will be “pulling more business away from UPS” in the process. He added, though, that UPS may benefit in the short-term as Amazon looks to find a home for some of the volumes it previously tendered to FedEx.
To offset the loss of any Amazon business, UPS will need to attract volume from all other online retailers, particularly the small- to mid-size shippers that generate higher yields for carriers because they can’t command the higher discounts routinely granted to customers like Amazon, Jindel said.
Because of its huge volumes, Amazon has been able to call the shots with its carriers. ShipWare’s Martinez estimated that its transportation rates and any accessorial charges not already waived are capped at a 1.5 percent annual increase. Accessorial charges, which are imposed by carriers for services that go beyond the basic line-haul – can account for as much as 35 percent of a shipper’s bill. Unless, of course, they are waived or are drastically reduced.
But there are hints that the pendulum may be swinging in the opposite direction. A couple of weeks ago, eMarketer, considered an authoritative e-commerce resource, said Amazon’s direct share of the e-commerce market, rather than being around 50 percent as the consultancy has long thought, may actually be closer to 38 percent. The revision came after Amazon Chairman and CEO Jeff Bezos said third-party merchant traffic was growing at a much faster rate than its traditional first-party business, where Amazon directly buys goods at wholesale and sells them at retail.
The e-merchant pile-on may also dilute Amazon’s outsize parcel influence in the years ahead. Businesses other than Amazon will account for more than half of the expected e-commerce revenue growth over the next five years, said Amit Mehrotra, analyst for Deutsche Bank. FedEx has said that daily U.S. parcel volumes will double from current levels to 100 million by 2026. FedEx said it ended the Amazon contract because it sees a much broader e-commerce market to support with its air services. Though it didn’t say as much, that reshaped market will likely be more lucrative since most merchants won’t receive Amazon-like discounts.
Analysts like Mehrotra and Kevin Sterling of Seaport Global Securities believe that in the wake of the FedEx move, the time is right for UPS to take a harder pricing line with Amazon. Sterling said UPS has already begun to adopt a firmer stand. However, the gauntlet may not be thrown down until the upcoming peak holiday shipping season. The ordering and shipping cycle will be compressed to just three weeks because Thanksgiving falls on November 28, putting additional pressure on Amazon’s resources, Sterling said. FedEx will not be available to fly Amazon packages, and Amazon’s air network will likely not be fully ramped up to handle the expected parcel avalanche. What’s more, UPS is no longer afraid to walk away from excess peak volume to maintain network fluidity.
The last time the peak season was this short was in 2014, according to Sterling. Then, Amazon deluged UPS with millions of unexpected last-minute parcels. UPS accepted them, and in the process gummed up its network. Hundreds of thousands of holiday packages were delivered late, leaving UPS with a reputational black eye and putting Amazon in full “blame game” mode. It was around that time, Sterling noted, that Amazon began developing its own air network.