Bloomberg Businessweek recently released a report by Devin Leonard, entitled “Will Amazon Kill FedEx?”. Fred Smith, CEO FedEx from the report:
Concerns about industry disruption continue to be fueled by fantastical -- and I chose this word carefully -- articles and reports,” Smith said on a conference call with analysts and investors. “In all likelihood, the primary deliverers of e-commerce shipments for the foreseeable future will be UPS, the U.S. Postal Service and FedEx.
Reading these words, my mind can't help but track back to to this statement by Research in Motion Co-CEO Jim Balsillie in 2007 following the release of the first iPhone:
It's kind of one more entrant into an already very busy space with lots of choice for consumers," Jim Balsillie said of Apple. "But in terms of a sort of a sea-change for BlackBerry, I would think that's overstating it.
Blackberry unit sales 2015: 7 million
iPhone unit sales 2015: 233 million
Back to the topic at hand, while there can be little doubt that the barriers to entry in the package delivery market are massive, we’ve seen this playbook before from Amazon in the form of adjacent innovation. Adjacent innovation is a strategy where a business leverages something they do well to develop a new product or service in a related market. Adjacent innovations tend to scale faster than a new product or service as you are leveraging an existing business within your organization. No tech company exemplifies adjacent innovation better than Amazon and no other tech company benefits from scale as much as Amazon.
From Online Retail to Internet Shopping Mall
Amazon started out as a retailer selling books online and gradually became a major player in retail by selling virtually everything online. eCommerce distribution has massive fixed costs but benefits greatly from automation and economies of scale and Amazon made massive investments in technology and fulfillment centers to serve their own online retail business.
In 2000, Amazon introduced an adjacent business, Amazon Marketplace, which enabled 3rd party retailers to sell on Amazon.com which brought more products and customers into the fold and enabled them to further scale the business. In 2006, Amazon leveraged their expertise in eCommerce fulfillment to create another adjacent business, Fulfillment by Amazon, which provides fulfillment services to small and mid-size merchants. This enabled Amazon to further scale their technology, services, and infrastructure to reach the economies of scale that allowed them to become the “winner take-all” eCommerce platform. In 2015, Amazon accounted for 60% of all U.S. online sales growth, and sales by 3rd party merchants on Amazon continue to grow, illustrating the success of Amazon Marketplace and Fulfillment by Amazon:
In the past, customers went to shopping malls; today customers go to Amazon. The retailers are on Amazon, because that’s where all their customers are. Amazon used adjacent innovation strategies to become the shopping mall of the Internet era.
While Amazon.com was becoming a retail juggernaut, Amazon technical teams were optimising internal cloud operations and building a world-class technology infrastructure to serve their own retail business. In 2006 Amazon launched Amazon Web Services (AWS) — yet another adjacent business — for cloud-computing services that has evolved into an enormously profitable product on its own. AWS has generated $8.9 billion in revenue over the last 4 quarters. A cloud-computing platform, like eCommerce distribution, benefits greatly from scale and automation. Companies have been moving to the cloud as AWS enables them to run software at massive scale, for less money, and at a far higher rate of availability and performance than they could do on their own. Amazon has built so much scale that the research firm Gartner estimated that AWS offers more than 10 times the computing capacity of the next 14 vendors combined. And while Amazon certainly faces strong competition with deep pockets, it is well-positioned to be a market leader for years to come due in part to their massive scale.
When it comes to Logistics, it’s becoming increasingly clear that Amazon intends to draw from its adjacent innovation playbook. Amazon has made waves in the industry of late with a series of moves that illustrate that it is serious about getting into the logistics business. Amazon recently leased 20 cargo planes to deliver goods to and from fulfillment centers, registered as an ocean freight forwarder in China, and hired former CEO of UTI Worldwide, a freight forwarder, as Vice President of Global Logistics. Amazon has also been adding sortation centers that receive shipments from Amazon’s fulfillment warehouses where packages are sorted by post code and then are delivered to the USPS for last mile delivery, cutting out the need for UPS or Fedex. While in the short run, these moves could be interpreted as a way to rein in shipping costs and provide increased capacity during peak periods, it has become increasingly clear that Amazon is searching for ways to lessen its dependence on 3rd party carriers.
Just like Amazon Marketplace, Fulfillment by Amazon, and AWS, logistics benefits tremendously from scale. Gene Munster, an analyst with Piper Jaffray, projects that Amazon will sell 7.6 billion items in 2016 and sales will increase by 75% to 12.6 billion items in 2020. This massive scale fits perfectly into Amazon’s adjacent innovation playbook - build a business to suit their own internal needs and then extend to third parties. There are, however, additional factors besides adjacent innovation working against FedEx, UPS, and the like that may give Amazon further motivation to expand into Logistics:
New paradigm in Retail - eCommerce has rapidly changed the retail landscape and Amazon are the ones blazing the trail. Amazon launched Prime Now in 2014 to combat “brick and mortar” retailers’ only remaining advantage - proximity to customers. Prime now is available in high-density urban areas and offers one and two hour deliveries to Prime members. There are Prime Now hubs in at least 27 cities that stock up to 25,000 items for rapid fulfillment at a low cost. Prime Now hubs and sortation centres not only enable Amazon to take capacity away from parcel carriers but also enable Amazon to raise consumer expectations for rapid order fulfillment at a low cost. Fast and cheap shipping has put customer convenience at the top of Amazon's priorities and at a minimum, I would expect next day delivery to become the new normal over time, just as free shipping became the new normal in 2005. This obviously will have a flow-on effect to incumbent logistics networks that are not designed for low-cost next day or same day deliveries.
Existing Logistics Networks and Amazon’s Consumer Focus: While there is no doubt that UPS, Fedex, and other logistics incumbents have a significant head start, these advantages may actually turn out to be disadvantages. The logistics infrastructure required to compete in eCommerce is vastly different (and is evolving) from traditional parcel carrier networks, namely that the old structure’s network and cost model are focused on businesses. Amazon on the other hand, started their logistics infrastructure with a singular focus on the consumer and eCommerce. They do not have the burden of retro-fitting their network to meet the needs of end consumers. In addition, Amazon does not have to balance expansion with an internally-competing pre-existing business to business parcel network. Lastly, Amazon’s culture starts with the customer and works backwards from there. Here is a great quote from Jeff Bezos’ recent letter to shareholders:
I’m talking about customer obsession rather than competitor obsession, eagerness to invent and pioneer, willingness to fail, the patience to think long-term, and the taking of professional pride in operational excellence.
Do Fedex and UPS think that way?
Potential Logistics Sea-Change: We could be in store for a massive sea-change in logistics with the advent of autonomous vehicles, robotics, and drones that could dramatically shift logistics distribution models. Although no one knows how these changes will play out, I see technology companies reaping their benefits to a much greater extent than old-guard logistics companies.
In short, based on Amazon’s incredibly successful forays into adjacent businesses and the paradigm shift in retail, it certainly is not “fantastical” to think that Amazon would invest massive sums of money to build the logistics infrastructure to compete with UPS and FedEx. What would be fantastical? Them not building it.