Amazon’s Newest Ambition: Competing Directly With UPS and FedEx

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To constrain rising shipping costs, the online retailer is building its own delivery operation

Just before the morning rush hour on a recent Thursday, a brigade of vans rolled up to a low-slung warehouse near Los Angeles International Airport.

Workers in bright green vests crammed some 150 Amazon.com packages into each truck before the fleet headed through the urban sprawl to customers’ doorsteps.

This logistical dance wasn’t performed by United Parcel Service Inc., FedEx Corp. or the U.S. Postal Service, all longtime carriers for the online retailer. It was part of an operation by Amazon.com Inc. itself, which is laying the groundwork for its own shipping business in a brazen challenge to America’s freight titans.

Tackling the delivery business, Amazon executives publicly say, is a logical way to add delivery capacity—particularly during the peak Christmas season. But interviews with nearly two dozen current and former Amazon managers and business partners indicate the retailer has grander ambitions than it has publicly acknowledged.

Amazon’s goal, these people say, is to one day haul and deliver packages for itself as well as other retailers and consumers—potentially upending the traditional relationship between seller and sender.

Some executives refer to the initiative as “Consume the City,” a nod to the company’s plans to build a massive delivery network that could eventually compete with such partners as UPS, according to people familiar the matter.

Executives at the freight giants are skeptical, and so are analysts and logistics experts. They say it would be difficult and costly to build a domestic delivery network to rival the big U.S. players, especially after the failed multibillion-dollar attempt by Deutsche Post AG’s DHL Express in the 2000s.

Memphis-based FedEx says it is spending more than $5 billion annually on expansion and upgrades; UPS says it shells out in excess of $2.5 billion. The two companies have managed to blanket the world with a total of roughly 4,000 hubs and other facilities to sort tens of millions of packages a day. Combined, they operate more than 1,000 planes and 200,000 vehicles to deliver packages to doors.

“The level of global investment in facilities, sorting, aircraft, vehicles, people to replicate the service we provide, or our primary competitor provides, is just daunting, and frankly, in our view, unrealistic,” says FedEx CFO Alan Graf. “We’ve been at this for 40 years.”

Atlanta-based UPS has played down any competitive threat. On a conference call with analysts, Chief Commercial Officer Alan Gershenhorn said UPS’s network would be “very difficult to match.”

In an emailed statement, an Amazon spokesman said “we are very happy to have the delivery capacity our carrier partners can provide. They provide a high quality service, and our own delivery efforts are needed to supplement that capacity rather than replace it.”

Inside the company, executives describe, in the words of one senior official, how Amazon “is building a full-service logistics and transportation network effectively from the ground up.”

Amazon’s push into the shipping sector reflects a willingness among today’s powerful tech companies to defy the traditional constraints of business and leap into new ones.

The company, which started out as an online bookseller, has gained credibility as a producer of TV programs and big-screen movies. Amazon Web Services, which provides data servers to big companies, is now its fastest-growing division with at least $10 billion in sales expected this year.

Now the stage is set for Amazon to move against the partners that have helped power much of its success so far. Shipping costs as a percentage of sales have risen every year since 2009. Last year, Amazon spent $11.5 billion on shipping, or 10.8% of sales, compared with 7.5% in 2010. Total revenue for the year was $107 billion.

The company could save $1.1 billion annually if it stopped using UPS and FedEx, according to Citigroup Inc. analysts. Keeping packages under its own control just over longer distances could save Amazon around $3 or more on a typical delivery, the analysts say. The average cost to ship a package via UPS or FedEx is $7.81, they estimate.

Amazon currently delivers its own packages from roughly 70 facilities in 21 states, having built most of them in the past two years, according to data from supply-chain consultancy MWPVL International Inc. Today, 44% of the U.S. populace is within 20 miles of an Amazon facility, compared with 5% in 2010, according to investment bank Piper Jaffray.

All of this helps to explain why Amazon wants more control over its delivery chain—from factories in China through U.S. ports to sprawling suburban warehouses and neighborhood package-sorting centers. It hopes to offer more delivery times, including hours not available from traditional carriers, say people familiar with the plan. The cost of such a system isn’t known.

To help oversee its delivery projects, Amazon this summer brought back Uber Technologies Inc. executive Tim Collins as a vice president of global logistics. Mr. Collins spent 16 years at Amazon, helping to lead the retailer’s European operations, before leaving the company in late 2014 to join Uber.

Amazon has also recruited dozens of UPS and FedEx executives and hundreds of other UPS workers in recent years, say people familiar with the matter.

The company is buying long-haul truck trailers to ship by ground, building delivery drones to conquer the sky and looking to manage shipping by sea. In August, it showed off the first in a fleet of 40 Boeing 767-300s it is leasing for its branded Prime Air logistics service.

Stitching together a full-fledged logistics network could give Amazon a piece of a world-wide delivery market that, according to financial services firm Robert W. Baird, generates roughly $400 billion in annual revenue.

It could also damage its relationships with UPS and FedEx. Amazon contributes around $1 billion to UPS’s revenue, according to people familiar with the matter. Perhaps more important, the retail giant’s heft helps both UPS and FedEx to be more cost effective by allowing drivers to drop off more packages in the same areas. If Amazon pulls too much business from the delivery giants, the carriers could respond by eliminating certain volume discounts.

Amazon already has pushed out some smaller parcel carriers. In the past two years, it has parted ways with or started reducing package volumes at several local and regional delivery partners, according to people familiar with the matter.

Currently, Amazon is focused on solving the riddle of the so-called last mile—the final and most expensive leg of a package’s journey to the doorstep.

To make last-mile deliveries profitable, logistics experts say, companies need shorter drives and more packages per stop. Amazon, they say, doesn’t yet have enough consumer deliveries to hit this threshold.

The company is conducting its trials in large cities such as Los Angeles, Chicago and Miami. Those places have a high density of members who belong to Amazon’s $99-per-year Prime unlimited shipping program. Gnarled traffic in those cities—especially in Los Angeles—also tests drivers’ mettle and speediness.

As part of its efforts, Amazon is making some deliveries using only trucks and infrastructure it oversees, people familiar with the matter say.

The retailer also has begun distributing boxes and packaging materials to a small number of Los Angeles customers so they, too, can use Amazon as a delivery service, the people say. The test helps ensure Amazon’s trucks aren’t empty when they return to warehouses and give customers more incentive to keep ordering from Amazon.

Amazon embarked in earnest on building its own last-mile network after UPS failed to bring orders to customers in time for Christmas in 2013, costing Amazon millions of dollars in refunds, according to people familiar with the matter. That holiday season, Amazon overwhelmed UPS and other carriers after it failed to accurately forecast its delivery needs, prompting chaos at sorting centers.

Since then, Amazon has more than doubled the number of warehouses in the U.S. to more than 180, according to MWPVL. That includes more than 70 local delivery stations and Prime Now hubs within reach of nearly every major metropolitan area. In many of those areas, Amazon can deliver merchandise in as little as one hour after receiving an order.

Just a few years ago, if an Amazon Prime customer in Atlanta ordered a $13 set of beer glasses only available from California, Amazon would load that order, with others, onto a tractor trailer and haul it to the closest UPS air hub. Next, a plane might ferry it to Louisville, Ky., and load it onto another flight bound for Atlanta. Then the package would be trucked to the nearest delivery center, sorted a final time and delivered by a UPS van. Such a journey could wipe out any profit for Amazon.

The company now aims to do more of the steering. If those glasses aren’t in stock at a fulfillment center near Atlanta, it could fly them there in its own planes and then pay the Postal Service to ship them a shorter distance. Or, contract drivers could make final delivery.

Amazon has flirted with delivery by Uber drivers and newspaper carriers. It has experimented with a program known as “I Have Space,” stashing inventory in warehouses owned by other companies.

A more established program called Flex hires so-called citizen-couriers, who work as freelance delivery people to pick up packages from warehouses using an Amazon app. It has expanded to nearly 30 metropolitan areas in the last year. Drivers can earn up to $25 an hour in two-hour shifts making deliveries, according to Amazon’s website.

Some Amazon executives believe that the on-demand contract driver model, which passes along fuel and insurance costs, could eventually become an important part of the company’s network.

Meanwhile, Amazon’s last-mile effort has become particularly visible in San Francisco’s relatively compact confines. Just two years ago, workers loaded rented delivery vans with packages from a modified trailer in a parking lot beside Candlestick Park, the former football stadium. Today, hundreds of Amazon-branded white trucks, dispatched from a giant warehouse near the airport, troll the city’s winding streets—even on Sundays.

Ken Wood is the founder of LJM Consultants. LJM helps clients negotiate “Best in Class” UPS/FedEx agreements. LJM was recently named the “best parcel auditing company in America” and was also inducted into Inc. Magazine’s Top 500/5000 fastest growing companies in America for 2013. To learn how LJM Consultants can help your company get the parcel contract you deserve, call 631-844-9500 or email kenwood@myLJM.com.