Amazon: Accelerating Decline In Shipping Costs Are Driving Future Valuation



Jan. 30, 2020 11:04 AM ET

Luke McCarthy

Long/short equity, medium-term horizon, tech



Amazon has seen double-figure growth in its logistics sector naming transport and logistics as competition for the first time in their 2018 SEC 10-K.

Amazon has built up a fleet of 50 cargo planes with 20 more expected before 2021 and with a $1.5 billion hub airport under construction.

Amazon’s recent exercise of warrants on its main aircraft wet-lease providers show commitment to the skies.

Quarterly shipping costs are expected to balloon in Q4 but shipping costs as a percentage of operational costs are falling.

Amazon (AMZN) has been muscling its way into the shipping and logistics industry for years, but has their recent move to the skies brought an opportunity for investors seeking future value? Will Amazon’s exponential growth in both ground and air delivery systems prove competition for FedEx (FDX) or UPS (UPS) in the coming years? Amazon listed transport and logistics as competition for the first time in their 2018 SEC 10-K filing. With Amazon’s incredible ability to rapidly increase scale, substantial customer base, existing fulfillment network and third-party programs I believe they can.

Overview Of Amazon's Fulfillment Empire

Amazon’s shipping cost in Q3 2019 was $9.6 billion, its highest ever in a single quarter. With the emergence of one-day shipping, Amazon has seen a significant increase in outbound shipping costs over the past 10 years with average annual growth in shipping cost from 2008–2018 being 34% vs. 23% growth in net product sales. Shipping cost grew from 12% of product sales in 2014 to 20% in 2018 with 2019 estimates being ~23%. We can expect shipping costs to continue to increase above revenue until Amazon can provide one day or less shipping to over 90% of total product sales.

Amazon Quarterly Shipping Cost:

Description: Amazon Quarterly Shipping Cost

Source: Company SEC Filing’s 10-Q’s

Amazon generates revenue in addition to cost related to outbound shipping, the true cost of shipping products to customers for Amazon is their net shipping cost. The diagram below shows the widening of the gap between shipping revenue (shipping fees charged and a percentage of Prime membership fees) and the cost of shipping (sortation and delivery centers and transportation costs). Amazon stopped reporting separated outbound shipping revenue in 2016. As Amazon increases distribution networks and begins to sell fulfillment to third-party sellers, Amazon’s net shipping cost will begin to fall. We can expect over the coming few years for Amazon to begin to cover a growing percentage of their own next day shipping cost with revenue generated through these new distribution channels.

Amazon continues to move away from its shipping partners (UPS, FedEx and, USPS) now fulfilling ~26% of its orders which CFO Brian Olsavsky said Amazon could do cheaper and better will save significant cost for Amazon.

Amazon Net Shipping Cost:

Description: AMZN - Net Shipping Cost

Source: Company SEC Filing’s 10-Q’s / 10-K’s

Ever wondered how Amazon can stock such a wide range of products and keep track of every product's supply chain and inventory control? Simple they don’t. Fulfillment By Amazon (FBA) is Amazon’s third-party fulfillment program where sellers from all over the world can use Amazon's network of 185 fulfillment centers to ship products. As shown below, the only step sellers need to take is sending inventory to an Amazon fulfillment center, Amazon does the rest for a small fee of course. Amazon charges a 15% fee on sales with a flat $1.00 fee to nonprofessional account sales, for this amazon will store and track inventory, package and ship products straight to the end consumer. This full-cycle approach allows sellers to interact with one company to fulfill orders allowing amazon to charge up to 50% less than conventional shipping costs with inventory management and storage included. This gives Amazon a significant edge when attracting new sellers and a broader product range vs competition such as eBay (EBAY) and Alibaba (BABA).

Fulfillment By Amazon (FBA) Seller Product Flow:


Source: FBA guide

Amazon has exponentially expanded its number of fulfillment centers with only 2 in 1997 growing to 110 in the US and 185 globally in 2019. Amazon has 33 more planned locations and is expected to expand further as one-day shipping is rolled out across the whole of the US and globally. Local fulfillment centers are key to Amazon's ability to provide the same or next day delivery to its over 100 million Prime members.

Why so many warehouses? According to an eMarketer analyst Amazon has eight times the sales volume of Walmart (NYSE:WMT), with Walmart having 42 warehouses to supply that demand Amazon’s warehouse growth looks set to continue.

Amazon is investing heavily in automation of its warehouses, with over 200,000 robots working in fulfillment centers already. Automation dramatically decreases costs with Amazon recently introducing packing robots four to five times more efficient than a human.

Amazon Fulfillment Centers Across the US:


Source: Map of Fulfillment Centers

Last-mile delivery accounts for ~53% of the total delivery cost. Currently, Amazon uses USPS, FedEx and UPS for last-mile delivery, this has significant cost implications for Amazon. Amazon has recently pushed employees to quit jobs in last-mile delivery and set up their own business, Amazon offered employees $10,000, discounts on 20,000 new vans Amazon recently purchased and insurance as an incentive. Covering the most costly element of the delivery process Amazon gains the ability to cut out service costs to third party providers and using the last-mile delivery program creates small and efficient independent enterprises reducing direct risk to Amazon while cutting per package delivery costs. Amazon has also explored other avenues to bring down last-mile costs including drones and autonomous curbside delivery baskets.

Amazon has also expanded its trucking fleet to a total of 20,000 trucks and has developed where Amazon often publishes rates at 4%-5% spot trucking quotes again saving significant cost on Amazon's substantial volume. Amazon has also been working on permits to operate freight services from China to the US showing a real tangible commitment to increasing its share of the shipping and logistics industry.

Fulfillment taking off

Owning aircraft is a costly business, Amazon currently leases 44 aircraft from 3 operators (Atlas Air (AAWW) – 17 aircraft, Air Transport Services Group (ATSG) – 28 aircraft and Southern Air – 5 aircraft) with 20 new aircraft on order expected by 2021. Amazon is currently focusing on bringing operations in house and building a hub and spoke air delivery network, recently taking over ground operations in Baltimore.


Amazon’s commitment to the air is concreted through warrant agreements made between Amazon and its two largest wet-lease operators. Amazon recently exercised 2 of these warrants for Atlas Air and Air Transport Services Group amounting to 5% of shares outstanding in both cases. Amazon holds the right to purchase up to 39.9% of Atlas Air and 19.9% of ATSG. Amazon gaining significant positions in its two main suppliers of planes is vital for stability in Amazon’s fleet, with these sizeable positions Amazon can push for board membership and force through change at shareholder votes to benefit them.

Source: Video

Amazon is currently building a $1.5 billion hub distribution terminal at Cincinnati/Northern Kentucky International Airport, Kentucky also has 14 Amazon fulfillment and sortation centers and 1 customer service center. Amazon currently operates around 110 flights per day), This capacity will significantly increase with the introduction of the new hub with parking space for up to 100 planes double Amazon's current fleet. Amazon’s main aim for its new hub is for the firm to be able to cut Prime delivery times in half to one-day, Amazon has already set aside $800 million to complete this goal.


In the second half of 2019, FedEx changed its tune on Amazon as competition with CEO Fred Smith naming Amazon as one of the 5 major logistics industry players something the firm has long since played down. FedEx currently carries ~10% of Amazon's US packages making up 1.3% of FedEx revenue in 2018, UPS carries ~25-30%, USPS carries ~40-45% with Amazon carrying ~25%. As Amazon moves away from these shipping partners their revenues for 2019 will have been negatively affected by 2% with it increasing to around 10% in 2025 according to Morgan Stanley’s research.

Amazon Shipping, Distribution, and Logistics US Competition:

Description: Amazon Shipping Competition

Sources: Company SEC Filing’s 10-K’s (AMZN, FDXUPS), Reuters, ForbesUPS

Amazon doesn’t currently have the infrastructure to compete in cost with UPS and FedEx, running 261 or even 681 planes have a significant economy of scale benefits in comparison to Amazon’s 50. However, Amazon’s new airport plans and orders for new planes could see its fleet reaching the mid-hundred point by 2025 and allowing for a platform to compete at the lower cost point.

Amazon has an extra significant cost to that of the other two shippers, storage and inventory management requires Amazon fulfillment centers to be significantly larger than the sortation and distribution centers for the shippers. This likely explains a large portion of the difference between Amazon’s shipping cost per unit of $15 in comparison to USP’s $9.2 and FedEx’s $4.2. however, analysts expect Amazon to be able to cut the cost of delivery per box to $6 when its complete fulfillment operations are on-line.

Amazon is competing for market share in the delivery of its goods, and they have a significant advantage over UPS and FedEx in this aspect. Why doesn't Amazon just stop using shipping partners? Amazon doesn’t currently have the infrastructure to compete delivering its shipments, its current costs are too high and as such using these partners in difficult to deliver in areas where costs for Amazon are significantly higher is beneficial.

Trump's Tweet Over Amazon’s Use of USPS:

Description: Twitter

Amazon's move from USPS as its last-mile delivery provider in the US is not just cost-based. In 2018, Trump showed his displeasure towards Amazon’s low-cost use of USPS for last-mile deliveries. Amazon wants to disassociate with any negativity towards its operations especially given Trump's ability to move markets and apparent displeasure towards Amazon.

Effect on future valuation

The effect of all this distribution shakeup can be split into its cost and revenue effects:


Amazon's current implied cost to ship packages at a rate of 2.5 billion per year in 2019 is $11; this cost is primarily made up of fulfillment center cost and shipping costs. Analysts believe that Amazon pays $7-$8 per package to ship using a shipping partner. This seems accurate given UPS and FedEx had an average per package shipping revenues of $11.02 and $8.97 and Amazon receives preferential high volume rates. As Amazon moves away from these shippers, the cost per package will fall towards $6, assuming shipping made up for 75% of $37 billion, Amazon spent on fulfillment last year we get a per-package cost of $8.25 for 2018. A move to $6 would imply a 27% saving per package or in 2018 would have saved $10 billion.

Using a discounted cash flow (DCF) Model, we can isolate the effect of a 27% decrease in shipping cost by 2028 on stock valuation. This model contains some fundamental assumptions and as such, we can’t take the exact valuation to be accurate however the two valuations shine some light to the true upside of the saving on shipping cost.

Discounted Cash Flow Model Assumptions:


Source: Company SEC Filing’s 10-K’s

Key assumptions for this DCF are:

·         Other than shipping costs all other variables remain fixed.

·         Amazon sees operating margin increases as efficiency is created and business structure moves towards high margin AWS.

·         Base Case - Shipping costs remain 13% of Operational Costs.

·         Cost Reduction Case – Shipping costs fall by 27% in comparison to the base case by 2028 (i.e. Amazon will be spending around ~$6 per package in shipping).

·         Cost Reduction Case – Shipping costs fall faster to begin as Amazon takes over easy urban delivery and slows towards 2028 as they cover more rural delivery locations.

Amazon Discounted Cash Flow Base Case:

Description: AMZN DCF

Source: Company SEC Filing’s 10-K’s, Forecasts

Amazon Discounted Cash Flow Shipping Cost Reductions:

Description: AMZN -DCF

Source: Company SEC Filing’s 10-K’s, Forecasts

Given these assumptions, Amazon could see a ~17% upside through the complete implementation of its full distribution network alone.


Amazon will also generate revenues from FBA and other third party programs. However, Amazon has and will continue to see decreasing direct revenue from delivery fees as more products are offered on Prime and Amazon’s lower shipping costs can be passed on to consumers. I see amazon’s shipping revenues being fairly insignificant in the long run unless Amazon intends to provide shipping services externally, with the only benefit being in a slight increase in total revenue and decrease in net shipping costs.


Amazon’s fulfillment empire is often overlooked by investors focusing on revenue figures and the growth of Amazon Web Services (AWS). Over the past 5 years, Amazon has become a significant player in the logistics industry and although it’s a high-volume low-margin business, it's key to Amazon's past and future success. The next big question is how quickly can Amazon scale its operations? Considering Amazon is spending $800 million to provide next day delivery, $1.5 billion on a new airport hub and has already gained a 26% share in its deliveries, it could be only a few years before Amazon's reliance on shipping partners is significantly reduced or even withdrawn.


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