Amazon exceeded market expectations in the fourth quarter of 2017 reporting revenues of $60.5bn, to show a remarkable year-on-year increase of 38%. Total sales for 2017 were $178bn, which is an increase of 31% over the previous year. Operating profit was up by 69%.
eCommerce vs Web Services
Interestingly, however, the greatest proportion of Amazon’s net profit (73%) came from Amazon Web Services, the cloud computing division. Amazon’s North American eCommerce business delivered $1.69bn operating profit on revenues of $37.3bn (4.5%) while the international eCommerce business made a loss of $919m on sales of $18.04bn.
At net profit level, the global eCommerce operation is thought to be loss-making. This may partly explain why Amazon has announced redundancies within its eCommerce division, particularly at its head office.
Building Scale
Within the UK, Amazon continues to power ahead with the building of four new distribution centres to be opened in 2018 at Rugby, Bristol, Bolton and Coventry. This will bring the total to seventeen distribution centres in the UK, accounting for more than 200m ft2 of warehousing and employing around 30,000 staff.
The reason given for the market’s acceptance of lacklustre margins from the eCommerce business is the importance of building scale. In North America, Amazon has achieved scale and is still only generating operating profits of 4.5%, less than that by John Lewis.
Automation
Whilst Amazon continues to grab the headlines with innovative ideas such as delivery by drone, the reality is that these innovations have not resulted in improved financial returns for its eCommerce business. It has built significant market share by establishing high awareness and integrating the supply chain to offer a superior customer service, but this has not resulted in higher margins. The reason is perhaps that, for the most part, Amazon still uses very conventional operating methods within its supply chain.
Whilst automation is growing, warehouse operations are still very manual and the scope to reduce transport costs will always be limited by the impact of regulatory restrictions on methods of operation. The size of a truck and the hours a person can work are both finite, imposing limitations on the benefits of scale for road transport operations.
Globalisation or Innovation
Does it continue to try and dominate the global eCommerce market, accepting that margins are highly vulnerable to an economic downturn, or focus on true innovation to attract far higher financial returns? Growth within Amazon Web Services has been impressive, but it has already started to slow. Like Apple, Amazon must continue to develop new products, but, unlike Apple, they are often disparate and have not materially improved the operating margins of the base eCommerce business.
One thing is certain: Amazon will continue to be a major presence in the eCommerce marketplace. The company will attempt to use its scale to drive down costs, either by the use of its purchasing power or by taking activities in house that might add to its limited margins. Given that many of the distribution services being taken in-house are relatively low margin, it is difficult to see how such a strategy will materially improve financial performance unless it can achieve significantly better operational synergy.
COMPETING ECOMMERCE RETAILERS
The concern among contractors is real. The drop in the share prices of both UPS and Fedex earlier in the year was, according to analysts, directly related to Amazon’s 2017 fourth quarter results. The thought of the increased purchasing power, or the decision to expand its own delivery operations, will certainly raise eyebrows in Atlanta and Memphis.
For those eCommerce retailers seeking to compete with Amazon, the lesson is fairly simple: they must establish an easy-to-use, one stop shop that offers excellent customer service. Key to achieving this will be the integration of systems and operational processes that include order processing, forecasting, warehouse management, transport operations and product-tracking. Amazon and other similar companies are continually raising customer expectations so that the service levels and product and consignment information acceptable just five years ago are no longer acceptable now.
END-TO-END FULFILMENT SERVICE
Critical to Amazon’s scale in fulfilment operations is its eCommerce hosting services, where hosted products account for approximately half of all shipments. For many eCommerce retailers, Amazon’s hosting has provided a route to market that they would not otherwise have had. The major logistics and network contractors can compete by offering comprehensive fulfilment services to match the merchandising service offered by Amazon, but without the risk they may one day compete directly by selling similar products. Unfortunately, market the development of fully-integrated services has been slow in the UK, with different contractors tending to specialise in one part of the supply chain rather than its totality.
Competing with Amazon in the medium term is not about drones, but about providing fully integrated supply chain system with the various links working together seamlessly. For both contractors and e-retailers it means focusing on a fully joined up operation that is easy for the customer to use, with excellent service and full transparency.