Amazon’s first quarter earnings report last week presented analysts and investors with a financial mystery.
The company’s profits were much higher than expected, an operating margin of 7.4 percent, almost double its operating margin from the previous year. But its guidance for the second quarter’s results was much lower — an operating margin in the range of 4 percent or 5 percent — suggesting that the company would be spending a lot more on … something. But what, exactly?
Between the earnings report and the company’s quarterly conference call, the speculation ran rampant, with analyst Gene Munster of Loup Ventures speculating on CNBC that Amazon was about to drop a bomb. He was right.
“We’re currently working on evolving our Prime free two-day shipping program to be a free one-day shipping program,” Amazon’s chief financial officer Brian Olsavsky revealed on the conference call. “We’re able to do this because we’ve spent 20 plus years expanding our fulfillment and logistics network, but this is still a big investment and [there’s] a lot of work to do ahead of us.”
The cost of this move: $800 million in additional spending, in the second quarter alone.
On this special episode of the GeekWire Podcast, we take a closer look at this fundamental change in the Amazon Prime membership program, a move that promises to significantly alter Amazon’s financials and accelerate the pace of global online commerce. Listen to the episode above, and continue reading for more details.
Why is this a big deal? Amazon introduced its Prime membership program 14 years ago, and free two-day delivery for Prime members has been the core benefit for many years. While Amazon has been adding benefits over the years as well as even speedier shipping on some items, it hasn’t upgraded the standard shipping timeline.
Amazon’s moves are often followed by its retail rivals, like Walmart and Target, so this strategy could set a new standard for delivery speeds around the world.
Beyond that, for Amazon investors, the costs of this program are significant, and unclear beyond the current quarter. The $800 million is about 1.3 percent of the company’s expected net sales for the second quarter. Amazon spent $7.3 billion on shipping in the first quarter, so it’s more than 10 percent of that.
Why is Amazon doing this? Many of the big retailers now have two-day shipping programs on many of their items. Plus, they’re taking advantage of their network of stores with order online, pick up in-store programs that get more people in the door. Amazon can’t match that because, even with Whole Foods, it doesn’t have a brick-and-mortar footprint on the same scale. So they have to find a new way to get ahead of the curve, and it appears faster shipping is where they’ve settled.
“It’s as simple as a price, selection, and convenience, which is the mantra that we talk about quite often,” Olsavsky said on the call. “Going to one-day increases the convenience and it increases the available selection into the consideration set.”
Amazon has only once disclosed its Prime membership: 100 million members and counting worldwide as of about a year ago. However, some of the research companies that follow Prime have estimated that membership growth is slowing. Faster shipping could certainly juice that growth once again.
Amazon is making record profits right now, something that is a little out of character for the company, which is accustomed to operating on razor-thin margins and was unprofitable in many past quarters. So you might say that the company had to spend its money on something.
Can’t Prime members already get free one-day shipping or faster? This is true, you can get some items on a speedier timeline than two-day shipping. However, that doesn’t include all Prime items, and some of these options come with extra fees. Amazon is effectively phasing out two-day shipping as its standard turnaround time for Prime and replacing it with one-day.
“Although we have many items that are available in one to two hours, and also same day, the vast majority of our selection is available to you in two days,” Olsavsky said. “We think that that will open up a lot of potential purchases that and will open up convenience to those customers.”
Amazon announced this news with very little fanfare. Earnings reports come out right after the market closes. Reporters, analysts and investors scan them for the big numbers — revenue, profit, etc. — and then dig deeper for interesting tidbits. About an hour later, executives jump on a call to share highlights and take questions.
The one-day Prime shipping move was not mentioned in the earnings release, it was not introduced during the opening remarks of the call either. It wasn’t mentioned until the second question on the call, when Olsavsky explained why Amazon was forecasting a lower operating margin in the second quarter.
From that point on, the news was the overwhelming focus of the call, as analyst after analyst tried to get more details, with relatively little success. The company isn’t saying, for example, what the costs of this program will be beyond what it will spend in the second program, or how quickly the majority of items will be available via one-day shipping for Prime members.
It became so much of a focus that Olsavsky had to do something awkward toward the end of the call to get to the other piece of information he was apparently waiting for someone to ask about. “I don’t want to run out of time here,” he said. “So I’m going to ask a question for myself about AWS because I want to get some information to you.”
That was ironic because Amazon Web Services is so important to the company’s profits, generating $2.2 billion in operating income in the most recent quarter, about half of the company’s overall operating income.
Is Amazon going to do this on its own, through its own delivery network, or will it still use UPS, FedEx and the USPS? Olsavsky said the company is “going to be using all of the available levers that we have right now,” signaling that it’s going to still be relying on those third-party partners. “We’ll just see how it develops going forward, but we’re going to need definitely the continued support of our external transportation partners.”
Where is this headed next? Five years ago, an Amazon patent filing described a technique called “anticipatory shipping,” in which the company would use predictive analytics to position an item close to a customer in anticipation of the person buying the product, to increase shipping times. According to the patent, inputs would include past purchases, wish lists or even how long you’ve been hovering over certain links.
It’s not clear how much of that technology has been rolled out already, but in 2012, the comedy group The Bilderbergers imagined where this could all be headed in this spoof video.
Who knows, maybe next quarter Amazon will be announcing its secret time-travel shipping plan. In the meantime, the shift to one-day shipping is a major move that we’ll be tracking closely.