Amazon Wrings Profit From Fulfillment as Spending Soars: Tech

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Photographer: Joshua Lott/Bloomberg

The Amazon Fulfillment Center in Phoenix, Arizona.

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Photographer: Joshua Lott/Bloomberg

The Amazon Fulfillment Center in Phoenix, Arizona. Close

The Amazon Fulfillment Center in Phoenix, Arizona.

Photographer: Joshua Lott/Bloomberg

The Amazon.com Phoenix Fulfillment Center in Phoenix, Arizona. Close

The Amazon.com Phoenix Fulfillment Center in Phoenix, Arizona.

Photographer: Joshua Lott/Bloomberg

A worker stocks merchandise at the Amazon.com Phoenix Fulfillment Center. Close

A worker stocks merchandise at the Amazon.com Phoenix Fulfillment Center.

Photographer: Emile Wamsteker/Bloomberg

Jeff Bezos, chief executive officer of Amazon.com Inc. Close

Jeff Bezos, chief executive officer of Amazon.com Inc.

Photographer: Joshua Lott/Bloomberg

Former President George W. Bush's book "Decision Points" sits on a cart at the Amazon.com Phoenix Fulfillment Center. Close

Former President George W. Bush's book "Decision Points" sits on a cart at the Amazon.com Phoenix Fulfillment Center.

Photographer: Joshua Lott/Bloomberg

Workers unload merchandise from boxes at the Amazon.com Phoenix Fulfillment Center. Close

Workers unload merchandise from boxes at the Amazon.com Phoenix Fulfillment Center.

Amazon.com Inc. (AMZN) executive Tim Collins shows off shelves of Buzz Lightyear dolls and boxes of Blow Pops as he describes how the world’s largest online retailer keeps up with orders.

Carrying handsets that use algorithms to help, employees must make the most efficient use of space in the 1.2 million- square-foot warehouse in Phoenix -- down to within a fraction of an inch.

“Putting a blender and jumper cables together is a pretty strange feat,” said Collins, head of North American fulfillment for Amazon. “Our job is to build infrastructure that can handle pretty much anything.”

Chief Executive Officer Jeff Bezos is trying to squeeze every penny possible from the 17 fulfillment centers he built for about $4.6 billion last year, part of a spending spree that sent operating expenses up 44 percent in 2011 and shaved 2.3 percentage points off margins, even as sales rose 41 percent. To reverse the pinch, Amazon is handling a broader range of products and offering services to third-party vendors, so that its giant warehouses themselves will become profit hubs.

“They’re building out fulfillment because they realize that fast and predictable delivery of product is a huge driver of their business,” Colin Gillis, an analyst at BGC Partners LP in New York, said in an interview. “With the revenue growth rate that they have, it’s not like they’re doing this just because they want to. They’re trying to catch up to their sales growth.”

Kiva’s Orange Robots

The investment in fulfillment centers last year -- the company’s largest operating expense, at 9.5 percent of sales -- brought the total number of warehouses to 69. To help further automate its order-fulfillment business, Seattle-based Amazon agreed to buy warehouse-robot maker Kiva Systems Inc. earlier this week for $775 million, the company’s biggest acquisition since its purchase of shoe retailer Zappos.com in 2009.

Kiva’s orange robots, which can dart under shelves of products and move them around, hasten fulfillment and are used by Quidsi Inc., the company behind Soap.com and Diapers.com that Amazon acquired for about $545 million last year.

Third parties that use Amazon’s warehouses and shipping services are helping to drive the company’s expansion. Units sold by outside retailers increased 65 percent last quarter and made up 36 percent of unit shipments, compared with 30 percent a year earlier. The shift helped earnings reach 38 cents a share in the fourth quarter, topping estimates, even as sales fell short.

Outside Vendors

That’s because receipts from outside vendors that sell on its site bring higher margins for Amazon. It logs the commission, usually about 10 percent, on any item sold by a third party as 100 percent profit and collects fees if the partner elects to fulfill through its chain of warehouses, according to Mercent Corp.

“You’re training the consumer to start and end their shopping process at Amazon, without necessarily considering online avenues or offline avenues for purchase,” said Mercent CEO Eric Best, whose company helps retailers improve online sales, including those on sites such as Amazon and EBay Inc. (EBAY) “Amazon actually controls the experience and can ensure that consumers are getting consistent, rapid fulfillment. And it’s zero inventory risk.”

Stowers and Pickers

To get items out the door at Amazon’s Phoenix warehouse, workers called stowers slot items into shelves divided by plastic and spaced at a distance that a computer has dubbed the most cost-effective. Their counterparts, called pickers, do the opposite in an area just big enough to optimize time spent reaching between shelves and pivoting to set orders on a conveyor belt, on their way to be packed and shipped.

Redcats USA, which sells mostly women’s apparel, yielded more than $10 million in revenue last year from sales through Amazon, said Yann Tanini, vice president of e-commerce at the company, owned by PPR Group.

Sellers like Redcats have an incentive to use Amazon not only for access to consumers -- unique visitors to the site reached 87.9 million in December, Nielsen estimates -- but also for fulfillment centers where programmers tweak algorithms on the spot to ensure products get in and out the door in the most efficient way possible. Redcats saw more than a 500 percent rise in sales on Amazon in its first year, making it worth the fee it pays, Tanini said.

Driving Traffic

“To get someone to come to your store, you pay in advertising, you pay by sending out catalogs,” Tanini said in an interview. “So you have to compare the commission to what you’re investing to drive traffic.”

Amazon usually took a 15 percent commission, Tanini said, implying it would have charged about $1.5 million. While that’s a small portion of the $48 billion in revenue Amazon generated last year, with more than third of total unit sales coming from outside vendors like Redcats, sales by third parties are boosting results, said Mercent’s Best, who used to work in Amazon’s third-party division.

More retailers have been signing up for Fulfillment by Amazon, or FBA, where the company stores their products in its warehouses, ships them and makes those items eligible for Amazon Prime free two-day shipping, Best said. Third parties pay the company $1 to pack an item, 37 cents a pound for weight handling and 45 cents per cubic foot for storage.

Fulfillment Fees

Amazon also offers fulfillment on orders that retailers don’t sell through its site. In those cases, the company charges the seller more for order and weight handling and doesn’t log a cut of the sale as revenue. Third parties have to opt in to FBA. Otherwise, they can sell on Amazon.com and fulfill themselves.

To ensure orders aren’t sitting in warehouses so long that it stops being cost-efficient, Amazon charges more the longer a product takes up space on its shelves, Best said.

“We’ve tried to set our fees for FBA very in-line with the true cost drivers of what’s going on,” Tom Taylor, vice president of FBA, said in an interview. “The Amazon retail business can be very effective, but it certainly can’t create the selection at the same pace that 2 million sellers are able to. Third party is growing much faster than the rest of online and, in some ways, greater than the average of Amazon itself.”

Shipping Costs Surge

At the same time, third-party sales have contributed to shipping expenses, which soared 55 percent to $4 billion, compared with the $1.6 billion in fees from outside vendors the company collected last year. That followed a 45 percent rise in shipping costs for 2010 -- a faster pace than the average increase of 24 percent annually in the four years prior, according to data compiled by Bloomberg. The company will need to find other ways to compensate for the higher spending, said Jason Helfstein, an analyst at New York-based Oppenheimer & Co.

“You either raise the price for Prime, you get people to put more items in the cart at once, or you sell more digital media, which has no shipping costs,” Helfstein said in an interview. “Those are the three ways you’ll ultimately get margins to grow materially. We don’t know yet how they’re going to do that and at what order and at what magnitude.”

So Amazon is wooing sellers, such as Amoretti, an arm of Noushig Inc. that sells flavored syrups and cocktail mixes, usually in bulk. The company has signed up for FBA as part of a plan to reach individual consumers.

“We have a joke -- Amazon gets our products to our customers faster than I can run out to the warehouse and grab it myself,” said Paul Barsoumian, customer-service supervisor at Amoretti. “It’s a huge number in terms of the savings. If you say nine different people have to touch an item before it goes through the door, compared with zero people when we fulfill through Amazon, it could be a 700 percent, 800 percent decrease in costs.”

‘Benefits in Scale’

Amazon’s size -- its market value is $87.5 billion -- lets it negotiate low rates with shipping carriers and pass on savings to sellers and consumers, Taylor said.

“In the case of transportation, we always have some benefits in scale,” he said. “The economics allow us therefore to go back and offer customers two-day shipping.”

Smaller retailers can’t match Amazon’s services, Taylor said, recalling a conference he attended where one such merchant was giving advice on how to cut fulfillment costs, telling the audience to pay attention to details, like shelf size.

“I’m in the audience thinking, well, it’s not only the size of the racks, it’s also the height of the racks, the type of equipment that you would get in there and the air pillow density and the pressure in the air pillow and the distribution of box size,” he said. “This is all the stuff Amazon loves to do. At some point, the seller should say, ‘This is the type of stuff I should outsource to Amazon.’”

To contact the reporter on this story: Danielle Kucera in San Francisco at dkucera6@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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