Amazon Puts The Best Possible Spin On An Overbuilt Network

Yesterday, Amazon
AMZN
issued a press release that highlighted the company’s investments across its global operations network to provide fast delivery for customers. Prime Day is July 12^th and 13^th. On Prime Day, Prime members in 20 countries have access to deals on everything from top national brands to products from third-party sellers. The press release cites the investment the company has made in their infrastructure to prepare for this surge in demand. Those investments include a supply chain network that includes more than 110 aircraft, 50,000 trailers, 400 fulfillment centers, 150 sortation centers, and 1,000 delivery stations across the globe. The company has also invested in goods to man robotics at their fulfillment centers and computer vision systems to assist in the sortation and labelling processes.

And with COVID, Amazon, like many other companies, was forced to pay front line logistics workers a higher salary. During COVID, warehouse space was not the retailer’s main constraint, having sufficient labor was. Last September, they increased their average starting wage in the United States to more than $18 an hour. It had been an average of around $17 since May of 2021. In some locations, the company was giving signing bonuses of $3,000. These increasing labor costs occurred while Amazon was nearly doubled the size of their workforce over the course of two years.

These investments allow Amazon to offer same-day delivery in 17 nations, including more than 140 metro areas in the U.S. and Europe. In many cases, Amazon can deliver these packages within hours of purchase. It is truly a massive and impressive network.

But the press release follows an admission at the end of their first quarter that the world’s largest online retailer had overbuilt their network. Amazon reported $2 billion in incremental costs from having excess fulfillment and transportation capacity. Meanwhile, their CFO
CFO
reports that inflationary pressures – increased fuel costs, increased costs of international shipping, etc. – added approximately $2 billion of incremental costs when compared to the previous year. These increased costs contributed to a net loss of $3.9 billion, after having a profit of $8.1 billion in the same quarter the previous year.

The new reality, Reuters reported, began to emerge halfway through 2021. “Amazon was on track to double its warehouse and delivery network, a feat necessitated by consumers’ embrace of at-home shopping to avoid COVID-19 infections in stores.” But “after the Christmas holiday, consumer demand dwindled, as always. Online sales dipped from a year ago, Amazon’s results showed. Brick-and-mortar stores beckoned shoppers once the Omicron wave subsided, and still others faced a choice between buying goods and filling their cars with high-priced gas.” Amazon’s chief financial officer admitted the company was “overbuilt for current demand.”

This did not make financial analysts happy. Michael Pachter, an analyst at Wedbush Securities, complained “Didn’t they see this coming when they built all these fulfillment centers?” Noting how Amazon doubled its already massive network, built over two decades, in just 24 months.

In short, Amazon got its long-term strategic capacity plan, based on their long-term projection of demand, wrong. Forecasting demand is tough enough when you are forecasting what will be sold in the coming quarter. But building warehouses takes two years. Creating an accurate two-year forecast is a very difficult proposition to begin with. Creating that forecast in a period of extreme economic uncertainty following a pandemic, even more so.

And while Amazon has excess warehouse capacity, which contributed to an embarrassing loss in the first quarter, many other retailers and logistics service providers are struggling to get enough capacity. In particular, these companies are struggling to build enough warehouse capacity close to metro areas to facilitate e-commerce. Amazon made a mistake, but not a critical one; the capacity will be needed.