Managerial Problem: Amazon's Delivery Services (P&B, pp. 191 & 221)

Amazon has a problem: It's too successful. It controls 44% of the U.S. e-commerce market, has well over $200 billion in annual sales, ships more than 1.2 billion packages a year, and has more than 100 warehouses, 7,500 truck trailers, and 40 airplanes. However, its rapid growth has made quick and inexpensive delivery of packages crucial to its operations. In 2017, it spent nearly $22 billion on shipping globally, or about 12% of its overall revenue.

1. To which market structure belong Amazon? Explain.

Amazon has relied on shipping using United Parcel Service (UPS), FedEx, and the U.S. Postal Service (USPS). Amazon worries that these delivery services are relatively expensive and have trouble delivering on time, especially during heavy shipping periods, near the holidays in December. Consequently, Amazon says that it needs to develop its delivery services.

Amazon uses or considers three approaches.

• First, its Flex service contracts with individuals who drive their cars to deliver packages for "the last mile."
• Second, it is developing a new service. It would contract with individuals to deliver packages for the last mile; however, these persons would use Amazon's new gray-and-blue delivery vans and wear black hats and blue-collared shirts with an Amazon logo.
• A third option is to create a shipping service to compete with UPS, FedEx, and USPS. Starting initially in Los Angeles, Shipping With Amazon (SWA) will pick up packages from businesses and deliver them to customers. However, to develop such a service able to compete with the large shipping companies would require an investment of many billions of dollars.

What issues should Amazon consider in deciding whether to rely primarily on other delivery services or develop its capabilities? Given that the up-front investment in SWA will cause Amazon to lose money for the first few years before turning a profit, how should Amazon decide whether this investment is worthwhile?

The answer to the first question turns on whether it is cost-effective to rely on markets or to vertically integrate or quasi-vertically integrate. Initially, Amazon used markets, contracting with UPS, FedEx, USPS, and others to deliver its package. Now, Amazon believes that relying solely on those services results in high shipping costs, reduces its flexibility, results in unreliable services during periods of peak demand, and leaves it open to opportunistic behavior by these companies.

Amazon's first response, Flex, was to contract with individuals, which lowers its costs; increases its flexibility; and decreases its reliance on the major delivery services, reducing the possibility of opportunistic behavior. Its second option of contracting with individuals to use its trucks for delivery is a form of quasi-vertical integration. It is similar to the Flex program.

The third option, SWA, is a form of vertical integration. It requires a significant investment initially, with a payoff in the future. This investment cannot pay unless its present value is positive.

Would an increase in interest rates make the Shipping With Amazon (SWA) option more attractive or less attractive to Amazon? Use the suggested questions below to answer this question.

1. Show formally using an equation involving interest rates to explain your answer.
2. Use an Excel sheet to confirm your answer to question. In the excel sheet, use 3%, 5%, and 7% interest rates.