Slow boat

Amazon faces double whammy from shipping costs

Rising shipping costs are taking a bite out of Amazon. One of the US internet retailer's biggest weapons against rivals has been fast and cheap delivery. The associated losses have been a clever marketing expense, driving top-line growth. But rising competition and higher delivery costs are blunting this edge - and dimming Amazon's profitability prospects.

Founder Jeff Bezos said from the beginning he cares about the long run. If the company is cheaper and more convenient than rivals, then it will maximise cash flows over time. That's why Amazon invests heavily in building warehouses close to consumers (last year's capital expenditure was $4.9 billion, and it acquired $4 billion of capital leases), is investing in drones for additional speed, and is willing to lose money on delivering everything from milk to books.

On average, customers have subsidised about half the actual costs of shipping over the past several years. In 2014, Amazon spent $8.7 billion, but only charged customers $4.5 billion, leaving shareholders to absorb the remaining $4 billion as losses.

Traditional retailers such as Walmart and Williams-Sonoma have increased online selling efforts, by also offering fast and discounted shipping - and same-day pickup in stores, which without bricks and mortar Amazon can't match. Meanwhile, carriers such as the postal service and UPS have raised rates by about 4 per cent annually to cope with all the demand.

The result is a steady increase in delivery costs, as Amazon tried to keep ahead. Shipping expenses as a percentage of net sales rose from 8.4 per cent in 2012 to 9.8 per cent last year. And these figures may understate the problem. Amazon's fast-growing virtual businesses, such as web services and video, aren't physically delivered.

Amazon has been charging customers more for delivery, for example, by raising the price of its Prime service by $20 last year. That's prevented associated losses from skyrocketing. But it has also caused growth to slow. Amazon's top line increased almost 20 per cent last year. That's respectable, but only half the rate it achieved in 2011.

Amazon's $175-billion market valuation is built upon the idea of the company either delivering fast revenue growth today or impressive profits tomorrow. Rising shipping costs threaten both.