UPS and Amazon: Made for each other?

Like most mega-companies, UPS Inc. (NYSE:UPS) is loath to publicly discuss customers or its relationships with them. It refuses to answer reporters’ questions about customers. It never mentions them in press releases or other media announcements. But the long-held custom went out the window last week. In announcing its fourth-quarter and full-year results, UPS not only disclosed a customer’s name, but chose perhaps the most visible company on the planet.

UPS said parcels tendered by Inc. (NASDAQ:AMZN) accounted for 11.6% of its 2019 revenue, which works out to about $8.6 billion from a base of $74 billion. In UPS’s 20-plus years as a public company, no single customer has ever made up such a large percentage of its annual revenue.

UPS lauded Amazon for tendering the type of parcels needed to boost U.S. next-day air volumes, which grew by 26% in the holiday-fueled fourth quarter and have grown by more than 20% in each of the past three quarters. The Amazon traffic, UPS said, will add density to its high-fixed-cost network, thus reducing unit costs and improving the profitability of each shipment.

UPS rarely does anything — public or private — by accident. Its unprecedented reference to such a high-profile company, and in particular the revenue it generated last year, could be interpreted as a vote of confidence in its relationship with Amazon, and perhaps vice versa. UPS wanted to disclose Amazon’s contribution because of the size, according to Steve Gaut, a UPS spokesman. Gaut told FreightWaves that the revenue impact of the Amazon business was magnified in light of smaller contributions from its international markets due to geopolitical concerns and macro weakness. UPS did not ask Amazon for permission to use its name, Gaut said. UPS declined further comment, and Amazon did not respond to a request for comment.

Most, if not all, of this defies conventional wisdom, which holds that Amazon will use UPS until it builds sufficient capabilities to capture most volumes on its own network. Amazon will then relegate UPS to less-efficient, single-stop routes, a shift already taking place, according to the theory. The scenario helped bring Amazon’s air and ground delivery contracts with FedEx Corp. (NYSE:FDX) to an end last year. It also fortifies Amazon’s reputation as a company that will partner with others up until it has learned the other’s business. Then, it will jettison the partner if the other party hasn’t done so first.

“This will be a symbiotic — sometimes beneficial, sometimes harmful — relationship, until it isn’t,” said Caroline Lyle, marketing director for consultancy Transportation Insight, referring to the UPS-Amazon alliance. “Both companies are using each other until they build out their networks and get the automation, scale and density that they need.”

Depending on the source, UPS delivers between 15% and 21% of Amazon’s parcels on an annualized basis. UPS accounts for about 23% of Amazon’s annual shipping costs and is its largest shipping vendor, according to data from iDrive Logistics, a consultancy that works closely with parcel carriers and with Amazon shipping customers. Amazon’s fourth-quarter shipping costs totaled nearly $13 billion, a 46% increase from fourth-quarter 2018 levels.

Right now, Amazon is taking more of the dense residential deliveries, leaving UPS, though having the additional scale needed to serve more residential neighborhoods, without the type of traffic it wants, Lyle said. Eventually, the rise in less-desirable Amazon volumes will force UPS to increase its rates, which will be anathema to Amazon, Lyle said. “This is the point on the graph where [the relationship] disconnects, and it will not be good for either party,” she said.

The tipping point could be Amazon’s increasing penetration of its Seller-Fulfilled Prime (SFP) business, in which third-party merchants select their own fulfillment provider and still maintain their status as sellers on Amazon’s 150 million-customer “Prime” channel as long as the delivery performance meets Amazon’s preset requirements. UPS is a mainstay of SFP users, and a substantive loss of that business to Amazon could trigger the separation, Lyle said.

Matthew White, an analyst at iDrive Logistics, said the interests of Amazon and UPS shareholders, though currently aligned, will eventually split as Amazon gains more confidence in its shipping prowess. UPS’s formidable resources and its 113 years of experience will mean little to Amazon and its white-hot ambitions, White said. “It is not so much about UPS lacking acumen, but rather Amazon repeatedly showing itself to be an exceptionally selfish partner with incredible internal capabilities,” White said.

Then there is the other side of the argument: that Amazon will see sustainable benefit in leveraging a fully integrated, highly efficient operator that’s reconfiguring its 

U.S. network that has handled 350,000 to 400,000 additional parcels per hour from 2018 to 2020 alone, and that has rolled out an expanded product portfolio seemingly tailor-made to Amazon’s needs. The day before announcing its financial results, UPS unveiled a slew of initiatives that include later cutoff times for drop-offs to support next-day ground deliveries to 98% of the U.S. population, expanded Saturday service that will reach 40 million additional U.S. consumers, and the launch of Sunday deliveries to most of the country, albeit initially through the U.S. Postal Service’s (USPS) infrastructure for last-mile. 

The multiple enhancements give UPS a “leg up in adapting to the structural consumer expectations shift towards next-day and seven-day delivery,” said Bascome Majors, analyst for Susquehanna Investment Group.

Amazon undoubtedly insources more of its deliveries than ever. It handled nearly half its own shipments in 2019, according to estimates from investment firm Morgan Stanley & Co. (NYSE:MS), an investment firm. Still, a seemingly never-ending surge in demand for products sold on its site means Amazon will be tethered to its delivery partners for some time to come. UPS will likely handle more of Amazon’s shipments in coming years, even as its percentage share of the total shipping pie declines.

Amazon could move goods cheaper, on a per-unit basis, on its own network than it can by outsourcing the deliveries. The question is if doing so would compromise its on-time guarantees, especially as more Prime deliveries qualify for one-day shipping and put more pressure on the network. For all the talk of Amazon becoming a stand-alone third carrier to FedEx and UPS, the “fact remains that Amazon is wholly reliant on a host of carriers,” predominantly UPS and USPS, said Rob Martinez, founder and co-CEO of consultancy Shipware, LLC. “Amazon’s continued double- digit growth means increased usage of UPS year-over-year.”

Still, Martinez thinks UPS needs Amazon more than the other way around. That’s because Amazon helps provide the density to offset UPS’s large fixed costs incurred by its U.S. network modernization, Martinez said. Meanwhile, Amazon is no longer the logistics newborn it was in 2014 when it began the journey, ironically after a disastrous 2013 peak season when UPS was the whipping boy for millions of late Amazon deliveries. With an expanding delivery operation and enormous volume clout, Amazon now holds most of the cards, Martinez said.

Unlike FedEx, which had long chafed under its dealings with Amazon and is now — if reports are to be believed — spearheading an anti-Amazon coalition of retailers, UPS has been all in with Amazon from day one, and still is. It is aware Amazon’s traffic comes with low yields given the company’s immense pricing power; fourth-quarter yields on UPS’ next-day air service fell 13% year-over-year largely due to the influx of Amazon parcels. Yet UPS’s enhanced network efficiencies will make the density work for it over time, the company believes.

Only time will tell if FedEx was prescient in bolting from Amazon, or if UPS will prevail by staying the course. “UPS made a sizable commitment at the beginning of the relationship, and now it has made a deal with the devil,” Lyle said. “It will be interesting in five years to see who made the correct decision.”