For the past few days, Supply Chain Matters has been focusing on various financial reporting results from select manufacturers to highlight significant supply chain implications.  We would be remiss if we did not comment on the reported financial results from one of the world’s most dominant online retailer and market disruptor, that being Amazon.

The diversified retailer reported it Q4-2012 and full year 2012 financial results this week.  For the crucial holiday focused fourth quarter, total worldwide revenues increased 22 percent, operating income increased 56 percent and gross margin increased over 3 basis points to 24.1 percent. Operating income, however, remains challenging at just 1.9 percent, rising slightly from 1.5 percent a year earlier. Increased profitability was attributed to improving business results in Amazon’s cloud computing and web services business. Sales increases were also reflected by increased participation of third-party merchants utilizing Amazon’s back-end fulfillment services.

Full year 2012 results featured a 27 percent increase in revenues to slightly over $61 billion. Consolidated operating income increased 6 percent to $1.6 billion.  North America revenues grew 30 percent while international grew 23 percent.

Supply Chain Matters will focus this commentary primarily on important signs stemming from Amazon’s physical fulfillment capabilities, which is a prime concern for some in our reading audience. Overall, the retailer’s operating expenses rose by 22 percent to almost $22 billion dollars, primarily from increases related to a 56 percent increase in technology investments and continued additions of physical distribution centers. A total of 20 fulfillment centers were added in 2012, with another 20 planned for 2013. The strategy unfolding is one of fulfillment located closer to major cities, to accommodate faster turnaround and same-day fulfillment capabilities while decreasing overall fulfillment shipping costs.

As we have noted in previous commentary, Amazon is deploying a strategy to tradeoff collection on individual U.S. state sales taxes, with leveraging state tax incentives to invest in fulfillment resources within that state.  While some may presume that Amazon’s long overdue payment of state sales taxes levels the retail competitive playing field, this retailer extracts further financial advantage. The online retailer has plans to have 20 million square feet of distribution and fulfillment capability by 2016, which is more than Wal-Mart. In the earnings briefing, Amazon’s CFO acknowledged that being closer to customers from a fulfillment standpoint helps to leverage distribution and transportation costs.

Much has been written and opined about Amazon and its threats to the traditional retail and online fulfillment model.  This author recently heard a superior presentation from Jim Tompkins, President and CEO of Tomkins International delivered at our local CSCMP Executive breakfast series. Jim’s charge to the audience is that every company and its associated supply chain arm needs to have a strategy regarding Amazon, and I totally concur with that statement. We may well view more corporate casualties in the coming months as a result of the “Amazon effect”.

Thus, it is rather important to dive into the Amazon numbers to determine important sign posts and trends regarding direction.  For instance, year over year inventory investment increased 21 percent while inventory turns decreased by a full turn to 9.3 turns. That reflects an increased burden of on-hand inventories most likely from taking on new fulfillment business models such as Amazon Supply in the industrial supplies sector.  Accounts payable, the determinant of how quickly Amazon pays its suppliers was 76 days, an increase of 2 days during the year.  Thus, being an Amazon  supplier comes with a financial working capital burden.

One of the wonders of the Internet is the ability to find important information.  Thus, we found a commentary featured on Seeking Alpha and penned by Timothy Phillips, Amazon Missed On All 5 Key Metrics, which uncovers some truly interesting metrics that should capture our community attention.  The premise of Phillips commentary is that while equity analysts may be pleased on the surface by Amazon’s latest performance, there are some “smoking guns” regarding five key metrics.

He analyzes the last eight quarters of E-Commerce revenues and concludes that while revenues have increased an average of 36 percent year-on-year, paid units shipped has averaged a 46 percent growth, equating to a 15 percent decline in average selling prices over the past two years. The implication is that fulfillment and shipping costs must improve by near 8 percent annually to have a positive impact on margins. We would add that ASP decline is a universal trend that concerns many supply chain executives. Also noted is that the trend of adding significant fixed costs with its continued deployment of fulfillment centers will have to be offset by other efficiency costs or increased revenues. Phillips argument is that any increase in fuel costs will add more direct margin pressure, and that the online retailer will have to find a way to garner increased shipping and fulfillment fees.

Finally, there is a conclusion that: “The law of large numbers is catching-up with Amazon in the North American E-Commerce market.” The argument is that growth in North America E-Commerce revenues have been on a steady two-year decline when compared with the aggregate market size potential.

Whether you agree or disagree with these and other conclusions, the important takeaways, in our view are the following:

  • By its corporate culture, Amazon is an industry disruptor, and always has more cards that haven’t been played or held beyond the public eye. A recent FORTUNE article describes the business strategy as “sell low- or no-profit devices to pump ever more volume onto its platform”.  Then again, the laws of the market, scale and sheer volume may be catching-up with the goliath, and thus Amazon may have to fine tune its business and stocking strategies. Inventory and fixed costs have risen and Wall Street will continue to demand higher expectations in revenue growth and margins.
  • What is playing out in same day or localized fulfillment capabilities needs to be carefully monitored, since it could disrupt the notions of today’s “last mile” delivery models.
  • If you are considering offering your products on Amazon’s platform, beware that Amazon will most likely seek an additional cut of revenues to justify its growing fixed cost fulfillment overhead.
  • If you are considering being a supplier to Amazon, be prepared to be abused in longer payments and vendor owned inventory practices.
  • If Amazon is a potential fulfillment threat, than your best strategy is to differentiate any way you can on better service for customers and suppliers.

Bob Ferrari