Following yesterday’s market close, Amazon announced that it reached agreement to acquire Federal Express for $56 billion. The move came as a surprise since Amazon had been investing heavily to build its own delivery system by creating regional sorting centers and partnering with the United States Postal Service to offer Sunday delivery. Industry analysts lauded the acquisition as a “brilliant strategic move” and consistent with Amazon’s history of placing big, bold bets. Amazon’s acquisition will undoubtedly put traditional brick and mortar retailers at an even greater disadvantage and is likely to accelerate the industry’s ongoing consolidation while also having implications for point of purchase displays, which is the world in which we play.
Before we take a closer look at what Amazon’s acquisition really means, it’s time to let you know that Amazon isn’t really acquiring FedEx. If you are like most people, you probably took the bait and believe what you just read. Why? Because Amazon is the quintessential disrupter, and acquiring FedEx would be super disruptive to the retail industry. So with our apologies for making your mind race, let’s dig in.
Amazon’s stock recently crossed the $800/share threshold, catapulting it into fourth position among the most valuable U.S. companies behind Apple, Google, and Microsoft. With a market cap of $382 billion Amazon would rank 45th on the World Bank’s list of Gross Domestic Product by country, ahead of countries like Norway and Ireland. Amazon has been public about its desire to find a 4th business to complement it 3 core businesses- Amazon Marketplace, Amazon Prime, and Amazon Web Services.
We could have tried to fool you with a headline like “Amazon Acquires Alibaba” or “Amazon Acquires Facebook” or even “Amazon Acquires Visa.” It’s easy to imagine what each of those acquisitions would do for Amazon. An Amazon-Alibaba combination would create a worldwide e-Commerce juggernaut. An Amazon-Facebook combination would enable Amazon to harness the purchasing power of 1.2 billion Facebook users while enabling it to build on Facebook’s dominant position in social media. Acquiring Visa would enable Amazon to become a major player in the global payments technology business, profit from Visa’s more than 100 billion financial transactions, and benefit from Visa’s 67% operating margin which dwarfs Amazon’s 3.2% operating margin. The problem with each of these potential acquisitions is that they are all too expensive. The market caps of Alibaba, Facebook, and Visa are $275B, $367B, and $195B, respectively. With such high flying market caps, an acquisition of any of these companies is unlikely.
So let’s get back to our rationale for the plausibility of Amazon acquiring FedEx. There are 4 reasons why a FedEx acquisition could make sense for Amazon:
1) Insurmountable Customer Service Advantage– Instead of searching for that illusive fourth business, Amazon could use a FedEx acquisition to create a “game over” position in its Amazon Marketplace and Amazon Prime businesses. For years, Amazon has been working to improve the delivery aspect of its business. Amazon understands the critical importance of logistics, distribution, and delivery in creating customer satisfaction. The company has been working on speeding up delivery and has been testing its own delivery service since 2014. Amazon’s shipping costs, which exceed $5B, have been increasing nearly 20% a year and also increasing as a percent of revenue. Despite building 15 sorting centers and partnering with the U.S. Postal Service to deliver packages to Prime members on Sundays, delivery-related problems continue to head the list of customer complaints.
Of the 500 million packages that Amazon delivered last year, the USPS delivered about 40%, while UPS delivered 20%-25% and FedEx delivered 15%-20%. Amazon’s rationale for partnering with the USPS is largely driven by economics: Amazon pays about $2 per package, which is about half of what they pay UPS and FedEx. However, there tends to be more problems with USPS deliveries, which has taken a toll on customer satisfaction. While the USPS has a well-developed infrastructure and delivery system, relying on the government for anything these days would seem to be a risky proposition. Amazon has also filed for permission to deliver via drones, but there are a lot of obstacles to be overcome, and it is difficult to see how a fleet of drones could make a meaningful dent any time soon in the half billion packages that Amazon delivers.
Just like in the cable business, the last mile is always the toughest and most expensive. With respect to customer satisfaction, the actual delivery has proven to be the Achilles Heal for Amazon. Acquiring FedEx might be the smartest thing Amazon can do to blow the competition away from a customer satisfaction standpoint. Amazon has the data, the infrastructure, and the customer relationships to make it work. FedEx has the “ground game,” systems, and logistics experience to deliver. In addition, FedEx has more than 1900 FedEx Office locations (formerly FedEx Kinko’s) that could immediately serve as the backbone for a network of customer pick-up locations.
2) Competition Killer– An acquisition of FedEx would create such a huge advantage for Amazon over its competitors that it is hard to imagine anyone ever catching up. Package delivery has been the one aspect of Amazon’s value chain that it has not controlled, and it is arguably the most difficult for every company competing in the e-Commerce space. Competitors can try to piece together a logistics and delivery system the way Amazon has to date, but without control, their results are likely to be no better than what Amazon has experienced. This is a classic case of when vertical integration makes sense. It is also likely to be the single most damaging thing Amazon can do to fight off Wal-Mart which recently acquired Jet.com.
3) Financial– If Amazon were to acquire FedEx for $56B, the acquisition would represent less than 15% of Amazon’s current market cap. While it is still a big acquisition, it is a small percentage of what Amazon would have to pay for Alibaba, Facebook, or Visa. So not only would it be an acquisition that Amazon could digest, but it would help to solve a critically important problem for the company.
While some analysts might argue that the package delivery business is an historically capital intensive and low profit business, for Amazon the acquisition would be accretive. FedEx would boost Amazon’s revenue of $121B by $53B. More importantly, FedEx has triple the operating margin of Amazon (9.5% compared to Amazon’s 3.2%) and would therefore likely raise Amazon’s average operating margin by over 50%. In addition, the acquisition would enable Amazon to nearly double its net income since Amazon’s net income is currently $1.9B compared to FedEx’s which is $1.8B.
It’s interesting to note that Amazon’s valuation is over 8 times greater than FedEx’s when the two companies are delivering nearly the same amount of profit to the bottom line. And it’s that point that leads us to the final financial argument for the acquisition: multiple expansion. Since the financial community rewards high tech growth companies at significantly higher multiples than companies receive in the transportation and logistics industry, the financial results that FedEx generates under the umbrella of Amazon would be rewarded at the higher multiples that Amazon enjoys, thereby creating additional value. There are a number of other financial justifications for an acquisition of FedEx, such as synergies between the two companies, but even just considering the arguments above it’s difficult to see how shareholders of both companies would not be enriched.
4) Strategic– There are lots of strategic reasons why acquiring FedEx would make sense for Amazon, some of which we have already touched on. So let’s just focus on the strategic value that Amazon could gain from FedEx’s data. Amazon already has a treasure trove of data from the billions of transactions it has executed. Amazon knows a lot about its customers, their purchasing patterns, and their buying behavior. One way in which Amazon uses this data is to find the best selling products, clone them under the AmazonBasics brand, and then sell them for a lower price. This practice is a little unsettling for Amazon sellers, but it hasn’t stopped Amazon from coming out with more than 3000 AmazonBasics products.
Now imagine adding the huge amount of consumer data that FedEx has to Amazon’s existing data base. FedEx has detailed customer information on both businesses and consumers that Amazon can leverage in its current business and the new business-to- consumer and business-to-business services it offers.
The main point of this blog is not to make the case for why Amazon should acquire FedEx, but rather to encourage retailers and brands to be thinking ahead about what types of disruption could impact the industry and how that disruption could forever change the competitive landscape and industry dynamics. Retailers need to be thinking about their uniqueness and what they have to offer that cannot be duplicated by an online experience. Point of purchase displays will have to evolve from good to great to capture shopper’s imagination at the point of sale, to drive impulse purchases, and to maximize destination sales. Amazon is here to stay and so is e-Commerce. Figuring out how to navigate the turbulent waters ahead will separate the winners from losers among retailers and brands.