Why Shipping with Amazon Doesn’t Need to Make a Profit

And How Startups are Using Operations as a Product

By: Spencer Weiss (M&T ‘20)

Last week, Amazon made an announcement that many considered perplexing. Shipping with Amazon (SWA) is a new initiative to make deliveries from third-party businesses to customers, competing with UPS and FedEx, companies that handle last-mile delivery for the online goods giant. The counterintuitive aspect is that last-mile fulfillment is typically the least-profitable segment of delivery and that Amazon does not own the requisite resources to make such deliveries in-house. Amazon only began leasing planes to make a portion of its own deliveries last year — and still contracts last-mile fulfillment to FedEx and UPS.

In order to make sense of SWA, one needs to understand the thesis behind Amazon’s operations. The Seattle merchant takes on massive fixed costs in the short term to ensure healthy margins on each sale and quickly gains as much scale as possible from a combination of its own operations and selling excess capacity to third parties. The willingness to sell capacity to third parties enables Amazon’s large investments in infrastructure, since Amazon alone may not have a large enough demand to necessitate a large project, and also allows for a profit to be made off of things that Amazon would have to do anyway. This model is fairly unique to Amazon and is known as the productization of operations.

Serving the Web and Serving Food

The first and most notable of Amazon’s uses of this model is Amazon Web Services. As Amazon grew in the early 2000s, it began to upgrade its internal web hosting infrastructure in anticipation of higher traffic on the site. However, in order to justify the cost of its improvements, it released tools to allow others to rent web hosting from Amazon’s excess capacity. As those initial tools developed into what is now AWS, they became profitable in their own right and spawned a new business segment for Amazon. Subsequently, all of Amazon’s server investments allowed it to expand its web services business and to scale its own online shopping site simultaneously.

Another entry in this pattern is Amazon’s recent high-profile acquisition of Whole Foods. The deal was a manifestation of Amazon’s desire to build out its food delivery infrastructure despite its meager activity in the grocery market in the past. Ownership of an established grocery chain allows the online merchant to immediately put a vast network of food infrastructure to work and gain Whole Foods’ proprietary brands for sale online. This demonstrates the evolution of the productization model from a tool generating economies of scale for Amazon to a strategy for growth into new markets without incurring losses on fixed costs.

Amazon’s fulfillment network has grown rapidly, but has only just begun to incorporate last-mile shipping capacity

Shipping Products by Shipping Products

Despite an ostensibly poor market, Shipping with Amazon fits the Seattle firm’s strategy. In an ideal world, Amazon would like to make all of its deliveries in-house to avoid splitting its margin with UPS and FedEx. Out of the spotlight, this process has already begun with the development of a vast network of distribution and warehousing centers, leaving last-mile fulfillment as the last shipping frontier. This final step requires fleets of trucks and employees that would initially go to waste until Amazon’s shipping operations are scaled up. This necessitates SWA — by charging other companies to use its new last-mile distribution network, Amazon can fill up the trucks that would have to be on the road anyway and make additional revenue on each added item, even if SWA starts out small.

This is why many analysts have needlessly decried the project. When viewed in a vacuum, Shipping with Amazon is not the best business decision. It would not generate a profit on its own without massive scale and significant up-front investments by Amazon. However, SWA does not need to make a profit. It simply needs to reduce Amazon’s shipping costs relative to prices charged by UPS and FedEx, and any additional revenue generated from the project is icing on the cake.

Amazon’s delivery network, much of which has transitioned to internal resources

Productizing the Operations of Other Firms

Unlike Amazon, startups focus on promoting their core product long before productizing the operations of the company would be practical. However, there is much opportunity to engage in the converse of this model — developing a product to improve the internal operations of another firm. For instance, Twine, a Weiss Tech House Innovation Fund portfolio company, is building tools for internal mobility within organizations. Its product allows companies to reduce the costs of hiring and training external job candidates and to prevent talent leakage from a company by stimulating internal hiring.

At the Weiss Tech House Innovation Fund, we are excited about these trends in enterprise software and have been lucky enough to fund multiple companies that have taken advantage of this landscape. We hope that operations technology continues to improve the processes of existing firms and provides opportunities for startups. If you would like to chat about operations and enterprise or are a Penn founder starting a company in the space, please feel free to reach out to us!

Spencer is an Innovation Fund Project Manager and our team’s Director of Sourcing. He is in Penn’s M&T Program. Spencer has previously published pieces on corporate strategy and research on cancer immunotherapy through Georgetown University.

Weiss Tech House Innovation Fund is dedicated to funding, promoting, cultivating, and supporting student entrepreneurship in the UPenn community. Working on a startup? Interested in partnering? Want to get involved? Drop us a line at apply.innovationfund@gmail.com.