The Wall Street Journal
By Greg Bensinger
Updated March 9, 2016 8:33 p.m. ET
Amazon.com Inc. is taking to the air with a fleet of planes, part of a broader effort to reduce its inflated shipping costs.
The Seattle retailer plans to shuttle merchandise around the U.S. using as many as 20 Boeing Co. 767 aircraft it will lease from Air Transport Services Group Inc. News of the deal sent the air-cargo transportation company’s shares soaring as much as 24% on Wednesday.
Amazon has taken steps to reduce its reliance on carriers such as United Parcel Service Inc. and FedEx Corp. by building out a ground network of couriers and new warehouses near or within urban centers for faster and cheaper delivery. The deal with ATSG would give Amazon control over roughly 15% of the packages it ships annually, according to Stephens Inc. analyst Jack Atkins.
“Amazon clearly wants to grow, and they need capacity to do so,” said Mr. Atkins. “UPS and FedEx are hesitant to build it out solely for one customer.” He said demonstrating an air-cargo effort would also give Amazon some additional negotiating leverage with its partners.
Amazon has been planning an in-house logistics network for years, but the project took on added urgency when some customers received gift orders late, after the Christmas holiday in 2013. Amazon blamed the carriers for the embarrassing episode and offered some customers refunds on shipping and $20 credits.
Executives at Amazon feel UPS’s traditional hub-and-spoke system is growing obsolete and is a particular liability during the crucial holiday selling season, according to people familiar with the matter. UPS said Amazon is “a good customer” and “we have a good relationship with them.”
Amazon’s effort is already visible. White delivery vans with Amazon’s familiar “a” logo are an increasingly common sight in larger U.S. cities, and customers say they are receiving more packages directly from uniformed Amazon deliverymen. The online retailer has added thousands of semitrailer trucks for delivery between warehouses and is experimenting with citizens making deliveries.
Over time, Amazon is likely to turn its delivery network into a business in its own right, charging other shippers to ferry packages and drop off merchandise. In China, for instance, it is seeking to serve as a middleman for shippers sending goods by boat to the U.S.
Baird Equity Research estimates the delivery and logistics market to be roughly $400 billion. Amazon counts shipping costs as one of its fastest-growing expenses, totaling 12.5% of sales in last year’s fourth quarter, up from 10.9% a year earlier. And the company paid $4.17 billion to service its shipping needs in the period, 37% higher than the year before.
Discussing the results in January, Amazon Chief Financial Officer Brian Olsavsky said Amazon had to take matters into its own hands when its partners, such as UPS, FedEx and the U.S. Postal Service, couldn’t handle it all. “Those carriers are just no longer able to handle all of our capacity that we need at peak,” the CFO said. “We have had to add some resources on our own.”
The lease deal with ATSG spans five to seven years, and the agreement to operate the aircraft is for five years. ATSG said on a call with investors it has been using five aircraft for a test with Amazon and will acquire eight more Boeing 767-300 passenger jets to convert to freighter use, and source seven from existing clients. The company said it would continue its existing relationship with DHL, another package delivery operator.
As part of an earlier trial with Amazon, ATSG ran a service seven days a week through its main hub at an airport in its hometown of Wilmington, Ohio. Flight tracking services showed aircraft traveling to and from airports near some of Amazon’s largest distribution centers.
An Amazon spokeswoman said the ATSG deal would help Amazon develop its Prime $99-per-year membership service, which analysts estimate has between 40 million and 60 million members world-wide.
Amazon declined to disclose terms of the deal or whether it has similar plans for overseas markets. Amazon’s push to resemble UPS has put some strain on the relationship between the two companies, people familiar with the matter have said.
Amazon doesn’t discuss its relationships with partners, while a UPS spokesman previously said “we will continue to work closely with Amazon and all our customers to help them solve their growth and customer service challenges. ”FedEx, for one, said it wasn’t surprised by the deal, adding that “Amazon continues to be a valuable FedEx customer.”
The head of France’s government-controlled parcel company La Poste told a local newspaper last month: “Amazon is our biggest customer. It is in the process of becoming our largest competitor.”
While the ATSG deal demonstrates Amazon’s ambitions, it would take years for the retailer to build a service to compete with the largest carriers. And it will continue to rely on others to get goods to far-off locales like rural Maine and Alaska.
The online retailer will secure warrants giving it almost 20% of ATSG’s equity and a board seat as part of the plan which follows a six-month pilot program. ATSG said the warrants were priced at $9.73 per share over a five-year period.
Shares of Air Transport Services rose nearly 17% to $13.73 in New York. The stock earlier hit an all-time high of $14.90. Amazon shares were roughly unchanged, while UPS and FedEx shares fell about 1%.
—Doug Cameron, Laura Stevens and Joshua Jamerson contributed to the article.
Original article can be found here: http://www.wsj.com