Trends in 3Pl / Customer Relationships Amazon Logistics

TRENDS IN 3PLAMAZON / CUSTOMER LOGISTICS Market Estimates, Benchmarking,RELATIONSHIPS and Predictions

NovemberJanuary 2019 2016

Phone: +1-800-525-3915 Website: www.3PLogistics.com Email: [email protected] ABOUT ARMSTRONG & ASSOCIATES, INC. Armstrong & Associates, Inc. (A&A) was established in 1980 to meet the needs of a newly deregulated domestic transportation market. Since then, through its leading Third-Party Logistics (3PL) market research and history of helping companies outsource logistics functions, A&A has become an internationally recognized key resource for 3PL market information and consulting.

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A&A’s market research complements its consulting activities by providing continually updated data for analysis. Based upon its unsurpassed knowledge of the 3PL market and the operations of leading 3PLs, A&A has provided strategic planning consulting services to over 30 3PLs, supported 20 closed investment transactions, and provided advice to numerous companies looking to benchmark existing 3PL operations or outsource logistics functions.

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Introduction 4 Market Overview 5 Parcel Market 6 Third-Party Logistics Market 7 Less-Than-Truckload Market 10 LTL Market Discussion and Growth 11 LTL and 3PLs 11 LTL and E-Commerce 11 International 12 E-Commerce Parcel and 3PL 13 E-Commerce Impact on Parcel Volumes 14 E-Commerce 3PL Market 16 Amazon Share of Market Summary 17 Benchmarking 18 Capital Expenditures 19 Warehousing and Fulfillment 21 Fulfillment and Sortation Space 22 Capital Expenditures 23 Facility Capabilities and Automation 25 Air 26 Fleet 26 Increasing Fleet Size 27 U.S. Hub Locations and Capacity 27 Capital Expenditures 28 E-Commerce and Air 29 Vehicles and Drivers 30 Third-Party Logistics Services and Assets 32 UPS 3PL Services 32 FedEx 3PL Services 32 Amazon as a 3PL 32 Predictions 34 Third-Party Logistics 35 Parcel & Ground Transportation 38 Warehousing & Facilities 41 Air & International 43 Technology 45 Challenges 46 ©2019 Armstrong & Associates 3 Introduction In becoming a global leader in e-commerce, Amazon has built significant logistics infrastructure and is competing with traditional logistics providers in warehousing and distribution.

This report details e-commerce logistics, its major competitors and Amazon’s impact on transportation and warehouse management. After establishing the current state of the markets in which Amazon plays, our analysis shifts to predict potential growth strategies which Amazon could pursue to leverage its logistics infrastructure and increase its footprint as a logistics provider.

©2019 Armstrong & Associates 5 Parcel Market We estimate the value of the U.S. parcel market at $95–$100 billion, with an estimated $11 billion for the remainder of North America. U.S. revenues grew at a rate of 8.3% in 2017, with a 5-year Compound Annual Growth Rate (CAGR) of 6.7%– 7.9%. All signs point toward promising growth (8–10%) in 2018 and 2019.

The market is dominated by UPS, FedEx, and the United States Postal Service (USPS). The remainder comprises national postal services (Canada Post and Correos de México), DHL, Amazon, and a number of small regional players.

North America's $111 Billion Parcel Market - By Share of Revenue

Other (DHL, Amazon, USPS Canada Post, Correos Mexico, 18% Regional) 11% FedEx 31% UPS 40%

Source: Company Reports, A&A Analysis

©2019 Armstrong & Associates 6 Third-Party Logistics Market UPS and FedEx’s models encompass more than parcel delivery. Both also operate as third-party logistics providers (3PLs). 3PL services include dedicated contract carriage, value-added warehousing and distribution, domestic transportation management, and international transportation management.

With $8.0 billion in global 2017 revenue, UPS Supply Chain Solutions (UPS SCS) is the ninth-largest 3PL in the world and the third-largest in the U.S.

FedEx (as FedEx Trade Networks/Supply Chain/SupplyChain Systems), with $3.0 billion in global 2017 revenue, is the thirtieth-largest 3PL in the world and the eleventh-largest in the U.S.

Together, UPS and FedEx represent 5% of the $220 billion North American 3PL market. Each company’s 3PL operations play a significant role in complementing and supporting the parcel business.

Top U.S. 3PLs by Gross Logistics Revenue (US$ Million)

$14,869 (Represents 39% of the U.S. 3PL Market) , $7,981 , C.H. Robinson $9,506 $5,541 $6,828 , , , $4,390 , $3,066 $6,921 XPO Logistics , , $2,934 UPS Supply Chain Solutions , $3,014 $3,396 Expeditors , $4,035 J.B. Hunt (JBI, DCS & ICS) , , Kuehne + Nagel (The Americas) Systems DHL Supply Chain North America Hub Group Burris Logistics Ryder Supply Chain Solutions FedEx TN/Supply Chain/SupplyChain Total Quality Logistics

Source: Company Reports, A&A Analysis

©2019 Armstrong & Associates 7 The 3PL market consists of four segments, with revenues and growth rates shown below. 2017 revenue growth was solid, leading us into a steadily growing market (estimated 4.7%–5.1% annual net revenue growth) for the next few years.

U.S. 3PL Market Growth by Segment

2017 Gross 2018E Gross 2017 Net % Change 2017 1995-2017 Net Revenue Revenue 3PL Segment Revenue vs. 2016 Net Revenue (Turnover) (Turnover) (US$ Billions) Revenue CAGR (US$ Billions) (US$ Billions) DTM 71.7 10.9 6.4% 11.1% 80.3 ITM 53.6 19.7 4.3% 11.3% 57.9 DCC 15.6 15.4 10.2% 7.0% 16.8 VAWD 40.1 31.1 2.5% 11.0% 41.3 Total* 181.0 77.1 5.0% 10.0% 196.3 *Total 2017 gross revenue (turnover) for the 3PL market in the U.S. is estimated at $184.3 billion. $3.3 billion is included for the contract logistics software segment. Total 2018 gross revenue (turnover) for the 3PL market in the U.S. is estimated at $199.7 billion. $3.4 billion is included for the contract logistics software segment.

U.S. 3PL Market Segment Net Revenues (1995–2018E) and CAGRs (1995–2017)

$35,000 1995–2017 CAGR: 11.0%

$30,000

$25,000 11.3% $20,000 7.0% $15,000

(US$ Millions) 11.1% $10,000

$5,000

Value-Added Warehousing & Distribution (VAWD) - Asset Based Dedicated Contract Carriage (DCC) - Asset Based International Transportation Management (ITM) - Non-Asset Based Domestic Transportation Management (DTM) - Non-Asset Based

©2019 Armstrong & Associates 8 UPS and FedEx play in most of these segments. UPS SCS is especially notable for its air freight forwarding managed volumes, while FedEx Trade Networks/Supply Chain/ SupplyChain Systems, with its 2015 acquisition of GENCO, is a leader in the value- added warehousing and distribution space. UPS Supply Chain Solutions and FedEx Trade Networks/Supply Chain/

SupplyChain Systems Comparison: Air and Ocean Freight Forwarding Volumes and Warehousing Space

Air Freight Forwarding Ocean Freight Forwarding Warehousing Space (Global) (Global) (North America)

Million Rank Metric Tons Rank Ocean TEUs Rank Square Feet

UPS Supply Chain Solutions 6 935,300 19 600,000 14 17.3

FedEx Trade Networks/Supply 276,400 10,000 35.4 Chain/SupplyChain Systems 23 50+ 7 Source: Company Reports, A&A Analysis

©2019 Armstrong & Associates 9 Less-Than-Truckload Market FedEx and UPS are also major less-than truckload (LTL) carriers. FedEx Freight is the largest LTL carrier in the U.S., with $6.3 billion in 2017 gross revenue, while UPS Freight is number five, with $2.6 billion in gross revenue.

Top 25 U.S. LTL Carriers by Gross Revenue (US$ , $6,341 Millions)(Represents 55% of the U.S. LTL Market) FedEx Freight , $3,304 , $3,033 , $1,116 , $1,379 , $556 XPO Logistics , $3,641 Old Dominion Freight Line , $402 , $447 YRC Freight , $281 , $208 , $571 UPS Freight , $2,596 , $754 Estes Express Lines , $2,476 , $263 , $229 ABF Freight System , $1,948 R+L Carriers , $1,580 Saia Motor Freight Line Holland , $1,132 Southeastern Freight Lines Averitt Express , $769 Central Transport Dayton Freight Lines Pitt Ohio Transportation Group AAA Cooper , $554 Roadrunner Transportation Reddaway , $412 New England Motor Freight A. Duie Pyle , $310 New Penn Motor Express Central Freight Lines Daylight Transport Oak Harbor Freight Lines Ward Trucking , $166

Source: Company Reports, A&A Analysis

Logistics costs for the U.S. LTL market were $62.4 billion in 2017. Together, UPS and FedEx account for $8.9 billion, or 14% of the LTL market.

Unlike the extremely fragmented full truckload (TL) market, the LTL market is concentrated. The top 25 firms account for about 55% of the market.

©2019 Armstrong & Associates 10 LTL Market Discussion and Growth Less-than-truckload shipments are usually 150-10,000 pounds, and consist of multiple shipments on a single truck. LTL operates within a static network of terminals (a hub and spoke model) and therefore allows for little flexibility; activities include pickup, origin terminal crossdocking, destination terminal crossdocking, line-haul, and, if a hub is utilized for an intermediate sort, break bulk sorting.

The American Trucking Associations (ATA) anticipates significant near-term revenue annual growth of 7.1% through 2021, and subsequently 5.8% per year through 2026.

Frequent pick-ups and delivery, smaller shipment handling overhead, dock labor costs, and a higher number of terminals and equipment result in high marginal costs compared with full truckload (TL). LTL and 3PLs About 25% of LTL is managed by 3PLs. Especially since 2009, freight brokers/ Domestic Transportation Managers (DTMs) have been expanding LTL volumes as they diversify offerings outside of traditional truckload brokerage.

With large seasonal peaks and cyclical capacity swings, UPS and FedEx benefit from integrating their LTL Freight and 3PL segments. Coyote Logistics, which was the fifth- largest DTM at the time of its acquisition in 2015, accesses UPS’s freight capacity on behalf of external customers, and secures excess capacity for UPS during peak periods. Coyote covers about $100 million in substitute line-haul for UPS. Coyote’s 2017 revenue was $2.4 billion. LTL and E-Commerce E-commerce has resulted in rising demand for LTL. E-commerce is characterized by smaller shipments with shorter lengths of haul. Speed is a factor too, as retailers may now be willing to ship smaller quantities in favor of speed.

A confluence of factors—pent-up demand, the rise of e-commerce, and tightening freight capacity—has also resulted in increasing rates. Spot rates have hit record highs in recent months, and industry experts expect this trend to continue through the year, and may even signal the foundation of a “new normal” in rates.

©2019 Armstrong & Associates 11 International Although the focus of this report is Amazon’s logistics potential in North America, the international businesses of UPS and FedEx act as a funnel into their respective U.S. domestic networks. This is an important element to consider when discussing North American growth.

Though DHL tends to be the leading provider outside the U.S., UPS and FedEx generate significant international revenues. UPS and FedEx handle door-to-door cross-border e-commerce delivery, across a suite of modes and services.

At UPS, about 21% of revenue is International. About half derives from Europe. UPS is also strong in Canada, Asia-Pacific (notably China), Latin America, and has placed emphasis on expansion in developing economies for a number of years.

At FedEx, 33% of revenue is International. The $4.9 billion acquisition of TNT Express strengthened its position in Western Europe, and, to a lesser extent, Africa and the Middle East. It also has a decent presence in Asia.

Cross-border e-commerce represents about 20% of all e-commerce, and its growth rate is double that of domestic e-commerce.

International Package operating margins, though falling, have exceeded 18% in the past three years, while domestic package hovers between 12%–14%.

UPS Adjusted Operating Margin, by Business Segment 25%

International Package 20%

15%

10% U.S. Domestic Package

5% Non-Package

Source: Company Reports,0% A&A Analysis 2009 2010 2011 2012 2013 2014 2015 2016 2017

©2019 Armstrong & Associates 12 E-Commerce Parcel and 3PL E-commerce retail now represents 9.8% of retail in the United States. The segment has grown at a 14.9% CAGR over the last five years, with little sign of slowing. We expect a 14.4% CAGR through 2022.

E-Commerce as a percent of the parcel market is about 30%. The remainder is buesiness-to-business (B2B) (about 50%), and non-e-commerce business-to-consumer (B2C) makes up the remaining 15%.

E-Commerce as a Percent of the North America Parcel Market

30%

E-Commerce Parcel Market - Share of Revenue and Volume

3% 3%

Revenue Share 48% 34% 12%

3% 4%

Volume Share 40% 25% 28%

UPS FedEx USPS Other Amazon Own Source: Company Reports, A&A Analysis

©2019 Armstrong & Associates 13 While UPS and FedEx comprise 65% of e-commerce parcel volume, together they account for 82% of revenue, due to an average revenue per piece more than twice as high as the USPS. E-Commerce Impact on Parcel Volumes UPS offers the most data-rich illustration of the effect of e-commerce on the business. UPS does not disclose e-commerce volumes, but it does provide ample information on B2C volumes.

UPS U.S. Domestic Package Annual Package Volume, Thousands

4,500,000

4,000,000

3,500,000

3,000,000

2,500,000

2,000,000

1,500,000

1,000,000

500,000

Source: Company Reports, A&A Analysis E-commerce has been a massive growth driver for parcel volumes. The most profound growth has occurred in the last 5–6 years. In fact, the majority of package volume growth during this time can be attributed to e-commerce. At UPS, B2C (which includes both e-commerce and non-e-commerce) as a percent of U.S. Domestic Package Volume increased from 40% in 2011, 45% in 2015, to 50% in 2017. B2C volume growth exceeded 8% in four of the last five years, with a 5-year CAGR of 9.9%. That’s compared with a total U.S. Domestic Package volume increase of 5.1%.

Meanwhile, B2B volumes have remained relatively flat, with growth rates of 0–3%. And in 2017, B2B volumes actually fell slightly. The steady growth of the segment seen prior to the 2008/2009 recession never recovered its pre-recession momentum.

E-commerce volumes have helped propel significant revenue growth in the U.S. Domestic Package segment.

$40,000

$35,000 U.S. Domestic Package $30,000

$25,000

$20,000 International Package $15,000

$10,000

$5,000 Non-Package

$0 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Company Reports, A&A Analysis Profitability, however, has been a challenge—note the stagnant and then falling U.S. Domestic Package operating margin in the last few years.

UPS Adjusted Operating Margin, by Business Segment 25%

International Package 20%

15%

10% U.S. Domestic Package

5% Non-Package

0% 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Company Reports, A&A Analysis

E-Commerce as a Percent of the U.S. 3PL Market

Source: Company Reports, A&A Analysis

Amazon is a significant customer of both UPS and FedEx. We estimate Amazon (and Fulfillment by Amazon) accounts for 6.5% of total UPS revenue and 4.7% of FedEx revenue.

Non-FBA Marketplace All Other Parcel Carrier Amazon + FBA Through Revenue Amazon UPS $ 4.3 $ 1.4 $ 9.8 FedEx $ 3.1 $ 1.0 $ 7.0 USPS $ 1.1 $ 0.4 $ 2.5 Other $ 0.2 $ 0.1 $ - Amazon Own $ 0.8 $ 0.3 $ - Total $ 9.4 $ 3.1 $ 19.2 Source: Company Reports, A&A Analysis

©2019 Armstrong & Associates 18 Capital Expenditures Comparison UPS, which has tended to devote about 4–7% of revenue to capital expenditures (between $2 and $3 billion), recently ramped up spending on network enhancements, technology investments, and sortation capabilities. The increase in B2C shipments has driven UPS to increase its volume capacities and lower costs through technological efficiencies. In 2017, capital expenditures reached 7.9% of revenue, with about half devoted to buildings and facilities.

UPS Capital Expenditures by Type (US$ Millions) $6,000 8%

7% $5,000 6% $4,000 5%

$3,000 4%

3% $2,000 2% $1,000 1%

$0 0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Buildings and Facilities Aircraft and Parts Vehicles Information Technology Capital Expenditures as a % of Revenue Source: Company Reports, A&A Analysis

FedEx has consistently devoted a greater percent of revenue to capital expenditures (8–10%), with a large portion spent on aircraft and related equipment. The company is reinvesting $2.5 billion in gains from new tax policies in its Memphis and Indianapolis air hubs, including sort systems, automation, space, and equipment.

FedEx Capital Expenditures by Type (US$ Millions) $6,000 12%

$5,000 10%

$4,000 8%

$3,000 6%

$2,000 4%

$1,000 2%

$0 0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Facilities and Other Package Handling and Ground Support Equipment Aircraft and Related Equipment Vehicles Information Technology Capital Expenditures as a % of Revenue Source: Company Reports, A&A Analysis

Amazon only ramped up its capital expenditures in the last five years or so. Most expenditures fall into two major categories—Technology Infrastructure and Fulfillment. We estimate the company spent $4.5 billion on capital expenditures related to fulfillment in 2017. Much of the Technology Infrastructure is devoted to AWS, and therefore not immediately applicable to Amazon’s logistics functions.

©2019 Armstrong & Associates 20 Warehousing and Fulfillment Comparison E-commerce facilities generally fall into three categories: fulfillment centers, sortation centers, and parcel fulfillment centers.

Fulfillment centers (FCs) store a wide variety of stock keeping units (SKUs). Key activities include break bulk, pick-and-pack order fulfillment, and returns management. FCs are usually larger than 500,000 square feet. The FCs of major e-commerce retailers often exceed 1 million square feet. Average clear heights range from 36–40 feet, with three or four mezzanine levels, and nine-foot pick module racking systems. They tend to be located on relatively low-cost real estate, near transportation and parcel hubs (so orders can be passed off once assembled at the fulfillment center), and along major highway routes.

Sortation is handled at sortation centers and parcel hubs, and cross-docking is a key activity. Some fulfillment may occur from a sortation center location, and therefore storage can include high-velocity SKUs. Sortation centers average between 100,000– 500,000 square feet with average clear heights of 24–36 feet. Again, sortation centers are located on relatively low-cost real estate. Amazon’s are mostly located near its fulfillment centers. Placement within a regional/hub-and-spoke distribution network factors into location selection.

Parcel fulfillment centers handle sortation for last-mile delivery, with cross-docking for delivery vans. Parcel fulfillment centers are smaller, usually 100,000 square feet or less, with low clear heights and many cross-docking doors. Parcel fulfillment centers are located within or on the periphery of metro areas.

Other types of specialized facilities include food-grade and cold-storage facilities (for fulfillment of food and grocery e-commerce orders), fulfillment centers for oversize items (to accommodate categories that are becoming increasingly common in e-commerce, such as furniture and appliances), returns centers, merchandise-specific warehouses (where SKUs are limited by type, such as books or apparel), and highly automated FCs (or infill facilities) to fulfill quick-turnaround delivery, such as Amazon’s Prime Now FCs for one- to two-hour delivery.

Finally, omnichannel retailers can co-locate e-commerce fulfillment centers at already existing facilities.

UPS U.S. Package and FedEx Amazon Facility Space Ground Facility Space by Type (Million Square Feet) (Million Square Feet) 140 140

120 120

100 100

80 80

60 60

40 40

20 20

0 0 UPS FedEx Fulfillment Outbound Delivery Other Centers, Sortation Stations Supplemental Centers Future Centers, and Return Centers Other Operating Facilities

Principal/Hub Operating Facilities Active Sq Ft Future Sq Ft

Sources: Company Reports, A&A Analysis

UPS owns and leases more than 1,000 package operating facilities. We estimate its 33 principal facilities comprise about 17.9 million square feet. The largest, in Chicago, accounts for 1.9 million square feet, and streamlines East/West Coast packages. The remainder comprise about 51.1 million square feet, for total U.S. Domestic Package facilities of 68 million square feet. The company also has 5 million square feet in progress/planned across 7 facilities. UPS runs a single network. All air, ground, domestic, international, commercial, and residential packages move through this integrated pickup and delivery network. Benefits include operational and capital efficiencies.

FedEx Ground, meanwhile, has 601 total facilities, 37 of which are hubs. 373 of these facilities are co-located with FedEx Home Delivery (B2C) operations, with an additional 38 FedEx Home Delivery locations. FedEx Ground hubs account for 17 million square feet. We estimate FedEx Ground’s facilities total 46.8 million square feet. FedEx’s Express facility space is discussed in the Aircraft section. FedEx Ground and Express segments operate as two separate networks. FedEx explains the benefit as the ability to “fine-tune” individual networks.

©2019 Armstrong & Associates 22 Amazon’s 124 facilities in the U.S. comprise 124.7 million square feet, with another 41.1 million planned or in progress. Its network is dominated by Fulfillment Centers. Its outbound sortation centers most closely resemble a UPS or FedEx sortation facility. Amazon’s 38 sortation centers comprise 11.3 square feet, far short of UPS and FedEx’s space. Though these facilities can be used to bypass UPS and FedEx and feed directly to the USPS our couriers, this is the equivalent of Amazon insourcing its sortation. The function is not (like UPS and FedEx’s facilities) to handle packages originating externally.

74 delivery stations totaling 6.2 million square feet handle sortation for urban last- mile delivery. They’re often located near airports, and between 60,000 and 100,000 square feet. As an example of how Amazon’s facilities work together: A package moving all the way through Amazon’s network will move from an inbound cross dock to a fulfillment center, on to a sort center, and then to a delivery station, USPS, courier, or Amazon Flex driver. Amazon’s sortation network allows improved speed, reduced costs (in comparison to using UPS/FedEx), and greater control of outbound shipments.

Capital Expenditures

Selected Capital Expenditures by Company (US$ Millions) $3,500

$3,000

$2,500

$2,000

$1,500

$1,000

$500

$0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

UPS - Buildings and Facilities FedEx - Facilities and Other FedEx - Package Handling and Ground Support Equipment Source: Company Reports, A&A Analysis

Increased volumes and the need to contain costs compelled both UPS and FedEx to increase capital expenditure in recent years. In particular, peak volumes have spurred UPS to invest in its network because the challenge of sourcing (and paying for) unexpectedly high seasonal capacity has proven a significant hit to profitability.

15% 15%

FedEx Express 10% U.S. Domestic Package 10%

5% Non-Package 5% FedEx Freight

0% 0% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

-5% -5%

Source: Company Reports, A&A Analysis

At UPS, capital expenditures have increased dramatically. Expenditures increased to $5.2 billion in 2017, up from $3 billion in 2016 and $2.4 billion in 2015. Investment in 2018 is expected to be even higher, at $6.5–$7.0 billion. UPS is investing in network optimization and automation. The company is also making investments in its top 30 processing hubs, including facility automation, package scanning and sortation technology, increasing capacity at certain hubs, improving software to manage new technologies, and the addition of new facilities. UPS also continues to establish facilities close to package recipients in order to fulfill deliveries faster, and has recently opened, expanded, or begun work on facilities in major metro areas.

FedEx’s Ground package volume—which includes e-commerce fulfillment—increased 9% in its 2016 fiscal year. As a result, FedEx has invested in sortation systems and adjusted its network to handle larger packages. FedEx Ground capital expenditures increased 28% from 2015 to 2016, to nearly $1.6 billion, with a similar level of investment in 2017. Sort facility expansion has been a major funnel for capital expenditure in the last three years. The company plans to double sortation capacity between 2016 and 2022, staying ahead of the expected need for capacity and using it as a differentiator. In fiscal year 2017, FedEx added 10 million square feet of facility space, including four major distribution hubs and 19 fully automated stations (bringing the automated facility total to more than 100). Sortation facility improvements are geared to accommodate a high throughput, to minimize handling, and allow more direct loading. Operation of the automated facilities requires about 30% fewer employees. Additional network expansion projects are planned for 2018.

©2019 Armstrong & Associates 24 Facility Capabilities and Automation On average, FedEx Ground facilities are newer than UPS’s, due to the company’s early history providing air/express services (and thus building out facilities later than UPS). More than 130 FedEx Ground facilities, including all of its hubs, are automated, with capabilities to flex to accommodate peak volumes, handle network disruptions, reroute packages in transit, and sort packages at any hub.

Today, about half of UPS packages pass through “more-automated” facilities. The company plans to have all eligible packages moving through automated facilities by 2022. Between 2018 and 2020, the company plans to increase sortation capacity in the range of 350,000–400,000 pieces per hour. Seven new “super hub” automated sortation facilities, to be opened by 2022, will have 30%–35% higher efficiency than their “less-automated” comparable counterparts. Facilities will also have room for future innovation such as robotics or advance irregular processing systems. There are some benefits to UPS’s choice to invest in automation now, including more compact technologies and lower costs. However, UPS will also face challenges. Upgrades will eat up capital for the next few years, with $20 billion capital expenditures expected over the next three years. Much of UPS’s labor force—260,000 UPS drivers—are represented by the International Brotherhood of Teamsters, which has a disinclination toward automated technologies that may decrease jobs.

Amazon’s facilities, built/equipped within the last 20 years, are highly automated too. The company’s 2012 acquisition of robotics firm Kiva for warehousing robotics is one example of Amazon’s tech-forward strategy.

Fleet Size by Company

581 670 40 800

700 87 50 600 12

500

400 340

300 620 10

200 40 100 241

0 UPS FedEx Amazon On Order Short-term Leased/Chartered Owned/Capital Leases Source: Company Reports, A&A Analysis

UPS has been building its air fleet since 1981, and now owns or has capital leases on 241 aircraft. Another 340 are short-term leased or chartered, mostly to handle peak volumes in November and December. UPS has 581 aircraft in use.

FedEx began air operations in 1973. It owns 620 aircraft, and leases 50, for a total of 670 currently in use. Its 285-strong feeder fleet operates in the 45 countries not served by direct FedEx Express air service. Most planes are owned by FedEx but leased and operated to third-party air carriers. Aircraft support global operations.

Today, Amazon’s Amazon Air (previously known as Amazon Prime Air) cargo airline has a fleet of 40 Boeing 767 planes, operated by Air Transport Services Group and Atlas Air. Ten remaining aircraft on order will bring fleet size to 50 by the end of 2020. Several of the planes are passenger jets converted to freighters, and future aircraft are also likely to be converted passenger planes. Amazon doesn’t run any international flights, but it’s likely the company will in the future.

©2019 Armstrong & Associates 26 Increasing Fleet Size New Boeing freighter aircraft list prices range from about $200 million to $400 million (UPS’s latest order is for 14 747s, each at $403.6 million list price). However, with discounts based on market demand, quantity purchased, and contract negotiations, UPS is probably paying half that. Most purchases are purchased through an operating lease, in which payments are made against a loan to assume ownership over time.

A 20-year-old converted freighter costs about 25%–30% the price of a same-size new freighter.

Leasing a converted freighter jet costs about $325,000 per month, while a new Boeing 767F jet is $600,000–$650,000 per month. U.S. Hub Locations and Capacity

Sort Air/Express Sort Air/Express Hub Facility Space Capacity (Million Square Feet) (Packages per Hour) 12 1,200,000

10 1,000,000

8 800,000

6 600,000

4 400,000

2 200,000

0 0 UPS FedEx Amazon UPS FedEx Amazon (Estimated) Regional/Metropolitan Locations Regional/Metropolitan Locations Primary/National Location Primary/National Location Source: Company Reports, A&A Analysis

UPS’s major U.S. hub, Worldport, is located in Louisville, Kentucky. With 5.2 million square feet of sortation space, the hub can handle 416,000 packages per hour. The hub processes more than two million packages per day, and up to four million during peak periods.

FedEx Express’s nine major sortation centers represent 10.2 million square feet of

Amazon is investing $1.5 billion in its Cincinnati/Northern Kentucky Hub. The two- phase project (operational by 2020 and complete by 2025–2027) will represent a hub with space/daily flights/sortation capabilities about 60%–70% of UPS’s Worldport facility, and 35%–40% of UPS’s total U.S. The hub will be able to accommodate at least 100 aircraft supporting up to 200 daily flights, with planned construction of sortation facilities totaling 3–3.5 million square feet. Twenty of Amazon’s aircraft are currently based at this hub, while the remainder run domestic point-to-point routes through 16 airports. Capital Expenditures

Selected Capital Expenditures by Company (US$ Millions) $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

UPS - Aircraft and Parts FedEx - Aircraft and Related Equipment UPS - Buildings and Facilities FedEx - Facilities and Other FedEx - Package Handling and Ground Support Equipment Source: Company Reports, A&A Analysis

At UPS, a four-year, $1 billion project beginning in 2006 increased Worldport capacity from 4.1 to 5.2 million square feet and 300,000 to 416,000 packages per hour in 2006. Previously, a $1 billion expansion that began in 1999 doubled the size of the hub from about 2 million square feet to 4.1 million, and increased sort capacity from 215,000 packages per hour to 304,000.

FedEx is investing $2.5 billion through 2025 in its two largest hubs. The company credits the investment to gains from the U.S. Tax Cuts and Jobs Act. $1 billion is dedicated to its World Super Hub, and $1.5 billion to its Indianapolis, IN, hub.

©2019 Armstrong & Associates 28 E-Commerce and Air Air freight is an attractive option for B2C e-commerce, with definite delivery dates, speed, and visibility. Air freight also moves at the speed of e-commerce; about 87% of international B2C e-commerce parcels travel by air, and in 2016 B2C e-commerce represented 83% of scheduled international mail tonne kilometers, a drastic increase over 16% in 2010.

In 2016, air freight demand grew 3.6%, year-over-year, almost twice the average five-year growth rate of 2.0%, and was followed by impressive 9.0% growth in 2017. Meanwhile, demand outpaced capacity growth in 2017, which increased at a rate of 3.0%, year-over-year.

E-commerce-driven trends include a shift from pallet to parcel, diffuse demand requiring additional origin/destination pairs, and speed to market and shorter cycle times result in shift from ocean to air. International manufacturers increasingly ship direct to consumer or to e-commerce fulfillment networks.

Demand for new/converted air freighters will continue to grow. Capacity is currently tight due to both cyclical and structural growth. Both new and converted aircraft supply is currently limited. If Amazon orders new aircraft, delivery would likely take 3–4 years. Converted planes could be put into service in less than a year. Amazon will almost certainly continue to have aircraft operated for the company in the near term.

Vehicles by Type 120,000

100,000

80,000

60,000

40,000

20,000

0 UPS FedEx Amazon

Tractors Trailers Pickups, Vans, and Straight Trucks Source: Company Reports, A&A Analysis

UPS owns nearly all of its vehicle fleet. The company also accesses its own network of 50,000 carriers (through its DTM, Coyote) for additional TL/LTL capacity. Drivers (along with other UPS employees) are represented by the International Brotherhood of Teamsters.

FedEx Ground, on the other hand, uses an independent service provider model. Owner-operators conduct linehaul and pickup-and-delivery operations. FedEx Express and Freight drivers are predominantly company employees.

UPS spent $34.6 billion on salaries, compensation, and employee benefits in 2017, compared to $23.2 billion at FedEx. As a percent of total operating expenses, UPS devotes 59% to salaries, compensation, and benefits, while at FedEx it’s a much lower 38%. FedEx has faced numerous and long-running lawsuits regarding the employee/contractor status of its owner operators. Last year, it paid $228 million in a settlement on a case dating back to 2003.

90%

80% Other

70% Depreciation and Amortization 60% Repairs and Maintenance 50% Fuel 40% Purchased 30% Transportation

Salaries, 20% Compensation, Employee Benefits 10%

0% UPS FedEx Source: Company Reports, A&A Analysis

Amazon has a fleet of 4,000 trailers (some reports indicate up to 7,500 trailers) for transport between warehouses and fulfillment centers. The company does not own tractors. Most transportation is handled through TL and LTL carrier partners, via 3PL partner capacity, parcel carriers, partnerships with last-mile delivery providers, or independent contractors using their own vehicles for last-mile delivery.

An initiative announced this past summer shows Amazon is taking more control of its last-mile delivery. By the end of 2019, Amazon expects to have a fleet of 20,000 vans, owned by fleet-management companies, that will then lease the vans to small delivery-service providers. The typical company will employ 100 drivers and lease 20–40 branded vehicles. This is similar to FedEx’s model and may attract some FedEx service providers to switch to Amazon. At the same time, this could prove a stronger case for independent service providers as contractors, which would be mutually beneficial for FedEx and Amazon to control labor costs.

©2019 Armstrong & Associates 31 Third-Party Logistics Services and Assets UPS 3PL Services (UPS Supply Chain Solutions) UPS Supply Chain Solutions (UPS SCS) services are highly integrated between value-added and package delivery services. UPS SCS cross-sells small package services and freight transportation to provide a full service suite. The 3PL operation contributes more than $3 billion in package business to the rest of the organization. UPS SCS has aligned supply chain operations around specific (and often high- margin) industry verticals: high-tech, healthcare, and retail/consumer goods. In particular, UPS SCS has accelerated quickly in the healthcare/medical space—a challenging yet profitable business. The company focuses on specialized but configurable services (standardized and repeatable services, with standardized IT and processes plus a common network of assets). In 2015, UPS made a major move into the U.S. Domestic Transportation Management/freight brokerage space with the $1.8 billion acquisition of Coyote Logistics. The company also performs air and ocean freight forwarding. Speciality services include spare parts logistics, technical repair and configurations, supply chain design and planning, and returns management.

UPS SCS has more than 500 facilities around the world with 34 million square feet of space. Owned and leased assets utilized by the segment include 1,327 tractors; 55 trucks; 4,618 trailers; and 237 aircraft. FedEx 3PL Services (FedEx Trade Networks/Supply Chain/ SupplyChain Systems) Likewise, FedEx’s DTM, value-added warehousing and distribution and ITM are services supporting FedEx Express package and LTL transportation. FedEx competes strongly in the value-added warehousing and distribution business, thanks to its 2015 $1.4 billion purchase of GENCO (rebranded as FedEx Supply Chain). GENCO also has notable strength as a reverse logistics 3PL. The 2016 acquisition of TNT significantly expands its 3PL business in Europe.

FedEx Trade Networks/Supply Chain/SupplyChain Systems has 170 facilities globally with 40 million square feet of space. Owned and leased assets utilized by the segment include 298 tractors and 1,094 trailers. Amazon as a 3PL Amazon is acting increasingly like a 3PL. We estimate Amazon is acting like a 3PL for 12% of all B2C e-commerce shipments. Third-party sellers on Amazon’s marketplace now represent more than half of all units sold through Amazon, and about half of

©2019 Armstrong & Associates 32 those sellers use the company’s “Fulfillment by Amazon” program. Retailers send inventory straight to a warehouse, where Amazon then manages inventory and arranges transportation to a customer’s doorstep. In return, Amazon charges a commission (about 15% of the sales price of each item), per-unit fulfillment fees, and monthly inventory storage fees.

As cross-border becomes increasingly important (a quarter of all third-party sales are cross-border, and international FBA sales saw 80% year-over-year growth in 2016), Amazon also offers some international transportation management services.

For the first time, Amazon will take on management activities in non-Amazon warehouses. As part of a new service called “FBA Onsite,” Amazon, which is a licensed freight broker, will manage transportation of products from the warehouses of third-party sellers to consumers.

• Amazon’s reached a tipping point: in 2017, the company announced that more units were sold by third-party sellers than by Amazon itself.

• Now that marketplace sales actually exceed Amazon’s own, the company has its sights set on improving third-party seller fulfillment. After all, consumers tend to think of anything purchased on Amazon as being “from Amazon,” not a third-party seller. Amazon has a coveted brand to protect. For Amazon, logistics is inseparable from brand.

• Amazon can pass efficiencies on to its third-party sellers, which, in turn, improves the customer experience and decreases prices. Amazon tends to pursue logistics activities where it believes it can drive efficiencies the market isn’t offering. Amazon’s been able to invest heavily in automated warehouses, prime (of both the lowercase and uppercase variety) fulfillment center locations, negotiated shipping rates, and warehouse/transportation/inventory management technology, to name a few.

• We expect third-party sales on Amazon’s marketplace to accelerate. Some will be partnerships with big brands/manufacturers. Already, brands like Nike and Sears have agreements with Amazon. As others founder, like J. Crew, they’re looking for new revenue sources. Scenario - On Track: Amazon Performs Some 3PL Services • Amazon will continue to expand Fulfillment by Amazon (FBA), which is used for the fulfillment of more than half of third-party seller units today. Its warehousing and transportation management services will allow Amazon to control the customer experience and make more deliveries “Amazon-quality.” The convenience of this service will continue to entice more third-party sellers. To manage costs and optimize efficiency, we also expect to see Amazon place more onus on shippers, as it has done in the past, with tighter inventory control and variable fees tied to peak period demand.

• Amazon will continue to tie Prime shipping to retail search results. Two- day shipping helps bump product listings to the top of a shopper’s search results. Although seller-fulfilled Prime is an option for shippers, this will continue to shift

• Amazon will continue to raise the bar for fulfillment speed. This is obviously a competitive advantage against other retailers—two days is better than five—but it is also a way to attract more of its own sellers to FBA. If sellers can’t find a way (or a 3PL) to offer two-day (or less) shipping, then FBA becomes an increasingly attractive option. Essentially, this makes it more challenging for shippers to operate without 3PLs in general, and Amazon in particular.

• Amazon will take advantage of current market conditions—which are only going to get more challenging for shippers—to attract shippers to FBA. E-commerce is starting to add up, with trucking, air, and rail rates increasing, while the labor market is tight and warehousing capacity remains limited. As shipper costs creep up, Amazon can afford to offer competitive rates on FBA. Scenario - More Aggressive: Amazon Gains Strength as a 3PL for E-Commerce Retail • Amazon will focus on 3PL services for its own third-party seller base, with Amazon Onsite. For the first time, Amazon will take on management activities in non-Amazon warehouses. Amazon, which is a licensed freight broker, will manage transportation of products from the warehouses of third-party sellers to consumers. Third-party sellers will assign Amazon-specific inventory within their warehouses, and manage that inventory through Amazon’s warehouse management system (WMS), which will be installed on the seller’s servers. The service was piloted on the West Coast with reports of nationwide rollout this year.

• Amazon will invest in shipping to gain share, and allow shippers to pass lower prices on to customers, by offering shippers competitive rates. Amazon has long been willing to invest on prices and service (via shipping). In the early days, Amazon actually turned a profit on shipping: it maxed out at $18.2 million in 1998. But by 2000, even while chastened by the bursting internet bubble, the company decided to invest in shipping, and Amazon took a $1 million loss on shipping that year. The next year, it added a “customer experience pillar” – “relentlessly lowering prices.” Amazon has directly stated the intention to offer competitive shipping offers: “We believe that offering low prices to our customers is fundamental to our future success, and one way we offer lower prices is through shipping offers.” For example, one estimate puts FBA Onsite rates “as much as 70% less than merchants would pay themselves.”

• Brand partnerships will have both a retail/marketplace component and an Amazon logistics component. Amazon could favor brands that partner with

• Amazon will pursue Shipping With Amazon, a service reported to be extended to non-Amazon sellers. In this scenario, Amazon will seek to become a leader in 3PL for e-commerce retail. Scenario - Most Aggressive: Amazon Expands Past E-commerce Logistics to Become a 3PL Serving Multiple Industries • If Amazon wishes to extend 3PL services to more industries than e-commerce, it’s likely it would need to pair the “more aggressive” scenario detailed above with a 3PL acquisition. Talks with XPO have been rumored, and the pairing could be a good one: XPO is already strong in e-commerce, retail, and big-box last mile, all of which fit with Amazon’s strategy, and the company’s numerous acquisitions have resulted in rapid growth and a wide range of services in the U.S. and Europe, which could pair well with Amazon’s cross-border European FBA network. Its domestic transportation management business would be a match-up similar to that of UPS/Coyote and provide Amazon with a way to harness capacity during peak periods. DSV, Kerry Logistics, and possibly CEVA are other possibilities.

• Volumes are rising (for Amazon and across the board for e-commerce), so Amazon must secure capacity.

• Macro trends, such as a low unemployment rate and an intensifying driver shortage, are causing trucking and parcel rates to rise. Amazon must control costs.

• There’s a lot of uncertainty, which could prompt Amazon to decrease its reliance on factors it can’t control. The President has tweeted vague yet menacing messages about both Amazon and the USPS, which hint that trouble looms for Amazon’s use of USPS as “their Delivery Boy.” With an estimated $1.1 billion of business with the USPS each year, it behooves Amazon to have an action plan in place due to policy uncertainty.

• Similarly, Amazon may want to decrease its reliance on UPS and FedEx. While the companies from all accounts have positive relationships, Amazon may want to avoid being harnessed to prices in an oligopolistic market as its logistics functions become increasingly important to its core business strategy. Scenario - On Track: Amazon Launches Amazon Delivery Service Partner Program • Amazon’s Delivery Service Partner program is well underway. By the end of 2019, Amazon expects to have a fleet of 20,000 vans, owned by fleet- management companies, that will then lease the vans to small delivery-service providers. The typical company will employ 100 drivers and lease 20–40 branded vehicles. Early interest indicates higher demand (amongst service partners) than anticipated. Amazon initially planned to order 4,500 vans when the program was announced in June, but expanded that to 20,000. Amazon will be able to keep costs down in this non-asset, non-employee model. This is similar to FedEx’s model and may attract some FedEx service providers to switch to Amazon. At the same time, this could prove a stronger case for independent service providers as contractors, which would be mutually beneficial for FedEx’s and Amazon’s longterm control of labor costs. We believe Amazon can maintain sufficient densities in urban areas, especially in conjunction with its existing sortation centers and delivery stations. By encouraging entrepreneurs, offering discounted equipment, and branded vehicles, Amazon is sowing seeds for a longterm, dedicated workforce.

©2019 Armstrong & Associates 38 • Taking control of the last mile also allows Amazon to expand delivery days and hours. FedEx just launched Saturday delivery, UPS is expanding its Saturday delivery to additional markets, and USPS already provides Sunday delivery for Amazon. Amazon could push the envelope and put pressure on its competitors with its own delivery schedule. Scenario - More Aggressive: Amazon Adds Additional Last-Mile Services • UPS and FedEx deliveries stop at a recipient’s doorstep. Amazon can differentiate bycrossing the threshold. “Amazon Key” allows in-home and in-car delivery for Prime members in eligible locations. While indoor delivery historically was limited to white-glove-type deliveries, Amazon and others are pushing the envelope and seeking ways to add value to the customer (Walmart, for example, will put groceries in the refrigerator).

• This can be especially relevant for last-mile delivery of heavy goods or those that need assembly/installation. We estimate the market size of the for-hire big-box last-mile delivery revenues is $11.5 billion. The market is growing upwards of 15% a year, as emerging e-commerce categories, such as furniture, appliances, mattresses, and even building materials are becoming increasingly popular. Amazon has already taken some steps towards pairing white-glove services with last-mile delivery. Sears’ Kenmore brand, which is now sold on Amazon, is eligible for Prime delivery and customers can get assembly/installation.

• In addition to assembly, through AmazonHomeServices, the company pairs services with its own devices. Customers can have Smart Home networks installed to pair with Alexa, which is a major priority for Amazon this year. Scenario - Most Aggressive: Amazon Builds Asset-Based Fleet to Rival UPS and FedEx, Offers Delivery Service for Non-Amazon Customers, and Establishes LTL Network • We think the scenario of Amazon developing ground capabilities to rival UPS and FedEx (an asset-based fleet, offering delivery services to external customers, and/or establishing an LTL network) is very unlikely at this time. We haven’t seen much to suggest Amazon is keen to have ownership of assets or take on the Selling, General & Administrative (SG&A) expenses of an employed driver network. LTL capacity could be better achieved, if needed, through the acquisition of a domestic transportation management 3PL.

• Amazon can consider an acquisition or partnership. XPO, which we

©2019 Armstrong & Associates 39 noted as an attractive acquisition target, is the leading provider of for-hire big-box last-mile delivery, with nearly 9% market share and $1 billion in revenue. It has seen 20%+ growth in the space in recent quarters. Parcel carriers have looked at the service too: UPS and Werner are said to have had talks about a partnership.

©2019 Armstrong & Associates 40 Warehousing & Facilities Amazon’s extensive and still-growing fulfillment/sortation network is a massive strength, with ample geographic reach in not just urban centers but second- and third-tier markets. The network was designed for speed, and facilities are new enough that they incorporate new technologies—automation, robotics, and its own warehouse management systems. Amazon should continue to wield this strength and raise the bar with technology, speed, and opportunities to optimize the network to work with its new last-mile program. Amazon could also leverage new physical locations as part of its fulfillment network. Scenario - On Track: Amazon Will Grow its Network While Managing Labor Costs and Improving Operating Efficiencies with Technology • Amazon’s fulfillment costs grew 43% last year, and net product sales grew 25%. Its U.S. fulfillment network square feet, currently totaling 124 million, has another 41 planned or in progress. All signs indicate that Amazon’s network will continue to grow.

• Amazon will improve productivity and efficiencies with robotics and other automation. Amazon has been rapidly adding robots to its warehouses. It currently has upwards of 100,000 in warehouses, compared with 15,000 in 2014. Its Amazon Robotics (previously Kiva Systems) robots cut “click to ship” time from 60–75 minutes down to 15. These robots use a “goods-to-person” approach, in which orders are picked by an automated guided vehicle and delivered to human workers for packing and shipping. This decreases labor costs and improves productivity. Picking items, however, is still the holy grail—picking is a major labor cost, especially so in e-commerce warehouses—and we’re not there yet. Amazon is certainly investing in research, though, and could potentially partner with a robotics company developing picking solutions, such as Swisslog, Kuka, Dematic, Honeywell, RightHand Robotics, Fetch Robotics, or IAM Robotics. Scenario - More Aggressive: Amazon Will Leverage Physical Retail Locations in its Fulfillment Network and Break Into New Categories • Amazon reportedly plans to open 3,000 AmazonGo physical store locations within the next three years. These would likely have a small footprint and be focused on convenience items, but a dual function could be to establish locations for package pickup and returns, similar to FedEx’s partnership with Walgreens. We haven’t heard much about Amazon’s returns locations inside Kohl’s stores, though the

©2019 Armstrong & Associates 41 program was recently expanded to include more stores. AmazonGo may be a better solution, or perhaps these stores could be co-located in some Kohl’s locations (Kohl’s has begun devoting space in its stores for food retailer partners).

• Amazon’s ambition for entering new categories, such as Grocery, will result in network expansion. Amazon’s largest-ever acquisition, the $13.7 billion purchase of Whole Foods in 2017, came with 472 Whole Foods stores and one million square feet of Distribution Center (DC) space. However, only about a third of the U.S. population lives within five miles of a Whole Foods store. Similarly, Amazon’s four million square feet of pantry/fresh fulfillment space is largely clustered around major markets in just 14 states. The company is reportedly seeking space for new, larger Whole Foods locations that include dedicated parking areas for delivery drivers. But as Walmart ramps up its e-commerce logistics ambitions, especially in a category like Grocery where it already has a major market share advantage, Amazon would benefit from establishing more temperature controlled space in more diffuse geographies. Additionally, we expect Amazon to require additional specialized fulfillment center space devoted to pharma, health care, business-to- business, furniture, and applicances e-commerce.

• The Amazon Delivery Service Partner program discussed previously suggests increasing importance of Amazon’s sortation centers and delivery stations. As its last-mile capabilities increase, we could expect to see these built out further.

• Amazon will continue to redefine the “new normal” for delivery speed as it expands its fulfillment network, providing the important competitive advantage and even ability to drive out rivals that can’t compete. Scenario - Most Aggressive: Amazon Makes an Acquisition to Expand its Footprint • Amazon could buy a physical store footprint for joint retail and logistics capabilities. Experts have suggested Nordstrom, Target, or Best Buy. We’d even throw Kohl’s, Home Depot, or Costco into the mix. Each could offer plenty of locations and many have already-solid store distribution. AmazonGo stores could also be adapted or co-located with some of the prime real estate controlled by these retailers. In the UK, Amazon is rumored to be eyeing Homebase (a leading home improvement retailer), hinting at an interest to expand its logistics network through a retail acquisition, though the UK is obviously a very different e-commerce market.

©2019 Armstrong & Associates 42 Air & International Based on Amazon’s several-year $1.5 billion investment at the Cincinnati/Northern Kentucky International Airport, we expect Amazon to ramp up this facility and continue to work with lessors/operators like Atlas Air to grow its fleet size for full utilization of the hub. As the hub won’t be operational until 2020 and complete until 2025–2027, we would expect any additional build out of regional hubs to come at the tail end or after the CVG hub completion.

The strategy for Amazon Air will depend on Amazon’s international expansion. Amazon has FBA fulfillment centers across North America, Europe, Asia, and Australia. Third-party sellers can ship products to either domestic or international fulfillment centers, and Amazon will provide value-added warehousing, transportation, and handle customs. International FBA sales are growing rapidly, with 80% year-over-year growth in 2016. Global sellers now represent a quarter of third- party seller sales. We know international is increasing in importance for Amazon, and the company has interest in developing e-commerce markets, such as India. Much of its cross-border FBA fulfillment seems to be intra-regional (such as within the European Union) today, and international expansion in developing markets would likely be less reliant on cross-border. If Amazon increases intercontinental FBA, this would impact its air strategy.

We think Amazon’s air network will be used to support its own logistics needs and to provide services through FBA, rather than selling space to others. Scenario - On Track: Maximize Fulfillment/Sortation Network for Speed Supported by a Single Air Hub • Amazon successfully pulls off two-day, next-day, and same-day delivery through its fulfillment/sortation network. Amazon offers this quick delivery while controlling costs. Its CVG hub will allow centralized sortation and distribution to airports near Amazon fulfillment centers. Scenario - More Aggressive: Establish Regional Air Hubs • Amazon could establish regional air hubs after completion of its CVG hub. Both UPS and FedEx operate hub-and-spoke networks, with Worldport and World Super Port as centralized locations. Amazon’s Cincinnati/Northern Kentucky facility could serve a similar purpose, though its sort facilities and capacity will be smaller than UPS and FedEx’s. Based on this initial hub investment, it could make

©2019 Armstrong & Associates 43 sense for Amazon to establish regional air hubs for more efficient operations. Scenario - Most Aggressive: Partner with DHL to Support International Air into CVG, with Own Domestic Air Network • Amazon could embark on a strategic partnership to jointly chip away at the UPS/FedEx/USPS oligopoly. DHL has a hub at the CVG, with sortation capacity of 108,000 packages per hour and 80 flights per day on 181 acres. DHL currently partnered with Amazon at the CVG since Amazon’s hub won’t be operational until 2020 and complete until 2027. DHL “provides a range of services to Amazon at the hub, including sorting operations and ground handling.” Amazon and DHL could partner to pair DHL’s international network with a domestic air network. Amazon could build out regional hubs in the U.S. This could help DHL improve its presence in the U.S. and Amazon to develop a domestic air network without having to go international at the same time. Both would be able to better compete with UPS and FedEx. DHL has excellent global parcel strength. DHL Express entered the U.S. market in 2001, peaked at about 4% market share, and dramatically downsized operations in 2009 due to a confluence of factors: service quality issues, a challenging integration with its express-delivery airline acquisition Airborne Express, and the beginning of the Great Recession. It has recently started to grow its Americas business, with 9.8% revenue growth in the region in 2017. The company has shown recent interest in the U.S., launching its Parcel Metro same-day and next-day delivery service in Chicago, New York, and Los Angeles.

©2019 Armstrong & Associates 44 Technology Due to the scale of Amazon, UPS’, or FedEx’s delivery networks efficiencies add up significantly. For example, as delivery density is fragmented by e-commerce shipments to residential destinations, route efficiency becomes increasingly important. UPS made a long-term investment in route optimization with its On‑Road Integrated Optimization and Navigation (ORION) program. ORION deployment was completed in 2016, and UPS says it saves the company about 100 million miles per year. According to UPS, while “daily volume and delivery stops increased 4.1% and 4.4%, respectively… average daily package miles driven only increased 0.2%.”

Amazon’s technology strength means that this is a space in which Amazon can shine, and carve out competitive advantage even as UPS and FedEx dwarf most aspects of its physical network. Scenario - On Track: Amazon Will License Logistics Technology • Amazon will license various logistics technologies. Amazon’s skilled in the art of “as-a-Service.” Amazon Web Services (AWS), Amazon’s cloud computing division, began as Amazon’s own internal cloud service. Before FBA was Fulfillment by Amazon, it was simply fulfillment for Amazon. With “FBA Onsite,” sellers will install Amazon’s WMS on their own servers. Scenario - More Aggressive: Next-Generation Technology Development • Amazon could expand technology licensing further and fill current gaps. Today, sellers (and parcel carrier customers) are working to improve forecasting and inventory planning, especially during peak periods. As a retailer, these are functions Amazon has surely developed internally. Amazon could license such software to its third-party sellers.

• Amazon can also help develop seller-facing and consumer-facing tools, from dashboarding to apps for rerouting packages and requesting delivery times.

• Amazon will continue development of novel fulfillment technologies and strategies, such as on-demand apparel manufacturing and try-before-you-buy apparel services.

• Amazon will continue ideation for the next generation of logistics technologies. It’s filed patents ranging from drones to new warehouse designs. Other visionary ideas include underground delivery tunnels and floating warehouses.

©2019 Armstrong & Associates 45 Challenges While we believe Amazon will be successful in the “On Track” scenarios, and even most of the “More Aggressive” scenarios, it will undoubtedly face a number of challenges.

Just as Amazon is developing capabilities to compete with 3PLs and parcel carriers, those providers are seeking ways to compete with Amazon’s logistics capabilities. FedEx Fulfillment offers a service similar to FBA, in which sellers integrate with marketplaces and ship products to warehouses for fulfillment. A number of 3PLs offer services for Seller Fulfilled Prime fulfillment. UPS’s investment in Optoro (a reverse-logistics technology provider) and acquisition of i-parcel (an international “e-commerce enabler”) show that the company is continuously seeking e-commerce investment/acquisition opportunities.

Amazon investors have always allowed the company leniency with low profit and reinvestment of cash into the business. However, the “More Aggressive” and certainly “Most Aggressive” scenarios we’ve included aren’t all concurrently feasible. Even though Amazon has been generating improved profit driven by its AWS and advertising businesses, the company will need to be selective in its logistics expansion plans. UPS’s and FedEx’s networks were developed over decades, with periods of focus on ground, air, international, and technological investment. Amazon may even choose to invest more internationally rather than domestically at this point, meaning it would likely only follow the “On Track” scenarios in the U.S.

If Amazon does choose to try to become a major parcel player, it would be embarking on that endeavor even as UPS and FedEx invest massive figures in their own technology, automation, facilities, assets, and capacities.

Entering an oligopolistic market is an exercise in game theory, so Amazon should tread carefully. With its “coopetition” relationship with FedEx and UPS, Amazon could risk upsetting pricing negotiations and access to service as it gains strength as a rival. This could be another reason to develop its strengths as a 3PL rather than a parcel carrier.

Meanwhile, the perception of technology companies has soured slightly, and Amazon has been hit with criticism from both the left and the right, a rare feat. As of late, ideas about Amazon as a monopolist have been circulating with frequent comparisons to the Robber Baron era. An exposé about worker conditions in Amazon warehouses materializes every few months, while UPS was recently voted #1 in Fortune magazine’s “World’s Most Admired Companies” rankings. Amazon must

With a focus on both technology and logistics, Amazon’s business could grind to a halt when faced with a virus like NotPetya, which cost both A.P. Moller-Maersk and FedEx’s TNT express hundreds of millions of dollars and endangered customer relationships. Logistics technologies must be built with prevention of network failures in mind.

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