Transforming Fulfilment: How Amazon's New Strategy Enhances Speed, Cuts Costs, and Reduces Environmental Impact

Amazon’s Q2 earnings release last Thursday led to a 10% drop in share price, driven by increased competition from Temu and Shein and a shift in customer behaviour towards lower-priced items. To counter this, Amazon's launch of a low-priced fashion and lifestyle site aims to address some challenges from these competitors. However, their revamped fulfilment strategy excites me more, as it promises significant benefits in cost reduction, speed, and environmental impact.

Reflecting on their focus focus on speed in Q1 2024 and their recent ?Prime day record, I recalled a YouTube video I shared with friends in 2022. The video illustrated a suboptimal network from a ?speed, cost, and environmental perspective—a counterintuitive approach given Amazon's high volumes.

The Old Fulfilment Model [US market Example]

Amazon’s previous fulfilment strategy did not prioritize optimal inventory placement, relying heavily on its Prime Air network to meet a 2-day delivery promise. This approach had several drawbacks:

1. Slower Speed: Consolidating volumes for 2-day delivery optimized the air network but slowed delivery times.
2. Higher Fulfilment Cost: Long-distance shipping within the US increased costs. Air transportation is more expensive than land, and maintaining high aircraft utilization forced suboptimal fulfilment. As volumes grew, so did capex and operating costs.
3. Environmental Impact: Air cargo, with its small load capacity and high CO2 emissions, significantly contributes to environmental deterioration.

In 2022, a more intuitive network for Amazon's scale (billions of shipments, especially in the US) seemed to be a regional/local model, moving to hyper-local where volume density supported it. It's great to see their focus has moved in this direction.

Key Factors for Success

To realize the benefits of improved speed, cost, and CO2 reduction, Amazon had to rethink its geographical strategy. For example, a smaller company fulfilling 2-5 million shipments annually in the US can cluster the market into at least six regions to localize shipping, achieving low cost economy delivery within 2-3 days for over 95% of their orders. With billions of shipments, Amazon should break down its geography into multiple regions/clusters, making these regions self-sufficient with inventory, throughput, labor capacity, and transportation network.

The critical input change is inventory placement. Traditionally, many shippers place inventory based on historical fulfilment patterns. If Amazon follows a similar algorithm, it will need to shift to placement based on “demand,” requiring high confidence in demand prediction. This may increase inbound costs to place first time right, but is outweighed by the cost savings in outbounding customer orders. The 80/20 rule is also prevalent in e-commerce—20% of SKUs contribute to over 80% of demand—meaning addressing these SKUs can deliver speed, cost, and environmental benefits for at least 80% of Amazon’s demand in the short term.

Fulfilled by Amazon (FBA)

Amazon treats each FBA sellers’ inventory uniquely, which complicates optimal placement. If FBA constitutes 50% of their fulfilment volume, having robust systems, demand forecasting, and inventory placement for FBA is crucial to maximizing benefits. New FBA sellers, lacking selling history, pose a challenge in initial placement but should stabilize over time.? Costs for FBA sellers to is already high – it will be interesting to see how Amazon manages this.

Labor Impacts

Differently placed inventory will require capacity changes across Amazon's network. To balance benefits and labor changes, they must phase their rollout, capitalizing on volume growth and peak ramps.

Redundant Capacity and Future Expansion

As Amazon transitions from its previous network to a more localized one, redundant capacities may emerge in some locations while high-demand regions may face shortfalls. Managing this redundancy while revisiting expansion strategies for future buildings will be essential.

Overall, Amazon's strategic shift is promising. ?By focusing on controllable inputs (inventory placement and fulfilment processes), they can drive results in cost, speed, and CO2 reduction. The savings can also be leverage to increase same-day volume, which is at a higher cost, to improve competitiveness and recover topline.?

Ideally, the full potential of these changes should manifest through 2025, reflecting in improved quarterly earnings [EPS or revenue recovery]. ?These adjustments will enhance customer experience (speed) and support Amazon's goal of net-zero emissions by 2040.