By Alexandria Sage - Analysis
SAN FRANCISCO (Reuters) - Online retailers cannot afford to raise shipping prices. The high cost of fuel is hurting the wallets of American consumers and businesses alike, but online retailer Amazon.com Inc and others will likely forgo shipping price increases on its discount programs this upcoming holiday shopping season for fear of alienating hard-pressed shoppers in the weak economy.
Long-term contracts with shippers may insulate Amazon and some others, even as companies small and large scramble to find other costs to cut. Margins could suffer more as time goes on, but the biggest companies could watch smaller rivals fade away as the move to online shopping continues to accelerate.
Avoiding shipping price hikes may appear foolhardy -- after all, the cost of diesel fuel has risen 154 percent in the last year. But companies such as Amazon and Overstock.com Inc rely on low or free shipping to stoke business in good times -- so any rise in bad times could be a major problem.
U.S. consumers have pared back spending in the weak economy and many have headed online, welcoming free shipping as they avoid unnecessary, gas-guzzling trips to the mall.
Free shipping is a major competitive advantage for Amazon, which has already been lowering prices to stave off rivals, said Forrester analyst Sucharita Mulpuru.
“They’ll continue to take the hit on the margins in spite of the fact that gas prices are high and shippers may pass on the cost to the E-commerce players,” she said.
U.S. carriers like United Parcel Service Inc, FedEx Corp and the U.S. Postal Service have been raising prices due to higher fuel costs.
But Amazon and some brick-and-mortar companies with major online businesses say they’ve largely been able to insulate themselves by being more efficient elsewhere in their businesses, whether through better distribution or less waste.
“We’ve so far been able to mitigate a substantial portion of the increased energy costs using techniques that are unrelated to raising the shipping costs to customers,” said Staples Inc Chief Financial Officer John Mahoney, citing gasoline-saving measures, more efficient truck routes and hybrid trucks in the fleet.
Overstock will not raise its blanket $2.95 shipping price on a full order, and fuel increases have not affected the company’s profit margins, Chief Executive Patrick Byrne said.
Large online shippers have bargaining leverage over transport carriers when it comes to contracts, Amazon and Overstock said.
“We can do a better job in keeping those price shocks from rippling through our system,” Byrne explained.
A Target Corp spokeswoman, meanwhile, said the free shipping it now offers won’t change much this holiday season: “Overall, we are always looking at lower shipping rates.”
SO WHO‘S PAYING?
Since its inception in 2004, discount program Amazon Prime, -- in which shoppers pay $79 a year for unlimited shipping -- has been a worry to Wall Street. It’s also been a mystery, since Amazon won’t disclose how much the program costs to run.
“Given the surge in fuel costs, it would seem at some level Amazon has got to be facing an impact, given the fact that Amazon Prime’s price has been the same since 2004,” Citigroup analyst Mark Mahaney told Reuters.
Amazon’s net shipping costs have been about 3 percent of revenue over the last five quarters, a spokeswoman said. But that revenue number includes sales Amazon makes off independent sellers advertising on its site who ship their own orders, meaning that the real shipping cost to Amazon would be a bigger percentage.
Amazon’s shipping costs rose 47 percent to $128 million from $87 million in its most recent quarter, while total sales, which again include sales from independent sellers, rose 37 percent.
“Clearly this has become an increasing source of loss to the company, and an increasing part of their cost structure,” Mahaney said, while noting that Amazon is “remarkably focused” on managing its costs.
Still, others on Wall Street see less to fear, at least in the short term. Jeffrey Lindsay of Bernstein Research said Amazon locked in its transport rates before the major oil price rise earlier this year, which makes them “fairly well protected” from margin deterioration.
“We believe people are too pessimistic on Amazon and underestimate their margins as a result,” he said, noting that if fuel prices continued to rise, the problem could rear its head next year for Amazon.
And while Amazon has not raised prices on Amazon Prime or Super Saver -- under which shipping is free with a minimum $25 order -- the company is “very effectively passing the costs” along on other rates, he said.
Moreover, he said, these higher incremental rates have a further benefit: The aversion to higher shipping prices means more Amazon customers opt to join Amazon Prime or buy more goods to qualify for Super Saver shipping.
However, smaller online retailers that aren’t as nimble as Amazon will be struggling this holiday with higher fuel costs and be forced to raise shipping prices.
“All of these companies are racing against this structural rise in gas prices. I am sure some of these companies will lose the race,” Mahaney said.