Amazon wants to deliver stuff, too? That's weird

Over the last 20 years, Amazon has taught us to buy everything on the web. At least in urban areas like mine, we are close to realising the dream of a retail environment that consists entirely of storefronts selling food and beverages, while delivery trucks whiz back and forth before diners beneath umbrellas. But is Amazon content with this amazing transformation? Hardly. Now, it seems, it wants to own not just our shopping, but the planes and trucks that deliver stuff to our doors.
In Bloomberg Businessweek, Devin Leonard reports on Amazon’s push into the shipping and logistics market. He makes a pretty strong case that if big shippers aren’t frightened by this development, they should be. “I fully expect Amazon to build out a logistics supply chain that others can use,” Leonard quotes former Amazon executive John Rossman as saying. “Over the next five years? I doubt it. Over 10 or 15 years? Oh yeah.”
The article left me with one big question: “Why?” What on earth does Amazon have to gain from vertically integrating like this?
I know that at least a few readers will be tempted to say “Because then, Amazon won't have to pay for shipping!” But of course, Amazon will have to pay for shipping. It will have to own planes and trucks, and hire employees to move boxes around. It will have many of the same costs as FedEx and United Parcel Service, up to and including the managerial bureaucracy and the need to provide profits for shareholders. What does it gain from bringing operations in-house?
That’s actually a really deep question for economists, because if you follow that thought all the way to its logical conclusion, you end up asking, “Why do firms exist?” Why don’t we all just act like traders in a village market, selling whatever we have at whatever price we can fetch for it? That seems like a silly question, but there’s no reason I couldn’t sell my articles to Bloomberg View one-by-one (many journalists make their living this way), and no reason that lots of other professions could not, in theory, be conducted as networks of independent contractors. So why aren’t they?
Nobel prizewinning economist Ronald Coase was the first person to tackle this question effectively, and the answer he came up with was “transaction costs.” Constantly negotiating over what is to be done, and how it is to be done, is expensive and time-consuming and sometimes can’t be done at all.
Bringing different activities under one corporate roof allows you to reduce a lot of the negotiation in favour of using authority to settle disputes. You never get rid of the need to negotiate entirely — as anyone who has ever managed a department can attest. But you can reduce it, and authority can be a more efficient way of settling disputes between different interests.
Authority also has costs, notably that it reduces initiative and flexibility. In the world of an economic model, we should see firms do all the tasks that can be managed more profitably through authority than through the price mechanisms of the market, and outsource all decisions where the market can handle things more efficiently. In the world we actually live in, of course, things are a little more complicated. But still, when a company starts doing something in-house that it used to buy in the marketplace, it’s a useful model to compare our real live company to.
And it’s pretty hard to think of reasons that Amazon is in this situation. Shipping’s not a monopoly, so it’s not prone to the profit-reducing problems you can see in markets where you have one big supplier facing off against one big retailer, both of them trying to claim excess profits. Nor is the market for shipping obviously inefficient in ways that cause customers of bad intermediate-goods suppliers to bring production of those goods in-house (think of companies developing their own electricity generation capacity in developing countries with unreliable power grids).
Getting something to my house before 6pm is not a complex task that’s hard to specify in a supplier contract. Nor do we have the situation you’ve seen in places like the auto industry, where suppliers and buyers often have the ability to make independent decisions (such as where to put new plants) that can give the other party excess negotiating power (because once your plant is built to be convenient for General Motors, it’s now more profitable to sell to GM than to any other automaker).
I mean, you can describe problems that Amazon has had with its shippers, as when Amazon’s package volume a few years ago overwhelmed the ability of the shippers to deliver them. But these aren’t problems that go away when Amazon starts shipping things itself. It's expensive to maintain a lot of excess delivery capacity that will only be used one month of the year, and that is true whether the capacity is maintained by Amazon or FedEx.
Solving a capacity problem is what Amazon did with its profitable web services business, which started because the company needed immense amounts of server power to manage its peak traffic volumes. But the cases aren’t really parallel. For one thing, selling computing power grew out of something that Amazon was going to be doing anyway: developing infrastructure tools for handling its website, its core business. Amazon Web Services, in other words, involved finding a profitable use for something that Amazon had to have, and couldn’t really get elsewhere. Amazon Shipping Services, by contrast, would involve something that Amazon can buy elsewhere, from companies who will compete with them if they try to sell those services on the open market.
There may be some logic to this move that I cannot see, and perhaps in 10 years I will shake my head at my inability to foresee the massive logistical juggernaut that Amazon Shipping Services became. On the other hand, one thing that doesn’t show up well in economic models, and does show up in a lot of real-world corporations, is the taste that corporate managers develop for empire building: for doing things because they can rather than because they should, and chasing size just to get bigger. If I were a FedEx manager, I’d be pretty worried about Amazon’s move into shipping. On the other hand, if I were an Amazon manager, I might be a little nervous too. - Bloomberg View