Here’s How Amazon Will Compensate for Rising Transportation Costs

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Amazon’s (NASDAQ:AMZN) new Prime price hike evidences its current struggle with ever-increasing transportation costs, but according to DC Velocity, the e-commerce giant now has another strategy up its sleeve to revamp its shipping efforts and avoid higher charges. The publication reported last week that Amazon is overhauling its delivery network so it can gain more control over its fulfillment infrastructure. A supply chain consultant, James Tompkins of Tompkins International, said earlier this month that Amazon is in the midst of dividing the nation into three segments based on population size, and from there, it will assign different fleets to serve each sector of its customers. The three segments will include the top 40 markets, which account for half about half the U.S population; the next 60 largest population areas that account for about 17 percent; and the remaining areas, which comprise about one-third.

According to DC Velocity, Amazon’s new distribution revamp will result in a number of new partnerships, as well as a few break-ups. Today, U.S. Postal Service (NYSE:UPS) handles much of Amazon’s current deliveries, but moving forward, Tompkins said it won’t play a big role in the network realignment — nor will FedEx Corp (NYSE:FDX). Rather, the top 40 markets will be served by a private fleet currently in construction by Amazon to supports its online grocery business, Amazon Fresh. A handful of regional parcel delivery carriers will serve the next 60, and the remainder will be served mostly by the UPS.

It is still unclear how soon Amazon plans to realize its new plans, but Tompkins said last week, via DC Velocity, “They are moving very quickly.” He explained that orders will soon be routed through the Seattle-based company’s 55 fulfillment centers, and as always, deliveries will be made the same day, the next day, or in two days at most. That’s why providers like FedEx and UPS are no longer as appealing to Amazon — they’re too slow for its business. Instead of relying on them for deliveries, the company will make sure that its inventory is sufficiently stocked at all of its fulfillment centers, and then it will rely largely on private fleets to execute the distributions.

It is thus clear that although Amazon is seemingly an expert at almost everything, it still struggles with common business setbacks such as rising transportation costs. According to the company’s filing with the Securities and Exchange Commission in 2012, as highlighted by DC Velocity, its shipping costs in 2012 exceeded shipping revenue by nearly $3 billion, and the company still expects its “net cost of shipping,” or the ratio of shipping costs to revenue to continue rising, especially as more customers take advantage of its Prime subscription program. That explains why Amazon hiked up the price of its famed program by $20 on Thursday. After weeks of rumors, Amazon officially increased the yearly fee for an Amazon Prime membership from $79 to $99, and that reflects the first time the company has increased the price of Prime in the program’s nine years of existence.

Amazon now recognizes that some of the consumer interest in Prime may drop off on account of the price hike, but that’s still a risk that the company really has no choice not to take. Chief Financial Officer Tom Szkutak warned investors of the company’s dire need to raise the price of Prime during the company’s most recent earnings, and he maintained, “Even as fuel and transportation costs have increased, the $79 price has remained the same. We know the customers love Prime as the usage of the shipping benefit has increased dramatically since launch. On a per customer basis, Prime members are ordering more items across more categories with free two-day shipping than ever before. With the increased cost of fuel, transportation, as well as the increased usage among Prime members, we’re considering increasing the price of Prime between $20 to $40 in the U.S.”

Amazon even ended up going easy on its Prime consumers, only raising the price for the subscription service next year $20 — at least for now. We’re not sure what the future will hold for the company’s prices, especially now that transportation costs are higher than ever. However, it is clear that current Prime members will still get access to free two-day shipping, the Prime Instant Video movie and TV streaming service, and certain free titles for the company’s Kindle tablets and e-readers. Rumors have also suggested that Amazon could be working on a music streaming service that will help Amazon plug its MP3s and give Prime members an added benefit to justify the price increase.

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