Amazon's next-day shipping ambitions are costing it a fortune

The latest quarterly earnings and guidance badly miss Wall Street's expectations, causing the stock to plummet Thursday.

Ben Fox Rubin Former senior reporter
Ben Fox Rubin was a senior reporter for CNET News in Manhattan, reporting on Amazon, e-commerce and mobile payments. He previously worked as a reporter for The Wall Street Journal and got his start at newspapers in New York, Connecticut and Massachusetts.
Ben Fox Rubin
4 min read
Amazon Fulfillment Center

Prepping packages at an Amazon warehouse in Thornton, Colorado

Helen H. Richardson/MediaNews Group/The Denver Post via Getty Images

Amazon's string of record quarterly profits appears to have collapsed after the company's bold plan to speed up its shipping saddled it with more expenses.

The world's largest e-commerce company on Thursday posted third-quarter earnings that badly missed expectations, despite better-than-expected sales. Its revenue prediction for the all-important fourth quarter, during the peak holiday retail season, was also soft.

Shares plunged 7% after hours on the earnings and guidance misses. The stock regained most of those losses Friday as investors focused on Amazon's faster-shipping project sparking higher revenue.

A primary culprit for the sour numbers was Amazon's new push to cut two-day Prime shipping to just one day, which has forced the online retailer to spend billions of dollars to ramp up its transportation and warehouse infrastructure and buy more inventory to bring popular products closer to customers.

During a call with reporters Thursday, finance chief Brian Olsavsky said heading into the fourth quarter he expects Prime one-day and related costs will "nearly double" from the second quarter, to approximately $1.5 billion. Still, he added that the heavy costs have already brought benefits, with revenue growth improving.

"We have seen very good lift and very good increase in the purchase behavior of Prime members," Olsavsky said on the call. "They're buying more often and they're buying more products."

Shipping costs, which were already moving higher in the second quarter, sky-rocketed 46% to $9.6 billion. Total operating costs jumped 26%. Olsavsky said the company has been investing heavily in Amazon Web Services, its cloud computing business, as well as devices and international growth, which also contributed to Amazon's headcount surging to 750,000 employees in the latest quarter, up nearly 100,000 people from just three months earlier. The biggest driver of that headcount increase was in Amazon's warehouse and shipping staff, Olsavsky said.

Watch this: Amazon Echo Frames put Alexa on your face

After four straight quarters of record profit, Amazon is again in heavy investment mode, this time as it shells out to speed up its Prime shipping service across the world. Earlier this year, the online retailer forecast it'd spend $800 million in the second quarter to help shift its two-day Prime shipping to one day in the US. It then said in July it spent even more than that.

Wall Street hasn't seemed too upset about rising costs at Amazon since investors have seen the Prime spending as a long-term win. Customers are also cheering the move, since it'll ensure they get their stuff even faster. In the prior second quarter, shipping costs jumped 36% to $8.1 billion, but the only folks that seemed worried about all that spending were Amazon's rivals who are struggling to keep pace. 

But the stock took a temporary dive Thursday, in part because investors were likely spooked by Amazon's weak holiday sales estimates. Wall Street over the years has seemed to stomach a lot of profit gyrations at Amazon, so long as its revenue keeps surging higher.

"Amazon's strategically necessary investments in next-day delivery continued to weigh heavily on its retail profitability, with sales growth in North America of around $8 billion more than offset by a $10 billion increase in operating expenses," Moody's analyst Charlie O'Shea said Thursday.

Amazon said in June that Prime one-day shipping already covered over 10 million items in the continental US and it's planning on ramping up that inventory as the year goes on. When asked Thursday, Olsavsky didn't offer an update on that number. Walmart, the world's largest retailer, is already working on matching Amazon's one-day push, saying in May it started offering next-day deliveries in Phoenix and Las Vegas. It's been working on expanding one-day shipping from there.

The latest quarter included Prime Day sales, which Amazon already said hit a new record, with the two day event surpassing last year's Black Friday and Cyber Monday combined.

Prime Day 2020 preview: The 50 weirdest deals we've ever seen

See all photos

For the third quarter, Amazon posted a profit of $2.1 billion, or $4.23 a share, far below Wall Street estimates of $4.62 a share. Profit the year earlier was $2.9 billion, or $5.75 a share. Sales of $70 billion, up 24% from last year, beat Yahoo Finance estimates of $68.8 billion. That percentage increase was also notably better than the 20% and 17% rise in the prior two quarters of this year.

The company's prediction for the fourth quarter was $80 billion to $86.5 billion in sales, below the $87.4 billion analysts expected.

The latest results come after Amazon had a rocky start to the year, with CEO Jeff Bezos going through a messy and public divorce and the company pulling out of its plans to locate a new major campus in New York City amid heavy pushback from local activists and politicians.

While both those scandals have since subsided, Amazon is now facing new scrutiny from US and European regulators and elected officials over its potential antitrust practices, with concerns that the company has become too dominant in retail. US Sen. Elizabeth Warren, a 2020 presidential candidate, has called for the company to be broken up.

Added to that, many of Amazon's own employees have started banding together to fight for unionization and other changes, and many activist groups have been protesting loudly for Amazon to cut its ties with US Immigration Customs and Enforcement.

Despite its many challenges, Olsavsky offered an optimistic view going into the holidays.

"I think we're well positioned to make it the best holiday ever for our customers," he said Thursday. "I think one-day should help."

Originally published Oct. 24, 1:10 p.m. PT.
Update, 2:10 p.m. PT on Oct. 24: Adds comments from Amazon's finance chief and Moody's analyst. Update, 10:44 a.m. PT on Oct. 25: Updates stock movement and adds more details.