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Amazon looks for outside help

Even as inked a pact with Borders Group to take over the brick-and-mortar store's Internet operations, the online retailer may be looking to outsource more of its own business.

In a research report Tuesday, Thomas Weisel analyst Sara D'Eathe said Amazon (Nasdaq: AMZN) recently put out a "request for a quote" (RFQ) to a large private outsourcing fulfillment, customer care and customer call center.

An RFQ is basically an invitation for a company to provide outsourcing services to Amazon, said D'Eathe. Connecting the dots, D'Eathe speculated that Amazon's reaching out to outsourcing firms may imply that the e-tailer "does not believe it can be efficient at fulfillment itself."

"Amazon is seeking new avenues to improve the economics of its business, in our opinion," D'Eathe said. "However, this is of course contrary to what Amazon is leading people to believe."

When a company outsources, it often sheds workers and facilities. It's not clear whether Amazon would be outsourcing its fulfillment, customer service or both, but farming out some key business functions would cut costs. Amazon has about 3,500 workers and has faced unionization efforts at the Seattle service center, where workers make between $11 and $14 an hour.

Amazon already outsources some of its U.S. business, including call center operations and fulfillment for certain products, a spokeswoman said. For instance, an outsourcer handles shipments of wireless products so it can pre-program cell phones before shipping them. Amazon outsources fulfillment for its Japanese operations

Although D'Eathe said she doesn't know the magnitude of Amazon's future outsourcing plans, many Wall Street analysts said they would cheer the business model shift--even though the payoff may not be immediate due to write-offs. Amazon, which reports first-quarter earnings April 24, spent millions on distribution centers in 2000 in an effort to be an all-encompassing online department store.

D'Eathe said she would "encourage the company to change its current business strategy so that it is more consistent with profitability."

If Amazon does outsource much of its fulfillment, it will be a dramatic change from the company's previous goals. Bolstered by a strong 1999 holiday season, Amazon acquired more than 4.5 million square feet of warehouse space worldwide by the end of 2000. Despite the company's efforts to offer everything from its core books, music and videos to patio furniture, it is using only 40 percent of its warehouse space.

Recent deals with Toys "R" Us and rumored talks with Wal-Mart and Best Buy indicate that Amazon may be changing its tune.

"If my back was against the wall, I'd be looking to outsourcing to cut costs," said Wit SoundView analyst Scott Milne.

Mixed signals
For its part, Amazon is sending out mixed signals about its outsourcing plans.

Although it did a deal with Toys "R" Us, essentially outsourcing inventory management, Amazon's partnership with Borders (NYSE: BGP) shows the e-tailer will also handle fulfillment. The Borders and Toys "R" Us deals are based on the notion that Amazon is the king of online sales and knows better than anyone how to handle fulfillment and customer service for online operations. So why does the company need to look to outside help?

"We're always looking to make the best possible blend of which types we do ourselves and which types we outsource," said Amazon spokeswoman Patty Smith. "The guideline is, can the outsourcer perform as well as we can, and are there economic benefits?"

Analysts said Amazon could outsource everything outside of its core books, music and video business. With each store Amazon has added, fulfillment costs have risen. Costs rose from 11 percent of sales in 1998 to 15 percent of sales in 2000.

Amazon has made efforts to trim those costs, announcing in January that it would close one fulfillment center in Georgia and operate its Seattle center on a seasonal basis. It also announced plans to consolidate its European customer service centers in an effort to bring down fulfillment costs.

Because Amazon's distribution centers are only 40 percent filled, "it would make sense for it to either fill the excess capacity by partnering with traditional retailers or take capacity out by closing down more distribution centers," D'Eathe said.

Potential partners?
Analysts declined to speculate on what companies would be likely outsourcing partners for Amazon, but computer distributor Ingram Micro surfaced as a candidate.

Although Amazon credited strong electronics sales for better-than-expected sales in the first quarter, analysts note that the online retailer lacks direct relationships with manufacturers. Simply put, Amazon's margins would improve dramatically if it could buy from suppliers at cost.

Ingram Micro, which helps Best Buy with its fulfillment, could dramatically cut Amazon's costs for its electronics store because of its close ties to a host of manufacturers.

"Let the experts do what they're best at," said Wit SoundView's Milne, adding that companies like Ingram Micro "are used to shoving boxes around."

Amazon could also outsource its customer service operations. "I think customer service outsourcing is something that all companies do to one extent or the other. I haven't heard (that it's) anything beyond (that)," said Tim Albright, analyst at Salomon Smith Barney.

The future
If Amazon carries out an outsourcing strategy, the company would essentially become a marketing company that dabbles with fulfillment when it comes to books, music and video.

Is that a flip-flop?

You bet, but everything has changed since those heady days when Amazon was a $300 stock. When raising capital was easy, Amazon spent big bucks to build warehouses in anticipation of the huge amount of business it would grab from other retailers.

It sounded like a great idea at the time.

"In 1999 you had to have your own fulfillment and have good customer service 99.9 percent of the time," Milne said. "The world has changed; the competitive pressures have eased."

One of Amazon's main rivals, eToys, has gone out of business. That's largely because eToys decided to spend heavily in 2000 on its own distribution centers. In 1999 it outsourced its fulfillment to FingerHut, a unit of Federated Department Stores, but ended the relationship over customer service glitches.

But that doesn't mean customer service would necessarily suffer if Amazon outsourced, Milne said.

"The days when you had to own all the fulfillment are gone," he said. "Finger Hut gave outsourcing your fulfillment a bad name, but there are plenty of companies that can deliver. It still comes in an Amazon box."

• Amazon surges on first-quarter outlook >