The economics of Amazon’s delivery drones

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Last December there was a lot of skepticism when Jeff Bezos, CEO and founder of Amazon, announced on the 60 minutes TV program that they were looking into using drones for delivering small packages. Many pundits called it a publicity stunt and nonsense! — timed for the biggest online shopping day of the year .

Bezos on the other hand was bemused and took pains to point out in his 2013 annual letter to shareholders that Amazon are serious about delivery by drones, writing: “The Prime Air team is already flight testing our 5th and 6th generation aerial vehicles, and we are in the design phase on generations 7 and 8.”

On their Prime Air Q and A page Amazon anticipate FAA’s rules for commercial drones will: “be in place as early as sometime in 2015.” And state: “We will be ready at that time.”

To be ready they are assembling a team said to already consist of between 45 to 50 employees and at least 10 additional personnel sought according to job openings on Amazon’s website.

Job postings for the Prime Air team range from a Patent Lawyer, to a Communications Manager, Software Engineers, Machine Learning Engineers, Executive Assistant, Project Coordinator, Research Scientist and Technical Program Manager.

To give you a taste of what the company is aiming for, the Communications Manager post indicates:

We’re looking for a communications leader for Amazon Prime Air, a new delivery system that will get packages into customers’ hands in 30 minutes or less using unmanned aerial vehicles.

So what’s driving Amazon’s Prime Air initiative?

Instant gratification from customers is clearly one element; providing outstanding service is another; as is staying ahead of the curve with innovative delivery and order fulfillment. All highly significant points in their own right to meet Amazon’s goal: “to be Earth’s most customer-centric company.”

Cost of transportation is another. Amazon’s total shipping costs in 2013 were $6.635 billion. They received shipping revenue of $3.097 billion and incurred overall losses of $3.538 billion related to shipping costs.

Amazon shipping costs

Amazon use several services for shipping, UPS, FedEx, US Postal, and others as well as developing their own City Pick Up points, delivery van service and Amazon courier cycles. Shipping is clearly a major cost factor to Amazon and one where they are focused on improving service whilst reducing cost.

Technical difficulties

In addition to the regulatory hurdles that must be overcome there are many technical difficulties.

Amazon is aiming for their drones to deliver shoebox size packages.

They probably do not want video onboard due to the extra weight on the drone and also privacy concerns, so will need another way of identification before customers can accept delivery, e.g. biometric identification or pin code to release the package provided with the consignment email – package drop off will be a challenge.

Wind will be a factor in delivery.

Sense and avoid – very few of the current breed of drones (especially the hobbyist drones) have sense and avoid capabilities and should not be flown where there are people or objects.

Amazon will want their drones to be as safe as regular manned planes. Piloted planes have 9.4 accidents per million flights, in other words statistically very safe.

CyPhy Works is possibly the leader in this drone technology with their tethered drones having already developed high payload, high wind, environmentally sealed systems.

GPS lock is an issue that has caused drones to drop out of the air and piloting inexperience is also a major issue, although one the FAA is looking very closely at and I’m sure Amazon will too – drones should never be operated without formal training and some license arrangements.

Another hurdle will be location for dispatch – most of Amazon’s Fulfillment Centers are outside major cities, although it is probable that the items Amazon will provide via Prime Air will be a vastly reduced inventory and kept at the Amazon Pick Up points or smaller Fulfillment Centers closer to major city centers.

These are just a few of the technical hurdles, not insurmountable and as Amazon state they will be ready when the FAA approve the use of commercial drones.

Will drones be more cost effective?

According to shipping-industry analysts Amazon typically pays between about $2 and $8 to ship each package, with the cheapest option through the Postal Service and the most expensive via UPS or FedEx.

Amazon may be able to get a premium price for the Prime Air delivery service – customers who want their package within 30 minutes may be prepared to pay a premium of say $15 to $20 per delivery. Irrational for a book that costs $18, but as behavioral economics shows humans do not always act rationally.

During a 15 hour window (7am to 10pm) one Prime Air drone could potentially make 30 deliveries (absolute maximum efficiency and at a significant stretch).

Assume the drones are fully in service for 360 days per year, this will be the equivalent of 10,800 deliveries per drone.

The drones will require 2 full time pilots. With drone pilot wages ranging between US$13 to US$23 per hour, plus fulfillment center costs, insurances, drone fees and service, the Prime Air Team overheads and development – the annual fees per Prime Air drone service – annual cost per drone could be a minimum of between US$105,000 to $186,000 per year.

Those numbers divided by the maximum number of deliveries per drone indicate that the Prime Air service could cost Amazon between $9.75 and $17.44 per delivery, which is okay if Amazon get a premium rate for 30 minutes delivery.

Amazon will want to get maximum number of deliveries and efficiencies out of the drone capabilities, whilst reducing the costs as close to $2 per delivery as possible and maximizing the revenue by providing the wow factor to customers. They will also be aiming to reduce the US$ 8.829 billion in cumulative shipping losses in the last three years.

At some stage don’t be surprised if Amazon seeks to move into the logistics business. The robots that they are deploying in their fulfillment centers and now with Prime Air Drones, Amazon are clearly building a high quality, high capability logistics service – and ultimately that is good news for consumers.

Photos: Amazon 2013 Annual Report and Amazon Prime Air Q&A

As Helen Greiner, CEO and founder of CyPhy Works says: “The shortest path between two points is as the drone flies.”

Updated: There is an interesting take on this article edited by Business Insider — The 4 reasons Amazon is dead serious about its Drone delivery service.

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22 thoughts on “The economics of Amazon’s delivery drones

  1. “Amazon may be able top get a premium price for the Prime Air delivery service – customers who want their package within 30 minutes may be prepared to pay a premium of say $15 to $20 per delivery. Irrational for a book that costs $18, but as behavioral economics shows humans do not always act rationally.”

    This isn’t necessarily correct. Whether $20 is worth the speedy delivery has nothing to do with the price of the product being delivered. It is dependent on the value gained to the specific customer by having the product more quickly, which can outweigh the cost of the product itself in some circumstances.

    To give an illustrative example, imagine that the $18 book is a textbook for a class in which you have a final exam tomorrow. The value you have for receiving the book today could easily outweigh the cost of the book + drone shipping, and 2 day delivery would make the book worthless to you (other than resale value). In other words, the marginal benefit of receiving the book more quickly easily could outweigh the marginal cost of faster delivery.

  2. “Amazon may be able top get a premium price for the Prime Air delivery service – customers who want their package within 30 minutes may be prepared to pay a premium of say $15 to $20 per delivery. Irrational for a book that costs $18, but as behavioral economics shows humans do not always act rationally.”

    This isn’t necessarily correct. Whether $20 is worth the speedy delivery has nothing to do with the price of the product being delivered. It is dependent on the value gained to the specific customer by having the product more quickly, which can outweigh the cost of the product itself in some circumstances.

    To give an illustrative example, imagine that the $18 book is a textbook for a class in which you have a final exam tomorrow. The value you have for receiving the book today could easily outweigh the cost of the book + drone shipping, and 2 day delivery would make the book worthless to you (other than resale value). In other words, the marginal benefit of receiving the book more quickly easily could outweigh the marginal cost of faster delivery.

    • > Perhaps Colin is in a country that uses commas where the US uses decimals.

      There’s a mix of styles:

      “Cost of transportation is another. Amazon’s total shipping costs in 2013 were $6,635 billion. They received shipping revenue of $3,097 billion and incurred overall losses of $3.538 billion related to shipping costs.”

      And the comma style should go with the language locale. AFAIK the only English language locale with comma as decimal separator is South Africa.

      • Thanks Andrew, I’m using exactly the same as Amazon in their annual report. But to be consistent with accounting standards I will amend all numbers to the same as $3.538 billion — good points — thanks to you both (and yes I’m in Europe:-))

    • Thanks Dave – the numbers are certainly billions – Amazon had Net Sales of US$ 74,452 billion in 2013 and US$183 billion cumulative over the last 3 years. Shipping and Fulfillment are highlighted as major cost factors in their annual report, and as the note to the accounts in the screenshot above indicate they expect these costs to increase. Hence the fact that they are working to reduce them through drones and other methods (eg. rolling out 10,000 Kiva robots in the fulfillment centers this year).

  3. Colin – why have a pilot dedicated full time to each drone? Instead, have the drones fly themselves during unremarkable portions of the flight, with pilots jacking in for the sensitive bits. Pilots could be assigned from a pool, too – no need to have the same pilot service a given drone throughout its flight. I bet you could predict resource requirements pretty accurately, so the size of the pilot pool could be closely watched.

    This way, you could have a fraction of a pilot per drone in the air. This should affect costs dramatically, no?

    • Great point Beau – multiple reasons for having a pilot. I should have been more explicit in the post, in the early stage (first 5 years of launch) — GPS lock will be an issue and other tech issues, Amazon also want to deliver within buildings as the majority of early deliveries will be in big cities, inside buildings GPS and other navigation methods can drop as they do on smartphones.

      Plus inside buildings sense and avoid is a big issue for drone manufacturers hence Amazon are looking at swarm approach. e.g. by 2019 they estimate 100,000 deliveries in NY city – that would mean 3,500 drones flying in NY just for Amazon at any one time – imagine FedEx, UPS and others flying commercial drones too at the same time.

      You are right though the numbers are based on the start up phase moving to full autonomy. Reading the regulations and looking at the history of eg military drones (which have an Enormous crew) the costs are based on the initial period at launch through several years and exclude R&D costs. I think it will be a good 4 to 5 years before the pool you suggest could be in place – but also it could be 4 to 5 years before Amazon get to the swarm level.

  4. Not sure this is such a good idea. Lately I’ve been watching a documentary series about drones Monday nights on Fox. The verdict? Much death and dismemberment already and it’s only at hour 5 of 12!

  5. Pingback: The 4 Reasons Amazon Is Dead Serious About Its Drone Delivery Service | Bawlbuster

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