Analysis: Amazon Air And ATSG Grow Together

Amazon's announcement that it will lease 12 all-cargo aircraft from a key contract carrier  demonstrates how the online retail and logistics giant has created a formidable private airline in the span of four years to keep up with the enormous growth of e-commerce.

The additional Boeing 767 freighters will expand Amazon's AMZN fleet beyond 80 aircraft by the end of 2021, and a new report from researchers at DePaul University in Chicago estimates Amazon Air could have about 200 aircraft at its disposal in seven to eight years. Amazon Air now operates almost 100 flights per day despite focusing primarily on North America, it said.

Having an air network to complement its ubiquitous ground-based shipping network allows the company to better control price and performance for overnight and two-day delivery promised to 105 million Prime members, and move inventory between fulfillment centers. Analysts say that having an in-house airline not only helps its own supply chain but positions Amazon to offer third-party, end-to-end logistics services like those of FedEx FDX and UPS UPS

The new aircraft stem from a December 2018 deal with Air Transport Services Group ATSG that gave Amazon options for 17 aircraft and increased rights to own a piece of its business partner. The dozen aircraft will be leased for 10 years, with options for Amazon to extend the term for three years, according to ATSG.

One of the converted freighters entered service last month and ATSG's leasing arm, Cargo Aircraft Management, is scheduled to deliver the remainder next year. More than two dozen CAM aircraft, flown and operated by sister company Air Transport International, are in service with Amazon today. CAM expects to have 31 of the midsize freighters under lease with Amazon by the end of the year and 42 in service by year-end 2021.

CAM typically purchases passenger planes that are 15 to 20 years old and then manages their conversion into freighters.

Amazon has not made a decision yet on who will operate the latest tranche of aircraft, a spokesperson said, but if history is precedent they will go to Air Transport International. Amazon is ATSG's second-largest customer after the Department of Defense and accounted for 23% of its revenue last year.

In exchange for the commitment for 12 more leases, Amazon will receive 7 million warrants to purchase ATSG stock, increasing its potential ownership stake to 38%. If Amazon leases five more aircraft under the 2018 deal, its equity stake in ATSG could reach 40% — double the investment rights granted in the initial 2016 partnership. So far, Amazon has not exercised any of the warrants granted by Wilmington, Ohio-based ATSG. 

Diversified carrier strategy

Amazon recently added Sun Country to its roster of outsourced air transport providers. The e-tailer last summer leased 15 converted Boeing 737-800 freighters from GE Capital Aviation Services and plans to place 10 of them with Sun Country, a traditional passenger airline that launched its cargo operation in late April. The aircraft are suitable for smaller markets where a 767 freighter — the model that dominates the Amazon Air fleet and has a 187,000-pound maximum payload — is not necessary. 

Amazon's other primary provider of leased aircraft and outsourced airlift, besides ATSG and Air Transport International, is Atlas Air Worldwide, which operates planes under its Atlas Air and Southern Air brands.

Having multiple air subcontractors spreads Amazon's risk, especially as it relates to labor relations with pilots, analysts say. Atlas Air, for example, has been embroiled in contentious contract talks with the Teamsters union for a long time. Last year, disaffected pilots conducted work slowdowns and sick-outs that led to service disruptions and Amazon transferring flying responsibility for two planes to ATSG.

"What Amazon has done is create a firewall around having direct exposure to pilot labor and pushed that to subcontractors," Brian Clancy, a partner at Logistics Capital & Strategy, told FreightWaves. "They want as many viable subcontractors within each of the payload range segments. They're trying to create an ecosystem where subcontractors are fungible. Next man up. I can plug and play.

"If you read the fine print on any of these contracts, they might have a contractual duration that might be multiyear, but when you look at all the outs, all the footnotes, they are very flexible to Amazon," Clancy said.

The Sun Country-Amazon marriage is timely for both parties, Clancy added. Amazon gets another partner it can play off against others, and Sun Country, now owned by private equity group Apollo Management, is in growth mode. 

Some of Amazon Air's future expansion could be in the form of smaller airlines, such as twin-engine turboprops or the Cessna 208B Super Cargomaster used by FedEx Express, or through the acquisition of another cargo airline, suggests the DePaul University study authored by Professor Joseph Schwieterman. And Clancy said at some point it will make sense for Amazon to upsize to Boeing 777 or MD-11 aircraft for international and domestic trunk routes.

Airport hubs

Amazon still relies heavily on FedEx Express and UPS for domestic air transport and DHL to haul international shipments. UPS, by comparison, operates about 265 aircraft and has about 300 aircraft in its fleet, when charters and lease are included. DHL Express operates over 260 dedicated aircrafts with 17 partner airlines, including Southern Air and ATSG subsidiary ABX Air. FedEx, the largest air cargo operator in the world, operates 679 planes (398 truck aircraft and 282 turboprop feeder planes), according to its latest quarterly report. 

Amazon's air network is decentralized and not designed to ensure nationwide next-day delivery, as FedEx and UPS systems do. Instead, Amazon air stations are located at secondary, cargo-friendly airports near major warehouses and within a day's truck drive of fulfillment centers.

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(Source: Chaddick Institute for Metropolitan Development, DePaul University)

Amazon this summer plans to open a 42-acre air terminal at Lakeland Linder International Airport, a general aviation airport near Tampa, Florida, after last month picking San Bernardino International Airport outside Los Angeles as its western hub and opening a regional hub at Fort Worth Alliance Airport in Texas last September.

"Amazon Air's network does not yet have the breadth to allow Amazon to provide the same range of service as FedEx and UPS. It is designed partially to compete with — and partially complement — the services of these other companies. Such complementarity is reflected in the fact that three of the five airports having the most Amazon Air flights — Cincinnati, Chicago Rockford and Ontario, Calif., — are large hubs for air-freight integrators," the DePaul report said.

FedEx and UPS also operate at San Bernardino airport and FedEx has a sort facility at Alliance Airport.

Amazon still is predominantly oriented toward second-day delivery, which makes having late-night flights less critical. About three-quarters of the Amazon Air flights evaluated by the DePaul researchers depart between 6 a.m. and 11 p.m., versus overnight for the big express carriers. Although FedEx and UPS schedules are highly predictable, Amazon's vary considerably.

"Amazon Air marches to the beat of a different drummer than FedEx or UPS.  It is more likely to operate flights during the daylight hours, operate from cargo-focused airports having little passenger traffic, and dynamically change schedules from one day to the next," Schwieterman said in an email.

Amazon is on track to open its primary air hub at Cincinnati/Northern Kentucky International Airport in 2021, which includes a $1.5 billion, 3 million-square-foot sortation facility. Amazon is currently using DHL's facility there to sort packages and service aircraft for Amazon's 14 routes from the airport. The ability to eventually handle 100 aircraft per day in a hub-and-spoke system could alter Amazon's approach.

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