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MAE214 | Economic Strategy for Business Assignment 1 | Economics

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1.  Amazon, FedEx, and UPS: Friend or Foe?
Amazon founded by Je¤ Bezos in 1994 and based in Seattle, Washington, is the world’s largest e-commerce marketplace and well-known for its disruption of well-established industries through technological innovation and mass scale. It is the largest Internet company by revenue in the world and the second largest employer in the United States. In 2005, Amazon launched Amazon Prime, a membership service o¤ering free two-day shipping within the contiguous United States on all eligible purchases for a ”¡at annual fee of $79. The service has proven to be a hit: there were 25 million Amazon Prime subscribers in Dec 2013, and the number has increased to more than 103 million in March 2019. From 2009 to 2018, Amazon’s worldwide shipping costs have grown …fteenfold, and the net sales increased by sevenfold in the same time. Accordingly, Amazion had to increase the annual subscription fee signi…cantly, and currently it charges $119 per year for the service.

FedEx founded in 1971 and headquartered in Memphis, Tennessee, is an American multinational courier delivery services company and known for its overnight shipping service and pioneering a system that could track packages and provide real-time updates on package location. The main operating unit, FedEx Express, provides next day air service within the United States and time-de…nite international service. FedEx Express operates one of the largest civil aircraft ”¡eets in the world and the largest ”¡eet of wide-bodied civil aircraft; it also carries more freight than any other airline. FedEx ranked No. 50 on the 2018 Fortune 500 list of the largest United States corporations by total revenue.

UPS founded in 1907 and headquartered in Sandy Springs, Georgia, is an American multinational package delivery company with its primary business in the time-de…nite delivery of packages and documents worldwide. Launched in 1988 to provide air delivery services, UPS Airlines became the fastest-growing airline in FAA history and today is the 10th largest airline in the United States. UPS ranked No. 44 on the 2018 Fortune 500 list of the largest United States corporations by total revenue.

In the following, we setup a simple game to analyze Amazon’s strategic partnership with FedEx and UPS, and its decision on vertical integration. Suppose Amazon estimates that the total number of purchases (and hence the number of deliveries) from all of its Amazon Prime members in the US each year can be approximated by the following equation:
D(t) = 500 + 400    (t    2013);

where D(t) represents the number of purchases (in millions) in year t; and t 2013: For example, in 2013, it is estimated that the number of purchases from its US Amazon Prime members is D(2013) = 500 + 400 (2013 2013) = 500 millions, and in 2019 this number is expected to increase to D(2019) = 500 + 400 (2019 2013) = 2900 millions. To provide the delivery service to its Prime members, Amazon has the following two options:
Option 1 (Vertical Integration). Amazon provides the delivery service by itself
Option 2 (Outsourcing). Amazon forms partnership with either FedEx or UPS, or both
To go with Option 1, Amazon has to build its own delivery ”¡eet and network, which incurs huge …xed costs. The yearly total cost (in millions) for Amazon to deliver parcels on its own is
T C(q) = 2000 + 2:1q;
where q is the number of parcels delivered (in millions). For example, if Amazon delivers 100 million parcels in a year, then the total delivery cost is T C(100) = 2000 + 2:1 100 = 2210 millions.

To go with Option 2, Amazon invites both FedEx and UPS to play the following two-stage game. In the …rst stage, both …rms simultaneously submit delivery service piece-rate fares to Amazon. Let FF denote the fare submitted by FedEx, and FU denote the fare submitted by UPS. FF and FU could be one of the following three values: $7 (high markup), $6 (medium markup), and $5 (low markup). In other words, each …rm has three strategies in this simultaneous bidding game. In the second stage, Amazon chooses to form partnership with the …rm that submits the lowest fare. If both …rms submit the same fare, then Amazon forms partnership with both …rms and they share the delivery duties equally. Both FedEx and UPS share similar delivery technologies which exhibit economies of scale, and the average cost for each …rm in year t with q parcels (in millions) delivered is
AC(q; t) = 250q + 4:2    0:08    (t    2013):

For example, if FedEx delivers 100 million parcels for Amazon in 2013, then FedEx’s average cost of delivery in 2013 is 250100 + 4:2 0:08 (2013 2013) = 6:7: Each delivery

The contract (partnership) between Amazon and the delivery …rm is renewed annually.
We …rst would like to determine Amazon’s optimal strategy in 2013 following the steps below:
(a) Calculate Amazon’s total shipping cost in 2013 under Option 1.
(b) Under Option 2, construct the payo¤ matrix (in millions) for the bidding game between FedEx and UPS in 2013. Find the equilibrium fare quotes, FF and FU ; in this game.
(c) Calculate Amazon’s total shipping cost in 2013 under Option 2 based on your answer in (b).
(d) Which option is Amazon’s optimal strategy in 2013? Justify your answer.
(e) Redo (a)-(d) for t = 2018:
(f) Suppose that under Option 1, Amazon is subject to a capacity constraint of M million parcels; that is, Amazon can take shipping in-house up to at most M million parcels per year. Redo (a)-(d) for t = 2019 with this additional restriction. In particular, show that Amazon’s decision on doing shipping in-house or not depends on the value of M:
(g) First go over the following two news articles:
Amazon is rapidly expanding its air ”¡eet to handle more of its own shipping (Feb 19 2019, CNBC News)
Amazon Delivers Its Shipping Intentions to FedEx, UPS, USPS via Regulatory Filing (Feb 5 2019, Fortune)

According to those reports, Amazon is aggressively expanding its air ”¡eet to rely less on FedEx and UPS in recent years. Early this year, Amazon introduced Scout robots that will do short-distance deliveries for Amazon customers in the near future. The following …gure also shows that in 2013, Amazon oursourced all of its deliveries to major shipping companies, while in 2018 26% of Amazon’s purchase deliveries were done in house. Are those simple “empirical …ndings” consistent with the theoretical results obtained in (d)-(f)? Do you agree with Amazon’s strategic direction of moving more shipping in-house? Based on your answers in (d)-(f), what are key determinants for a …rm to decide whether to pursue vertical integration (or tapered integration) or not?
(h) (2 Marks) First go over the following news articles:

FedEx says it will no longer deliver Amazon packages with its fast shipping service (June 7 2019, Business Insider)
A key metric in FedEx’s …nancial statements underscores why the shipping giant dropped Amazon as a customer (June 27 2019, Business Insider)
FedEx stopped ”¡ying your Amazon Prime packages in June because the partnership wasn’t pro…table enough — and UPS has the same problem (July 11 2019, Business Insider)

According to those reports, FedEx made a strategic decision to not renew its Express service contract with Amazon in June 2019. On the other hand, UPS is committed to support and maintain a long-term partnership with Amazon. Based on your answers in (d)-(f), explain why the two …rms made such di¤erent strategic decisions.

2. Business Proposal: The Empire of Amazon was started out of Je¤rey P. Bezos’ small garage, and the global social media giant Facebook was started as a college website design project. So every great story has a humble beginning.
Here is the beginning of your great business story. The purpose of this exercise is to get you to learn how to write a real (but shortened) business proposal. First read the following interesting and successful business story of Honest Tea at https://www.honesttea.com/our-story/. This story tells us that to start a business you should ask yourself the following questions:
   (i) Can you …nd a (pro…table) gap in the market?
  (ii) What products or services will you business provide to …ll this gap?
 (iii) What is the mission or philosophy of your business?
  (iv) How to position your products or services in the market?
   (v) What is your pricing strategy?
  (vi) What is your marketing strategy?
 (vii) Who will be your main competitors?
(viii) What are your competitive advantages in the market?
  (ix) How to maintain your competitive advantages?

Now do some brainstorming and come up with a real and feasible business idea with your group members. Then you can start to write a concise business proposal to your potential investors/customers.
You may use the original business plan of Honest Tea as a template, or you may use the template here: Plan. Most banks provide useful information for people who would like to start a business. The following are from NAB and ANZ:

Your business proposal should include the following elements:
  (i) Mission Statement
 (ii) Company Story (brief and to the point)
(iii) Product/Service Description and Production
 (iv) Pricing and Product Positioning
  (v) Market Opportunity, Competitive Advantage and Marketing
Most importantly, YOU MUST UTILIZE THE CONCEPTS LEARNED IN THIS UNIT TO WRITE THIS PROPOSAL. The proposal should be about 8-10 pages. Use …gures wherever possible –usually they are more informative than words. Marking of the proposal is based on the following criteria: (i) Completeness, (ii) Readability, (iii) Feasibility, and (iv) Creativity.

3. Individual Re”¡ection:
This question asks you to write an individual re”¡ection (rather than a group re”¡ection): Each member in the group should submit her/his own re”¡ection. Thinking back to your learning so far in this unit and your time at Deakin, re”¡ect on the value that the economics discipline has brought to your proposal, and to business more broadly. Include in your re”¡ection (recommended: 100 words per dot point):
(a) How economic theory enhanced the development of your business proposal
(b) How economics o¤ers valuable analysis and insights to industry. Link your discussion here to recent problems in business or government discussed in the media.
(c) Link the skills that you have discussed to the Economic Learning Standards for Australian Higher Education (ELS). Which of these skills have you utilised in this assignment, and how? In which areas do you see room for improvement in your own professional development?
(d) Aside from working as an economist, what other job roles are of interest to you? Discuss at least two non-economist opportunities (e.g. consider graduate roles). DeakinTALENT’s Jobs and Internships listing will be useful here.
Please remember that when writing re”¡ectively, it is expected you write in the …rst person (i.e. ‘I’ or ‘me’), or ‘we’in the context of teamwork.

Resource on re”¡ective writing:

An interesting resource is the Economic Society of Australia’ resource on why students should study Economics: http://esacentral.org.au/news/16007/study
F Late assignments will not be accepted without a valid excuse.
F In a group assignment, as a group member, you need to make sure that you communicate well with group members, maintain good group dynamics and keep things on the right track. Deakin’s group assignment policy can be found here:

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