Dive Brief:

• Amazon bore $6 billion in added Q1 costs as it faced excess fulfillment and transportation capacity in addition to less efficient warehouses and inflationary pressures, CFO Brian Olsavsky said on the company's earnings call Thursday.
• While some of Amazon's fulfillment network hires during the quarter covered employee absences amid the omicron variant surge, the company "quickly transitioned from being understaffed to being overstaffed, resulting in lower productivity," according to Olsavsky.
• With demand cooling off from pandemic-driven highs, Amazon is now focused on improving operational productivity and cost efficiencies rather than growing its staffing and network capacity, Olsavsky said. The company had a peak of 1.7 million employees in Q1 but "were able to work that down" to 1.6 million by the quarter's end.

Dive Insight:

Amazon's growth has skyrocketed throughout the pandemic, doubling the size of its operations and nearly doubling its workforce over a two-year period.

"Capacity decisions are made years in advance, and we made conscious decisions in 2020 and early 2021 to not let space be a constraint on our business," Olsavsky said. "During the pandemic, we were facing not only unprecedented demand, but also extended lead times on new capacity, and we built towards the high end of a very volatile demand outlook."

The tide has turned, however, as consumers have slowed their e-commerce spending activity in recent months. Net sales at Amazon's online stores dropped 3% YoY in Q1, while Amazon's fulfillment expenses jumped nearly 23%. UPS, which counts Amazon as its largest customer, reported an unexpected drop in home delivery volume earlier this week. March e-commerce sales saw their weakest gain in more than three years, per GlobalData research.

Amazon aims to rightsize its massive fulfillment network in response to demand now falling back to pre-pandemic levels. But this process won't happen overnight — Olsavsky said it will take several quarters for Amazon to grow into the current capacity it has built out. The company expects to take a $4 billion hit in Q2 in connection to lower productivity, overcapacity and inflationary pressures.

Excess labor and fulfillment capacity also represent a shift in problems than those Amazon executives have detailed on previous earnings calls.

In July, the company was focused “squarely on adding capacity to meet the current high customer demand,” Director of Investor Relations Dave Fildes said at the time. Three months later, Olsavsky said labor was the company's "primary capacity constraint," creating $4 billion in added costs. In early February, omicron added to Amazon's staffing challenges.

On Thursday's call, Olsavsky detailed how conditions changed after Amazon had staffed up to avoid labor constraints.

"We hired more people and then found ourselves overstaffed when the omicron variant subsided rather quickly, at least from our standpoint in warehouses," he said. "So, the issue has switched from disruption to productivity losses to overcapacity on labor."

One issue that has been present throughout the past year is inflation, specifically for transportation costs and wages. The war in Ukraine has amplified inflationary pressures as fuel costs have climbed, and Amazon is looking for ways to offset the higher prices. This year, it hiked the price of its U.S. Prime membership and introduced its first fuel and inflation surcharge for sellers using its fulfillment services.

Amazon is among the companies that will continue to face pressure to increase prices and reduce operating costs in response to inflation, Edge by Ascential CEO Deren Baker said in emailed comments.

"Amazon has had a challenging quarter, however, the challenges that the company is facing are shared throughout the retail sector," Baker said. "Inflationary pressures and rising shipping and logistics costs put pressure on retailers and brands across the board."