If the FAA gives Amazon clearance for commercial rollout of its drone delivery service, Prime Air could deliver a five-pound package for $1 in 30 minutes. Here’s how.

Editor’s Note: This article was republished in its entirety with permission from ARK Invest.

In December of last year Amazon announced Prime Air, the company’s plan to deliver future packages by drone. While the media and others mocked this announcement, UAV delivery is likely to disrupt traditional package delivery significantly.

If the FAA gives Amazon clearance for commercial rollout of its drone delivery service, the price that a consumer would pay for the delivery of a five-pound package could be as low as $1.1 Just as impressive, delivery times could drop below thirty minutes.

We believe that there are at least 400mm annual shipments from Amazon to US customers that would be eligible for drone delivery. The drones are relatively inexpensive so an investment of less than $100mm could prove sufficient for the cost of the drones and support infrastructure.

Combined with service, maintenance and fueling of the drones we believe that Amazon would have to spend roughly $300mm annually to support the drone delivery program at full penetration. 400 million packages delivered for $300 million in operating expenses and with a $100 million capital investment implies that Amazon could earn a healthy return on capital pricing the service at $1 per delivery.

As shown below, Federal Express (FDX) and United Parcel Service (UPS) cost 8-13 times more for much longer delivery times for a small package.

Pricing for Fedex, UPS, and USPS assumes a 5 lb. package delivered from Amazon’s HQ to an address 9 miles away in Bellevue, WA. Dimensions are 8-5/8? x 5-3/8? x 1-5/8. Rates shown are the quickest, cheapest ways to deliver the package using each vendor.

Consumers will enjoy low cost and convenience, while Amazon stands to make considerable profit. At $1 per package, Amazon’s internal rate of return on its UAV investments should exceed 120%. Because delivery of a five pound package will cost $0.14,3 the margin will allow Amazon to break even after the first year. High return is achievable even with estimates for infrastructure, drone investment, and operating expenses, which are primarily labor driven. We assume that human operators are responsible for drone landing and takeoff.

We assume takeoff and landing of all drones is done manually for regulatory, safety and technical reasons. Amazon would likely have to hire thousands of drone operators who would be tasked with remotely monitoring drone landings. If Prime Air were off the ground in the US, this could provide hundreds of millions of dollars in wages to US employees. We assume each operator would be responsible for less than a handful of drones.

However, depending upon the operating expenses of the program it may make strategic sense for the company to effectively offer the program free to Prime members across all its major US metros.

Before US drone delivery becomes a reality, Amazon faces significant regulatory hurdles. The FAA approves commercial use of drones on a case-by-case basis, and regulations are stringent. The agency recently granted Amazon approval for drone testing, but the drones are not allowed to fly over public property, and must be in an operator’s line of sight at all times. Until the rules change, US commercial rollout of Prime Air seems unlikely.

Aside from regulatory hurdles, Amazon must address the safety and reliability of drones. A common criticism is that “see and avoid” technology needs significant improvement. Newer systems do have air traffic control and crash prevention technology. For Amazon, cameras could be part of the solution allowing remote operators to control takeoffs and landings.

While the FAA has been dragging its feet, Amazon has taken advantage of less strict drone regulations abroad. Prime Air development centers are located in the UK and Israel, and test flights have been conducted in Canada and India. If the FAA is too slow to relax US drone restrictions, Amazon will initially launch Prime Air internationally.