TUNKHANNOCK, Pa.—Atop a hill at the end of a road called P&G Warehouse Way sits a warehouse stocked with Pampers diapers, Bounty paper towels and other items made by Procter & Gamble Co. It also houses an ambitious experiment by Amazon.com Inc.
Each day, P&G loads products onto pallets and passes them over to Amazon inside a small, fenced-off area. Amazon employees then package, label and ship the items directly to the people who ordered them.
The e-commerce giant is quietly setting up shop inside the warehouses of a number of important suppliers as it works to open up the next big frontier for Internet sales: everyday products like toilet paper, diapers and shampoo.
The under-the-tent arrangement is one Amazon's competitors don't currently enjoy, and it offers a rare glimpse at how the company is trying to stay ahead of rivals including discount chains, club stores and grocers.
Logistics have long been crucial to success in retail. Years ago, Wal-Mart Stores Inc. set up a system that lets suppliers monitor what needs to be replenished.
Amazon instead is going out to its suppliers with a program it calls Vendor Flex. By piggybacking on their warehouses and distribution networks, Amazon is able to reduce its own costs of moving and storing goods, better compete on price with Wal-Mart and club stores like Costco Wholesale Corp., and cut the time it takes to get items to doorsteps.
A few of Amazon's rivals have caught wind of the arrangement and aren't happy about it. "Retailers don't like things that benefit their competitor but not them," said Anne Zybowski, vice president of retail insights at consulting firm Kantar Retail.
Yannis Skoufalos, P&G's global product supply officer, said the company values its relationships with all its customers and works closely with many retailers to help reduce costs in their supply chains and meet their unique needs. For example, P&G works with warehouse clubs to keep its products in stock without taking up too much storage space inside the stores.
Household staples have traditionally been considered too bulky or cheap to justify the cost of shipping. Americans currently buy just 2% of such goods online, retail analysts estimate. Yet even that sliver of business was worth $16 billion in 2012, according to Nielsen Holdings NV, and the research firm believes online sales will grow by 25% a year to $32 billion in 2015.
Consumer-products makers selling through Amazon like the idea of locking shoppers into their brands with the subscription program, and in some cases help fund the discounts. AFP/Getty Images
More efficient distribution and changing consumer habits are unlocking the market. If online sales of consumer packaged goods could rise to the 6% share the Internet claims of retail overall, Amazon could generate an extra $10 billion in revenue selling nonfood consumer goods, up from less than $2 billion currently, estimates Mark Mahaney, an Internet stocks analyst at RBC Capital Markets in San Francisco.
"This is one of the biggest growth areas for Amazon," Mr. Mahaney said.
"We continue to innovate on behalf of our customers to offer fast delivery, low prices, and vast selection," an Amazon spokeswoman said.
The company signaled its interest in selling consumer staples online with its $500 million acquisition in 2011 of Quidsi Inc., the owner of Diapers.com and Soap.com that subsequently added sites selling toys and pet supplies, among other things.
P&G began sharing warehouse space with Amazon around three years ago and has expanded the practice. Amazon is now inside at least seven P&G distribution centers world-wide, including spots in Japan and Germany, said a person familiar with the matter.
The economics of the arrangement benefit both sides. For Amazon, co-location reduces the cost of storing bulky items like diapers and toilet paper and frees up space for the Web retailer to stock higher-margin goods in its own distribution centers. The location in northeastern Pennsylvania is 5 miles from one of P&G's largest plants, which makes diapers, paper towels and toilet paper, and within a day's drive of major cities in the U.S. Northeast and Canada. The warehouse also stocks other P&G products from pet food to razors to shampoo.
P&G, meanwhile, saves on the transportation costs that it would have incurred trucking products to Amazon's regional distribution centers. Plus, it gets Amazon's help in boosting online sales, a priority for many in the industry.
Amazon is already inside or in talks to enter the warehouses of companies including Seventh Generation Inc., Kimberly Clark Corp. and Georgia Pacific Corp., people familiar with the matter said.
Seventh Generation said it is in talks with Amazon to ship its diapers, baby wipes and cleaning products directly from its warehouses. Chief Executive John Replogle said more than 20% of the Burlington, Vt., company's sales come via the Internet—a percent that has doubled from five years ago, he said.
"This is the fastest-growing part of our business," Mr. Replogle said.
Kimberly Clark and Georgia Pacific declined to comment.
Amazon—which posted $61 billion in sales in 2012, up 27% from a year earlier—has a service called Subscribe & Save to tap into that area of growth. With items like vitamins, cereal and toilet paper, Amazon automatically ships them to customer's doorsteps on a regular schedule. Shoppers that buy at least five eligible items per shipment get a 15% discount.
Consumer-products makers selling through Amazon like the idea of locking shoppers into their brands with the subscription program, and in some cases help fund the discounts.
Clorox Co., whose Brita water filters, Burt's Bees skin-care products, and namesake disinfecting wipes are increasingly sold online, often via Amazon, is expecting companywide sales from e-commerce to hit $200 million in 2020, up from $75 million in the fiscal year ended in June.
A.G. Lafley, P&G's recently returned CEO, has identified e-commerce as one of the biggest opportunities for the Cincinnati-based company, which is trying to accelerate sales in an economic environment where growth is hard to find. P&G doesn't disclose what percentage of its sales come via the Internet, but the growth is faster than other retail channels, notes Bernstein Research analyst Ali Dibadj. P&G's Pampers and Luvs diapers, Duracell batteries, Gillette razor cartridges and Braun shavers are among the items that consumers are increasingly buying online, company executives say.
In recent years, P&G's online sales of diapers have grown sharply. The company's goal is to get consumers who buy diapers online to add more of its products like skin cream and laundry detergent to their orders as well.
P&G has long honed its ability to sell products in physical stores with shrewd in-store marketing and packaging designs. But it is a neophyte in the world of online sales and could use Amazon's help.
"They need to figure out what they can do to influence online sales," said Mr. Dibadj. "This is a whole new world for P&G."
—Greg Bensinger contributed to this article.
Write to Serena Ng at serena.ng@wsj.com