DC Velocity - Digital 2018

about the profitability problem last December during the company’s quarterly analyst call, acknowledging that there are e-commerce shipments it doesn’t make any money on. T. Michael Glenn, FedEx’s number-two executive until he retired at the end of 2016, said on the call that FedEx had “discontinued relations with a few customers” during the peak holiday season because their shipping profiles didn’t align with the company’s objectives of volume expansion and yield improvement.

Steve Gaut, UPS’s chief spokesman, said in an e-mail accompanying its fourth-quarter results on Jan. 31 that the company must be “appropriately compensated” for the costs of expanding its physical and IT networks. At UPS, where B2C traffic in 2018 is expected to exceed busi-ness-to-business (B2B) volumes for the first time ever, 2017 capital expenditures will total $4 billion, up more than 30 percent from 2016 levels.

UPS is spending hundreds of millions of dollars to automate its “tier one” U.S. hubs that today handle a little more than half its domestic volume. The modernization should improve network productivity by up to 25 percent when the work is done sometime in 2019. This will allow UPS to route up to 60 percent of its total U.S. ground volumes through tier-one hubs, according to Rob Martinez, president and CEO of Shipware LLC, a consultancy.

FedEx Ground, the ground parcel unit that handles the
bulk of FedEx’s e-commerce deliveries, has added four
major U.S. hubs and 19 automated stations in the past year
alone, a 10 million-square-foot expansion. Smith called the
pace of the build-out “one of the most remarkable things
I’ve seen in my career.”
However, massive investments will take a bite out of the
carriers’ revenues if the traffic mix isn’t optimal. UPS’s
fourth-quarter revenue came in lighter than expected, in
part because more customers used its cheaper “SurePost”
service, where shipments are tendered to the U.S. Postal
Service (USPS) for last-mile delivery, rather than moving
solely through the UPS network, where the company could
charge more. Wall Street proceeded to punish UPS’s share
price in the short run; from Jan. 31 through Feb. 2, the
price of UPS’s shares fell about $11 a share. FedEx shares
fell about half that amount. (Both companies’ shares have
rebounded as of Feb. 10, the day this story was filed.)

At UPS, domestic B2C operating margins have ranged between 10. 9 percent and 14. 7 percent from the start of

2013 through the fourth quarter of 2016, according to SJ data. However, B2C margin growth has been compressed, albeit slightly, over that time. From the end of 2013 through the end of last year, domestic margins have fallen by 0.6 percent, SJ said. (See Exhibit 2.)

A ROBUST TOOLKIT

Retailers should take heed of the carriers’ comments about price adjustments. First off, there aren’t many alternatives. USPS offers low prices and abundant last-mile capacity, but Smith on the analyst call argued that as a primarily last-mile carrier, USPS doesn’t have the capabilities to deliver the so-called “upstream” services to parcel shippers and their customers. Then there is Amazon.com Inc., the Seattle-based e-tailer that is building out a transport and logistics network to fulfill orders placed on its website as well as those of third-party merchants using Amazon’s services. Amazon has been taking merchant business that used to belong to FedEx and UPS, according to Jindel. In addition, many of Amazon’s direct customers were once the customers of retailers that used FedEx and UPS, Jindel said. Still, for retailers already competing with Amazon, using its delivery services would be akin to sleeping with the enemy.

If history is any guide, UPS and FedEx will find ways to surmount the e-commerce challenge. They raise their published rates annually, though they often agree to givebacks in return for large volumes. They have squeezed retailers in recent years by charging more for shipments that fail to meet certain dimensional parameters, and they continually impose an array of “accessorial” charges, fees for services beyond the basic delivery.

The carriers also laid down the law this past peak season, putting retailers on notice that the rules of the game had changed. Both adjusted their time-definite express delivery commitments during the critical final week before