While all transportation sectors have had to deal with huge volume upticks related either directly or indirectly to e-commerce expansion, parcel has probably faced the biggest challenge. UPS and Fedex—which control the lion’s share of the domestic parcel business—continue to adjust and fine-tune their operations to handle the growth while trying to increase profit margins.
A two-part challenge
The basic issue for all parcel carriers is that their companies were built on serving business-to-business (B2B) customers. Usually this meant delivering numerous parcels from one origin to one destination, such as repair parts from a national supply depot to a limited number of industrial destinations. Typically, these destinations were constructed for receiving many packages every day and located in population centers.
Business-to-consumer (B2C) e-commerce shipments, on the other hand, require deliveries of single parcels to many destinations—usually someone’s residence, often located in a suburb. The rise in e-commerce shipments led to a decline in delivery density for parcel carriers, which radically altered their cost structures. Carriers’ costs rose because their trucks were having to travel greater distances.
Additionally, parcel carriers historically based their pricing on shipment weight, and there was no incentive for shippers to be efficient in packaging. E-commerce increased the number of lightweight shipments that were being packaged in overly large boxes using excess packaging material. The rise in e-commerce made it more difficult for parcel carriers to pack their trucks efficiently and reduce their asset utilization. This served to give the carriers a twofold blow in terms of cost control, as weight per shipment declined at the same time that their trucks were driving longer distances for delivery.
Parcel carriers responded to the packaging issue by introducing dimensional weight to ground parcels in 2015. With dimensional weight pricing, parcel carriers set a density target, and any parcel that falls below that threshold will be charged more than its actual weight to make up the deficit. Since then, carriers have continually changed the formula that they use to calculate dimensional weight, so that shippers have had to pay more for lightweight packages.
UPS and FedEx responded to the distance issue by partnering with the United States Postal Service (USPS) to handle the final delivery segment for them. UPS named their service “SurePost,” while FedEx branded their offering as “SmartPost.”
Stress at the USPS
These changes seem to have helped UPS and FedEx to successfully navigate the increase in e-commerce business. In the first quarter of 2021, UPS reported a much improved margin with revenue up 10.2% from last year while cost increased only 2.2%. In its last financial reporting, FedEx posted year-to-year sales growth of 20% while operating margin improved from 19.2% to 24.8%.
The Post Office, however, continues to struggle with the increase in parcel shipping. A recent U.S. Government Accountability Office analysis reported that the USPS had lost $69 billion over the past 11 fiscal years. For 2020, the Post Office posted a loss of $9.2 billion, while revenues increased by $2 billion to a record $73 billion. As one would expect, package delivery ramped up sharply for the year, growing 19%, while traditional mainstays first-class mail (-4%) and advertising mail (-15%) both declined.
The reality is that the Post Office was built for mail, not parcels. All of its internal sorting equipment and conveyors were designed for letters. Earlier this year, USPS did announce a $100 surcharge on any oversized parcel with a length and girth exceeding 130 inches. This indicates that while USPS isn’t as aggressive in pricing as the big parcel carriers, it is aware of the extra cost associated with freight that doesn’t suit its internal handling system.
Nevertheless, USPS still needs to spend a lot of money to really gear up for parcels. But it is unlikely that Congress will approve the needed cash infusion to make things better, given that the Post Office’s annual losses are in the billions of dollars. So do not look for any improvement soon. Instead, the sorry state of the Post Office is that the more parcel business it does, the more money it loses. And as the Postmaster General told Congress, there is no end in sight for USPS fiscal woes.
The quest for efficiency
Improvements and changes are continuing to happen at UPS and FedEx, however. In late January—about six months after Carol Tomé took over as the first woman and first non-UPS employee to lead the company—UPS announced the sale of its less-than-truckload (LTL) unit. Many shippers shrugged off this move with the observation that since they used UPS only for parcel freight, the sale made no difference to them. To the contrary, the impact of this move on the parcel sector is just becoming evident.
Tomé announced that the company’s objective was to be better … not necessarily larger. In other words, after the sale, the company planned to be laser focused on the parcel sector. As I see it, for parcel shippers, this means higher prices, and for UPS, increased profitability.
One example of that focus is that UPS has begun to emphasize services for small companies, including the creation of a small shipper solutions team. These types of shippers no doubt appreciate the shipment tracking, expert advice, and financial services now offered through a partnership with Chase Bank. But the new offering is also beneficial for UPS because it means the company is dealing with shippers that have less negotiating strength than large companies, thus delivering better pricing to UPS.
At the same time, many large shippers have been given significant rate hikes with the accompanying message of either pay up or find another parcel carrier. The largest shippers have also learned that they will be hit with higher UPS shipping costs for the 2021 holiday season. Like it did in 2020, UPS has announced it would impose big surcharges for the peak shipping period between October 31 and January 15. This year’s surcharges will be applied to companies that tendered more than 25,000 packages during any week following February 2020, the last month of normal business before the COVID-19 pandemic. At the extreme, the surcharge could be as high as $6.15 per package if shipments exceed 500% of the established threshold. The parcel threshold is based on combined volume of all residential air and ground shipments, as well as parcels moving via SurePost. It is worthwhile noting that the key designation is “residential” which clearly indicates how sensitive UPS is to the impact of e-commerce.
Further, parcels requiring “additional handling” are already bearing a fee of $3.50 per package—a 16% increase above normal pricing. For peak shipping (October 3 through January 15) that fee will jump to $6 per package. Surcharges on oversize parcels just increased 27% to $40 per package and will leap to $60 per package for the October 3 through January 15 time period.
The real pain for shippers will come from parcels exceeding the UPS size limit, meaning they cannot be conveyed and must be handled manually through the system. On October 3, the oversize parcels will absorb a $250 surcharge on top of the normal $920 charge. The added cost will send the message that if a shipper is foolish enough to give UPS parcels it doesn’t want to handle, severe punishment will ensue.
UPS’s renewed focus on the parcel sector and careful attention to pricing has paid off. Recently the company reported a profit margin improvement, which it attributed to more shippers getting lower pricing discounts. Additionally, UPS’ stock price has risen 33% since the sale of its LTL unit. During the same timeframe, the Dow Jones Industrial Average and FedEx shares were only up about 12%.
FedEx Ground is similarly making changes to increase efficiency and cut costs. For many years, Pittsburgh, Pennsylvania-based transportation expert Satish Jindel has opined that FedEx could reduce costs by over $1 billion annually if it combined the operations of FedEx Ground and FedEx Air. CEO Fred Smith had kept the two divisions totally separate since acquiring Caliber System to create FedEx Ground in 1998. Apparently, FedEx finally concurs with Jindel—who, by the way, learned the business as a FedEx executive and is a personal friend of Smith—as the company has started to combine some operations between the divisions.
FedEx has also announced that it is utilizing software to identify which SmartPost shipments it could cost effectively deliver itself as opposed to passing them along to the USPS. Obviously, this change will help FedEx increase route density, which will result in greater efficiency. Meanwhile USPS will suffer as it loses the less costly shipments, leaving them primarily with the less profitable business.
The takeaway for parcel shippers? More than ever, it pays to be efficient and cooperative. It’s worth it to work on being an efficient shipper—especially before starting negotiations with your parcel carrier—because the less efficient shippers will always pay more. Finally, while you should strive for cooperation with your carrier, you should also pay attention to details so you have full understanding of all charges.