Parcel express roundtable: Solving parcel’s perplexing puzzle
Carrier revenue was beginning to recover at the end of 2009, and our experts expect positive growth over the coming years. However, pricing in this market segment will continue to be complex for parcel shippers—even more so than in years gone by.
By Patrick Burnson, Executive Editor -- Logistics Management, 1/1/2010
When we conducted this roundtable last January, DHL was exiting the U.S. and our panel of experts was contemplating how a “slugfest” between UPS and FedEx would play out. And while shippers waited to see if service levels would weaken, USPS was waiting in the wings to pick up the pieces. At the time, it seemed that the biggest worry most industry insiders had was whether duopolistic pressure would prevail in a marketplace already under severe strain.
In an effort to determine the new challenges ahead for parcel express shippers in 2010, Logistics Management reconvened last year’s roundtable participants. We’re joined again by Doug Caldwell, vice president of Parcel Research; Gerard (Jerry) Hempstead, a former DHL executive who now heads up his own parcel consulting firm; Rob Martinez, president of Navigo Consulting Group who brings a cool statistical vigor to our session; and David Ross, vice president and transportation analyst with the Stifel Nicolaus research team.
Readers will note that when manufacturers and retailers were forced to run down inventory levels at the beginning of last year, the express industry was badly affected. However, the latest quarter shows that revenues are starting to recover, and our experts expect positive growth over the coming years, albeit at low levels. Looking for a common observation? Pricing in this market segment will continue to be complex for parcel shippers—even more so than in years gone by.
Logistics Management: When we got together last January, the consensus among analysts was that the overnight express market was in a steep decline. Have we hit bottom yet?
Doug Caldwell: Well, accessorial charges will continue to take an ever increasing percentage of the total spend. UPS has adjusted both the ground and air fuel surcharge indexes, which could be a mixed bag for shippers because they could end up paying lower fuel surcharges on air shipments but higher on ground shipments.
Overall, we’re starting to see some indicators that we may have indeed found the lowest point. The carriers themselves—here in the U.S. and particularly in Europe—were seeing some of our retail and “eTail” clients start to run low on peak season inventories. And at this point, the only way to backfill Asia sourced inventory is by air freight or express parcel.
Gerard Hempstead: I agree with Doug. We will shortly see all those UPS and FedEx contracts with former DHL customers come up for review and most likely re-leveling and rationalizing. Therefore, a top domestic priority for both companies will be to improve package yields.
David Ross: Good point, Jerry. If you recall, the free fall in the overnight express market occurred principally in “FIRE” industries (financial, insurance, and real estate), overnight’s biggest customer base. It appears we are nearing bottom but may not be quite there yet. The overnight express market should remain highly cyclical and improve as the economy recovers, but the improvement in ground package service the last few years has caused many customers to trade down (from air to ground) in service level. We believe some of this market share shift is permanent.
Rob Martinez: I’m with you on this one, David. The decline in air volumes is a secular trend that will continue. Pricing is as much as 70 percent less than air services, and ground fuel surcharges are typically less. Apart from declines in overnight shipping due to technologies and other consumer preferences, shippers have been more comfortable with the high level of service provided by ground carriers with 1-day to 5-day service, package tracking, and money back guarantees. Moreover, two-thirds of U.S. Commerce has migrated to a short-haul model with deliveries within 600 miles of origin.
LM: With DHL out of the domestic picture now, how has the landscape changed over the past year?
Martinez: DHL’s departure has done little to change the domestic landscape, and its volume had an insignificant impact to overall performance of UPS and FedEx. Many shippers were concerned that without DHL in the market to keep FedEx and UPS honest, pricing would rationalize. However, due to carrier declines in package volumes, revenues, and earnings, we have not yet seen any significant changes with regards to pricing policies.
Hempstead: That’s right, Rob. With DHL now out of the way and the competitive landscape primarily defined by FedEx and UPS, the economic engine for earnings growth in 2010 will have to be reducing discounts, increasing base rates, and increasing accessorial charges.
Ross: In fact, the economy contracted so quickly that the benefit UPS, FedEx, and USPS got from DHL’s exit was essentially lost in the rounding. DHL only had 5 percent of the U.S. parcel market to begin with, so with general freight volumes down double-digits this past year, there was nowhere to hide for either big carrier.
The pricing picture did not firm up immediately as UPS and FedEx both raced in to grab DHL share; but over time, DHL’s exit should improve pricing prospects for both FedEx and UPS. USPS is now the third option—but not always the lower-price alternative.
LM: In our 2009 roundtable, all of you were pretty bullish on the prospects of USPS. Can we justify that now?
Caldwell: I think we can justify that prediction. At least on the package side of the business, the USPS appears to be more than holding their own. Take a look at FedEx SmartPost, which has “last mile” delivery by USPS. That service has grown an incredible 73 percent over the last year to over a million shipments per day. Priority Mail continues to take market share, as shippers downgrade from premium overnight. And their brand new “cube based” pricing is already generating a lot of interest.
Hempstead: Indeed, the USPS has introduced some cleaver pricing this year for transactions that play to their strengths. They are competitive for the most part in transactions that are one pound to five pounds, and the greatest number of shipments available in the marketplace are one pound, and most of these shipments weigh less than one pound. The USPS took a very modest increase for parcels for 2010, although they don’t discount their tariff to the degree the commercial players do.
Ross: We still like the long-term prospects of the USPS in the U.S., but it will certainly take time. Shippers want a viable third option for small package shipping, but the USPS needs to improve not only its network but also its tracking and tracing technology, billing, pricing, and general perception to better compete with FedEx and UPS.
Martinez: I’m still optimistic about the USPS’ prospects to grow market share. They offer many unique advantages for shippers, especially to the residence. Products like Priority Mail and First Class Mail Packages offer a terrific value for many shippers, and the fact that USPS does not charge residential add-ons, fuel surcharges, delivery area surcharges and many other accessorial charges is a plus for shippers.
LM: What has been the economy’s effect on service levels?
Caldwell: As the carriers started tightening their belts, a big concern of many shippers was that service would start to suffer. Well, at least for now, the carriers have done a very good job of cutting out the fat while avoiding the bone. On-time performance is quite good right now, and that’s true for the big four—UPS, FedEx, DHL and TNT—as well as many of the regional and national carriers, such as Purolator and CanPar in Canada, and GLS and ParcelForce in Europe. It’s a highly competitive environment, and no carrier can afford to have the “cutting service” tag next to their name.
Hempstead: I agree with Doug in that service has not been hampered at all due to the changes in volumes at the carriers. Some would claim that service has improved because the carriers have less to handle. The service audits of UPS and FedEx over the last year have seen no degradation of service.
Ross: We believe that this is partially due to carriers cutting costs significantly and partially due to increased shipper scrutiny of service levels in this downturn. With the technology investments made every year by UPS and FedEx, we believe service levels should be restored to and even improve upon prior levels.
LM: Where are rates headed?
Ross: Rates are headed higher, and fuel surcharges should continue to be a significant part of the shipper’s bill. As long as there is limited competition in the parcel market and the players compete rationally, shippers should expect modest rate increases every year—if for no other reason than to cover the annual labor inflation at UPS due to its Teamsters labor contract.
Martinez: Well, everyone knows by now that carriers have announced 5.9 percent rate increases for express services effective January 2010 (partially offset by 2 percent reduction in fuel surcharges). Including 2010’s increase, Express rates will have increased a staggering 32.1 percent since 2006.
And of course, those are the increases that have been “announced.” Depending on a shipper’s distribution, it’s much more likely that the increases will amount to significantly more. Moreover, accessorial charges will continue to increase. FedEx has already announced an additional Delivery Area Surcharge to select remote zip codes for residential shipments as well as new Minimum Billable Weight charges. For example, the FedEx Tri-tube packaging will incur a six-pound minimum weight charge.
Caldwell: A top priority among carriers going into 2010 will be margin improvement, and carriers are likely to be less patient in carrying what they consider to be marginal accounts. For many of our clients, there is a relatively new area that we are focusing on—characteristics analysis and improvement. If you’re a shipper and you’ve pretty much maxed out your discounts, it’s a whole new field of opportunity for savings. And the carriers love it—it can be a win for them as well.
Hempstead: I’ll add that the toughest thing for the carriers to deal with now is that over the last two years shippers have become more sophisticated in substituting lower cost shipping options to obtain the transportation objective without necessarily compromising the service provided to the recipient.
More and more companies have figured out that the level of service to a zone 2 is exactly the same for ground service as it is for next day air, but at a fraction of the cost. When the economy comes back, hopefully the wasteful use of next day air will not. It’s my belief that these shipments that are rationally routed now are gone from the air market basket forever.
LM: Finally, what have shippers learned in the past year about cutting costs and mitigating risk?
Caldwell: The departure of DHL from the U.S. domestic market was a big wake up call for many shippers—even those who weren’t using DHL as their primary carrier. Shippers we talk to are starting to take a closer look at risk aversion strategies. If we look back to the mid and late ’90s, a common industry practice at the time was to use multiple carriers—perhaps UPS for ground shipments, FedEx for express, and maybe a third carrier for international.
Then beginning around 2001 the trend started shifting toward a single carrier model. The increasing use of so-called “bundled pricing” really drove that trend. Now we’re seeing the trend go full circle, back toward the use of multiple carriers, each serving a niche in the supply chain.
Hempstead: As long as there is excess capacity the larger shippers will be able to command a significant discount but perhaps not as good as what we saw this past year. What the commercial carriers are attempting to do is restrain shippers from using the services of the parcel negotiating companies because of the impact the carriers have seen when a professional is employed by a shipper.
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