strange bedfellows

Changing business models and the emergence of e-commerce have created some surprising new alliances in the small-package arena.

By -- Logistics Management, 11/1/2000

A "bomb" of sorts was unexpectedly delivered to the small-package industry at summer's end when it was reported in the business press that the U.S. Postal Service (USPS) and its erstwhile arch-foe, FedEx, were actively discussing a "potential strategic alliance" in the small-package industry. Both the USPS and FedEx confirmed the reports. "Among the subjects being discussed are the Postal Service's providing 'the last mile' of delivery for some FedEx products, and use of the FedEx transportation network for some Postal Service products," said a representative for the USPS.

That news surprised industry observers. "FedEx and the Postal Service are definitely making some incestuous noises," observes Ed Wolfe, an analyst at investment banker Bear Stearns who focuses on the expedited market. "This is absolutely stunning."

Predictably, United Parcel Service (UPS), which is perceived to be the obvious target of any such partnership, vehemently opposes the concept. "This is ... about using facilities and people that public taxes pay for to benefit a single private company-and to the detriment of [its] competitors," says Norman Black, media relations director at UPS. "And we have a real problem with that."

To many observers, this startling development was only the latest in a series of events that have utterly changed this quarter of the transportation industry. "This area is undergoing an absolutely tumultuous period in its evolution," says Ted Scherck, president of the Colography Group, an Atlanta-based technical research and consulting organization that specializes in expedited transport. "One would think that a 30-some-year-old market would be maturing and that the fundamentals of the business would be mellowing out. Exactly the opposite is true."

Challenging Big Brown

In fact, the story of the small-parcel industry in the United States is a story of near-monopoly that has been challenged by fierce and innovative competitors over the last 30 years. The 92-year-old UPS, which dominated ground delivery in the United States for most of the 20th century, currently has nearly a 48-percent share of the expedited cargo marketplace. (See Figure 1.) Although UPS's operations were regulated, the carrier had very little in the way of competition during its first half-decade of operation-in effect, it became a monopoly. The company built up an all-encompassing national ground network, concentrating first on retail deliveries to residences, then moving into the business-to-business market.

For years, its only real competitor was the U.S. Postal Service, which today accounts for about 25 percent of the small-package market. That lack of competition reportedly led both carriers over the years to pay little attention to customer service.

But then in the 1970s, a new and intrinsically different kind of competition appeared when FedEx hit the runways and the streets. Wolfe of Bear Stearns says the impact on the marketplace was both psychological and logistical: "[FedEx founder] Fred Smith [believed] that if he could provide an incredibly time-sensitive service, people would pay whatever he needed to provide that service. He was right."

As FedEx began cutting into UPS's market share, the ground carrier countered by getting into the air-express business itself, linking the new service with its ground network. In turn, FedEx moved to strengthen its ground game by acquiring the Caliber group of companies, including RPS (now called FedEx Ground). As competition continued to heat up, both UPS and FedEx Ground initiated delivery guarantees for ground service. Today, FedEx accounts for about 18 percent of the expedited cargo market in the United States.

During the years that the FedEx-UPS battle was brewing, other carriers that concentrated on various niche markets emerged, including Airborne Express, DHL, Emery, and TNT. They were quickly followed by a number of smaller regional companies.

The Draw of Discounts

As those developments unfolded, the second largest player in the market, the USPS, remained largely on the sidelines, competing aggressively for international documents but little else.

That all changed last year. "In January 1999, a new class was established for parcels," says Gerry McKiernan, manager of communications for expedited services at the USPS. "If private carriers want to do work-sharing with us, they receive discounts on their postage. In other words, the farther they bring the packages into our system, the less sorting we have to do, and the better their deal is. Depending on their involvement, they can realize 60 to 70 percent savings on postage costs," he explains.

Airborne, Emery, and DHL saw the advantages of such an arrangement and quickly entered into somewhat different delivery agreements with the Postal Service.

Airborne is taking the fullest advantage of the discounts by bringing small packages all the way to the USPS Delivery Destination Units, the final step before neighborhood delivery. That service, called Airborne@Home, is Airborne's first venture into ground delivery, says Tom Branigan, the carrier's director of communications. "For years, the company has been seeking a way to profitably-and that's the operative word-serve the residential delivery segment. Our bread and butter for years has been business-to-business service and about 87 percent of our shipments are five pounds and under," he adds. "The bottom line is that up until these USPS discounts were made available, it would have been too costly for us to get into residential delivery."

Emery's agreement differs in that it involves larger shipments of multiple packages, such as computer systems or home-entertainment components. The business-to-

consumer service is called Parcel@Home; it can handle multiple-piece shipments weighing up to 70 pounds each, says Rocco Sacci, director of corporate communications at Emery.

The process begins at the customer's distribution center with a palletized pickup. The shipment is then flown to Emery's hub in Dayton, Ohio, and subsequently delivered to the USPS Regional Sortation Centers for ZIP-code sorting. Options include two-, three, or four-day service, depending on destination and/or shipper selection. Shipments can be tracked through either Emery's or the Postal Service's computer systems.

DHL's agreement is essentially the reverse of the previous arrangements (DHL handles the final deliveries in foreign countries) and is presently much more limited in scope. "Our alliance with [DHL] is in a narrow area-expedited documents only," explains McKiernan of the USPS.

The U.S. Postal Service has long worked with foreign postal services through an international postal cooperative organization, essentially handing off mail to them for delivery, he explains. But because some foreign postal services are inefficient, express pieces may take 10 days to two weeks to be delivered in some countries.

To solve that problem, USPS last year entered into an agreement with DHL to deliver expedited documents from JFK International Airport with a two-day delivery guarantee that currently covers more than 200 countries, McKiernan says. The program has been successful and the relationship is likely to grow, he adds. "[W]e are working with them with an eye to expanding into the small-package realm fairly soon."

Given the background of these agreements, it's not surprising that UPS takes issue with the proposed USPS-FedEx alliance. "Those other contracts were the result of USPS's issuing an RFP (Request for Proposal) and requesting bids," says Black of UPS. "They looked at anybody who wanted to bid on doing line-haul work in the background and then negotiated terms and awarded contracts.

"But this is ploughing new ground entirely, talking about putting FedEx drop-off boxes in post offices or letting FedEx customers give their FedEx packages to the postman," he continues. "We believe this raises both public policy issues and antitrust concerns, and we don't think either Congress or the Postal Rate Commission will ever let it happen."

Statistics and Strategies

The present controversy aside, the express segment of the industry has grown significantly over the past six years in comparison with the heavy freight sector. Express shipments showed growth of 2.80 percent in 1999, while growth in heavy freight shipments was down by 2.98 percent. (See Figure 2.)

A number of industry observers agree that increased competition in the small-package arena and carriers' expansion into new market segments are responses to radical changes in customers' attitudes and marketplace demands. Issues that are shaping the express industry today include the following:

• A growing demand for JIT/time-definite services. Now that the major players are offering delivery guarantees for ground transportation that is typically priced at one-fourth the cost of air-express service, many shippers have realized that just-in-time (JIT) doesn't necessarily mean that a shipment must move overnight.

"JIT means time-definite and reliable," says Wolfe of Bear Stearns. "If it gets there when it's supposed to almost 100 percent of the time, even if that takes four days, then the manufacturer can set his assembly lines and prepare his marketing plans around that date." Ground-based carriers that can offer reliable transit times and lower rates, therefore, are now eating into the air-express carriers' market share. "What has happened is that the service gap has narrowed between ground and air with these guarantees of reliability," Wolfe says, "but the price differential remains because of the expenses intrinsic to operating the planes."

Wolfe further notes that for the 10 years prior to 1999, ground transport grew at an annual rate of only 1 to 2 percent. Since the beginning of last year, though, that market has grown 4 to 5 percent. Conversely, air express grew by 10 to 12 percent for 10 years, but is now down to 4 to 5 percent annual growth.

• A switch to "pull" inventory management. According to the old "push" inventory business models, periodic sales meetings determined how much product could be sold, and assembly lines would crank out as much volume as possible. Whatever wasn't sold was discounted, and whatever couldn't be discounted was scrapped.

But new logistics capabilities have given rise to a "pull" inventory system that is having a significant impact on parcel carriers. "According to this system, you wait for the order, then have assembly parts brought in JIT via small-package carrier," Wolfe explains. More and more these days, he reports, that carrier handles some assembly in a warehouse located near one of its transportation hubs as well. "The small-package carriers are seeing tremendous growth in this area working with the technology industry, and it will spread to other sectors of manufacturing. This will mean more shipments and smaller shipments to supply the 'pull' inventory on time," he predicts.

• The rise of e-commerce and e-tailing. Under traditional business models, a manufacturer could control where sales would come from depending on where it deployed its sales force, where it sent catalogs, and which geographic markets it targeted. The Internet has changed this radically.

"When you put up a Web site, you have no control over where your orders are going to come from," says Scherck. As a result, he says, online retailing has tended to disperse product demand; shipments that used to move in consolidation now must be broken up into many more separate packages and are moving in a lot more line segments.

"In many cases, what used to be a consolidated shipment of 30 units is now moving in 30 individual shipments-and increasingly those shipments are going to residential delivery points," Scherck reports. "This represents an impressive increase in small-package volume, and there is no reason to expect this to change."

Carriers Expand Into New Areas

Along with this consistent growth has come increased competition and a proliferation of strategic innovations and offerings by the major players. In particular, carriers are responding to shippers' demands for "one-stop shopping" by expanding into new service areas.

One of the U.S. Postal Service's major focal points has been returned goods. "The biggest headache in e-commerce is returns," observes McKiernan. "You can sit in your living room and place an order and it's delivered. But you couldn't return things from your living room-until now." The USPS has arranged for some e-tailers to place a link to a special Postal Service product-return address on their Web sites. Customers can go to that address, click on it, and print a return label to be affixed to the package, which is then picked up at the door by the postman.

FedEx, for its part, recently moved heavily into the ground transport sector through its acquisition of the former RPS, now rebranded as FedEx Ground. The package carrier expanded further with the introduction of FedEx Home Delivery, a unit that was specifically designed for the growing business-to-consumer market, says Steve Barber, senior communiations specialist. Home Delivery operates as a division of FedEx Ground and offers a number of delivery options, including delivery by appointment. The network's capability is expected to reach 80 percent of the U.S. population by next fall and complete coverage the following year, he adds.

Barber reports that FedEx's air-express revenues are still the major share of its business at $7.5 billion, up 4 percent this year, as opposed to ground at $2 billion in revenues. But the ground sector shows a much stronger growth rate of 8 percent.

At UPS, the fastest-growing part of the company is its Logistics Group, according to Black. "We expect this to continue as more companies turn to outside experts to manage their logistics efforts," he says. "The global supply chain literally means the demise of the warehouse. When you order a customized computer package, the components probably come from at least four different locations, are pulled together by a small-package carrier like UPS, and are delivered at once to your doorstep."

TNT Worldwide Express, with facilities in more than 200 countries, is getting into the Internet age by arranging partnerships with online service companies. One such deal involves AnythingOvernight.com, a Web-based consolidator of parcel and heavy freight shipments. Shippers that use the consolidator's Web site can click on the TNT logo and obtain access to the carrier's complete array of global express services. After reviewing the options relative to package size, delivery time, and destination, the customer can then obtain rate information, print shipping labels, schedule a pickup, track the shipment, and notify the intended recipient of all pertinent information.

Curtis Watson, vice president of sales and marketing, sees this and other business developments as a continuing source of rapid growth for air-express carriers. "Approximately 80 to 85 percent of our business in the United States involves small packages," he says. "All of this involves shipping abroad, and we are projecting very aggressive revenue growth in this sector."

DHL, meanwhile, has plans to increase its logistics presence in the United States substantially, setting up small stocking centers throughout the country to facilitate two- and four-hour delivery commitments and offering a variety of value-added services to customers. "We concentrate on the express/small-package sector, and there are three major areas that we want to play in," says David Douthit, director of the company's Worldwide Express Logistics division. "The first is service-parts logistics, which meets the two- and four-hour delivery requirements of computer and aerospace component shippers. The second is managing the failed-part return process. The third we call direct express inventory, in which we centralize a company's inventory and provide final assembly or other value-added services usually related to market- or country-specific requirements."

According to Douthit, all of DHL's logistics strategies are built around its global capabilities. He notes that the two- to four-hour delivery demand is becoming a requirement in the medical, high-tech, and aerospace industries and now represents 60 percent of the Worldwide Express Logistics division's business.

By all accounts, the small-package carriers will have to scramble to stay ahead of the game in the months to come. Regardless of which way the U.S. economy goes, says Scherck, these companies are likely to see continued growth. "The rate of growth of the small-package sector may slow, based on what happens with the economy in general," he says. "But if the economy worsens, then businesses are going to become even more concerned about carrying inventory than they are now, and they're going to have to use small-package distribution increasingly to fill orders. So even in a slowdown, the small-package carriers should continue to gain share of total shipments."

Freelance writer John Paul Quinn reports on a broad range of business topics for journals in the United States and Europe.