The end of the year is a stressful time. On a personal level, there are the holidays to deal with: Visits with the in-laws, waiting in lines at the mall, wondering if everybody really did like the gifts you gave them…

On a professional level, it can be even more trying. For many companies, this is the end of the fiscal year, when finance and logistics professionals alike come under pressure to make year-end numbers look good—and to come up with favorable but realistic projections for the coming year. Perhaps the following scenario will sound familiar:

John has exactly 24 hours to put the finishing touches on the numbers he’ll need for an investor conference call recapping his company’s fourth-quarter results. The fourth quarter was good, but not great: good revenue growth, good production improvements, but poor cost numbers. As CFO, John didn’t produce the results, but he has to explain them. He takes a deep breath, and a sense of confidence finally starts to settle in. The fourth-quarter results shouldn’t affect the company’s stock price as long as plans for the coming year are solid, and he’s certain that his cost planning and goals are realistic. “As soon as the final budget comes in from logistics,” he thinks, “I can button this up and approve the final earnings outlook.”

Then comes a quick rap on the door, and the director of logistics walks in, a somber look on her face. “John, I have the logistics budget for next year. We need to talk. It’s going to be much worse than we initially projected.”

If you ship small packages, this could become a very familiar story in early 2007 as you begin to understand the true impact of one of the most significant rate hikes in recent memory. Anyone who doesn’t know the score is bound to experience sticker shock: The major parcel carriers have announced general rate increases (GRIs) averaging 4.9 percent, but most shippers are seeing actual increases of at least 5.5 percent. In some cases, rates could jump by as much as 8 to 10 percent.

What can you tell your CFO about the 2007 rate hike and its impact on your company’s costs? Breaking down these increases into three “layers”—base rates; accessorials and surcharges; and broader business issues in the parcel-transportation industry—will help you understand your costs and forecast them more accurately.

If you are like most people who are given the task of forecasting annual parcel-transportation budgets, you usually have applied a 3 percent to 4 percent increase across the board in anticipation of the “average” rate increases that FedEx, UPS, and DHL typically announce each year. While many shippers have been moderately successful with this practice, it does not provide an accurate cost forecast. Here are a couple of reasons why that is true:

Copycat carriers: UPS and FedEx have fallen into a “who blinked first?” game when it comes to what, when, and how they announce rate increases. This has created an opportunity for whichever carrier waits it out to optimize its own rate-increase announcement.

That was the case in early November 2006, when FedEx started the ball rolling by announcing a 3.5 percent general rate increase for U.S. domestic and export express-package and freight shipments. That increase included a 5.5 percent base-rate hike that was “offset” by a 2 percent reduction in the fuel surcharge. This is the second consecutive year that FedEx has announced an express-rate increase before UPS did—but without hinting at any change in ground-service rates.

UPS then announced in December that it would increase its ground rates by an average of 4.9 percent—one percentage point higher than last year’s 3.9 percent rise. UPS also announced that its base rates for ground residential service would be the same as its commercial base rates, with the residential surcharge applied separately. This is a departure from UPS’s previous strategy of maintaining separate base-rate charts for commercial and residential ground services. This year, moreover, rates for UPS Hundredweight service increased by 5.9 percent on average, compared to a 4.5 percent increase a year ago.

Once UPS published its new ground rates, it didn’t take FedEx long to match those changes in its own ground-service rates. The only significant difference between them is that FedEx’s published ground rates for packages weighing more than 70 lbs. are 5 cents less than those published by UPS. DHL, meanwhile, proceeded as in years past and simply matched UPS’s and FedEx’s ground-rate increases.

“Average” ground-rate increases: Although the carriers announced an “average” 4.9 percent change, it is difficult to see where an average customer would get an increase of less than 5.5 percent.

It’s important to look closely at the actual impact on your rates based on both weight and zone (distance). Across Zones 2 through 8, the average increase for packages weighing from 1 to 70 lbs. was 5.77 percent. (See Figure 1 for a zone-by-zone breakdown.) Rates for packages weighing from 1 lb. to 5 lbs. increased an average of 5.5 percent, while rates for packages weighing 31 lbs. to 70 lbs. increased 5.99 percent on average. The rate increase for the 6 lb. to 30 lb. weight cells was very consistent at an average of 5.48 percent.

Both UPS and FedEx imposed similar increases in surcharges and accessorial charges in many areas, and these are likely to have a significant impact on some shippers’ overall costs. Here are some things to watch for:

Dimensional weight applies to ground service: In an unusual move, UPS announced in a letter to customers in September (three months ahead of its GRI announcement) that dimensional (DIM) weight ratings used for air and international packages would apply to ground service beginning January 1, 2007. It was no surprise that shortly thereafter FedEx matched that change with an announcement of its own regarding DIM weight.

Dimensional-weight ratings take a shipment’s density into account. (The method for calculating DIM weight for ground packages is shown in Figure 2.) Some specific industries and customers will be substantially affected by the change to DIM weight for ground packages, but the impact has been largely overhyped and a number of incorrect and dramatic examples have been used to bring attention to the change.

The key to managing the potential costs you may incur under the new rules is to fully understand your contract and properly apply the DIM-weight rules to determine your net cost increase.

A number of methods are available for properly assessing the impact of the change to DIM-weight ratings. The most effective is a model that will help calculate the conversion from the old rule, which applied surcharges for oversized (OS) packages, to the DIM-weight system.

The most critical issue related to this change is the future impact on costs if the carriers should decide to lower the threshold used to apply the DIM-weight rule in order to bring more ground volume under the new rule. Look for any early signal from UPS or FedEx that indicates they will drop the 5,184-inch qualifier. And consider conducting a first-quarter review of your carton-purchase schedules so you will have time to make any box-size changes that may help you avoid unnecessary dimensional-weight charges.

Accessorial charges on the rise: There are more than 90 accessorial charges (for providing certain handling and delivery services) that can be applied to your account. Some of these are known in advance of shipping, some are assessed during shipping, and some are assessed after your package has been delivered. There are many changes in accessorial fees, and the impact varies from mild to significant. Just two examples:

• An Additional Handling Charge of $6 will apply to all packages weighing more than 70 lbs. The base rates for packages weighing 70 lbs. and up have been reduced in order to offset the additional cost. This is not a uniform offset, as generally the resulting rates for packages over 70 lbs. in Zones 2 through 6 have declined by anywhere from 2 percent to 10 percent, whereas rates in Zones 7 and 8 have increased by 3 percent to 6 percent.
• One of the most significant changes for UPS residential customers is that the residential surcharge for ground service will now be added on to the total transportation charge. This puts UPS on par with the way FedEx handles ground residential shipments. Be aware: Current ground incentives will not apply to the residential surcharge. (Incentives will also no longer apply on residential surcharges for air shipments.) If your distribution profile reflects a high percentage of residential volume, you could see a double-digit overall cost increase for those packages.

Accessorial fees can account for as much as 30 percent of your total transportation bill. The 2007 increases, moreover, can be in excess of 15 percent for some shippers. Another significant issue associated with the accessorial charges is that this growing set of rates and billing rules allows the carriers to impose increases outside of their standard zone and weight charts. Keep in mind that increases in accessorial fees are not included in an announced GRI; the result is that the number given out as the “average” increase doesn’t tell the whole story.

Is it rates or is it fuel? UPS and FedEx both announced increases in domestic air and international rates, and then offset them by a reduction in their fuel surcharges. In the last two years, the fuel surcharge has been capped, raised, capped, and raised again before being lifted. This strategy has allowed both carriers to introduce a larger base-rate increase while shifting the risks associated with rising fuel costs directly to the customer’s budget. A detailed look at the domestic air rates by zone also shows that the larger increases generally were in Zones 6 through 8, which represent the longest distances.

The air-rate charts remain one key area where you can find significant differences between UPS and FedEx base rates. UPS hit its Next Day Saver and Second Day rates the hardest, with some increases exceeding 9 percent. FedEx raised its Second Day Air rates the most, with rates for some low-weight package rising by more than 15 percent compared to last year.

FedEx also announced that it will now apply a fuel surcharge to some accessorials that previously were not subject to this surcharge. They include the delivery-area and residential-delivery surcharges as well as surcharges for oversized packages, Saturday pickup and delivery, and freight pickup and delivery, among others. Some of FedEx’s changes put them on equal footing with UPS. But there are still significant differences between the two that will affect each customer in a unique way, so it’s critical that you evaluate the characteristics of your own distribution patterns to assess the impact.

In order to better forecast pricing changes, you need to look at the broader business and competition conditions affecting the small-package transportation industry. The changes to this year’s rate structures are really no surprise when you consider these “macro” issues:

Postal consolidator files for Chapter 11, and capacity shrinks: One of the early indicators that rate changes might be on the way was the March 2006 bankruptcy of the large postal consolidator APX and the resulting market reaction. The hybrid model of postal consolidation accesses deeper points in the postal system by “drop shipping” into U.S. Postal Service (USPS) points, including Bulk Mail Centers (BMCs), Sectional Facilities (SECs), and Destination Delivery Units (DDUs). A customer can receive better service and rate structures using this model instead of handing packages over to a local USPS facility.

Postal consolidators provide a competitive option to UPS and FedEx residential services, and they have served many large cataloguers and retailers well. The bankruptcy of APX left many customers on short notice with few competitive options other than going back to UPS, FedEx, or DHL, and it left the three carriers well-positioned to gain residential market share under unique conditions that allowed them to manage yield.

Postal rate case for 2007: In May of 2006, the Postal Service Board of Governors approved the filing of an Omnibus Rate Case with the Postal Rate Commission that proposed an average increase of 8.5 percent for the spring of 2007. The USPS apparently has learned from its private-industry counterparts how to announce a GRI: Although some rates will rise by less than the announced 8.5 percent, you have to look hard to find them. For example, under the scheduled changes, you could see the rate for a 5 lb. Parcel Post Zone 1 and 2 package moving inter-BMC go up 21.7 percent. The good news is that because the rate case was not signed into law until December of 2006, the market has had plenty of time to evaluate the proposed rates and formulate strategies.

Labor negotiations: In 2006 both UPS and FedEx resolved pilot contracts that had been in negotiations for several years. Pay increases in some cases topped 10 percent, significantly adding to the carriers’ base costs. UPS also faces another contract negotiation in 2008 with the International Brotherhood of Teamsters. Keep an eye on the progress of those negotiations: Raising base rates is one way carriers can prepare for an increase in labor costs.

As you can see from the many changes we’ve discussed here, each year it becomes more challenging for logistics professionals to accurately measure the bottom-line impact of increases in small-parcel rates and surcharges.

To identify the key impact areas for your company and make sure you understand and can quantify upcoming changes, sit down and discuss them frankly with your parcel carriers, or seek assistance from qualified transportation consultants. Otherwise the 2007 general rate increase is likely to give you a serious case of sticker shock.