Going Postal
Savor the irony of a $7 billion, seven-year deal between FedEx Corp. Chief Executive Frederick W. Smith and the U.S. Postal Service. The guy who built his career and a $20 billion (estimated fiscal 2001 sales) company demonizing the blundering bureaucracy now carries water for it—or, at least, its priority and express mail and some of its first-class mail—and is going to put FedEx boxes in more than 10,000 post offices. The $1 billion in extra revenue each year is nice for Memphis-based FedEx, whose annual growth threatens to dip to 8% after galloping at a compound annual rate of 12% since 1996.
But perhaps Smith should have turned down the dough and instead swapped his services for access to USPS' 300,000 carriers. That's where FedEx is weakest: on the ground. The transportation company owns 51% of the overnight delivery market—the payoff for an air network that reaches 211 countries and electronic tracking systems that tell shippers what time a package arrived in Toledo or Thailand. The rub: The fastest growth is in shipping parcels by truck. And United Parcel Service has 70% of that market.
Playing catch-up, FedEx expects to spend $170 million to build a home delivery network by 2003. That's on top of the $1.2 billion it spent to buy American Freightways last November to gain wider coverage in the less-than-truckload market carrying loads of 500 to 2,000 pounds. But building a piecemeal network may take five to ten years—or longer, given a slowing economy and a planned 13% drop in spending by FedEx this year to $2 billion.
A prolonged downturn, of course, means less cash to build out a ground system. Domestic express volume is likely to be flat during the current fiscal year ending May 31. Buoyed by international traffic, earnings are expected to increase 8% to 14% over last year—but that includes a recent 4.9% rate increase and fuel surcharges of 1.3% to 4%.
Fact is, FedEx is more vulnerable than UPS in a slump because it has way too much overhead and unused capacity. Which is one reason that FedEx nets (before interest and taxes) only 7 cents on the revenue dollar, compared with 15 cents at ups. This, despite the fact that UPS' work force is much more unionized. "There is no question that our margins are not high enough and we need to get them into the double-digit range," says FedEx Chief Financial Officer Alan B. Graf Jr.
Not so easy. For years Fred Smith has insisted on keeping FedEx's ground and air operations separate. That way, the company qualifies as an air freight company under the 1926 Railway Labor Act, which requires a vote of its entire 200,000 work force (rather than a single trucking terminal) before a union like the Teamsters can muscle in.
But the price of keeping FedEx's trucking operations nonunion is a bloated cost structure. The company has five mostly separate shipping networks of trucks, airplanes, sales forces and workers— one for overnight service, one for ground packages, one offering critical shipments, another to move cargo globally and logistics operations (contracts to manage factory inventories, and so on). Result: a system so inefficient that some customers were receiving four separate invoices, a practice FedEx says it is changing as it seeks ways to trim costs. Salespeople are also now being trained to cross-sell products offered by different divisions.
Wall Street has been on Smith's back to combine operations. That's something he won't do. "If you try to serve too many market segments with the same operating unit, either you suboptimize service levels or you increase costs," Smith insists.
FedEx doesn't exactly have money to burn. It owes $6.2 billion, including off-balance-sheet debt (such as for airplane operating leases), giving it a debt-to-capital ratio of 55%. Compare that with UPS' lean ratio of 23%. UPS will generate $2.1 billion this year in free cash (net plus depreciation, minus necessary capital expenditures), compared with FedEx, which is only hoping to be free cash positive.
In short, it's not going to be easy to find the money to build a ground network. These may be bumpy years for FedEx, which will lose $50 million this year on home delivery. That could climb to $70 million or $80 million in a soft economy—or if ups launches a price war.
UPS can inflict other damage. There's nothing to stop it from putting its own drop boxes in the same post offices across the U.S. that will soon start accepting FedEx packages. And there is increasing vulnerability overseas, where FedEx now dominates. ups recently ordered 60 new A300-600 Airbus cargo jets. Each wide-body plane can carry 10,000 packages.
By the Numbers
Sky Kings
Chief executives are girding
for battle as one-to-three-day
delivery starts outpacing
next-day shipment.
Fredrick Smith of FedEx.
10%
FedEx's share of the
ground-package market.
James P. Kelly of UPS
149,000
The number of trucks, tractors
and vans in the fleet.
Robert S. Cline of Airborne
3 million pounds
The largest package shipped
(parts for ocean liner).
Sources: CSFB; companies.
