Going its own way – Fedex

FedEx Corp., by any estimation, must be classified as one of the biggest success stores in the history of American business. Founded in 1973 by Fred Smith, who is still chairman and chief executive, as an overnight document and small-package delivery service, the company has become a cultural icon — its name a verb. It hasn't lost money since 1992, and it's a world leader in air express, a transportation sector that has been growing at an annual rate of about 13%, twice the rate of general air cargo.

Yet while FedEx is often mentioned in the same breath as United Parcel Service and, increasingly, Deutsche Post World Net, it has been moving in a distinctly different direction from those companies. Today it has a portfolio that in some ways barely resembles that of its two larger rivals.

Specifically, UPS and Deutsche Post World Net have both moved aggressively and publicly into the rapidly growing third-party logistics business. FedEx, while dabbling in logistics, has spent the last few years diversifying away from its core U.S. express business, assembling a large ground transportation network in the U.S. that now accounts for 220f its total revenue.

FedEx in 1998 spent $2 billion to acquire Caliber System, a deal that has allowed it to develop a large regional less-than-truckload and small-package ground business. The Caliber deal included Viking Freight, a leading less-than-truckload carrier. Combined with American Freightways, which FedEx acquired last year, the company now claims to be the leader in the regional LTL market. That is a business in which firms such as UPS, Airborne Express and DHL, which is 51 % controlled by Deutsche Post, don't compete.

Supply-chain management is such a minor part of FedEx's overall portfolio that the company does not disclose revenue for that business. The company lumps it together with FedEx Trade Networks — which includes the forwarder and customs broker Tower Group International — into a category called "other" on its financial statements. That category produced revenue of $135 million in the quarter ended Feb. 28, less than 30f FedEx's total revenue for the quarter. FedEx restructured its supply-chain services unit last year and took a $22 million charge against earnings.

The FedEx supply-chain unit provides outsourced fulfillment services for several companies in the electronics business, including Hewlett-Packard, DirectTV and Philips Semiconductor. Its services include pick-and-pack, shipment and coordination of transportation, with the customers having visibility of parts throughout their network. FedEx also manages a dedicated fleet for General Motors that moves parts from 900 different suppliers to its power-train, engine transmission and component plants in North America.

In contrast, UPS Logistics Group reported revenue totaling $236 million in the first quarter and $1.4 billion last year. UPS, which last year acquired Fritz Cos., a leading customs broker and forwarder, has also said it's looking for more deals.

Deutsche Post, the partially privatized German Postal Service, has, under chairman Klaus Zumwinkel, a stated goal of becoming a global powerhouse in the logistics field.

In pursuit of that goal, it has acquired Danzas Corp., a Swiss-based forwarder, and Air Express International, which was the biggest U.S. air forwarder. Today, Danzas AEI ranks as the world's largest air forwarder and third-biggest ocean forwarder, with net sales of $8.2 billion last year.

In addition, Deutsche Post now owns 510f DHL, one of the four big competitors in the global express industry, along with FedEx, UPS and TPG, the Dutch logistics, mail and express carrier, which operates as TNT. Deutsche Post has stated that it's looking for additional acquisitions, with the U.S. a prime target.

It's not hard to see the interest. The third-party logistics market in the U.S. is projected to nearly double from $56 billion in 2000 to $108 billion in 2004, according to USBX Investment Research.

FedEx is much more coy about its future plans — spokeswoman Shirlee Clark laughed when asked whether it's planning a major acquisition. But in an indication of where FedEx has pinned its plans for growth, it has made the most of its 1998 purchase of Caliber, positioning itself in the growth-oriented ground sector — a relative bright spot in the U.S. transportation industry compared to the declining domestic air segment.

In addition, the Caliber units, including RPS, the second-largest U.S. provider of business-to-business small-package ground delivery services after UPS, have provided a needed diversification for the company, offsetting sluggish air-express traffic due to weakness in the manufacturing and high-tech sectors.

FedEx Express, the core business unit, experienced a 3 0rop in revenue to $11.33 billion during the nine-month period ending Feb. 28. FedEx Ground, formerly RPS, reported a 19% revenue increase in the nine-month period to $1.97 billion, representing 130f FedEx's total revenue for the period. On the profit side, the results stand out even more; FedEx Ground's operating income rose 76% to $209 million, or 230f total corporate operating income. Operating income at FedEx Express fell 17% to $575 million.

The regional LTL carriers, Viking and American Freightways, are being rebranded as FedEx Freight. That unit contributed $1.44 billion in revenue during the first nine months of the fiscal year, or 90f the total. Operating income during the period was $117 million, up from $18 million the year before, though that is an inexact comparison because the American Freightways purchase was being completed at that time.

Other units, including FedEx Trade Networks, FedEx Supply Chain Services and FedEx Custom Critical, a Caliber unit formerly known as Roberts Express, saw their revenue drop 46 0uring the nine-month period, from $840 million to $457 million. Operating income for the companies in the "other" category was only $4 million, compared with $22 million the previous year.

Trucking is not the only area in which FedEx has diversified to its own benefit. While FedEx Express' performance in the first nine months was disappointing, it would have been a lot worse had it not been for its contract with the U.S. Postal Service to provide airlift for much of the agency's Priority Mail traffic. That traffic grew substantially after the Federal Aviation Administration imposed a ban last fall on passenger flights carrying pieces of mail weighing more than one pound. FedEx officials decline to say how much revenue they are getting from the Post Office, but when they signed the contracts in January 2001, they estimated the value at $7 billion over seven years.

Scott Flower, an analyst with Salomon Smith Barney, cautioned, however, that the deal might not be the long-term boon it was initially thought to be. Postal traffic might drop due to the July 1 price increase for Priority Mail and the availability of cheaper belly space on passenger planes. Flower estimated that FedEx has been handling some 500f Priority Mail.

While it lags Deutsche Post and UPS in ocean forwarding, FedEx is taking initial steps to cater to shippers who demand ocean transit, which some believe is an increasingly popular mode of transport because of its low cost compared to airfreight. In February FedEx Trade Networks launched inbound ocean-forwarding services through Tower, which FedEx acquired in early 2000.

FedEx has also placed heavy emphasis on its home-delivery business offered through FedEx Ground. It expects to offer coverage to every ZIP code in the U.S. by September.

The home-delivery operation, described by FedEx as the only one in the industry with a money-back guarantee, has bolstered revenue at FedEx Ground. But the key to the ground unit's double-digit growth has been its ability to respond to shippers' desire for cheaper deferred services.

Whether that represents a long-term cyclical trend or a short-term response to shippers' need to cut costs in a weak economic environment remains to be seen. The company expects these services will draw customers in closer and siphon off business from UPS.

Reflecting the relative weakness of its international supply-chain management business, FedEx is not able to match its rivals in trade finance. In a major move, UPS last year acquired First International Bancorp, a leading provider of export loans and working capital to small and medium shippers. Deutsche Post offers trade finance through its New York-based PB Capital unit.

Clark said FedEx customers have not demanded trade finance services. "We don't feel that's our core competence," she said.

Back in the domestic arena, FedEx is expanding on another front through what it calls FedEx Custom Critical, the former Roberts Express. The unit specializes in large shipments averaging 3,000 to 4,000 pounds that must be delivered immediately, usually by a dedicated truck over a distance of 300 to 400 miles. The biggest demand comes from industrial customers facing a plant shutdown or needing to move heavy equipment for a trade show.

While the opening of the Paris hub two years ago strengthened FedEx's presence in Europe, it's clearly an underdog there against Deutsche Post, UPS and TPG. FedEx's initial entry into the intra-European business was a disaster. A $254 million write-off for restructuring in Europe caused a net loss in the 1992 fiscal year, the last time the carrier lost money.

In Asia, FedEx has a clear advantage over UPS in the express business, thanks to its 1989 purchase of Flying Tigers, a move that established the company in the trans-Pacific market. The subsequent purchase of Evergreen International Airlines' rights to all-cargo service to China was another big step, as was the creation of its intra-Asia hub at Subic Bay in the Philippines in 1995.

UPS, however, is catching up, after launching its own flights to China last year. It now has 64 trans-Pacific flights a week compared with 80 for FedEx. UPS also opened its own intra-Asia hub at the former Clark Air Force base in the Philippines on April 1.

Nevertheless, DHL claims to be the market leader in Asia, with a 34hare of all international express shipments from the region.

In Latin America UPS gained the upper hand on FedEx by purchasing Challenge Air Cargo, one of the largest cargo carriers serving that market. FedEx tried to acquire Challenge in 1996. Several years later UPS approached Challenge. The deal, completed in August 2001, gives UPS a decided edge, although much of the traffic on its aircraft is standard air cargo rather than the high-yielding, high-growth door-to-door business preferred by all the express carriers.

FedEx strengthened its presence in the key Brazilian market by announcing long-term agreements on April 17 with three local transport companies that will provide regional coverage to areas representing 900f the country's gross domestic product. As in other markets, FedEx has benefited from cutbacks by passenger carriers, thus picking up traffic that might otherwise have flown in the bellies of passenger airlines serving Latin America.

Monday, May 06, 2002