Airlines compete for mail business under a series of new USPS performance-based contracts

Several airlines have begun competing for mail business under a series of new U.S. Postal Service performance-based contracts. But optimism about significant revenue improvements is tempered by ongoing passenger airline security restrictions on parcel size mail and volume declines in the postal service’s air express products. The new contracts are a departure from the old practice of equally sharing business among air carriers, and part of the U.S. Postal Service’s effort to transform itself into a modem, cost efficient, self-sustaining enterprise. USPS said it expects the contracts, which became effective June 28, to increase efficiency and improve service.

“It’s the most dynamic change in 20 years,” USPS spokesman Mark Saunders said. “Up until now the airlines have looked at this business as a given. Now they have to earn it. If they don’t perform, they will lose it to their competitors.” USPS uses more than 15,000 commercial passenger, flights to move about 170 million pieces of mail each day. Direct marketers depend heavily on the USPS for parcel, expedited and global delivery services.

The nation’s mail company awarded 18 contracts to 34 airlines, some of which teamed up to bid on routes. The total dollar value of the three-year contracts will not be available until the end of each fiscal year, when total mail volumes flown by the airlines are tabulated. Last year, the USPS paid the airlines about $370 million to haul mail. The new contract offers airlines incentives for superior service and requires carriers to take more responsibility for managing the flow of mail through their networks. Under previous contracts, the USPS set a flat pay rate for all participating carriers and routed the mail flight by flight. Carriers were just responsible for flying the mail. If more than one airline operated on a specific lane, the postal service had to tender equal portions to each carrier.

Now USPS can shift business to better performing airlines. The new contract requires all airlines by late September to begin scanning mail bins at four points along the way — when mail is dropped off at the carrier facility, when the carrier loads it onto a flight, during transfers to connecting flights, and when the airline turns it back over to USPS: Scan results are automatically forwarded to USPS so it can keep track of mail shipments and hold carriers accountable for meeting on-time standards.
“If they miss a scan, they don’t get paid. If an airline is not meeting our service standards they could lose that route,” Saunders said.
“We are looking forward to working with the airlines, but the mail will go on the carrier that provides the best service at the most competitive rates that are in the best interests of our customers.” When confronted by lack of capacity with a top-performing carrier, postal officials said, the agency will select the carrier that offers the next-best value to handle the overflow.

In the early stages of the contract it is hard for participating carriers to gauge how much mail volume and revenue particular routes will generate. “We have an initial idea of what we could expect, but it is going to be fluid based on our capacity and ability to deliver service,” said Gary Swanson, managing director sales and marketing for Delta Air Logistics. “In some lanes, we will have to trim some mail volumes, but we will pick it up on other lanes where other carriers can’t handle it.”
Some airlines favor the competitive bidding process because it allows them the ability to capture market share and achieve economies of scale necessary to operate a mail service. After the Sept. 11, 2001 terrorist attacks, passenger airlines were banned from carrying mail weighing more than one pound in their belly holds. The drop in volume combined with the provision to equitably divide the mail meant that airlines weren’t getting enough traffic to cover the cost of maintaining a mail handling and processing infrastructure, according to USPS and industry officials.
Smaller airlines that do not have the systems or capacity to conduct sophisticated routing could end up losers under the new system, unless they team with a big airline.

Officials at Delta Air Logistics, the cargo side of Delta Airlines, see the new contract as an opportunity to capture even more of the mail market. The Atlanta-based airline has partnered with United Airlines Cargo to expand its network coverage and has invested in a sophisticated dispatch system to route the mail.

Delta and United “see this as a big win because of how we are positioned based on our rates and volume. We won’t know how big until the dust settles on how everything is going to be routed long-term,” Swanson said in an interview.
“We expect some significant increase in volume for mail, but we don’t expect it to have any negative effects on our air freight shippers,” Swanson said. The frequency of Delta flights enables the airline to quickly move bumped cargo or excess mail onto another flight if capacity tightens, he said.

In exchange for letting the airlines bid their own rates, USPS is putting the onus on the airlines to handle their own dispatch. USPS will still determine which carriers mail goes to, but the airlines will take over routing the mail by flight, Swanson said. Delta selected Menlo Worldwide Technologies to provide a scanning and tracking system, but developed its own software to route the mail, he said.

The routing technology is adept at matching capacity with loads on the second leg of connecting flights, something USPS had to do manually, he said. The USPS system did a good job of arranging point-to-point movements, but couldn’t handle managing capacity on complex transfers. Delta's system can manage a situation in which mail bound for Little Rock, Ark, for example, feeds into the Atlanta hub from several cities. The system determines which mail bags get priority for limited capacity on the next flight without human intervention, Swanson said. Several airlines have approached Delta about leasing the system for their own use, he added.

As Delta makes changes to its passenger schedule or capacity changes, logistics managers can use the system to route the mail to another hub, shift mail to different flights or use United’s network to maintain service commitments for its largest cargo customer.

Screening Mail

Domestic passenger airlines have lost about $250 million per year due to the security restrictions on heavier mail, according to Air Transport Association estimates. In a speech to the Chicago Economics Club in February, Delta Airlines Chief Executive Leo Mullins put the revenue impact to Delta of federal restrictions on U.S. mail and freight at about $80 million. Swanson said the revenue hit was primarily a reflection of the 39-percent drop in mail revenue ton miles flown by the carrier to 143.4 million for the eight months ending August 2002, compared with the same period in 2001.

In an effort to help the airlines recapture some of the lost parcel business, the Transportation Security Administration last November began a test program at 11 airports to use explosives detection canine units to screen mail on passenger aircraft. The return of postal business could be a big boon to passenger airlines struggling for revenue in a soft travel market.
The TSA said in late May it wants to expand the program to all major airports by the end of the year in order to reopen all mail carriage on passenger aircraft. TSA spokeswoman Chris Rhatigan said five more airports will have mail checked by dogs this summer. The mail is taken to one security facility where the dogs go through it before it is distributed. Participating airports in the initial stage include those in Los Angeles, San Francisco, Honolulu, and San Juan, Swanson said.
TSA has most of the dogs it needs, but has to come to terms with each airport, airlines and local law enforcement departments that provide the dog handlers, on procedures for delivering and searching the mail within a guaranteed timeframe, adding different shifts and distributing the cost, Rhatigan said.

“It’s important because it gets the revenue stream back on the airplane. One of our missions is to help get the economy moving again,” Rhatigan said.
“The dog’s mobility, ability to search large volumes of items quickly and high level of accuracy in detecting explosives are indeed extremely important assets as we further develop screening policies for air cargo,” David Kontny, director, TSA National Explosives Detection Canine Team Program, said in a statement.

A major advantage of using dogs is that they rarely generate any false positives compared with 20 percent to 30 percent false hits of x-ray scanners and other explosives detection systems, Jack Boisen, Continental Airlines vice president, told a supply chain security forum at the U.S. Chamber of Commerce in April.

“The problem is we are 20,000 dogs short,” Boisen said. The dogs can only work for 30 minutes at a time before they tire and their sense of smell begins to diminish. Delta is optimistic the TSA program will help the industry regain postal business, Swanson said. “The key is it has to be everywhere”

FedEx Partnership

After the Sept. 11 attacks, the USPS diverted a large percentage of parcels to trucks, for trips less than 12 hours. The move to alternative providers continues the trend of outsourcing more line haul transportation to focus resources on the USPS’ specialty – retail delivery. The USPS contracts with approximately 6,000 to 7,000 trucking firms to move mail between postal facilities, Saunders said.

USPS maintains it has been able to maintain on-time service since the security rules went into place at less cost. Trucks are one-fifth the price of air transportation (12 cents vs. 60 cents per pound), but not all the restricted mail is moving by truck. USPS puts some of the larger mail on FedEx Express’ dedicated daytime network under a contract for First Class and Priority Mail carriage that went into affect just days before 9/11, and the overflow goes on FedEx overnight flights at a higher rate.

In order to guarantee space when needed USPS buys capacity on FedEx planes by the cubic foot, rather than using the weight times distance formula used by commercial airlines, and pays for it whether it is used or not. The contract requires FedEx to provide 443,000 cubic feet of cargo space per day and carry 250,000 pounds of Express mail cargo at night.
“The passenger portion was reliable, inexpensive lift comparatively,” said Michael White, director of cargo at the Air Transport Association. “It gives the postal service a very good system for hauling mail around. They don’t have to own any planes, they can get first rights to fly in the cargo bin (after baggage), and they have no set contract for space.”

Saunders said commercial airlines generally offer more competitive rates on short haul routes while FedEx is more competitive cross country.

USPS has also upgraded its technology to better exchange information with transportation suppliers. The new Surface-Air Management System will allow the USPS to manage the routing of mail to trucking companies and its dedicated FedEx air fleet. SAMS assigns a unique dispatch and routing tag to each tray, sack or container. It also has the ability to assign surface routes, and manage the capacity of the first leg of transportation by splitting out mail by class and to track manifests online. USPS says SAMS eventually could be tied to a Web-based system that would enable business customers to track where their mail is within the postal system in the same way shippers can trace their FedEx and UPS packages. SAMS is also being tested to determine whether the system can be applied to truck and rail carriers.

How much postal service parcel business returns to the airlines is an open question since the USPS has discovered it can meet its delivery schedules through FedEx and ground transportation. Although commercial airlines provide frequent service, postal officials determined they could dispatch a lot of mail between 1am and 3am in the morning and ‘still have it ready for the morning shift to sort.

Postal officials are pleased, too, with the reliability and service FedEx is providing under the $6.3-billion, seven-year contract. The partnership, which permits FedEx to locate overnight service collection boxes at post offices nationwide, gives USPS access to the FedEx network at a more affordable rate, because the postal service is helping generate extra revenue for the express carrier by utilizing FedEx planes that normally sit idle during the day. USPS also said it is saving $1 billion in air transportation costs, reaching more cities with guaranteed overnight service, more consistent two- and three-day Priority Mail service and improving efficiency by replacing multiple regional contracts for shared air service with a single, more manageable, national contract for integrated air transportation.

“FedEx has helped us raise our First-Class and Priority Mail scores to record levels,” Postmaster General John Potter told the USPS Board of Governors last October. “Express Mail service performance is the highest it’s been in four years.”

Mail Loses Ground

Another obstacle to a parcel business recovery for airlines is the hard fact that mail volumes are trending down at USPS. In the fiscal third quarter ended May 16, growth in total mail volumes was flat for the second quarter in a row. First-class mail volume declined 566 million pieces, or 2.4% year over year, while standard mail increased 3.2%, less than the 3.5% growth forecast. First-class mail volumes have dropped seven consecutive quarters. Express mail volume dropped 12.3%, following similar declines the previous three quarters using year-to-year comparisons. Priority Mail fell 14%, the 11th consecutive quarter of declines – the last four of which have been between 9% and 15%. Standard mail grew 638 million pieces, but not enough to offset the volume declines in high-margin products and periodicals. Package service volume rose 12.3% in the quarter, led by a big jump in bound printed matter.

“To some degree, we believe shippers may be trading down from Priority Mail to Parcel Post in order to save money and given the fact that both products are now priced on a zoned basis,” Bear Steams transportation analyst Edward Wolfe said in a July 2 note. Last summer USPS switched to a system by which the Priority Mail postage rate is determined by combination of zones a package has to cross and the weight.

USPS attributed revenue and volume budget shortfalls to increasing use of e-mail; intense competition from private package delivery companies such as FedEx, UPS, Airborne Express, DHL; the shift by businesses to ground delivery services; and a sluggish economy that caused people to conduct fewer transactions and purchase fewer goods for shipment.

One positive on the horizon for USPS is the Federal Communication Commission’s new “do not call” list of consumers seeking to avoid telemarketers. The USPS said in its third quarter report that standard mail volume could benefit from this new marketing restriction as direct marketers seek less intrusive ways to get their message into households.