2015 Parcel Express Roundtable: Shippers Looking for Leverage

By April 20, 2015 News
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While the parcel express and ground delivery market may not be as diversified as other modes, that doesn’t diminish the fact that the market is on very solid footing, with strong margins that match its high level of service and its ability to meet changing customer needs on the fly.

To be sure, one thing hasn’t changed in the parcel sector: UPS and FedEx firmly remain the big dogs in the pound, with the United States Postal Service (USPS) continuing to make inroads in its parcel and last-mile endeavors. However, the USPS remains far too financially hindered to grasp a bigger bite of the action.

Against this backdrop, the duopoly of UPS and FedEx has more pricing leverage than ever before thanks to GRIs that recently kicked in, coupled with the anticipated benefits of dimensional weight pricing (dim weight)—a shift that shippers need to fully embrace and understand in order to keep their budgets at an acceptable level.

Observers are also keeping an eye on the impact e-commerce is making on the parcel market, a reality that’s bending the rules in terms of how the parcel players approach service and how shippers are required to change their playbook to meet increasing demand in delivery activity.

Helping Logistics Management put the current market into perspective this year are Jerry Hempstead, president of Hempstead Consulting, a parcel advisory firm; David Ross, transportation and logistics director at investment firm Stifel Nicolaus; and Rob Martinez, president and CEO at Shipware LLC, an audit and consulting services company.

Over the following few pages, this expert trio will provide their insight into what’s driving the current parcel market, the pricing picture, as well as what shippers need to watch for in the future. Our panel contends that a major underlying theme is for shippers to explore their options when it comes to addressing service needs and firmly know their freight and its related characteristics.

Logistics Management (LM): How would you describe the current parcel marketplace?

David Ross: I would describe it as dynamic. Even though UPS and FedEx dominate the market and the headlines, specifically as it relates to home delivery, there’s a lot of experimentation going on by smaller companies—and some larger non-transportation organizations—to try and break into the home delivery market. So, we expect some changes over the next few years.

Rob Martinez: To build on David’s thoughts, I would say it abounds with opportunities. While FedEx and UPS continue to focus on revenue enhancement by raising rates, regional parcel carriers, postal consolidators and the U.S. Postal Service each represent terrific opportunities for shippers to not only reduce costs, but also improve Services.

Jerry Hempstead: Since DHL exited the domestic parcel landscape in January 2009, shippers have been left with a duopoly. UPS and FedEx have grown larger and more profitable, mostly because as one carrier goes up in price or adds onerous rule changes, so does the other. On the positive side, both have been able to add to the number of terminals, hubs, delivery vehicles, add new and more efficient aircraft, and continuously raise the bar on service.

The downside of this is that we now have a situation where there’s an incredible barrier to entry to add another integrator. No investor has the financial wherewithal to build out a competing service and weather significant financial losses until it can reach critical mass to become profitable. The best shippers can hope for is the success of regional players, or niche players, and the USPS who can carve out pieces of business and help with lightweight parcels.

LM: How would you describe the current rate and pricing environment for parcel shippers?

Martinez: Simply put, the 2015 GRI was the mother of all rate hikes for several reasons. First, FedEx and UPS eliminated the three cubic foot exception before dimensional pricing kicks in for ground packages. With the 2015 rate increases, dimensional weight pricing will apply to all ground packages, triggering increases as high as 50 percent or even more on some packages.

Second, rates went up an average of 4.9 percent for all services, with 7 percent increases for 2-day to 3-day air.

Third, rates for lightweight (1 pound to 30 pounds) ground shipments—which represent 85 percent of ground package volumes—increased more than the “average” of 4.9 percent. For example, 1-pound to 10-pound ground packages shot up 6.2 percent. Fourth, FedEx will change the tables used to calculate fuel surcharges this month, increasing fuel surcharges an additional 1 percent to 4 percent. The compound effect of all of the increases is staggering, making 2015 the most significant GRI in history.

Hempstead: With the new GRIs in effect and the three cubic foot dimensional exemption for domestic ground transactions gone, the environment is oppressive. Some shippers are adept at negotiating and caps on the amount of the annual increase in their contracts or their rates are set from a previous base—and not off the new base pricing. Some of these shippers are also protected from unilateral rule changes or have concessions in place for dim weight. Most do not. As a result, shippers this year are looking at significant cost increases, and I suspect much greater than that which they budgeted for. E-commerce companies, I predict, will be the hardest hit. If they’re oblivious to the impact of the dim weight rule change, they may be in for a big wake-up call when they look at their books in March when the January bills hit the general ledger.

Ross: As Jerry and Rob mention, the environment is unfavorable. Demand is growing

significantly in the small package arena, so those supplying the capacity are able to increase prices without negatively impacting volumes—with the exception of air express, which should continue to lose share to lower-cost ground options over time. Even the USPS has been raising its rates, on average. Add to that the dim weight change recently implemented, and the one area where shippers had been getting a steal—lightweight, bulky packages—has now been fixed in carrier pricing to more accurately compensate the transportation companies for true costs.

LM: Where do you see rates going in 2015 and what’s driving them?

Ross: Rates will go higher, as usual, just due to the standard annual rate increase put in place by UPS and FedEx. But in addition, there’s a change to the ground pricing structure to where all packages now qualify for dim weight pricing. This should drive bulky, lightweight package rates significantly higher.

So, shippers will vary significantly in the rate increase that they should expect this year, depending on shipping patterns and package characteristics. But if fuel prices stay low or move lower in 2015, then shippers will see net increases than otherwise would be the case due to the lower fuel surcharges.

Martinez: Again, for UPS and FedEx, rates continue to go up in 2015 as the two carriers continue to focus on revenue enhancement. While most of the regional players are also taking annual increases, the majority should continue to maintain more favorable dimensional pricing compared to FedEx and UPS. The USPS offers a competitive pricing edge with new, lower pricing for Priority Mail and ounce-based pricing for First Class Parcel.

LM: How are market conditions affecting service and what role is the improving U.S. economy playing?

Martinez: Service has been terrific, even during the peak season holiday volume surge. If the transportation companies’ volumes are the bellwether for the economy, then the economy’s recovery is well underway. Parcel volumes continued to grow for FedEx, UPS, and the USPS, and I’m hearing of significant growth from several regionals. Growth and profitability has a direct impact on service since each of the carriers reinvest in systems and fleet improvements, acquisitions, technology, and other capital expenditures.

Ross: I agree with Rob that service is improving. These rate increases are not just going into carrier bank accounts, as a lot of money is invested each year to improve the customer experience, whether it be for tracking and tracing, delivery intercept, faster transit times, or improved on-time performance.

Hempstead: Volume has been the real driver of the service improvements. E-commerce has created a flood of packages, and that’s transformative for the carriers.The ever-increasing parcel count has strained the existing networks, and so the carriers have to build more hubs. More sortation hubs––and the new ones are highly engineered and automated––improve service and help to reduce per package costs.

LM: How is the ongoing emergence of e-commerce changing the parcel marketplace?

Martinez: I’ll say that “changing” isn’t really the right word in this regard. Instead, I’ll say that e-commerce is redefining the parcel marketplace. Shipping is one of the most important components of e-commerce as it shapes consumer behavior. From free shipping to same-day service, leading e-commerce businesses have long used a variety of shipping promotions as a competitive differentiator.

As a result, ecommerce now accounts for nearly half of all parcels shipped. Moreover, e-commerce has created cooperative agreements like FedEx SmartPost and the USPS, companies that have historically competed for each other’s business.

Hempstead: E-commerce is creating the increase in package count that makes all the other drivers hum. The landscape, however, has changed dramatically and the ever-increasing demand for B2C deliveries has led to inventive hybrid solutions to get items to homes in a cost effective manner.

Ross: Rob and Jerry are both correct. It’s also about adding more packages to the mix, requiring a bigger network––more facilities, some bigger facilities. It’s also allowing for competitors to come in and try and compete with the big boys.

Interestingly, there’s a merging now of the traditional brick-and-mortar retail model with the newer e-tailing model, as we see not only traditional stores increasing their online presence, but original Web-only companies now establishing physical store locations to better reach their customers. We think this omni-channel trend should continue, driving not only increased B2C shipments but increased B2B, too.

LM: Related to e-commerce, can you see a situation in which Amazon becomes a player in the parcel space and brings delivery operations in-house, or would that not make sense for them, given their current arrangements with existing carriers?

Ross: Yes, we do see a scenario where Amazon takes control of its deliveries, but it doesn’t mean that will be the best option for the company. Amazon has already started moving freight in-house on a small scale in certain cities and on a larger scale in the past year via direct injections into the USPS for last-mile with its new sortation center Network.

Hempstead: Amazon will continue to be a customer of the integrators, of the USPS, and of the regional carriers. Amazon needs lots of service levels, and they need to always be driving to get their costs down. One can’t be blind to the fact that Amazon is opening its own network of distribution centers separate, apart, and distinct from its fulfillment centers.

Obviously Amazon wants more control over the customer service experience, and they’re constantly driving out cost and time. Amazon is not precluded from opening up its network to other firms who have the ability to sort down to a particular level.

This can all be done in a fairly automated way by Amazon, and would add additional critical mass to their model if they decide to offer such a service. I think they have their hands full right now getting the model right for their own rapidly growing business.

Martinez: While it’s true that Amazon is slowly rolling out its own delivery fleet branded as Amazon Logistics, it would be difficult for any company to compete with UPS and FedEx on any significant scale. Amazon shipped 608 million packages in 2013. UPS shipped 4.3 billion, including an estimated 200 million packages for Amazon.

I’m quite confident that Amazon has the management team, finances, and infrastructure to handle a percentage of its parcel deliveries. But it will take years, if ever, for Amazon’s logistics unit to supplant parcel delivery companies like UPS. What’s more likely is that Amazon Logistics package deliveries will eventually be limited to only a few densely populated markets.

LM: What is your take of the USPS, given its ongoing financial challenges?

Hempstead: If you remove the financial obligation for the pre-funding of retiree healthcare benefits, the USPS ran at a profit. They need to continue to drive down costs, and they need to finish the rationalization of the network design that they began several years ago. With automation, the USPS does not need all the plants it has, and they don’t need all of the post offices that they have.

Ross: The USPS is the biggest carrier of residential B2C deliveries in the U.S. by a wide margin, so we believe that the organization is well positioned to continue growing its delivery volumes and capacity. The problem is the government involvement, which has resulted in a molasses-pace for any change and saddled the USPS with pension debt. At some point, we hope the USPS is allowed to raise First Class Mail rates more and become a more profitable entity that can then invest in more equipment and technology to improve service, but we’re not there yet.

LM: What advice do you have for parcel shippers in 2015?

Martinez: Analyze, optimize, and diversify. We’re seeing shippers save 25 percent to 40 percent through a combination of least-cost routing, modal, and carrier optimization including the USPS, UPS, FedEx, and regional parcel carriers.

Hempstead: The key to cost control is data. The integrators make it easy to pull down one’s billing history with shipment detail each month. Using pivot tables, shippers should have processes and metrics to see if the wrong services are being used—like using next-day air service when the same service can be obtained for a quarter of the price by substituting guaranteed ground service.

Ross: Reduce package size and look at carrier options. There’s more out there than just UPS and FedEx, although they remain reliable options. In addition, know your freight. The more detail you can give the carriers, the better pricing you can get as they don’t have to guess as much at their costs to handle it.

LM: Have regional parcel players made inroads in market share gains in the last year? What can they do to better compete with the “big boys?”

Martinez: While regional carriers like OnTrac, Eastern Connection, LaserShip, Spee Dee, LSO, Pitt-Ohio, Prestige Delivery, and others have been making inroads and growing market share, collectively these firms still represent less than 5 percent of the overall parcel market. However, recent surveys indicate that shippers are more open to alternatives to FedEx and UPS in order to cut costs.

Regionals offer many benefits over the national carriers, including cost savings, larger next-day delivery footprint, later pickups, earlier deliveries, easier contracts with fewer accessorial charges, same-day delivery options, and customized solutions. The regionals will also likely be the beneficiaries of the trend for retailers to “regionalize” inventory—geographically staging fulfillment operations near customer clusters to decrease shipping times, reduce costs, and better serve customers.

Hempstead: The regional players are growing. In the grand scheme of things, they’re not on the radar of the integrators. They carve out pieces of business in defined geographies, but can only provide limited service, mostly against the big guys ground offerings and mostly on residential transactions due to the fact that the fees imposed by the big guys leave plenty of room for margin.

Ross: Yes, they’ve certainly made inroads, but they have a long way to go. We believe that regional parcel carriers as a group have less than 2 percent of the market. In fact, 50 percent growth in their volumes would only take them to about 3 percent share, so there’s plenty of runway for them. The regionals can also better compete by improving the marketing of their services because a lot of shippers simply don’t know about them.

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