Friday, March 19, 2010

Why the Postal Service Matters: FedEx Needs It

The financial data unveiled along with the FedEx earnings report that was announced yesterday revealed how closely tied the fortunes of FedEx and UPS are tied to the Postal Service.  FedEx is one of the Postal Service's largest suppliers.  It provides the postal service with a significant portion of the $2 billion spent on air domestic air transportation annually.   FedEx uses the Postal Service to deliver a significant portion of its light weight ground parcels.

While the size of the air transportation contract with the Postal Service is proprietary, FedEx reports its use of the Postal Service as a delivery supplier.  The following chart shows that FedEx's Ground delivery service has increasingly relied on the Postal Service to deliver parcels.  The shift to Postal Service delivery of ground parcels began in the fall of 2008 (FedEx's FY 2009 2nd quarter).
The shipments delivered by the Postal Service for FedEx Ground generally are 1) lighter weight than those that FedEx Ground delivers itself; and 2) more likely require delivery to a household address. FedEx Ground charged its customers less than $4 per shipment.  Of that the Postal Service received about $2 per shipment and FedEx Ground recorded the rest as its revenue. The most recent quarters for which the Postal Service and FedEx provided data had the Postal Service recording revenue of $1.92 per shipment and FedEx recording revenue of $1.59 per shipment.  Using the Postal Service to delivery lighter weight and home delivery shipments, allows FedEx to:
  • Offer customers a delivery product with an attractive price.   With an average price running below $4, FedEx Smart Post offers a service that allows companies selling large quantities of light weight items on the web to offer those products at an attractive delivered price.
  • Improve the profitability of its delivery contractors, and in particular home delivery contractors by increasing the average revenue per shipment they deliver.  By shifting low weight shipments to the Postal Service FedEx Ground increases the total revenue associated with all shipments delivered on a delivery route as low revenue items are removed from the contractor delivered network. This is most important for home delivery contractors who can deliver fewer shipments per day as the number of items delivered per stop and the distance between stops are greater than those routes in the same geographic area focused on commercial addresses.  It is hard to imagine any contractor able to cover his costs and earn a profit at $1.92 per shipment.
  • Grow its parcel delivery business faster.   Volume growth requires increasing the capacity of the network and in particular delivery routes and delivery drivers.   The use of the Postal Service allows FedEx to better manage this growth and to ensure that its own network grows only as rapidly as heavier weight shipment volume grows.  Also, FedEx Ground would be less likely to invest in the marketing and distribution capacity required to accommodate growth if it had to use some of the $1.59 it now generates per shipment for profitably handling marketing and distribution of the lightweight parcel service to pay for delivery. 
  • Grow its parcel delivery more profitably.   Even though FedEx Ground uses a contractor model, it is not immune to the economics associated with delivery networks.  Growing delivery network capacity to handle the growth in low revenue deliveries (i.e. light weight shipments that with rates of $4 or less) can create significant pressures on profit.  Paying the Postal Service around $2 per piece allows FedEx to earn a larger profit on light weight and home delivery shipments than it could if its contractors delivered the same item.
The recent growth in FedEx Ground's use of the Postal Service has contributed to FedEx Ground's gains in market share.  In it's most recent quarter FedEx Ground's daily originating shipment volume grew 13.9% year-to-year while United Parcel's daily ground parcel volume declined by 2.9%.   Clearly the ability of FedEx Ground to continue to grow its business and more than likely United Parcel Service find a way to stop the slide in market share will depend on the continuing existence of a reliable and competitively priced parcel delivery service that the Postal Service now offers.

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