Fedex Likely To Benefit From Change In Pricing Mechanism

FedEx recently announced a change in its pricing mechanism for FedEx Ground packages. Effective January 1 2015, FedEx Ground may charge customers on the basis of package size. ^[1] Presently, this “dimensional weight” pricing is applied to all packages for FedEx Express and is limited to packages greater than three cubic feet for FedEx Ground.

The direct impact of the change in pricing mechanism will be seen on bulky-yet-light products ordered online such as toiler paper rolls, towels, shoes, diapers, etc., which will attract higher shipping costs once the new pricing mechanism becomes effective. E-retailers will have to come up with ways to counter the effect of the price increase on their operating expenses.

For FedEx, the change in pricing mechanism may work for or against them. Higher prices may either increase revenues and improve margins or lead to loss of business and decline in package volumes if customers move to other shippers that offer lower shipping rates.

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Dimension Based Pricing Will Help Improve FedEx’s Revenue And Margins

Loaded with bulky-yet-light packages, FedEx trucks are left with excess weight carrying capacity but no volume carrying capacity. Since these packages are charged according to their weight, revenue generated per truck is low compared to what could have been earned if the packages were heavy and occupied less space. Additionally, a larger number of trucks are required to carry higher volumes of the bulky yet light packages, resulting in an increase in costs. This leads to a decline in margins since higher costs are spread over lower revenues.

The new pricing mechanism will help FedEx charge higher rates for these bulky-yet-light packages since it would be based on “dimensional weight”. In simple terms, dimensional weight means the possible weight that can be carried in a box of particular dimensions. It has been estimated that the cost of shipping a one pound package with 12 inch sides will increase by 41% once the dimensional weight pricing mechanism is effective. ^[2] The increase in rates will help FedEx generate higher revenues and will also lead to higher margins due to better price realization.

However, FedEx’s customers have the option to choose from delivery services offered by United Parcel Services (NYSE:UPS) or the United States Postal Services (USPS), neither of whom have announced any changes in their pricing mechanisms till now. Customers may use this leverage to negotiate lower rates from FedEx. If customers shift to FedEx’s competitors, FedEx’s ground package volumes may decline. Not only will this impact its revenues but also lose out on its market share in the ground package delivery segment. FedEx has a low market share in the ground package delivery segment and captures around 50% less daily ground package volume than UPS .

Nevertheless, UPS and FedEx have a history of following each other’s rate changes. Therefore, there is high probability that UPS will also change its pricing mechanism. This will help both FedEx and UPS since their customers will lose any leverage to negotiate contracts and will have to pay higher rates, leading to higher revenues for both companies. The customers will somehow have to absorb the higher costs or in turn pass it on to their customers.

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1. FedEx announces pricing Changes, May 2 2014, www.fedex.com [↩]
2. Web Shoppers Beware: FedEx to Charge by Package Size, May 7 2014, online.wsj.com [↩]