Why UPS Chose To Follow Fedex’s Pricing Mechanism
Recently, FedEx (NYSE:FDX) had announced a change in the pricing mechanism for its Ground packages from absolute weight based to dimensional weight based which would lead to higher prices for shipping packages (Read our article here – Fedex Likely To Benefit From Change In Pricing Mechanism). At that point in time we had concerns about the impact of the change in pricing mechanism on FedEx. Any increment in revenues or margins that FedEx would have expected to generate would only be possible if United Parcel Services(NYSE:UPS) had mimicked the change. This is because otherwise customers would have opted for UPS’s services. However, UPS has followed FedEx’s footsteps and announced a change in its pricing mechanism as well.
On June 17 2014, UPS announced that effective December 29 2014 dimensional weight will be used to calculate the billable price of all Ground packages in the U.S. and Standard packages to Canada. [1] UPS already applies dimensional weight pricing for its domestic and international air services, Standard ground services to Mexico, and for Ground packages in the U.S. and Standard to Canada packages measuring 3 cubic feet or larger.
It might seem odd that UPS chose to follow FedEx and shift to dimensional weight based pricing. UPS could have left its pricing mechanism unchanged and benefitted from an increase in package volume since many customers would shift from FedEx to UPS in search for lower costs. However, UPS chose to mimic FedEx and give up on that opportunity. We believe that the reason behind this is that UPS is focusing on improving margins at its U.S. Domestic Package segment which includes Ground packages.
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If UPS left its pricing mechanism unchanged, it would have likely seen growth in its volume and revenue for its Ground segment. However, margins would have remained unchanged meaning that the same percentage of revenues would have trickled down to the bottom line. UPS would have had to employ more resources to cater to the higher package volumes but would have realized the same percentage of profits.
With dimensional weight based pricing, UPS would be able to improve its margins through better price realizations. Its revenue per package would increase and rates would be more aligned with costs, thereby improving margins (For more information about how dimensional weight based pricing improves margins please refer to our previous article here). Therefore, with the same resources UPS would be able to convert a larger percentage of revenues to profits.
UPS is already a market leader in the ground segment with package volumes twice of FedEx. Therefore it made sense to focus on margins rather than increasing its lead in the ground package delivery market. An improvement in margins would lead to higher net income and earnings per share and would be beneficial for shareholders.
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Notes:- UPS Announces Dimensional Weight Changes, June 17 2014, www.ups.com [↩]