USPS’ Rate Reductions May Pose A Threat To UPS And FedEx’s Market Share

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The Postal Regulatory Commission (PRC) recently approved rate changes proposed by the U.S. Postal Service (USPS) for its Priority Mail Product, [1] which may prove to be a threat for United Parcel Service (NYSE:UPS) and FedEx’s (NYSE:FDX) e-commerce package business. These changes, which will be effective from September 7, 2014, will lead to lower rates for USPS’ Priority Mail services based on Commercial Base and Commercial Plus pricing. USPS’s Commercial Base and Commercial Plus pricing are options available to businesses that ship a high volume of light weight packages, for example, e-commerce businesses. It is likely that U.S. e-commerce players will find this move favorable and may choose to avail USPS’ services for their deliveries, instead of UPS and FedEx.

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USPS’s rate reduction, and UPS and FedEx’s change in pricing mechanism will lead to a vast pricing differential

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UPS, FedEx and USPS are the major players in the U.S. e-commerce package delivery business with volume share of approximately 54%, 30%, and 16% respectively between themselves. UPS and FedEx had recently announced a change in pricing mechanism for their ground segment (the segment that largely caters to e-commerce packages), from weight based to dimension based, in order to realize better price for the packages delivered (Click here to read our article). The change in pricing mechanism is expected to lead to a 30-50% increase in rates for package shipment. [2] The reason behind the change in pricing mechanism was that e-commerce packages were generally light in weight but high in volume, and therefore occupied larger space in trucks, leading to depressed margins. Dimensional pricing would lead to better price realization and help in improving margins.

Since both, FedEx and UPS, had announced the change in pricing mechanism at relatively the same time, and since they are the dominating players in the U.S. e-commerce package delivery, the price increase was expected to go unchallenged and their market shares unhindered. Most of the regional and local players were expected to follow the change in pricing mechanism. However, USPS decided to go the other way.

USPS reduced prices for its Priority Mail Commercial Plus and Commercial Base services by 2.3% and 0.9% respectively. The reduction is expected to lead to a 30-50% decline in rates for weight categories most used by e-commerce players, which ranges from 6-20 pounds. Presently, USPS generates revenue per package of $7.60 from its Priority Mail services. [3] This compares to $7.96 for UPS’s Ground service. [4] FedEx’s revenue per package for its Ground segment cannot be directly compared to UPS or USPS. FedEx’s Ground segment comprises of two services – Ground and SmartPost (SmartPost utilizes USPS’ services to make final delivery). Ground service revenues are gross figures, whereas SmartPost revenues are reported net of postage paid to USPS. [5] The combination leads to reduced overall revenue per package since reported revenues are lower. However, we believe that FedEx’s Ground segment revenue per package is somewhat in line with that of UPS’ Ground service.

Therefore, a reduction in rates by USPS, followed by an increase in rates by UPS and FedEx, will lead to USPS’ rates being significantly lower than that of UPS and FedEx. E-commerce players will likely shift to USPS given its lower rates, leading to a decline in UPS and FedEx’s market share.

E-commerce businesses are looking for alternative options to reduce costs

In the past few years, there has been a general shift in preference towards lower shipping options. Retail customers and businesses are opting for cheaper means of shipping their letters, packages and freight, even if it means waiting for a few extra day. This is clearly evident from the volume mix of UPS and FedEx’s services. In their recent quarterly results, volumes of UPS and FedEx’s deferred and economical services increased, whereas time-sensitive and premium service volumes decreased or remained relatively stagnant (Click here to read our article on UPS’ recent quarter results, or here for  FedEx’s recent quarter results). Since the current scenario suggests that businesses are more likely to opt for lower priced shipping services, it is possible that they will choose USPS over UPS or FedEx.

E-commerce companies prefer to avail low-cost delivery services in order to keep their shipping costs to a minimum. They use free shipping options as an incentive to attract customers. At the time when UPS and FedEx announced the change in their pricing mechanism, it was believed that e-commerce players will try to renegotiate their contracts or bear the higher costs themselves or pass it on to their customers, all situations likely to lead to a decline in profits. According to Kewill, a transportation-management software provider, shippers are looking for ways to minimize package size to keep their costs low. [6] However, e-commerce companies now have the option to keep their costs low by availing USPS’ services. They may also choose to leverage this low-priced alternative in order to renegotiate contracts with their existing package delivery service provider.

Additionally, major e-commerce players such as Amazon and eBay, are already developing in-house solutions for delivering their products. UPS and FedEx’s price increase offers further incentive for such companies to pursue their own package delivery solutions. If these in-house solutions prove to be sustainable and economical, then this may significantly reduce UPS and FedEx’s market share in the e-commerce package delivery business.

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Notes:
  1. Order Approving Changes In Rates Of General Applicability For Priority Mail, August 15 2014, www.prc.gov []
  2. Web Shoppers Beware: FedEx to Charge by Package Size, May 7 2014, online.wsj.com []
  3. USPS 2013 10-K SEC Filing, www.usps.com []
  4. UPS 2013 10-K SEC Filing, www.ups.com []
  5. FedEx 2014 10-K SEC Filing, www.fedex.com []
  6. With FedEx And UPS Rate Increases Looming, Shippers Explore Their Options, August 19 2014, www.forbes.com []