Cost Management Measures To Drive UPS’ U.S. Domestic Margins

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United Parcel Service

United Parcel Service (NYSE:UPS) conducted its annual investor conference on November 13, 2014. During the conference, UPS outlined its plans to rein in its U.S. Domestic average cost per package, which has been growing significantly due to the rapid increase in business-to-consumer (B2C) packages primarily driven by e-commerce growth. UPS’ strategies include package consolidation, efficient pricing mechanisms, convenient pickup and drop off locations as well as using advanced software to help route delivery.

UPS believes that these cost management measures will enable it to increase its U.S. Domestic operating profits by 8-10% annually through 2019. [1] The impact of these measures will also be seen over its earnings per share, which are expected to grow 9-13% annually through 2019.

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E-commerce is driving revenue and costs

UPS’ U.S. Domestic packages have been having a good run due to the flourishing e-commerce business in the U.S. In 2013, UPS’s U.S. domestic package volume grew 3.7% on account of 17% growth in the U.S. e-commerce sales. [2] In the third quarter of 2014, average daily domestic package volumes grew 6.2% on account of e-commerce sails. Though, e-commerce sales have been driving UPS’ U.S. Domestic revenues, it has also pushed up its costs.

Over 2000 to 2010, UPS’ U.S. Domestic average cost per package has increased at an average rate of 2.3% annually. [1] With e-commerce packages expected to account for more than half of the UPS’ U.S. Domestic package volume, the associated costs are also expected to rise. It is because of these growing costs that UPS has decided to work upon various strategies that will help prevent any further large increases.

Delivering to Access Points will help reduce costs

One of the major cost drivers for UPS is the repeated delivery attempts it has to make when the recipient is not at home. Repeated delivery attempts lead to higher fuel and labor costs. Also, undelivered packages occupy non-revenue generating space in trucks and UPS hubs, which essentially is a cost to the company. In order to counter these missed deliveries, UPS offers UPS My Choice and UPS Access Point network, [3] which allow the recipient to choose a convenient pick-up location or locker for their deliveries, and collect the packages upon producing valid IDs and tracking numbers.

By delivering to Access Point locations or lockers, UPS will not have to make last mile deliveries to the recipient’s residence, thereby saving up on fuel expenses and time. Every minute that a UPS truck driver saves every day leads to savings of around $14.5 million a year. [3]

Presently, there are 300 UPS Access Point locations in New York City and Chicago. UPS is working on installing self-service smart lockers in Chicago. It plans to add 4,400 UPS Stores to its Access Point network, significantly increasing its pick up locations. [4] By the end of 2015, UPS expects to add 8,000 Access Point locations in key markets in Europe and the Americas. Currently they have 12,000 Access Point locations only in seven countries in Europe. UPS’ My Choice services will be expanded to 15 countries in North America and Europe.

Synchronized Delivery Solutions to help increase delivery density

It often happens that shoppers make purchases from multiple websites. However, not all of them provide the same date of delivery due to some constraints. For logistics companies like UPS, this could mean making deliveries to the same address day after day. UPS believes that such situations offer an opportunity to reduce costs. With its Synchronized Delivery Solution (SDS), UPS will be coordinating with multiple e-commerce sites such that all packages going to a particular address are delivered on the same day. [3] For instance, if a shopper was to purchase two products from e-retailers A and B, with e-retailer B advising delivery in three days whereas A can deliver in two days, then UPS will hold the package from e-retailer A for one extra day and deliver it along with the package from e-retailer B on the third day.

Using this mechanism, UPS will be able to save up on fuel expenses and time since it will be making just one trip to one address. It can use the time saved to make other revenue-generating deliveries.  

ORION will help increase operational efficiency and reduce fuel expenses

One of UPS’ primary measures to reduce costs is its route optimization software ORION (On-Road Integrated Optimization and Navigation). Launched in 2012, ORION helps reduce fuel costs, miles driven and air pollution by suggesting the most efficient route for delivery. It will help save $50 million annually for every mile reduced per day per driver. [3] ORION is expected to be deployed across all of UPS’s routes in US by the end of 2016.

Dimensional weight based pricing will lead to better price realizations

Loaded with bulky-yet-light packages such as ordered online such as toiler paper rolls, towels, shoes, diapers, etc., UPS’ 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.

Post December 28 2014, UPS will use dimensional weight to calculate the billable price of all Ground packages in the U.S. and Standard packages to Canada. [5] With dimensional weight based pricing, UPS should be able to improve its yields through better price realizations. Its margins should also increase since rates would be more aligned with costs.

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Notes:
  1. 2014 Investor Conference – Kurt Kuehn Presentation, November 13, 2014, www.ups.com [] []
  2. UPS Quarterly Historical Income and Operating Data, January 30 2014, www.ups.com []
  3. 2014 Investor Conference AM Presentations, November 13, 2014, www.ups.com [] [] [] []
  4. UPS Gives Online Shoppers Around the World Delivery Confidence, Control and Convenience, October 08, 2014, www.ups.com []
  5. UPS Announces Dimensional Weight Changes, June 17 2014, www.ups.com []