UPS’s Margins To Improve With Increased Operational Efficiency

United Parcel Service’s (NYSE:UPS) fourth quarter results were severely impacted by a surge in its operating expenses. The company invested significantly in its network in order to cater to the growing e-commerce package volumes, causing its operating expenses to overshoot and margins to decline. Since then, UPS has been looking to ensure that such an increase in operating expenses is avoided.

We believe that there are three key strategies that will help UPS improve its margins and reduce operating expenses in the future. Most prominent is the implementation of dimensional weight pricing for e-commerce package volumes. The accelerated launch of UPS’ On-Road Integrated Optimization Navigation (ORION) system will help reduce expenses and improve margins. Another factor is the implementation of a peak-based surcharge.

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Dimensional Weight Pricing To Boost E-Commerce Package Revenues

In June of 2014, UPS announced that dimensional weight would be used, starting in December, to calculate the billable price of all Ground packages in the U.S. and Standard packages to Canada. ^[1] The change in pricing mechanism was aimed at generating higher revenues from lightweight e-commerce packages, which occupy a large space in UPS trucks. When charged simply on the basis of their weight, these products would generate revenues which did not justify the space they occupied. In order to charge a fair value for its most important asset, the space in its trucks, and also more efficiently cover operating costs, UPS decided to move to a dimensional weight based pricing.

Dimensional weight can be calculated by multiplying the length, breadth and height of the package, and then dividing by 166. The change in pricing mechanism could result in a 30-50% increase in revenue per package for bulky-yet-light products ordered online such as toilet paper rolls, towels, shoes, diapers and purses.

ORION Will Help Increase Efficiency, Reduce Fuel Expenses

UPS recently announced that it will be accelerating the launch of ORION, which will help reduce the distance traveled by its drivers in the U.S. by 100 million miles annually, when fully implemented in 2016. ^[2] By the end of 2015, Orion will be deployed to 70% of U.S. routes.

The ORION software is a route optimization software that is intended to improve delivery times and decrease fuel expenses for its ground fleet. Upon successful integration into its operations, the software is expected to save close to $50 million for every mile of route shortened per driver. ^[3] The deployment will also help reduce carbon dioxide emissions, vehicle maintenance costs and save 10 million gallons of fuel annually.

UPS To Add Peak Based Surcharge

UPS’ investments in its network have successfully paid off to an extent, as evidenced by its improved delivery rates. On December 24, the busiest day of the season, FedEx managed to reach a delivery rate of 98%, compared to 83% last year. ^[4] However, sub-optimal use of its resources led to an increase in operating expenses. Overtime and training costs for the seasonal workers and an increase in contract carrier rates added further pressure to its operating margins.

At its earnings meeting, UPS announced that it will be implementing a season based surcharge, with deliveries made on peak days carrying a higher surcharge. ^[5] Industry experts believe that this is the best possible solution to help logistics companies to cover their operating costs, which are bound to surge with volumes.

The impact of this change will be limited to UPS SurePost and residential packages. However, the benefits of peak-based surcharges will not be realized immediately, as UPS will be implementing this change over the course of a few years as it renegotiates contracts when they are due.

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1. UPS Announces Dimensional Weight Changes, June 17 2014, www.ups.com [↩]
2. UPS Accelerates Use of Routing Optimization Software to Reduce 100 Million Miles Driven, March 2, 2015, www.ups.com [↩]
3. 2014 Investor Conference AM Presentations, November 13, 2014, www.ups.com [↩]
4. FedEx, UPS step up their holiday shipping performance, January 1, 2014, www.washingtonpost.com [↩]
5. United Parcel Service’s (UPS) CEO David Abney on Q4 2014 Results — Earnings Call Transcript, February 3, 2015, www.ups.com [↩]