Just How Important Is The E-Commerce Boom To UPS and FedEx?

by Trefis Team
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The rise of the e-commerce industry is one of the reasons why investors expect shipping companies such as FedEx Corporation (NYSE:FDX) and United Parcel Services (NYSE:UPS) to do well in the long run. In the latest quarter, FedEx Ground’s revenues jumped 12% to $2.78 billion helped by a 10% volume gain in traditional ground services and a 25% volume surge in Smartpost services. While the e-commerce boom definitely benefits shipping companies, the impact may not be as big as one might think.

Online retail giants such as Amazon are now building distribution centers that are closer to the customers. Due to high transportation costs, companies now prefer to have multiple distribution warehouses located closer to the customers in big cities rather than a centralized hub. Amazon is also using more of its delivery trucks now that the products have to be delivered over a shorter distance. [1]

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This could result in a lower proportion of express delivery services for shipping companies. Express delivery services tend to be more profitable since shipping companies charge a premium. In short, even if the total volume of shipping orders continues to rise at a brisk pace, margins might get thinner due to higher demand for less profitable services. Even within ground services, a greater proportion could be the shorter distance orders. Delivery companies charge their clients on the basis of distance and the shortest distance orders are generally the least profitable.

Globally, there has been a shift for deliveries from the faster and more expensive air express segment to the slower and cheaper ground/sea transportation. Companies across the world are implementing cost-cutting measures and no longer spend as they did before the 2008 crash. Moreover, a decade of high fuel prices has resulted in deliveries getting more expensive. As a result, clients are ready to wait longer and prefer the slower and cheaper modes of delivery. Moreover, due to the utilization of inventory management software, companies now hold on to less inventory than they used to. This means they can afford to get shipments delivered within three or four days as opposed to the very next day.

FedEx has traditionally had a stronger presence in the air express segment but shifting business dynamics have forced the company to adjust to the changing external environment. It is already in the process of reducing its fleet size as well as employee head count as part of its multi-year restructuring.

Alibaba To Steal Chinese Domestic Market Share?

Internationally too, the e-commerce business is booming, but UPS and FedEx aren’t necessarily the only beneficiaries.

Take China for instance. The country’s domestic delivery market holds huge potential. In 2011, FedEx forecasts China to grow five-fold to $26 billion in 10 years. [2] But FedEx and UPS are allowed to operate independently in only a select few cities approved by the government. Their clients are generally multi-national corporations from whom they can charge premium prices.

But as you go deeper into the Chinese cities and rural areas, it is the local delivery companies that are thriving. Companies such as Alibaba are tying up with local Chinese companies in order to expand their distribution networks. [3] The online retail giant has joined hands with five delivery companies and is spending a whopping 100 billion yuan (~$16 billion) in the next eight years to develop an extensive distribution chain. Thus, it remains to be seen if FedEx or UPS can capitalize on the e-commerce boom.

We have revised our estimate to $112 for FedEx, which is roughly in line with the current market price.

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Notes:
  1. Twist of Freight for UPS and FedEx, August 15, 2013, bloomberg.com []
  2. FedEx, UPS Get a Toehold In China’s Express Delivery, September 10, 2013, wsj.com []
  3. Alibaba Building China Delivery Net in Shift to Consumers, July 24, 2013, bloomberg.com []
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