UPS vs. FedEx: Ground Wars

UPS's rapid ascent leaves FedEx scrambling

Clad in a blue lab coat, a technician in Singapore waves a scanner like a wand over a box of newly minted computer chips. With that simple act, he sets in motion a delivery process that is efficient and automated, almost to the point of magic. This cavernous National Semiconductor Corp. (NSM ) warehouse was designed and built by shipping wizards at United Parcel Service Inc. (UPS ) It is UPS's computers that speed the box of chips to a loading dock, then to truck, to plane, and to truck once again. In just 12 hours, the chips will reach one of National's customers, a PC maker half a world away in Silicon Valley. Throughout the journey, electronic tags embedded in the chips will let the customer track the order with accuracy down to about three feet.

While the logistics are extraordinary, they tell only half the story. A similar warehouse in Singapore was constructed seven years ago by UPS rival Federal Express. But FedEx Corp. (FDX ), as it's now called, never managed to make the operation pay off. "They dropped the ball," says Kelvin Phillips, National's director of worldwide logistics. The FedEx team was inflexible, he explains. They forced the chipmaker to ship everything the most expensive way, via overnight air express--even if a shipment didn't require that kind of speed. And under FedEx, the Singapore warehouse never delivered on its promise of streamlining chip inventory. Finally, in 1999, Phillips yanked the business from FedEx and handed it to UPS, which rebuilt the operation from scratch. In the two years since, the team in brown has slashed National Semiconductor's inventory and shipment costs by 15%.

The Singapore story is no isolated triumph for UPS. Over the past two years, the company has quietly shed its image as the slowpoke of shipping. Be it e-tailing frenzy or dot-com crash, UPS has captured customers by bombarding them with choices: fast flights vs. cheap ground delivery, simple shipping or a panoply of manufacturing, warehousing, and supply-chain services. In the U.S. and several foreign markets, UPS has grabbed a commanding lead over FedEx--and not just in everyday package delivery but in the New Economy services such as logistics. In North America, UPS has even snagged the distinction of preferred carrier to the Web generation: The company handles 55% of all online purchases, vs. 10% for FedEx. "UPS is doing things in e-commerce that other companies are just starting to talk about," says Jack R. Staff, chief economist at Zona Research in Redwood City, Calif.

The ascent of UPS charts a reversal of fortune in one of the fiercest rivalries in Corporate America. It was FedEx, after all, that pioneered both overnight delivery of packages and the ability to track their journey using computers. These 1970s' era innovations rocked the shipping industry and helped set the stage for the Internet Revolution of the 1990s. Even now, FedEx rules in certain areas of air freight. Its carefully burnished brand still says "absolutely, positively" to thousands of loyal customers--and not without reason. FedEx is one of America's great success stories, extolled for its customer service. David Lord, the founder of now defunct dot-com e-tailer, hails the enthusiasm FedEx brought to his business in its early stages. The shipper went so far as to keep trucks idling outside his small company, ready to move orders as soon as they came in. "I was nobody, but FedEx treated me like a king," he recalls.

Nevertheless, on many fronts, UPS is winning the battles. And the companies' diverging fortunes are starting to show up on the bottom line. In revenues, both giants enjoy comparable growth: UPS surged 11% in 2000, to $30 billion, while FedEx's revenues grew 8.8%, to $18 billion. But in the same period, UPS raked in $2.8 billion in profits, giving it an operating margin of 15.3%. That's roughly double the margin at FedEx, which eked out just $688 million in profits. As the economy slows and competition gets more brutal, both companies are feeling the pain. FedEx's profits were down 4% in its latest quarter, and UPS's were down 8.9% in the quarter ended Mar. 31. FedEx has warned that things will get worse.

FedEx Chairman Frederick W. Smith and other top executives declined to discuss these results with BusinessWeek. But William G. Margaritis, FedEx's corporate vice-president for worldwide communications and investor relations, insists that the company's performance is up to snuff. "FedEx has a proven track record of delivering solid financial results," he said in a written response to questions from BusinessWeek. "Our compound annual earnings-per-share growth rate over the past 10 years is 15.6%."

In the view of many analysts and industry execs, however, UPS now has a pronounced advantage in several hotly contested areas. In addition to its overwhelming lead in ground shipping and its online triumphs, UPS can point to a logistics business that is growing by 40% a year. FedEx is struggling to reverse a decline in this area.

Even in sectors where FedEx still rules, UPS is catching up quickly. FedEx has a commanding lead in the profitable overnight service, for example, delivering more than 3 million such packages daily in 200-plus countries and accounting for 39% of the market. UPS is No. 2, with 2.2 million overnight packages--but its volume has been growing faster than FedEx's for at least three years. In 2000, UPS's overnight business grew at 8%, compared with FedEx's 3.6%. And UPS's operating margin on its domestic air-express service is higher--24% vs. 6%--according to Gary H. Yablon, a transportation analyst at Credit Suisse First Boston.

In his written response to BusinessWeek, Margaritis denied that the company is losing significant ground. "UPS has never caught up and passed FedEx in any arena," he wrote, "certainly not when it comes to reliability, technology initiative, global reach, or brand strength."

So what accounts for UPS's growth in overnight? The company trumpets its decision in 1999 to integrate overnight delivery into its vast ground-transportation network. UPS, like FedEx, still uses planes to make most such deliveries. But in the past two years, its logisticians have also figured out how to make quick mid-distance deliveries--as far as 500 miles in one night--by truck, which is much less expensive than by air. As a result, UPS's overall cost per package is $6.65, compared with FedEx's $11.89, according to CSFB. Even though FedEx also uses trucks for short hauls, "UPS has a real cost advantage," says John D. Kasarda, director of the University of North Carolina's Frank Hawkins Kenan Institute of Private Enterprise and a former FedEx consultant.

UPS's core strength is its fleet of 152,000 brown trucks, which reach virtually every address in the U.S.--and increasingly, the world. FedEx has belatedly begun to build its own home-delivery system. But the cost of duplicating a system UPS has spent nearly 100 years building could prove prohibitive. And with $3 billion in cash on hand, UPS could easily wage a price war against FedEx, which isn't generating any spare cash. "This is a game FedEx can't win," says Peter V. Coleman, a transportation analyst at Banc of America Securities. That leaves FedEx dependent on an air-delivery system that is increasingly expensive to operate.

COPYCAT. To appreciate how deftly UPS has turned things around, one must consider how badly the company was tripped up by its rival's meteoric success. UPS had experimented with air delivery for decades. But it was 27-year-old Frederick W. Smith, a Yale University graduate and Vietnam War veteran, who got the idea off the ground in 1971. Within five years, Federal Express was soaring--and the package-delivery business would never be the same.

UPS didn't counter with its own overnight service until 1988. The explanation for this may lie in its corporate culture. UPS was founded as a messenger service 94 years ago by James E. Casey, who ran the company like a military operation, ordering recruits to be polite at all times and to place speed above all other virtues. To this day, workers at UPS headquarters are forbidden to drink coffee at their desks.

This rigid culture didn't breed risk-taking. But by the mid-1980s, FedEx's success had earned a deep respect from its competitor. Not only did UPS begin to ape FedEx's tactics, it was able to duplicate the results--and often at a lower cost. UPS drivers started following their rivals' trucks to learn their methods and to poach customers. "It was warfare," says ex-FedEx exec Christos Cotsakos, now chairman of online broker E*Trade Group Inc. "We were soldiers at FedEx on a holy crusade."

Poling its customers, UPS learned that they desired Fed-Ex-style express and tracking services--and that required better information technology. It took UPS 15 years to build a computer system that rivaled FedEx's renowned Cosmos system. But UPS chose a wiser approach. While FedEx forced customers to adopt its proprietary software, UPS designed logistical software that worked with any corporate system. And where FedEx shunned alliances until recently, UPS jumped into partnerships with giants such as Oracle Corp. (ORCL ) and IBM (IBM ). Its cheaper shipping rates also won UPS the allegiance of dot-com leaders--while they lasted. And when the bubble popped, UPS came to rest on solid brick-and-mortar--namely, Wal-Mart Stores (WMT ), Ford Motor (F ), and others in that class.

Carefully mimicking FedEx, UPS gradually mastered the intricacies of logistics. But retrofitting a computer-centric culture to this erstwhile trucking company proved a Herculean effort. Well into the 1990s, a 1950s' style engineering culture ruled at UPS, complete with myriad rules addressing everything from women's dress to cafeteria protocol. On the road, drivers followed near-military regimens after being drilled on such details as how to quickly buckle and unbuckle seat belts. So when faced with Internet-era business challenges, top execs felt the company needed a fresh start. In 1994, they set up a new logistics group in a building a few miles north of the main campus in suburban Atlanta. Soon, many employees were clamoring to switch over to the new unit. "Everyone knows now that logistics is the place where you can get ahead," confides one junior UPS executive.

The new unit quickly paid its way. UPS's logistics revenues--excluding conventional shipping activities--grew 58% last year, topping $1 billion, and is poised for an additional 40% spurt. "I expect UPS to double its logistics business within the next four to five years," says Edward M. Wolfe, a transportation analyst at Bear Stearns & Co. In contrast, he says: "FedEx has loss momentum."

FedEx won't break out its results in logistics. But the company tacitly acknowledged a setback when it announced a thorough overhaul of the business late last year. From now on, it will focus solely on providing technology solutions to customers--showing them new ways to track packages, for example. FedEx's Margaritis derides UPS's hands-on approach as old-fashioned "pick-and-pack warehousing." And he says FedEx is reevaluating all of its logistics accounts, looking to weed out ones that don't fit the new strategy.

FedEx will have to move fast to avoid more defections from customers such as National Semiconductor. E-tailer dumped FedEx for UPS because the former "just didn't have the software and systems for us to revolutionize our operations," says Purchasing Director Michael Climo. UPS redesigned's business from warehouse to Web site, plugging its package-tracking software into's site so customers could use the feature without leaving the site. But it studiously left options open--visitors can even select shippers other than UPS. SmartHome staffers used to field about 60 calls a day from customers with shipping queries. Now, those staffers can spend their time making sales pitches.

Meanwhile, in the Old Economy, UPS is winning giant customers such as Ford Motor Co., which uses UPS's computerized logistics to route cars more efficiently to its dealerships. In a year, Ford has reduced delivery times by 26% and saved $240 million, says Frank M. Taylor, Ford's vice-president for material planning and logistics. "Speed is the mindset at UPS. They'll meet a deadline at any cost," Taylor says. UPS Chairman James P. Kelly chalks it up to the company's slow-and-steady work ethic. "We've spent the past seven years studying where we should be long-term," he says.

While FedEx backpedals in logistics, UPS is in growth mode. And it has figured out how to manage distribution for many companies at one central location--a massive warehouse in Louisville, Ky. Here, UPS handles storage, tracking, repair, and shipping for clients such as Sprint, Hewlett-Packard (HWP ), and Nike (NKE ) using a mix of high- and low-tech methods. Computerized forklifts scan in new inventory while people in sneakers dash across the vast warehouse to pluck products, box them, and ship them out. In short, UPS uses expensive technology only where it cuts costs.

HUBRIS. The story of UPS's remarkable comeback is mirrored--almost blow for blow--by miscalculations and botched opportunities on the part of FedEx. And while FedEx has instituted some promising initiatives in recent months, many analysts believe that it may be too late for FedEx to make up for lost ground.

The seeds of FedEx's current woes were sown in the late 1980s. That's when Smith and other top execs--blinded by annual earnings growth averaging 40%--fell into hubris. According to one former executive who asked to remain anonymous, Smith ignored opportunities to build up a residential ground-delivery network, instead putting all of the company's eggs in higher-cost air transport. Says the UNC's Kasarda: "UPS moved quicker into FedEx's turf than FedEx moved into that of UPS." And while Smith's early romance with computers gave him critical traction on the Internet, the technology is now undermining the choicest part of FedEx's operations: overnight delivery, which makes up 50% of its revenues. FedEx's own numbers show that about one-quarter of this business, or 749,000 parcels, are letter-size envelopes. Expand this category to include legal briefs, manuscripts, contracts, and other documents, and the category makes up fully 40% of FedEx's overnight traffic. Virtually all of this material can be transmitted electronically or posted online and downloaded when the need arises.

For now, digital delivery is in its infancy, and the impact on FedEx is less than catastrophic. Overnight shipments of letter-sized parcels fell just 2% year-to-year in the quarter ended Feb. 28. But Brian Clancy, a principal at Arlington (Va.) transportation consultant MergeGlobal Inc., expects more precipitous declines. Online security is improving quickly, he notes. And businesses are starting to adopt contractual devices such as digital signatures. As these technologies mature, the electronic transit of everything from real-estate closings to legal settlements is poised to explode--at the expense of shipping. "FedEx is definitely exposed," says Clancy.

So is UPS. But since the company still derives most of its business from ground delivery, it is far less dependent on overnight service. And it doesn't share FedEx's worries about the bottom line. Despite operating in the greatest economic boom in its history, FedEx remains narrowly profitable. "The company is woefully underperforming," says BofA analyst Coleman.

Margaritis repudiates this critique. He says FedEx anticipated the threat from the Net years ago. "That's why we've expanded into new lines such as home delivery and logistics," he says.

In the meantime, FedEx intends to strengthen its own already-formidable position in foreign markets. Right now, only 10% of all deliveries outside the U.S. are overnight. Consultants believe the leader now is Brussels-based DHL International Ltd., controlled by Deutsche Post, which has an estimated 20% to 25% of the international overnight market. But FedEx is tied for second place with TNT Post Group (TP ), each with about 10% to 15% of the market. UPS is third, with an 8%-to-12% share. FedEx's intercontinental parcel service grew 11% in the nine months ended Feb. 28. That's faster than any of FedEx's other operations. To juice it even further, FedEx has become the first shipper to gamble on Airbus Industrie's A380-800F air freighter. The triple-decker, which hasn't been built yet, will travel nonstop to just about anywhere in the world within 48 hours while carrying nearly twice the payload of the largest existing jet freighter.

FedEx is even making some progress in the ground war with UPS. It recently struck a $7 billion distribution deal with the U.S. Postal Service, hoping to squeeze more revenue out of every plane. The Postal Service will help fill planes that are now flying partially empty. As for FedEx's own trucks, they have served largely as the last leg in overnight delivery. But four years ago, FedEx spent $500 million to buy a ground network to serve businesses. This year, it will shell out an additional $150 million to expand the system in hopes of reaching all U.S. homes by 2002. The strategy, explains Margaritis, is not to compete "head-to-head" with UPS but rather to skim off the best customers with a new portfolio of premium services. FedEx charges extra for those services, which include night and Saturday deliveries--neither of which is now offered by UPS.

FedEx recognizes that its dependence on a jet fleet saddles it with the highest cost structure among all shippers. Indeed, the company has largely been cash-flow negative over its 30-year history, due to heavy investments in expansion. The latest drain is FedEx's ground-delivery system. Wall Street, however, is now demanding that the company show positive cash flow. FedEx promises to comply by the end of the year, by cutting costs and squeezing more revenue out of current operations. "Our mantra now is not just to grow, but grow profitably," says Margaritis. At least some of the company's fans are encouraged. "FedEx is on the right path," says Roger Mendel, a vice-president at Northern Trust Corp. (NTRS ), which owns 1.1 million FedEx shares.

But even Mendel says the company has a lot of work to do. Overseas, rival UPS has scored a major coup: It won six new direct air routes to China from the U.S. in January. Transportation Dept. in January, breaking FedEx's six-year stranglehold on such traffic. As for FedEx's U.S. strategy, analysts say buyers still aren't biting at its premium services.

BofA's Coleman sees little evidence that FedEx's new efforts on the ground will pay off. Because it insists on running its four main services as independent businesses, the company misses out on the cost-saving synergies that UPS has mastered. And while FedEx's nascent residential ground-delivery service has captured 11% of the market, it can't keep up with UPS, which spends $70 million-plus a year to expand its ground facilities. Analysts estimate that FedEx is already losing $18 million a quarter on residential ground delivery.

No one is counting the wily Smith out of the game altogether. But in the long run, his fleet of red-and-blue planes may prove no match for the countless ranks of UPS's slow-moving brown trucks or its bulging war chest. Like the tortoise in the old fable, UPS is progressing slowly but surely. And in this particular chapter of the story, the hare's stumbles are only helping the tortoise reach his goal.

Corrections and Clarifications "Ground wars" (Industries, May 21), about UPS vs. FedEx, requires clarification. The story gave the market-share numbers for delivery of online purchases as 10% for FedEx and 55% for UPS. FedEx says a more accurate measure is a recent study from showing 16% for FedEx and 36% for UPS. The table listing unit costs and profits for the two companies mislabeled the air and ground delivery categories as U.S. The figures were for worldwide operations. Another table said FedEx has 43,500 trucks. FedEx says the total vehicle count, including its long-haul business, is 94,800. And FedEx planes are no longer blue and red but purple and orange. See the letter in Readers Report.

By Charles Haddad in Atlanta with Jack Ewing in Frankfurt

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