FedEx and the future of e-commerce October 2014

Back in the late 90s FedEx briefly branded itself as the “Official Airline of the Internet”. It seemed plausible — transactions would be increasingly be conducted online and, for example, Amazon, the new electronic bookstore might carve out a small niche for itself in the publishing market, while FedEx was perfectly positioned to provide rapid physical transport for goods ordered through websites.

It hasn’t quite worked out like that. FedEx is still the world’s largest air express operator, with a current fleet of 300 jets and 356 turboprops, but its traffic volumes have been stagnant or in decline for some time. Its relationship with the internet and e-commerce has been complicated.

FedEx reported a pre-tax profit of $2.1bn on revenues of $27.1bn in its last financial year (to May 2014), a respectable overall 7.6% margin. FedEx’s strategic aim is for an operating margin of 10% and an additional $1.6bn in pre-tax profits by 2016. But FedEx’s strategy is not based on traffic growth but on cutting costs, rationalisation and yield increases.

At the operating level FedEx breaks down its performance by segment. It is perhaps surprising to note how modest the profitability of the air operation, FedEx Express, is compared to that of the boring Ground segment. Even the traditional Freight segment produces a higher margin. In the first quarter of FY 2015 FedEx’s margin improved to 8.5%, with Express at 5.4%, Ground 18.6% and Freight 10.6%.

Indeed, a key element of FedEx’s strategy in recent years has been to “work with customers to shift deferred Express volumes to FedEx Ground” and to “transition international deferred shipments out of the FedEx Express air network on certain lanes”. This has enabled FedEx to reduce its jet fleet by 35 units over the past four years, and its plans are for a continuous contraction in aircraft over the next six years. As the table below shows, the jet fleet is to be reduced by 9% between this year and 2020, and payload capacity by 11%. There will be no further aircraft capex in the foreseeable future, a contrast to ten years ago when FedEx placed a launch order for 25 A380Fs, which was subsequently cancelled. However, the new 767s will provide a significant improvement in operating costs, lowering trip costs by 30% compared to the MD10.

FedEx management are quite optimistic about the near term for two basic reasons. First, they see improved economic conditions — FedEx’s own forecast for US GDP growth is 2.2% for this year and 3.1% for next, with e-commerce growing at three times this rate. Second, they hope to consolidate recent gains in yields, specifically by intruding a new charging system for Ground service based on weight rather than volume. Rival UPS is following FedEx’s lead in this pricing initiative.

However, e-commerce has developed in ways that not necessarily benefited FedEx and the other integrators. Most obviously the volume of documents and contracts that formerly was air-expressed has greatly diminished with email. Just in Time inventory control is not as dominant as previously, partly because hardware has become much more reliable and much less expensive, reducing the cost of inventory held by retailers. Software is now universally downloaded over the internet rather than dispatched as discs in a polystyrene-filled package.

In FY2014 the volume of FedEx packages transported by air in the US domestic market was about 7% below that of ten years ago. In 2004 FedEx had just stated a major international expansion but the volume of International Priority packages was roughly the same last year as it was then.

A worrying development for the integrators is a change in distribution strategy by the big e-commerce retailers in order to reduce their own shipping costs. Amazon is decentralising its warehouse network away from its Seattle base, building new facilities in, initially, San Francisco, New York, Boston and Chicago and ultimately targeting the top 50 urban markets. Wall-Mart is doing something similar. The additional cost of the new facilities will, Amazon expects, be outweighed by savings generated by cutting FedEx and UPS out of the distribution chain and using its own, franchised local delivery companies under the Amazon brand. Fulfilment costs, which are mostly transport-related, have risen to 15% of Amazon’s revenues, up from 11% in 2009.

Amazon’s ultimate aim for Amazon is to guarantee one day, or even one hour, delivery to customers — as close to physical shopping as possible. Google is moving inexorably into this market with a slightly different concept — here the customer orders online and a local courier company, branded Google Express, picks up the good from the shop and delivers it to the customer’s home.

The e-commerce giants are not, however, guaranteed success. FedEx and UPS that logistics is a complicated business in which they have decades of experience. Their customers are not going to leave them for the new e-commerce upstarts.

Then, there is a further technological break-through on the near horizon — commercial drones delivering air cargo (after all, wars are now been fought using drones). Amazon’s Prime Air, using an octopus-looking unmanned aircraft, is according to Amazon, ready for service from a technological point of view, and only requires FAA approval. In the UK Balpa, the pilots union, has recently been lobbying for strict regulation of drones on safety grounds. Balpa expects drones “the same size as small passenger aircraft” to be operating commercially within ten years. Amazon thinks within two years.