The Perfect Solution for Online Retailers

by Eric A. Brill

(January 17, 2017)

The US Postal Service is prominently mentioned here, but without the usual lament about declining first-class mail or unfunded pension liabilities. The Postal Service is presented as it should be: not indispensable, but strong, well-positioned and reliable – an ideal partner for the savvy entrepreneur who seizes this lucrative opportunity.

A Sorry State of Affairs

Illegal price fixing? You decide.

UPS and FedEx dominate the booming US consumer-parcel market – well over 80% market share overall, even higher in some areas. They exploit their market power by setting identical high ground rates. (Most consumer parcels are “ground” parcels.) Wonder about UPS Ground rates but misplaced your rate table? Just check your FedEx rate table. US ground-rate tables are identical for UPS and FedEx – every weight, every zone. Over a thousand rates, identical to the penny. No exceptions.*

* Compare (1) UPS Ground rates (US) at pages 68-71 of UPS Rate and Service Guide (July 11, 2016); with (2) FedEx Ground rates (US) at pages 106-108 of FedEx Service Guide (July 1, 2016). Zero-to-150 pounds, all distances. Both carriers add an identical large surcharge for deliveries to residential addresses, and another identical large surcharge for deliveries to certain zip codes (even higher for certain remote zip codes). Their continental-US "delivery area surcharge" zip codes are essentially identical (a small handful of differences among tens of thousands of zip codes). Both carriers also add a fuel surcharge – usually identical but a few cents different at times. More on these surcharges appears below, especially at the next footnote.

Coincidence?

In days gone by, this might have raised eyebrows at the Justice Department. Not today. Lawyers for UPS and FedEx are prepared if anyone accuses them of being what critics say they are: a price-fixing duopoly. Large shippers don’t pay list rates, they will argue. They negotiate complicated contracts. The resulting rates are heavily discounted and vary considerably.

Do they? 

UPS and FedEx demand that customer contracts be kept confidential, but outsiders sometimes learn their terms. Their answer to this question:

Sometimes, but not often.

Sometimes UPS and FedEx offer significantly different discounts to a particular shipper. More often, though, both carriers offer the shipper similar discounts – even identical discountsOnce UPS knows what rates FedEx is offering a shipper, and vice-versa, each carrier predictably will match the other’s offer or undercut it only slightly. Both will press the shipper to base its choice on non-price factors – service and reliability, for example. 

In any event, many online retailers – even those who receive substantial discounts – grumble loudly about UPS/FedEx pricing. With good reason: UPS/FedEx rate hikes far exceed inflation. Between May 2000 and May 2016, for example, the Consumer Price Index rose 39%. The UPS/FedEx floor rate for residential ground parcels – the 1-pound, Zone 2 list rate (there is no Zone 1), the minimum paid by most UPS/FedEx shippers regardless of their discounts – jumped far more: 182%.** Although most online retailers pay much less than list rates to UPS/FedEx, contractual discounts typically are percentage-keyed to list rates (usually with a minimum set at the undiscounted floor rate). As a result, the steep rise in list ground rates has hurt nearly all UPS/FedEx shippers, large and small.

** The alarming 2000-2016 price increase owes partly to surcharges added over the years, which have increased even more than base rates. The 182% price jump reported here reflects only the “big three” surcharges: fuel, residential-address, and delivery-area. The first two apply to every ground parcel delivered to any residence. The last one applies to most US zip codes and roughly 25% of US addresses; it is “population-weighted” in all calculations here to reflect that it is not payable on deliveries to 75% of US addresses. In 2000, none of these “big three" surcharges was payable. All of them were “built in” to the base rate.

Each rate hike by itself may be tolerable, but their cumulative effect has been severe – death by a thousand paper cuts. An even better metaphor: the gruesome “frog in hot water” experiment. If a frog is dropped into a pot of hot water, it will jump out immediately. But if the water starts at room temperature and is heated slowly, the frog will paddle around contentedly until it boils to death.

Many online retailers “boil to death” every year. Few understand the reason any better than a puzzled frog. Some survivors recognize the danger, however, and it grows worse each year. UPS/FedEx rate increases matter little to a retailer selling only $500 items. But how many do? Rate increases matter a great deal to retailers selling low-cost items, especially since buyers increasingly demand “free shipping” and abandon on-line shopping carts when sellers do not offer it.

Shipping is never free, of course. Someone pays for it. If buyers won’t, sellers must. And so online retailers are squeezed – pressed by consumers from one direction, by UPS and FedEx from the other. 

What can they do?

Most respond meekly. They strike the best deals they can with UPS and FedEx, cut costs elsewhere if they can, boost prices to cover shipping costs, and try to persuade themselves that customers won’t balk. Some customers won’t; others will – at some point, very many will. Some retailers switch to Priority Mail, especially for lighter-weight parcels (or even first class mail, for very light parcels). Some use lower-priced regional carriers where they can. Many use a fast-growing hybrid service offered by both FedEx (SmartPost) and UPS (SurePost): Parcels are advanced to destination-end post offices for “last-mile” delivery – slower than regular UPS/FedEx ground service, but significantly cheaper. 

A handful of very large retailers "go direct” – especially Amazon. It has such high volumes (40% of the US e-commerce market by year-end 2015) that it can truck parcels directly to destination-end post offices, from which "last-mile" postage is very low. At times Amazon skips the post office entirely, hiring destination-end couriers to deliver parcels directly to homes, or delivering them itself (sometimes in “Amazon Fresh” trucks designed to deliver fruits and vegetables). Nonetheless, even Amazon relies heavily on UPS and FedEx, shipping many millions of packages through each carrier. 

Though it pays lower rates, Amazon must ask itself the same questions as other retailers:

1. Are shipping costs too high?

2. If so, are inflation and fuel prices to blame?

The answers:

(1) Yes – shipping costs are too high. 

Amazon, for example, loses several billion dollars each year on shipping, and that loss is growing by leaps and bounds. In 2015, Amazon's one-year net shipping costs (shipping charges paid minus shipping charges collected from customers) were over $5 billion, an even higher percentage of sales than in previous years. Amazon's net shipping costs jumped even faster in 2016 – to an astonishing $4 billion in just one quarter (ending September 30, 2016), with even larger losses expected for the December (Christmas) quarter. Other online retailers have had similar experiences – or worse.

(2) No – inflation and rising fuel prices are not to blame.

UPS and FedEx raise ground rates far faster than inflation or rising fuel prices require, for one simple reason: They can. Each knows its main competitor will do exactly the same, yielding ground-rate tables that are identical except for the company name at the top of the page. 

UPS and FedEx still compete with one another – each insists, for example, that its deliveries are quicker and more reliable, or that its customer service is better – just not on the basis that matters most to shippers: price. Their matching ground rates should come as no surprise. Consumer-parcel shipping has been growing at double-digit rates for many years, and the trend appears likely to continue. Not to exploit market power in such heady times would be to waste it. UPS and FedEx are not wasteful. Exploiting their market power requires cooperative pricing, not bidding wars. They understand this.

But this stark fact leaps out: The US consumer-parcel market is sufficiently uncompetitive that UPS and FedEx are able to dominate it despite their high “cooperative" ground rates. A  huge profit opportunity exists underneath this UPS/FedEx pricing umbrella.

A Better Way – Fast, Low-Cost Shipping for Online Retailers

A savvy entrepreneur can enable online retailers to slash shipping costs, with very large profits left over for the entrepreneur. Here’s how: 

Build and operate a high-speed, low-cost sorting hub in a central location (or two), and link it by truck to regional Postal Service facilities in destination areas. 

Most on-line retailers have simple shipping needs. In the continental US, a single distribution center (two, at most) usually is enough, if it is near a sorting hub that has two attributes: 

1. Parcels can be sorted quickly and cheaply to many destinations. (The system pictured below, for example, can sort 8,000 parcels per hour to hundreds of destinations – at a far lower installation cost (about $500,000) and operating costs than a comparable UPS/FedEx facility.)

2. The hub is located where sorted parcels can be trucked quickly to their destination areas – not to their actual destinations (that is where the Postal Service comes in), just to their destination areas. 

Fast sorting to many destinations is not necessary in a “many-points-to-many-points” network. UPS and FedEx networks are that type. At each sorting facility along the way, parcels are sorted to fairly few places – other regional hubs or destination-end delivery stations. 

Regardless of equipment capability at a UPS/FedEx sorting hub, actual sort speed – arrival time to departure time – is severely limited by the need to wait for incoming parcels from many locations. For example, a San Francisco-bound parcel from New York typically will not leave a UPS hub in St. Louis until San Francisco-bound parcels from Chicago and Memphis have also been received, sorted, and loaded onto the San Francisco-bound truck. Though UPS and FedEx have sped up deliveries in recent years (at ever-higher rates, as explained above), multiple sorts – sometimes half a dozen, occasionally even more – remain standard operating procedure. This inevitably will continue because UPS and FedEx networks inevitably will remain many-points-to-many-points” networks.

But a single sort – just one – is enough in a “one-point-to-many-points” network. Such a network is impractical for UPS or FedEx, but is exactly the type of network that a focused new competitor could use. From a Louisville hub (for example), such a network might look like this:


What might such a sorter look like? Too much detail would reveal the inventor's “secret sauce,” but ours might look like this from above:





This model would permit the Postal Service to exploit its strengths. For several decades, it has encouraged shippers to deposit parcels at destination-end post offices for “last-mile” delivery. Predictably, this focus has begat FedEx SmartPost and UPS SurePost – the largest users of the Postal Service’s "last-mile" services. But it has mired the Postal Service in a low-margin market segment. UPS and FedEx continually press the Postal Service to cut last-mile rates, upsetting both the Postal Service and UPS/FedEx drivers. In addition, numerous local delivery companies – many of them “gig economy” newcomers whose independent-contractor couriers reportedly upset some parcel recipients – have sprung up and driven down last-mile profits still further. This trend seems likely to continue.

Market segments other than "last mile” are far more appealing. UPS/FedEx dominate these segments, largely because participation requires a considerable infrastrucure that few would-be competitors possess. One obvious candidate is the Postal Service, but it long ago bowed out of this segment by focusing on last-mile delivery, relegating its long-distance offering (Parcel Post) to near-oblivion. With some help, however, the Postal Service is poised to snatch a much larger share (and more of the “last-mile” segment in the process).

The Postal Service – specifically, Priority Mail – performs very well in “end to end” deliveries. Two personal examples: A large package Priority-Mailed from San Francisco reached its destination mailbox in a small New England college town the next day. A home-baked loaf of bread – possibly still warm from the oven – Priority-Mailed from San Francisco a week later also reached its destination mailbox the next day, this time in central Ohio. In both examples, however, the Postal Service’s impressive end-to-end performance depended on its air-lift contract with FedEx, which almost certainly transported both packages cross-country. While the Postal Service can count on air-lift assistance going forward, whether from FedEx or another air carrier, its “end to end” performance inevitably will depend on that carrier – which also may be a competitor.

Cross-country transport is irrelevant, however, for someone who taps into the Postal Service network in destination areas. This is feasible because the Postal Service has rationalized its parcel-delivery network over the past two decades, closing or “re-purposing” over two-thirds of its regional parcel hubs. Today it covers the entire continental US from just 141 destination-area hubs (with a few additional hubs in Alaska, Hawaii and US territories). 

The Postal Service now is doing exactly what needs to be done. Every day and night, it transports many thousands of parcels among its destination-area regional facilities, and from those facilities to local post offices for next-day delivery. Apart from UPS and FedEx, no private parcel carrier offers this capability. Workable alternatives have been cobbled together using smaller “national” carriers such as DHL, Newgistics and OSM – sometimes with regional carriers and local courier companies added to the mix – but “one stop shopping” is available only from UPS, FedEx or the Postal Service.

Most important, the Postal Service can perform just as well as UPS and FedEx (while charging much less) in this new parcel-shipping model: 

 Private Origin Hub + Private Trucks + Postal Service = 100% Coverage at Lower Prices ***

*** The numbers used below – 37, 141 and 171 – are based on 2015 Postal Service information. Some numbers may have changed or hereafter may change, but a change almost certainly will not affect the analysis. Indeed, lower numbers (more likely) would be favorable.

The Postal Service should exploit its pre-“last mile" strength by striking deals aimed at feeding its destination-area regional hubs – not just post offices. The model described here would accomplish this. In the continental US, for example, parcels would be sorted and sacked to 171 sort destinations at our origin hub (Louisville), then trucked to just 37 Postal Service facilities. The Postal Service would advance some of the pre-labeled sacks (unopened) to 104 additional facilities. The map at this link shows the 37 drop points and the 141 total parcel facilities (37 + 104 = 141; some Postal Service regional hubs handle multiple sort locations, which is why parcels would be sorted to 171 sort locations rather than 141). 

Once a pre-sorted sack reaches the Postal Service facility that sorts to the parcels’ destination post offices (but not until then), the sack would be opened. The parcels inside would be merged with other incoming parcels, and then sorted and forwarded to local post offices that night for next-day delivery by uniformed mail carriers. Roughly 75% of all parcels would reach customer homes in one day from the Postal Service drop-off facility (two days from our Louisville facility). The remaining 25% would require an extra day. “Overnight” parcels would be handled separately – deposited with an express carrier near the private origin hub. Very heavy packages, or those destined for Alaska, Hawaii, US territories or a foreign country, would take longer and cost more, but even those deliveries would be quicker and cheaper than UPS/FedEx. Coverage would be 100% world-wide.

The Perfect Solution

With such a model, consumer parcels can be delivered quickly and cheaply from a single private hub (or two hubs, in the example above) to homes throughout the US and the rest of the world – at a huge profit for the entrepreneur who brings this about. If the sorting facility also can handle order-packing and other pre-shipping steps (the system pictured above can), an online retailer’s total fulfillment costs – warehouse shelf to customer’s home – can be cut drastically, with an even larger profit left over for the entrepreneur. 

– Eric A. Brill

© Eric A. Brill 2017