FedEx Corp. (NYSE:FDX) and UPS Inc. (NYSE:UPS) have a holiday message for their big customers: Prepare to pay up or prepare to pound sand.
An extraordinary year for parcel shipping will conclude with an equally extraordinary peak season. Carriers are bracing for unprecedented volumes as the normal holiday shop and ship hysteria meets the abnormal nine-month surge in e-commerce as consumers continue to avoid stores due to the coronavirus pandemic.
Just as unprecedented, however, will be the surcharges levied by the carriers to deliver all these domestic parcels. For the first time, peak surcharges to handle “standard-size” parcels, the familiar packages that carriers process through their automated conveyor systems, will be pegged to a range of shipper volumes. And it will be the big shippers, companies accustomed to leveraging their massive volumes to win rate discounts, that bear the brunt of the fees. Small to midsize customers that typically pay higher rates throughout the year will be exempt from the surcharges unless their volumes exceed thresholds that would be hard to reach even during the holidays.
At UPS, the surcharges kick in at 25,000 parcels per week from a combination of air and ground residential deliveries, as well as its SurePost service with the U.S. Postal Service (USPS) where parcels are inducted deep into the USPS network for last-mile deliveries. At FedEx, the threshold is 35,000 parcels shipped weekly by air or ground for residential and commercial deliveries. The FedEx surcharges will apply only to residential deliveries, however.
FedEx will levy separate surcharges on each parcel shipped via its own induction service with USPS, known as SmartPost. Because FedEx and UPS tend to move in lockstep when it comes to such fees, UPS may respond by establishing its own stand-alone surcharge on SurePost traffic.
The first of FedEx’s standard-sized parcel levies kicks in Nov. 2 and runs until Dec. 13. The second cycle begins Dec. 14 and runs through Jan. 17. All of UPS’ standard-size parcel surcharges take effect Nov. 15 and run through Jan. 16.
The surcharges are steep, running $1 to $5 per package depending on service type and volume levels. The specific charges are based on a complex formula called the “peaking factor.” For example, a FedEx customer whose weekly peak volume makes it surcharge-eligible will pay a $1-per-package levy if its weekly traffic is 110% to 200% above the volumes tendered during the February-early March 2020 period. That was before the pandemic and the shelter-in-place directives designed to stem its spread sent e-commerce and parcel delivery demand soaring.
The surcharges will rise as a shipper’s peak volumes escalate above the February-March period. This spells trouble for large shippers because the surcharges will be set against the pre-pandemic period when volumes were relatively low. It may be easy for a big shipper, especially during what is expected to be a very active season, to hit volume levels that would trigger surcharges as high as $5 per package.
To add insult to injury, the carriers have extended the surcharge period by two weeks to mid-January, presumably to capture fees on the expected mountain of holiday returns. What’s more, “special-handling” charges to transport so-called nonstandard parcels, goods that are outsized or that require some form of special handling, along with so-called “overmax” shipments, parcel lingo for big items that have no business moving in a small package network, will go into effect weeks earlier than they have in the past.
About 80% of business-to-consumer (B2C) e-commerce is transacted over the holidays, and the surcharges, depending on their severity, could push even big shippers into the red. Dave Sullivan, vice president of professional services for Shipware LLC, a parcel consultancy, warned in an email last week that shippers who historically rely on profitable holiday volume to carry them through the rest of the year “could be negatively impacted to a degree that they may not recover from.”
Pricing Power
The carriers said the surcharges are needed to recoup the higher costs of delivering residential packages amid volume surges that will continue well into 2021. But it goes deeper than that. With demand far exceeding capacity, FedEx and UPS have pricing leverage they haven’t seen in years. In a seller’s market for services and potentially big profits to be had, they are determined to hold the surcharge line, experts said.
In the close-knit parcel shipping world, anecdotes about the carriers’ assertiveness are flying fast and furious. Mark Magill, vice president of business development for regional parcel carrier OnTrac, said FedEx and UPS are telling their big customers that their traffic “`is not profitable. Here’s your giant rate increase, take it with a smile or we won’t pick up from you.’”
Big customers typically win deep discounts from the carriers because of their enormous volumes. Yet the discounts, combined with a high cost to serve massive volumes, often depress carrier margins. Amazon.com, Inc., (NASDAQ:AMZN), the nation’s biggest e-tailer and UPS’ largest customer, tenders deeply discounted traffic that produces subpar yields for the carrier, said Dean Maciuba, director of consulting services for consultancy Logistics Trends & Insights LLC. FedEx, fed up with jumping through hoops for Amazon with unacceptable profits to show for it, ended their relationship in 2019.
Maciuba said UPS, which in 2019 generated about 11-12% of its $74 billion in annual revenue from Amazon, has begun a strategy of “putting distance” between the two so it can shed the shipper’s unprofitable traffic. In the near term, UPS’ message to Amazon is to “start moving more of your crummy shipments on your own during the holidays,” he said.
Carol B. Tome’, UPS’ newly minted CEO, said as much during her first analyst call on July 30. Tome’ didn’t mention Amazon by name. Nor did she refer to UPS’ surcharge policy. Yet she told analysts that “there’s an opportunity on the pricing side to do what we need to do.” It is easy to interpret those remarks as the company taking a harder line on accepting marginally profitable freight during the holidays and beyond, experts said.
Tome´ dismissed concerns that the surcharges could inflict severe damage on shippers’ holiday margins. E-merchants are capable of incorporating higher delivery prices into the cost of their products without consumers ever noticing it, she said.
Amazon self-handled two-thirds of its July traffic this year, according to data from consultancy ShipMatrix. However, the company has struggled to consistently hit its delivery commitments under its popular Prime service due to the elevated volumes triggered by the pandemic. The company’s peak volumes will put July’s traffic levels to shame, and it is scrambling to add 50% more fulfillment and distribution capacity to handle the anticipated crush. Amazon may find it has little choice but to pay UPS more in exchange for capacity assurance over the holidays, experts said.
Perhaps the most significant long-term takeaway from the peak season is how much UPS will ding Amazon on surcharges, if Amazon responds by moving more traffic in-house, and if the relationship begins to fray as a result. Amazon declined to comment. “Our goal is always to ensure that we have mutually beneficial relationships with all of our customers,” a UPS spokesman said in an e-mailed statement. The company declined further comment.
Shipper Recourse
Big shippers do have recourse, according to parcel consultants that help shippers manage their carrier relationships. They can shop around other carriers and even services like Freightquote, a unit of C.H. Robinson Worldwide Inc. (NASDAQ:CHRW) and UberFreight (NYSE:UBER) that might offer lower rates and fewer, if any, surcharges. They can segment their traffic so parcels of a less time-sensitive nature could move with lower-cost carriers like USPS.
Both approaches have caveats, however: The first is that peak surcharges are catching on with other carriers. USPS has announced its first-ever surcharge, which will apply to large commercial users like FedEx, UPS and consolidators like Pitney Bowes Inc.’s (PBI) Newgistics Inc. unit that aggregate merchants’ traffic and dump bulk volumes into the postal network. FedEx and UPS will pass through those increases in the form of significant markups on their SmartPost and SurePost services, respectively.
Even regional parcel carriers, which typically have lower rates and add-on fees than the big boys, are getting into the surcharge act. Three of the regionals, OnTrac, LSO and LaserShip, plan to apply their own peak season levies. OnTrac and LSO cover all of California and Texas, respectively. LaserShip covers 22 states from New England to Florida.
The second concern is that shippers could lose their contract discounts with FedEx and UPS if they spread around their traffic too freely. Discounts are awarded based on tiers of parcel spending with each. Diverting too much traffic from either, or from one to the other, could drop a shipper into a lower spending tier, and with that a less attractive discount. Shippers will need to determine if the possible loss of year-round discounts justifies trying to avoid the peak surcharges, consultants said.
Shippers may have more success in presenting a business case as to why they should be exempt from the surcharges. John Haber, CEO of Spend Management Experts, a consultancy, said non-retailer shippers with robust year-round volumes stand a better chance of escaping the surcharges than retailers who cram the bulk of their traffic into the holidays.
According to Maciuba, FedEx and UPS will likely grant exemptions to customers that, based on the carriers’ analysis, generally tender profitable freight throughout the year. The reason, he said, is that the carriers want the business year-round and don’t want to alienate the companies supplying it. By contrast, shippers failing to meet the carriers’ profitability standards will be hit with increases without the carriers giving it a second thought, Maciuba said.
Shippers who try to plead their case with the carriers need to fully quantify the severity of the surcharges in terms of the incremental cost that will be incurred and the impact on margins and profitability, according to Sullivan of Shipware. He added that shippers must be vocal about the consequences of the surcharges on their bottom lines. “Shippers can’t assume that the carriers have their best interests in mind,” Sullivan said. “They won’t get anything if they don’t ask for it.”
Above all, shippers need to act now if they already haven’t, and they should make their customers understand what’s at stake, according to experts. If possible, shippers should incentivize their customers to accept slower shipping times, and to spread out high volumes over a multi-week period, if possible, to avoid additional fees, they said.
Uncharted waters
The parcel industry is in uncharted waters. Neither FedEx or UPS imposed surcharges on standard-size parcels last holiday season. No one knows if the 2020 programs are the shape of things to come, or a one-time event based on a year that’s been like no other. The COVID-19 surcharges that the carriers imposed in the spring will be replaced — at least temporarily — by the peak surcharges. But they may return in mid-January once the peak surcharges drop off.
Magill of OnTrac said the peak surcharges are just the start of a cycle of higher year-round rates for big shippers. Magill noted that UPS will be throttling back on infrastructure expansion in 2021. A cutback in the rate of capacity growth, outside of peak-season needs, will lead to higher rates in the years ahead should parcel volumes remain as strong as most people expect, Magill said. Indeed, Tome´ noted on the earnings call that UPS had pulled forward $750 million in infrastructure investment into 2020 from 2021.
Maciuba said the industry has entered a period of “dynamic pricing” where the carriers will raise rates “as they see fit” based on their evaluations of shipper profiles. The leverage has swung to FedEx and UPS, he said, meaning that the days of big shippers taking volume-driven discounts for granted are effectively over.
Haber of Spend Management Experts warned, however, that the carriers may be biting off more than they can chew. Big shippers have long memories, he said. In addition, the parcel world, just like everything else in business, runs in cycles. Shippers that have long cast their lot with FedEx and UPS will not take kindly to the carriers’ current measures, and will pointedly remind them when the cycle turns, Haber said. “Shippers will remember this,” he warned.
For now, one constituency is very happy: Wall Street. If share price movements are any indication, investors and analysts have telegraphed a very favorable turn in the carriers’ fortunes. FedEx shares, which traded under $90 a share in mid-March, closed Aug. 31 at $219.84 a share. UPS shares closed the day at $163.62, roughly doubling in price over the same time frame.
