The U.S. Postal Service’s decision this week not to renew a contract with FedEx, worth more than $1.5 billion per year, for domestic air transport and award it to UPS after more than two decades actually benefits all three parties, according to industry analysts.
At face value, the arrangement seems a blow for FedEx (NYSE: FDX), which will lose one of its biggest customers when the existing contract expires on Sept. 29. And it raises questions about how UPS (NYSE: UPS) can make a decent profit flying mail if rival FedEx was struggling to do so.
But experts said the change meets the needs of the three organizations, each of which is undergoing substantial transformation in a shifting parcel environment. For FedEx Express, losing the postal business means it now has the freedom to aggressively move ahead with shrinking its large air network in conjunction with a huge corporate initiative to control costs.
The new agreement has a minimum base term of five and a half years, under which UPS will transport first-class mail, Priority Mail and Priority Express Mail.
“It’s a win-win-win,” Satish Jindel, president of parcel shipping consultancy ShipMatrix, told FreightWaves.
The long-standing relationship between FedEx and the U.S. Postal Service was widely expected to change. The only question was whether FedEx would relinquish some, or all, of the air cargo business.
It was difficult for the express carrier to eke out a profit as the Postal Service in recent years shifted volume from air to ground transportation to improve truck utilization and reduce expenses as demand for next-day service decreased. The quasigovernmental agency implemented new delivery standards to help with that transition. It now promises Priority Mail service in one to three days instead of two and has extended delivery windows for Ground Advantage packages. The latest goal is to cut overall transportation costs by $3 billion over the next two years.
A large portion of FedEx Express’ air network is geared to daytime flying for the Postal Service. The company had to absorb more per-unit operating costs as the traditional postal subsidy for its fixed infrastructure slowly evaporated. FedEx’s payments from the Postal Service dropped to $1.6 billion in the fiscal year that ended Sept. 30, 2023, from $1.9 billion, said David Hendel, a transportation attorney at Culhane Meadows who tracks the Postal Service’s top suppliers. His report last year showed FedEx’s revenue from the Postal Service was more than $2.1 billion in fiscal year 2021.
Company executives repeatedly made clear that they were willing to walk away from the postal business unless it included more favorable terms and a smaller route structure.
Jindel said losing the postal contract is a blessing in disguise for FedEx, which is undergoing a watershed consolidation of its FedEx Express, Ground and Freight units into a single network — something management gave a lot of thought to before proceeding and projects will provide $4 billion in annual efficiency gains.
“It probably makes sense for them not to be aggressive in trying to retain that business, and focus on getting the integration right. And then, when that opportunity comes up again, they may be in a more cost-effective position to bid on it,” said Jindel, a founding member of small-package carrier RPS that FedEx acquired in 1998 and renamed FedEx Ground.
FedEx’s campaign to take out $4 billion in structural costs by the end of fiscal year 2025 already includes accelerating the retirement of aging aircraft, parking underutilized aircraft until demand picks up and relying more on truck feeder services. The company is also redesigning the air network to move express and deferred shipments in segregated overnight and daytime blocks to improve efficiency.
Barclays transportation analyst Brandon Oglenski said in a research note that FedEx is likely to remove significant capacity from its air network next year when it no longer needs infrastructure to support the Postal Service, which will help boost the Express unit’s profit margins.
Freight experts said FedEx will be able to cut daytime flying and consolidate routes.
“With the U.S. Postal Service now out of the picture, and volume decreasing, FedEx will probably look to consolidate aircraft operations in small-to-medium-sized markets within close proximity, to drive savings,” said Dean Maciuba, managing partner at Crossroads Parcel Consulting and a longtime FedEx executive. “However, this type of operational change could also drive earlier pickup and later delivery times in the market that loses its aircraft.”
The risk is that shippers, which prefer the latest pickup and earliest delivery times possible, could seek out other carriers.
Anthony DeRuijter, an analyst at global research firm Third Bridge, said FedEx could collapse routes for Great Falls and Billings, Montana, for example, “and take out redundant flight hours.”
Another way FedEx can reduce costs, Maciuba explained, is by outsourcing ground support services at smaller air stations that are currently held by more expensive employees or shrinking teams by combining duties since there will be fewer flights.
Savings will be less if management redeploys aircraft under the new “Tricolor” initiative to go after more deferred freight, Oglenski said. FedEx has said it plans to use international and domestic daytime flights to handle shipments common to the less-than-truckload sector, which it distinguishes from low-yielding general cargo typically handled by freight forwarders.
Pilots will be one of the primary losers as FedEx shrinks its airline. A FedEx executive said in a private meeting late last year, reported by FreightWaves, that up to 300 pilots would no longer be needed if postal flying were substantially reduced. The number of surplus pilots is likely higher than that with the contract’s complete termination now confirmed.
UPS to run different postal playbook
On the other side of the ledger, UPS gets a contract with a five-and-a-half-year minimum base term that adds about $1.5 billion to its top line and volume to increase density on its trunk routes in a market with slow growth opportunity.
Some investment analysts expressed concern that UPS’ returns from the Postal Service business will be marginal and won’t help achieve the target 13% operating margin by 2026.
Jindel said that won’t be a problem because UPS is laser-focused on costs and will save money by using its ground network to support the air cargo contract — something FedEx wasn’t able to do because its air and ground networks were siloed.
“UPS has been running an integrated air and ground network for over 25 to 30 years. I don’t see them having to add any extra airplanes. So it helps them offset that fixed cost and spread that over another base of packages,” he said.
Oglenski agreed, saying UPS likely offered the Postal Service cheaper linehaul transportation services “by relying less on air capacity, especially between market locations that can be reached with one to two day trucking solutions.” UPS might need to deploy some incremental air assets in the daytime air network because its fleet is much smaller than FedEx’s, he added, but any extra costs are probably covered through the new contract.
Plus, the postal volumes help backfill Second-Day Air volumes UPS has lost in recent years as Amazon does more two-day delivery with its own logistics network, noted Derek Lossing, a former Amazon logistics executive who runs consulting firm Cirrus Global Advisors, on LinkedIn. UPS said average daily package volume fell 7.4% in the fourth quarter, with the deferred air product falling faster (18.9%) than next-day air or ground.
UPS also had an advantage in its negotiations with the Postal Service, Jindel said. For years, FedEx and UPS have offered retailers products that balance speed and price by injecting packages in the postal network for final-mile delivery. FedEx over time shifted that last-mile delivery traffic in-house to FedEx Ground drivers, while UPS still gives 60% of SurePost packages to the post office. And UPS Mail Innovations gives nearly 100% of its lightweight parcels and bulk mail, such as annual reports, to the Postal Service for the last mile.
“You would have to expect that the post office would look more favorably to them for the air service,” Jindel said.
Click here for more FreightWaves stories by Eric Kulisch.
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