Strategic Leadership

Assignment: Reflection Paper 2 Reflection Paper 2

This assignment covers chapter one, Strategic Leadership: Managing the Strategy-Making Process for Competitive Advantage, and two, External analysis: The Identification of Opportunities and Threats.  Write 3-4 pages in response to the questions below, including the questions that refer to Case # 14 in the back of your textbook.  Please include the questions in your paper. Then

Chapter 1 Questions:

What is competitive advantage, and how does it relate to a company’s business model?

Describe the strategic planning model, and who is involved in the strategy-making process

Describe the SWOT analysis, its components, and how it aids a company in making strategic decisions. Provide examples of each component in the SWOT analysis.

What are the various levels of management, and how do they participate in the process of strategic decision making?

 Chapter 2 Questions:

Define “Industry”, “Business” and “Sector”. How are these related?

How can Porter’s five-forces model aid in strategic decision making?

Descris”, and industry competition (“Threat of Substitutes”) affect the external threats a company faces. Provide examples of each.

Describe the industry life cycle, what strategic groups are, and what mobility barriers are.

Read Case # 14 Given

Discussion Questions for the Case “Given”

1. Analyze the gastrointestinal endoscopy industry and identify where the key opportunities and challenges are for Given.

2. What are some of Given’s advantages and weaknesses in this market?

 

 

14 case study

The small package express delivery industry is that segment of the broader postal and cargo industries that specializes in rapid (normally one to three days) delivery of small packages. It is generally agreed that the modern express delivery industry in the United States began with Fred Smith’s vision for Federal Express Company, which started operations in 1973. Federal Express transformed the structure of the existing air cargo industry and paved the way for rapid growth in the overnight package segment of that industry. A further impetus to the industry’s development was the 1977 deregulation of the U.S. air cargo industry. This deregulation allowed Federal Express (and its emerging competitors) to buy large jets for the first time. The story of the industry during the 1980s was one of rapid growth and new entry. Between 1982 and 1989, small package express cargo shipments by air in the United States grew at an annual average rate of 31%. In contrast, shipments of air freight and air mail grew at an annual rate of only 2.7%.1 This rapid growth attracted new entrants such as United Parcel Service (UPS) and Airborne Freight (which operated under the name Airborne Express). The entry of UPS triggered severe price cutting, which ultimately drove some of the weaker competitors out of the market and touched off a wave of consolidation in the industry. By the mid-1990s, the industry structure had stabilized with four organizations—Federal Express, UPS, Airborne Express, and the U.S. Postal Service— accounting for the vast majority of U.S. express shipments. During the first half of the 1990s, the small package express industry continued to grow at a healthy rate, with shipments expanding by slightly more than 16% per annum.2 Despite this growth, the industry was hit by repeated rounds of price cutting as the three big private firms battled to capture major accounts. In addition to price cutting, the big three also competed vigorously on the basis of technology, service offerings, and the global reach of their operations. By the late 1990s and early 2000s, however, the intensity of price competition in the industry had moderated, with a degree of pricing discipline being maintained, despite the fact that the growth rate for the industry slowed down. Between 1995 and 2000, the industry grew at 9.8% per year. In 2001, however, the volume of express parcels shipped by air fell by 5.9%, partly due to an economic slowdown and partly due to the aftereffects of the September 11 terrorist attack on the United States.3 Growth picked up again in 2002, and estimates suggest that the global market for small package express delivery should continue to grow by a little over 6% per annum between 2005 and 2025. Most of that growth, however, is forecasted to take place outside of the now mature North American market, where the annual growth rate is predicted to be 3.8%.4 In North America, the biggest change to take place in the early 2000s was the 2003 entry of DHL into the North American market with the acquisition of Airborne Express for $1 billion. DHL is itself owned by Deutsche Post World Net, formally the German post office, which since privatization has been rapidly transforming itself into a global express mail and logistics operation. Prior to 2003 DHL The Evolution of the Small Package Express Delivery Industry, 1973–2006 14 CASE Copyright © 2007 by Charles W. L. Hill. This case was prepared by Charles W. L. Hill as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Reprinted by permission of Charles W. L. Hill. All rights reserved. For the most recent financial results of the company discussed in this case, go to http://finance.yahoo.com, input the company’s stock symbol, and download the latest company report from its homepage. C211 342927_case14_pC211-C223.qxd 8/22/07 1:58 PM Page C211 lacked a strong presence in the all-important U.S. market. The acquisition of Airborne has given DHL a foothold in the United States. Still, DHL has a very long way to go before it can match the dominance of UPS and FedEx, particularly in the important air express market (see Exhibit 1), although the scale of its parent, which in 2005 had revenues of $60 billion, suggests that it could use its deep pockets to support aggressive expansion in North America. The Industry Before FedEx In 1973, roughly 1.5 billion tons of freight were shipped in the United States. Most of this freight was carried by surface transport, with air freight accounting for less than 2% of the total.5 While shipment by air freight was often quicker than shipment by surface freight, the high cost of air freight had kept down demand. The typical users of air freight at this time were suppliers of time-sensitive, high-priced goods, such as computer parts and medical instruments, which were needed at dispersed locations but which were too expensive for their customers to hold as inventory. The main cargo carriers in 1973 were major passenger airlines, which operated several all-cargo planes and carried additional cargo in their passenger planes, along with a handful of all-cargo airlines such as Flying Tiger. From 1973 onward, the passenger airlines moved steadily away from all-cargo planes and began to concentrate cargo freight in passenger planes. This change was a response to increases in fuel costs, which made the operation of many older cargo jets uneconomical. With regard to distribution of cargo to and from airports, in 1973 about 20% of all air freight was delivered to airports by the shipper and/or picked up by the consignee. The bulk of the remaining 80% was accounted for by three major intermediaries: (1) Air Cargo Incorporated, (2) freight forwarders, and (3) the U.S. Postal Service. Air Cargo Incorporated was a trucking service, wholly owned by twenty-six airlines, which performed pickup and delivery service for the airlines’ direct customers. Freight forwarders were trucking carriers who consolidated cargo going to the airlines. They purchased cargo space from the airlines and retailed this space in small amounts. They dealt primarily with small customers, providing pickup and delivery services in most cities, either in their own trucks or through contract agents. The U.S. Postal Service used air service for transportation of long-distance letter mail and air parcel post.6 The Federal Express Concept Founded by Fred Smith Jr., Federal Express was incorporated in 1971 and began operations in 1973. At that time, a significant proportion of small package air freight flew on commercial passenger flights. Smith believed that there were major differences between packages and passengers, and he was convinced that the two had to be treated differently. Most passengers moved between major cities and wanted the convenience of daytime flights. Cargo shippers preferred nighttime service to coincide with late-afternoon pickups and next-day delivery. Because small package air freight was subservient to the requirements of passengers’ flight schedules, it was often difficult for the major airlines to achieve next-day delivery of air freight. Smith’s aim was to build a system that could achieve next-day delivery of small package air freight (less than seventy pounds). He set up Federal Express with his $8 million family inheritance and $90 million in venture capital (the company’s name was changed to FedEx in 1998). Federal Express established a huband-spoke route system, the first airline to do so. The hub of the system was Memphis, chosen for its good weather conditions, central location, and the fact that it was Smith’s hometown. The spokes were regular routes between Memphis and shipping facilities at public airports in the cities serviced by Federal Express. C212 SECTION A Business Level Cases: Domestic and Global U.S. Market Share Estimates for Small Package Delivery Market, 2006 Ground Market Air Express Organization Share Market UPS 63% 35% FedEx 19% 45% U.S. Postal Service 16% 6% DHL NA 10% Other 3% 5% Source: Raw data from John Kartsonas, “United Parcel Service,” Citigroup Global Capital Markets, November 13, 2006, B. Barnard, “Logistics Spur Deutsche Post,” Journal of Commerce, November 8, 2006, page 1. EXHIBIT 1 342927_case14_pC211-C223.qxd 8/22/07 1:58 PM Page C212 Every weeknight, aircraft would leave their home cities with a load of packages and fly down the spokes to Memphis (often with one or two stops on the way). At Memphis, all packages were unloaded, sorted by destination, and reloaded. The aircraft then returned back to their home cities in the early hours of the morning. Packages were ferried to and from airports by Federal Express couriers driving the company’s vans and working to a tight schedule. Thus, from door to door, the package was in Federal Express’s hands. This system guaranteed that a package picked up from a customer in New York at 5 p.m. would reach its final destination in Los Angeles (or any other major city) by noon the following day. It enabled Federal Express to realize economies in sorting and to utilize its air cargo capacity efficiently. Federal Express also pioneered the use of standard packaging with an upper weight limit of seventy pounds and a maximum length plus girth of 108 inches. This standard helped Federal Express to gain further efficiencies from mechanized sorting at its Memphis hub. Later entrants into the industry copied Federal Express’s package standards and hub-and-spoke operating system. To accomplish overnight delivery, Federal Express had to operate its own planes. Restrictive regulations enforced by the Civil Aeronautics Board (CAB), however, prohibited the company from buying large jet aircraft. To get around this restriction, Federal Express bought a fleet of twin-engine executive jets, which it converted to minifreighters. These planes had a cargo capacity of 6,200 pounds, which enabled Federal Express to get a license as an air taxi operator. After 1973, Federal Express quickly built up volume. By 1976, it had an average daily volume of 19,000 packages, a fleet of 32 aircraft, 500 delivery vans, and 2,000 employees, and it had initiated service in 75 cities. After three years of posting losses, the company turned in a profit of $3.7 million on revenues of $75 million.7 However, volume had grown so much that Federal Express desperately needed to use larger planes to maintain operating efficiencies. As a result, Smith’s voice was added to those calling for Congress to deregulate the airline industry and allow greater competition. Deregulation and Its Aftermath In November 1977, Congress relaxed regulations controlling competition in the air cargo industry, one year before passenger services were deregulated. This involved a drastic loosening of standards for entry into the industry. The old CAB authority of naming the carriers that could operate on the various routes was changed to the relatively simple authority of deciding which among candidate carriers was fit, willing, and able to operate an all-cargo route. In addition, CAB controls over pricing were significantly reduced. The immediate effect was an increase in rates for shipments, particularly minimum- and high-weight categories, suggesting that prices had been held artificially low by regulation. As a result, the average yield (revenue per ton mile) on domestic air freight increased 10.6% in 1978 and 11.3% in 1979.8 Freed from the constraints of regulation, Federal Express immediately began to purchase larger jets and quickly established itself as a major carrier of small package air freight. Despite the increase in yields, however, new entry into the air cargo industry was limited, at least initially. This was mainly due to the high capital requirements involved in establishing an all-cargo carrier. Indeed, by the end of 1978, there were only four major all-cargo carriers serving the domestic market: Airlift International, Federal Express, Flying Tiger, and Seaboard World Airlines. While all of these all-cargo carriers had increased their route structure following deregulation, only Federal Express specialized in next-day delivery for small packages. Demand for a next-day delivery service continued to boom. Industry estimates suggest that the small package priority market had grown to about 82 million pieces in 1979, up from 43 million in 1974.9 At the same time, in response to increasing competition from the all-cargo carriers, the passenger airlines continued their retreat from the all-cargo business (originally begun in 1973 as a response to high fuel prices). Between 1973 and 1978, there was a 45% decline in the mileage of all-cargo flights by the airlines. This decrease was followed by a 14% decline between 1978 and 1979. Instead of all-cargo flights, the airlines concentrated their attentions on carrying cargo in passenger flights. This practice hurt the freight forwarders badly. The freight forwarders had long relied on the all-cargo flights of major airlines to achieve next-day delivery. Now the freight forwarders were being squeezed out of this segment by a lack of available lift capacity This problem led to one of the major postderegulation developments in the industry: the acquisition and operation by freight forwarders of their own fleets of aircraft. Between 1979 and 1981, five of the six largest freight forwarders became involved in this activity. The two largest were Emery Air Freight and Airborne Express. Emery operated a fleet of sixty-six aircraft at the end of 1979, the majority of which were leased from other carriers. In mid-1980, this fleet was providing service to approximately 129 cities, carrying both large-volume shipments and small package express. Airborne Express acquired its own fleet of aircraft in April 1980 with the purchase of Midwest Charter Express, an Ohio-based all-cargo airline. In 1981, Airborne opened a new hub in Ohio, which became the center of its small package express operation. This enabled Airborne to provide next-day delivery for small packages to 125 cities in the United States.10 Other freight forwarders that moved into the overnight mail market included Purolator Courier and Gelco, both of which offered overnight delivery by air on a limited geographic scale. Industry Evolution, 1980–1986 New Products and Industry Growth In 1981, Federal Express expanded its role in the overnight market with the introduction of an overnight letter service, with a limit of two ounces. This guaranteed overnight delivery service was set up in direct competition with the U.S. Postal Service’s Priority Mail. The demand for such a service was illustrated by its expansion to about 17,000 letters per day within its first three months of operation. More generally, the focus of the air express industry was changing from being predominantly a conduit for goods to being a distributor of information— particularly company documents, letters, contracts, drawings, and the like. As a result of the growth in demand for information distribution, new product offerings such as the overnight letter, and Federal Express’s own marketing efforts, the air express industry enjoyed high growth during the early 1980s, averaging more than 30% per year.11 Indeed, many observers attribute most of the growth in the overnight delivery business at this time to Federal Express’s marketing efforts. According to one industry participant, “Federal Express pulled off one of the greatest marketing scams in the industry by making people believe they absolutely, positively, had to have something right away.”12 Increasing Price Competition Despite rapid growth in demand, competitive intensity in the industry increased sharply in 1982 following the entry of UPS into the overnight-delivery market. UPS was already by far the largest private package transporter in the United States, with an enormous ground-oriented distribution network and revenues in excess of $4 billion per year. In addition, for a long time, UPS had offered a second-day air service for priority packages, primarily by using the planes of allcargo and passenger airlines. In 1982, UPS acquired a fleet of twenty-four used Boeing 727-100s and added four DC-8 freighters from Flying Tiger. These purchases allowed UPS to introduce next-day air service in September 1982—at roughly half the price Federal Express was charging at the time.13 Federal Express countered almost immediately by announcing that it would institute 10:30 A.M. priority overnight delivery (at a cost to the company of $18 million). None of the other carriers followed suit, however, reasoning that most of their customers are usually busy or in meetings during the morning hours, so delivery before noon was not really that important. Instead, by March 1983, most of the major carriers in the market (including Federal Express) were offering their high-volume customers contract rates that matched the UPS price structure. Then three new services introduced by Purolator, Emery, and Gelco Courier pushed prices even lower. A competitive free-for-all followed, with constant price changes and volume discounts being offered by all industry participants. These developments hit the profit margins of the express carriers. Between 1983 and 1984, Federal Express saw its average revenue per package fall nearly 14%, while Emery saw a 15% decline in its yield on small shipments.14 Beginning around this time, customers began to group together and negotiate for lower prices. For example, Xerox set up accounts with Purolator and Emery that covered not only Xerox’s express packages but also those of fifty other companies, including Mayflower Corp., the moving company, and the Chicago Board of Trade. By negotiating as a group, these companies could achieve prices as much as 60% lower than those they could get on their own.15 The main beneficiary of the price war was UPS, which by 1985 had gained the number 2 spot in the C214 SECTION A Business Level Cases: Domestic and Global 342927_case14_pC211-C223.qxd 8/22/07 1:58 PM Page C214 industry, with 15% of the market. Federal Express, meanwhile, had seen its market share slip to 37% from about 45% two years earlier. The other four major players in the industry at this time were Emery Air Freight (14% of market share), Purolator (10% of market share), Airborne Express (8% of market share), and the U.S. Postal Service (8% of market share).16 The survival of all four of these carriers in the air express business was in question by 1986. Emery, Purolator, and the U.S. Postal Service were all reporting losses on their air express business, while Airborne had seen its profits slump 66% in the first quarter of 1986 and now had razor-thin margins. Industry Evolution, 1987–1996 Industry Consolidation A slowdown in the growth rate of the air express business due to increasing geographic saturation and inroads made by electronic transmission (primarily fax machines) stimulated further price discounting in 1987 and early 1988. Predictably, this discounting created problems for the weakest companies in the industry. The first to go was Purolator Courier, which had lost $65 million during 1985 and 1986. Purolator’s problems stemmed from a failure to install an adequate computer system. The company was unable to track shipments, a crucial asset in this industry, and some of Purolator’s best corporate customers were billed 120 days late.17 In 1987, Purolator agreed to be acquired by Emery. Emery was unable to effect a satisfactory integration of Purolator, and it sustained large losses in 1988 and early 1989. Consolidated Freightways was a major trucking company and parent of CF Air Freight, the third largest heavy shipment specialist in the United States. In April 1989, Consolidated Freightways acquired Emery for $478 million. However, its shipment specialist, CF Air Freight, soon found itself struggling to cope with Emery’s problems. In its first eleven months with CF, Emery lost $100 million. One of the main problems was Emery’s billing and tracking system, described as a “rat’s nest” of conflicting tariff schedules, which caused overbilling of customers and made tracking packages en route a major chore. In addition, CF enraged corporate customers by trying to add a “fuel surcharge” of 4 to 7% to prices in early 1989. Competitors held the line on prices and picked up business from CF/Emery.18 As a result of the decline of the CF/Emery/Purolator combination, the other firms in the industry were able to pick up market share. By 1994, industry estimates suggested that Federal Express accounted for 35% of domestic air freight and air express industry revenues; UPS had 26%; Airborne Express was third with 9%; and Emery and the U.S. Postal Service each held onto 4% of the market. The remainder of the market was split among numerous small cargo carriers and several combination carriers, such as Evergreen International and Atlas Air. (Combination carriers specialize mostly in heavy freight but do carry some express mail.)19 The other major acquisition in the industry during this time was the purchase of Flying Tiger by Federal Express for $880 million in December 1988. Although Flying Tiger had some air express operations in the United States, its primary strength was as a heavy cargo carrier with a global route structure. The acquisition was part of Federal Express’s goal of becoming a major player in the international air express market. However, the acquisition had its problems. Many of Flying Tiger’s biggest customers, including UPS and Airborne Express, were Federal Express’s competitors in the domestic market. These companies had long paid Tiger to carry packages to those countries where they had no landing rights. It seemed unlikely that these companies would continue to give international business to their biggest domestic competitor. Additional problems arose in the process of trying to integrate the two operations. These problems included the scheduling of aircraft and pilots, the servicing of Tiger’s fleet, and the merging of Federal’s nonunionized pilots with Tiger’s unionized pilots.20 During the late 1980s and early 1990s, there were also hints of further consolidations. TNT Ltd., a large Australian-based air cargo operation with a global network, made an unsuccessful attempt to acquire Airborne Express in 1986. TNT’s bid was frustrated by opposition from Airborne and by the difficulties inherent in getting around U.S. law, which currently limits foreign firms from having more than a 25-percent stake in U.S. airlines. In addition, DHL Airways, the U.S. subsidiary of DHL International, was reportedly attempting to enlarge its presence in the United States and was on the lookout for an acquisition.21 Pricing Trends In October 1988, UPS offered new discounts to highvolume customers in domestic markets. For the first time since 1983, competitors declined to match the cuts. CASE 14 The Evolution of the Small Package Express Delivery Industry, 1973–2006 C215 342927_case14_pC211-C223.qxd 8/22/07 1:58 PM Page C215 Then in January 1989, UPS announced a price increase of 5% for next-day air service, its first price increase in nearly six years. Federal Express, Airborne, and Consolidated Freightways all followed suit with moderate increases. Additional rate increases of 5.9% on nextday air letters were announced by UPS in February 1990. Federal Express followed suit in April, and Airborne also implemented selective price hikes on noncontract business of 5%, or 50 cents, per package on packages up to twenty pounds. Just as prices were stabilizing, however, the 1990–1991 recession came along. For the first time in the history of the U.S. air express industry, there was a decline in year-on-year shipments, with express freight falling from 4,455 million ton miles in 1989 to 4,403 million ton miles in 1990. This decline triggered off another round of competitive price cuts, and yields plummeted. Although demand rebounded strongly, repeated attempts to raise prices in 1992, 1993, and 1994 simply did not stick.22 Much of the price cutting was focused on large corporate accounts, which by this time accounted for 75% by volume of express mail shipments. For example, as a result of deep price discounting in 1994, UPS was able to lure home shopping programmer QVC and computer mail-order company Gateway 2000 away from Federal Express. At about the same time, however, Federal Express used discounting to capture retailer Williams-Sonoma away from UPS.23 This prolonged period of price discounting depressed profit margins and contributed to losses at all three major carriers during the early 1990s. Bolstered by a strong economy, prices finally began to stabilize during late 1995, when price increases announced by UPS were followed by similar announcements at Federal Express and Airborne.24 Product Trends Second-Day Delivery Having seen a slowdown in the growth rate of the next-day document delivery business during the early 1990s, the major operators in the air express business began to look for new product opportunities to sustain their growth and margins. One trend was a move into the second-day delivery market, or deferred services, as it is called in the industry. The move toward second-day delivery was started by Airborne Express in 1991, and it was soon imitated by its major competitors. Second-day delivery commands a substantially lower price point than nextday delivery. In 1994, Federal Express made an average of $9.23 on second-day deliveries, compared to $16.37 on priority overnight service. The express mail operators see deferred services as a way to utilize excess capacity at the margin, thereby boosting revenues and profits. Since many second-day packages can be shipped on the ground, the cost of second-day delivery can more than compensate for the lower price. In some ways, however, the service has been almost too successful. During the mid-1990s, the growth rate for deferred services was significantly higher than for priority overnight mail because many corporations came to the realization that they could live with a second-day service. At Airborne Express, for example, second-day delivery accounted for 42% of total volume in 1996, up from 37% in 1995.25 Premium Services Another development was a move toward a premium service. In 1994, UPS introduced its Early AM service, which guaranteed delivery of packages and letters by 8:30 a.m. in select cities. UPS tailored Early AM toward a range of businesses that needed documents or materials before the start of the business day, including hospitals, who were expected to use the service to ship critical drugs and medical devices; architects, who needed to have their blueprints sent to a construction site; and salespeople. Although demand for the service was predicted to be light, the premium price made for high profit margins. In 1994, UPS’s price for a letter delivered at 10:30 a.m. was $10.75, while it charged $40 for an equivalent Early AM delivery. UPS believed that it could provide the service at little extra cost because most of its planes arrived in their destination cities by 7:30 a.m. Federal Express and Airborne initially declined to follow UPS’s lead.26 Logistics Services Another development of some note was the move by all major operators into third-party logistics services. Since the latter half of the 1980s, more and more companies have been relying on air express operations as part of their just-in-time inventory control systems. As a result, the content of packages carried by air express operators has been moving away from letters and documents and toward high-value, low-weight products. By 1994, less than 20% of Federal Express’s revenues came from documents.27 To take advantage of this trend, all of the major operators have been moving into logistics services that are designed to assist business customers in C216 SECTION A Business Level Cases: Domestic and Global 342927_case14_pC211-C223.qxd 8/22/07 1:58 PM Page C216 their warehousing, distribution, and assembly operations. The emphasis of this business is on helping their customers reduce the time involved in their production cycles and gain distribution efficiencies. In the late 1980s, Federal Express set up a Business Logistics Services (BLS) division. The new division evolved from Federal Express’s Parts Bank. The Parts Bank stores critical inventory for clients, most of whom are based in the high-tech electronics and medical industries. On request, Federal Express ships this inventory to its client’s customers. The service saves clients from having to invest in their own distribution systems. It also allows their clients to achieve economies of scale by making large production runs and then storing the inventory at the Parts Bank. The BLS division has expanded this service to include some assembly operations and customs brokerage and to assist in achieving just-in-time manufacturing. Thus, for example, one U.S. computer company relies on BLS to deliver electronic subassemblies from the Far East as a key part of its justin-time system. Federal Express brings the products to the United States on its aircraft, clears them through customs with the help of a broker, and manages truck transportation to the customer’s dock. UPS moved into the logistics business in 1993 when it established UPS Worldwide Logistics, which it positioned as a third-party provider of global supplychain management solutions, including transportation management, warehouse operations, inventory management, documentation for import and export, network optimization, and reverse logistics. UPS’s logistics business is based at its Louisville, Kentucky, hub. In 1995, the company announced that it would invest $75 million to expand the scope of this facility, bringing total employment in the facility to 2,200 by the end of 1998.28 Airborne Express also made a significant push into this business. Several of Airborne’s corporate accounts utilize a warehousing service called Stock Exchange. As with Federal Express’s Parts Bank, clients warehouse critical inventory at Airborne’s hub in Wilmington, Ohio, and then ship those items on request to their customers. In addition, Airborne set up a commerce park on 1,000 acres around its Wilmington hub. The park was geared toward companies that wanted to outsource logistics to Airborne and could gain special advantages by locating at the company’s hub. Not the least of these advantages is the ability to make shipping decisions as late as 2 a.m. Eastern time. Information Systems Since the late 1980s, the major U.S. air express carriers have devoted more and more attention to competing on the basis of information technology. The ability to track a package as it moves through an operator’s delivery network has always been an important aspect of competition in an industry where reliability is so highly valued. Thus, all the major players in the industry have invested heavily in bar-code technology, scanners, and computerized tracking systems. UPS, Federal Express, and Airborne have also all invested in Internet-based technology that allows customers to schedule pickups, print shipping labels, and track deliveries online. Globalization Perhaps the most important development for the long-run future of the industry has been the increasing globalization of the airfreight industry. The combination of a healthy U.S. economy, strong and expanding East Asian economies, and the move toward closer economic integration in western Europe all offer opportunities for growth in the international air cargo business. The increasing globalization of companies in a whole range of industries from electronics to autos, and from fast food to clothing, is beginning to dictate that the air express operators follow suit. Global manufacturers want to keep inventories at a minimum and deliver just in time as a way of keeping down costs and fine-tuning production, which requires speedy supply routes. Thus, some electronics companies will manufacture key components in one location, ship them by air to another for final assembly, and then deliver them by air to a third location for sale. This setup is particularly convenient for industries producing small high-value items (for example, electronics, medical equipment, and computer software) that can be economically transported by air and for whom just-in-time inventory systems are crucial for keeping down costs. It is also true in the fashion industry, where timing is crucial. For example, the clothing chain The Limited manufactures clothes in Hong Kong and then ships them by air to the United States to keep from missing out on fashion trends.29 In addition, an increasing number of wholesalers are beginning to turn to international air express as a way of meeting delivery deadlines. The emergence of integrated global corporations is also increasing the demand for the global shipment of contracts, confidential papers, computer printouts, CASE 14 The Evolution of the Small Package Express Delivery Industry, 1973–2006 C217 342927_case14_pC211-C223.qxd 8/22/07 1:58 PM Page C217 and other documents that are too confidential for Internet transmission or that require real signatures. Major U.S. corporations are increasingly demanding the same kind of service that they receive from air express operators within the United States for their farflung global operations. As a consequence of these trends, rapid growth is predicted in the global arena. According to forecasts, the market for international air express is expected to grow at approximately 18% annually from 1996 to 2016.30 Faced with an increasingly mature market at home, the race is on among the major air cargo operators to build global air and ground transportation networks that will enable them to deliver goods and documents between any two points on the globe within forty-eight hours. The company with the most extensive international operations by the mid-1990s was DHL. In 1995, DHL enjoyed a 44% share of the worldwide market for international air express services (see Exhibit 2).31 Started in California in 1969 and now based in Brussels, DHL is smaller than many of its rivals, but it has managed to capture as much as an 80% share in some markets, such as documents leaving Japan, by concentrating solely on international air express. The strength of DHL was enhanced in mid-1992 when Lufthansa, Japan Airlines, and the Japanese trading company Nisho Iwai announced that they intended to invest as much as $500 million for a 57.5% stake in DHL. Although Lufthansa and Japan Airlines are primarily known for their passenger flights, they are also among the top five airfreight haulers in the world, both because they carry cargo in the holds of their passenger flights and because they each have a fleet of all-cargo aircraft.32 TNT Ltd., a $6 billion Australian conglomerate, is another big player in the international air express market, with courier services from 184 countries as well as package express and mail services. In 1995, its share of the international air express market was 12%, down from 18% in 1990.33 Among U.S. carriers, Federal Express was first in the race to build a global air express network. Between 1984 and 1989, Federal Express purchased seventeen other companies worldwide in an attempt to build its global distribution capabilities, culminating in the $880 million purchase of Flying Tiger. The main asset of Flying Tiger was not so much its aircraft but its landing rights overseas. The Flying Tiger acquisition gave Federal Express service to 103 countries, a combined fleet of 328 aircraft, and revenues of $5.2 billion in fiscal year 1989.34 However, Federal Express has had to suffer through years of losses in its international operations. Start-up costs were heavy, due in part to the enormous capital investments required to build an integrated air and ground network worldwide. Between 1985 and 1992, Federal Express spent $2.5 billion to build an international presence. Faced also with heavy competition, Federal Express found it difficult to generate the international volume required to fly its planes above the breakeven point on many international routes. Because the demand for outbound service from the United States is greater than the demand for inbound service, planes that left New York full often returned half empty. Trade barriers have also proved very damaging to the bottom line. Customs regulations require a great deal of expensive and time-consuming labor, such as checking paperwork and rating package contents for duties. These regulations obviously inhibit the ability of international air cargo carriers to effect express delivery. Federal Express has been particularly irritated by Japanese requirements that each inbound envelope be opened and searched for pornography, a practice that seems designed to slow down the company’s growth rate in the Japanese market. Federal Express has also found it extremely difficult to get landing rights in many markets. For example, it took three years to get permission from Japan to make four flights per week from Memphis to Tokyo, a key link in the overseas system. Then, in 1988, just three days before the service was due to begin, the Japanese notified Federal Express that no packages weighing more than seventy pounds could pass C218 SECTION A Business Level Cases: Domestic and Global International Air Express Market Shares, 1995 Company Market Share DHL International 44% Federal Express 21% UPS 12% TNT 12% Others 11% Source: Standard & Poor’s, “Aerospace and Air Transport,” Industry Surveys, February 1996. EXHIBIT 2 342927_case14_pC211-C223.qxd 8/22/07 1:58 PM Page C218 through Tokyo. To make matters worse, until 1995 Japan limited Federal Express’s ability to fly on from Tokyo and Osaka to other locations in Asia. The Japanese claimed, with some justification, that due to government regulations, the U.S. air traffic market is difficult for foreign carriers to enter, so they see no urgency to help Federal Express build a market presence in Japan and elsewhere in Asia.35 After heavy financial losses, Federal Express abruptly shifted its international strategy in 1992, selling off its expensive European ground network to local carriers to concentrate on intercontinental deliveries. Under the strategy, Federal Express relies on a network of local partners to deliver its packages. Also, Federal Express entered into an alliance with TNT to share space on Federal Express’s daily transAtlantic flights. Under the agreement, TNT flies packages from its hub in Cologne, Germany, to Britain, where they are loaded onto Federal Express’s daily New York flight.36 UPS has also built up an international presence. In 1988, UPS bought eight smaller European airfreight companies and Hong Kong’s Asian Courier Service, and it announced air service and ground delivery in 175 countries and territories. However, it has not been all smooth sailing for UPS either. UPS had been using Flying Tiger for its Pacific shipments. The acquisition of Flying Tiger by Federal Express left UPS in the difficult situation of shipping its parcels on a competitor’s plane. UPS was concerned that its shipments would be pushed to the back of the aircraft. Since there were few alternative carriers, UPS pushed for authority to run an all-cargo route to Tokyo, but approval was slow in coming. “Beyond rights” to carry cargo from Tokyo to further destinations (such as Singapore and Hong Kong) were also difficult to gain. In March 1996, UPS sidestepped years of frustrations associated with building an Asian hub in Tokyo by announcing that it would invest $400 million in a Taiwan hub, which would henceforth be the central node in its Asian network. The decision to invest in an Asian hub followed closely on the heels of a 1995 decision by UPS to invest $1.1 billion to build a ground network in Europe. In September 1996, UPS went one step further toward building an international air express service when it announced that it would start a pan-European next-day delivery service for small packages. UPS hoped that these moves would push the international operations of the carrier into the black after eight years of losses.37 Industry Evolution, 1997–2006 Pricing Trends The industry continued to grow at a solid rate through 2000, which helped to establish a stable pricing environment. In 2001, things took a turn for the worse, with recessionary conditions in the United States triggering a 7.6% decline in the number of domestic packages shipped by air. Even though the economy started to rebound in 2002, growth remained sluggish by historic comparison, averaging only 4% per annum.38 Despite this, pricing discipline remained solid. Unlike the recession in 1990–1991, there was no price war in 2001–2002. Indeed, in early 2002, UPS pushed through a 3.5% increase in prices, which was quickly followed by the other carriers. The carriers were able to continue to raise prices, at least in line with inflation, through to 2006. They were also successful in tacking on a fuel surcharge to the cost of packages to make up for sharply higher fuel costs in 2001, and again during 2005 and 2006.39 During 2002–2006, the average revenue per package at both UPS and FedEx increased as more customers opted for expedited shipments and as both carriers shipped high proportions of heavier packages.40 Continuing Growth of Logistics During 1997–2006, all players continued to build their logistics services. During the 2000s, UPS was much more aggressive in this area than FedEx. By 2006, UPS’s logistics business had revenues of over $6 billion. UPS was reportedly stealing share from FedEx in this area. FedEx reportedly decided to stay more focused on the small package delivery business (although it continues to have a logistics business). Most analysts expected logistics services to continue to be a growth area. Outside of the North American market, DHL emerged as the world’s largest provider of logistics services, particularly following its 2006 acquisition of Britain’s Exel, a large global logistics business. Despite the push of DHL and UPS into the global logistics business, the market remains very fragmented. According to one estimate, DHL, now the world’s largest logistics company, has a 5.5% share of the global market in contract logistics, UPS has a 3% share, and TNT has a 2.2% share.41 The total global market for contract logistics was estimated to be worth over $200 billion in 2005. In 2006, TNT sold CASE 14 The Evolution of the Small Package Express Delivery Industry, 1973–2006 C219 342927_case14_pC211-C223.qxd 8/22/07 1:58 PM Page C219 its logistics business to Apollo Management LP for $1.88 billion so that it could focus more on its small package delivery business. Expanding Ground Network In the late 1990s and early 2000s, all the main carriers began supplementing their air networks with extensive ground networks and ground hubs to ship packages overnight. With more customers moving from overnight mail to deferred services, such as second-day delivery, this shift in emphasis became a necessity. Demand for deferred services held up reasonably well during 2001, even as demand for overnight packages slumped. Prices for deferred and ground services were considerably lower than were prices for air services, but so were the costs. UPS has been the most aggressive in building ground delivery capabilities (of course, it already had extensive ground capabilities before its move into the air). In 1999, UPS decided to integrate overnight delivery into its huge ground transportation network. The company spent about $700 million to strengthen its ground delivery network by setting up regional ground hubs. By doing so, it found it could ship packages overnight on the ground within a 500-mile radius. Because ground shipments are cheaper than air shipments, the result was a significant cost savings for UPS. The company also deferred delivery of about 123 aircraft that were on order, reasoning that they would not be needed as quickly because more of UPS’s overnight business was moved to the ground.42 FedEx entered the ground transportation market in 1998 with its acquisition of Caliber Systems for $500 million. This was followed by further acquisitions in 2001 and 2006 of significant U.S. trucking companies, including the 2006 acquisition of Watkins Motor Lines, a provider of long-haul trucking services in the United States with sales of around $1 billion. Watkins was rebranded as FedEx National LTL. By 2002, FedEx was able to provide ground service to all U.S. homes, giving it a similar capability to UPS. In addition, FedEx struck a deal in 2001 with the U.S. Postal Service (USPS), under which FedEx would provide airport-to-airport transportation for 250,000 pounds of USPS Express Mail packages nightly and about 3 million pounds of USPS Priority Mail packages. The Priority Mail would be moved on FedEx planes that normally sit idle during the day. The deal was reportedly worth $7 billion in additional revenues to FedEx over the seven-year term of the agreement. In addition, FedEx was expected to reap cost savings from the better utilization of its lift capacity.43 Bundling Another industrywide trend has been a move toward selling various product offerings—including air delivery, ground package offerings, and logistics services— to business customers as a bundle. The basic idea behind bundling is to offer complementary products at a bundled price that is less than would have been the case if each item had been purchased separately. Yet again, UPS has been the most aggressive in offering bundled services to corporate clients. UPS is clearly aiming to set itself up as a one-stop shop offering a broad array of transportation solutions to customers. FedEx has also made moves in this area. Airborne Express started to bundle its product offerings in mid-2001.44 Retail Presence In 2001, UPS purchased Mail Boxes Etc. for $185 million. Mail Boxes Etc. had 4,300 franchisees, most in the United States, who operated small retail packaging, printing, and copying stores. At the time, Mail Boxes Etc. was shipping some 40 million packages a year, around 12 million of which were via UPS. UPS stated that it would continue to allow the Mail Boxes stores to ship packages for other carriers. In 2003, the stores were rebranded as the UPS Store. While some franchisees objected to this move, the vast majority ultimately switched to the new brand.45 In addition to the franchise stores, UPS has also begun to open wholly owned UPS stores, not just in the United States, but also internationally, and by 2006 had 5,600 outlets. In addition to the UPS Store, UPS put UPS Centers in office supplies stores, such as Office Depot, and by 2006 it had some 2,200 of these. In 2004, FedEx followed UPS by purchasing Kinko’s for $2.4 billion. Kinko’s, which had 1,200 retail locations, 90% in the United States, focused on providing photocopying, printing, and other office services to individuals and small businesses. FedEx has plans to increase the network of Kinko’s stores to 4,000. In addition to providing printing, photocopying, and package services, FedEx is also experimenting with using Kinko’s stores as mini-warehouses to store C220 SECTION A Business Level Cases: Domestic and Global 342927_case14_pC211-C223.qxd 8/22/07 1:58 PM Page C220 high-value goods, such as medical equipment, for its supply-chain management division.46 Deutsche Post and the Entry of DHL In the late 1990s, DHL was acquired by Deutsche Post. Deutsche Post also spent approximately $5 billion to acquire several companies in the logistics business between 1997 and 1999. In November 2000, Deutsche Post went private with an initial public offering that raised $5.5 billion and announced its intention to build an integrated global delivery and logistics network. Many believed it was only a matter of time before the company entered the United States. Thus, few were surprised when in 2003 DHL acquired Airborne. Under the terms of their agreement, Airborne Express sold its truck delivery system to DHL for $1.05 billion. Airborne’s fleet of planes were spun off into an independent company called ABX Air, owned by Airborne’s shareholders, and which continues to serve DHL Worldwide Express under a long-term contract. This arrangement overcame the U.S. law that prohibits foreign control of more than 25% of a domestic airline. In the meantime, DHL spun its own fleet of U.S.-based planes into a U.S.-owned company called Astar, also to escape the charge that its U.S. airline was foreign owned. Between 2003 and 2005, DHL reportedly invested some $1.2 billion to upgrade the capabilities of assets acquired from Airborne.47 The DHL acquisition created three major competitors in both the U.S. and global delivery markets (see Exhibit 3 for a comparison). By the fall of 2003, DHL had launched an ad campaign aimed at UPS and FedEx customers promoting the service and cost advantages that they would benefit from because of its merger with Airborne. DHL targeted specific zip code areas in its advertising promoting its claim to be the number 1 in international markets, something important to many companies given the increasing importance of global commerce. In its ads, DHL reported that “current Airborne customers will be connected to DHL’s extensive international delivery system in more than 200 countries.”48 DHL’s stated goal is to become a powerhouse in the U.S. delivery market. While its share of the U.S. small package express market remains small at around 10%, DHL clearly stands to benefit from ownership by Deutsche Post and from its own extensive ex-U.S. operations. When it first acquired Airborne, Deutsche Post stated that the U.S. operation would be profitable by the end of 2006. However, the company ran into “integration problems” and suffered from reports of poor customer services and missed delivery deadlines. Now management does not see the unit turning profitable until 2009— although the express delivery service is profitable in the rest of the world. DHL lost some $500 million in the United States in 2006 and is forecasted to do the same in 2007.49 In 2005, Deutsche underlined its commitment to building a global logistics business when it purchased Exel of Britain for $7.2 billion. Exel was one of the CASE 14 The Evolution of the Small Package Express Delivery Industry, 1973–2006 C221 The Major Express Package Operators in 2005 FedEx UPS DHL (Deutsche Post) TNT Revenues $32,294 million $42,581 million $32,646 million1 $12,500 million3 Net Income $1,806 million $3,870 million $405 million2 $951 million Employees 221,000 407,000 280,000 (DHL only) 128,000 Countries Served 220 200+ 220 200+ Aircraft 671 579 420 NA Average Daily 14.8 million 6 million NA NA Shipment Volume Sources: Company documents. 1 Revenues and profits are for DHL only. DHL accounts for 57% of Deutsche Post revenues. 2 Loss in United States reduced DHL’s operating profits by $500 million in 2005. 3 Figures for TNT include logistics business, which was sold off in 2006. EXHIBIT 3 342927_case14_pC211-C223.qxd 8/22/07 1:58 PM Page C221 largest independent third-party logistics companies in the world with extensive operations in Europe, Asia, and North America. Combining Exel with Deutsche Post’s existing businesses created a global logistics business with projected revenues of $25 billion, four times as large as the logistics business of UPS. Quickly on the heels of this acquisition, DHL won a contract worth $3 billion over ten years to manage the supply chain and deliver some 500,000 products to the 600 hospitals in Britain’s National Health Service.50 Continued Globalization Between 1997 and 2006, UPS and FedEx continued to build out their global infrastructure. By 2006, UPS delivered to more than 200 countries. Much of the within-country delivery is handled by local enterprises. The company has five main hubs. In addition to its main U.S. hub in Louisville, Kentucky, it has hubs in Cologne, Taipei, Miami (serving Latin American traffic), and the Philippines. In 2002, UPS launched an intra-Asian express delivery network from its Philippines hub. In 2004, it acquired Menio World Wide Forwarding, a global freight forwarder, to boost its global logistics business. In the same year, it also acquired complete ownership of its Japanese delivery operation (which was formally a joint venture with Yamato Transport Company). In 2005, UPS acquired operators of local ground networks in the UK and Poland, and it is pushing into mainland China, which it sees as a major growth opportunity. Like UPS, FedEx serves more than 200 countries around the world, although also like UPS, most of the local ground delivery is in the hands of local partners. FedEx has recently been focusing on building a presence in both China and India. The company has announced the development of a new Asian Pacific hub in Guangzhou, China. This will be FedEx’s fourth international hub. The others are in Paris (handling intra-European express), the Philippines (handling intra-Asian express), and Alaska (handling packages flowing between Asia, North America, and Europe). In 2006, FedEx signaled its commitment to the Chinese market by buying out its joint venture partner, Tianjin Datian W. Group, for $400 million. The acquisition will give FedEx control of 90 parcel handling facilities and a 3,000 strong work force in China.51 While UPS and FedEx dominate the U.S. market for small package express delivery services, in Europe DHL and TNT lead with 23% and 11% respectively (TNT, formally an Australian enterprise, was acquired by the Royal Netherlands Post Office in 1996). In the intercontinental market, DHL leads with a 36% share, while in intra-Asian traffic Asia Yamato of Japan is the leader with a 20% share, followed by Sagawa with 16% (see Exhibit 4). The fragmented nature of the European and intra-Asia Pacific markets suggest that much is still at stake in this increasingly global business. C222 SECTION A Business Level Cases: Domestic and Global Market Share (%) for Small Package Express, 2005 EXHIBIT 4 100 80 60 40 20 0 Intercontinental Other UPS Fedex DHL TNT Percent Intra-Europe U.S. Intra-Asia Pacific Source: Estimates from TNT posted on company website at www.tnt.com.