Dimensional Doomsday? UPS CEO hints dimensional pricing change could be announced within a month

In what was described as a “fireside chat” between Bernstein analysts and UPS CEO Scott Davis during an investor-relations meeting on Wednesday, Davis called the approach “sensible” when asked whether the global shipping leader would follow in the footsteps of its largest competitor and apply dimensional weight pricing to all ground shipments.

Davis went on to say that UPS is investigating all options with regard to the decision in an effort to determine the best approach.

According to the Bernstein findings, sent to investors after the meeting, investors should expect an official decision within a month. The report says that UPS concedes that “there will be some box adjusting on the customer front.”

Bernstein’s note to investors said UPS believes that “overall, it will be a win-win for both customers and UPS, since customers will reduce shipping costs and UPS will gain capacity.”

The potential for adverse customer selection, should UPS not follow, is also part of the decision process, according to the report.

On May 2, FedEx turned the shipping industry on its head by announcing it would apply dimensional weight pricing to all ground shipments, effective January 1, 2015. Each carrier implemented dimensional pricing models, which derive a “billable” weight for packages based on cubic-inch measurements divided by a published rate factor of 166, to compensate for capacity issues presented by large, lightweight packages. To date, any ground package smaller than three cubic feet (5,184 cubic inches) will be charged based on the actual weight of the shipment. Packages that measure above that threshold will be billed based on the greater of the dimensional and actual weights.

In 2015, however, that will change for FedEx customers, likely resulting in significant cost increases for businesses that ship lightweight items – like pillows, lamp shades or shoes – in larger boxes. FedEx stands to gain about $350 million in additional revenue following the move, and Kevin Sterling, a BB&T Capital Markets analyst, said he projects the shift will boost FedEx’s annual operating income by $180 million, according to a May 8 report by The Detroit News.

Because UPS possesses a larger ground network than FedEx, those numbers could be even more mouth-watering for UPS and its investors.

Naturally, how UPS will react is the burning question being asked by decision makers eager to brace for the potential impact in the New Year and beyond. Based on the historical correlation between things like new service offerings and pricing changes among the world’s top shipping competitors, the overwhelming opinion is that an adoption of the same model by UPS is a foregone conclusion.

And while Davis stopped short of confirming that assumption, his comments have certainly fanned the flame.

Of course, it can be argued that UPS stands to gain in the long run, should it break the chain of mirroring FedEx’s price increases; even if only temporarily. If UPS could avoid the temptation, even for a year, it likely would gain market share by gobbling up companies that abandon FedEx out of fear of eroding profitability. Wholesale carrier shifts are often time-sensitive, resource-hungry initiatives that many companies prefer to avoid. Were UPS to stand pat for a period before eventually implementing the same pricing change, customers acquired during the transition period would seemingly have little incentive to go back from whence they came.

Another potential alternative would be for UPS to simply reduce its current dimensional threshold below three cubic feet.

Still, hundreds of millions of dollars in additional revenue brought in with the simple flip of a switch is likely to put dollar signs in the eyes of even the world’s largest shipping company.

Then, of course, there are the customers…

While analysts in every industry delve into dissecting billions of aggregate numbers in an effort to determine what the overall impact would be on their companies, a Ph.D. in rocket science is not necessary to ascertain that prices certainly are not coming down.

What’s the worst that could happen if UPS makes the switch?

A 346 percent cost increase; that’s what.

Yes… Three. Hundred. Forty. Six.

A Zone 8, 1-pound shipment spaciously arranged in a 12x12x36 inch box – which represents the current dimensional weight pricing threshold for each carrier – would cost $7.71 for the remainder of 2014. Next year, however, the price for that same package would soar to $34.41.

Specifically, dimensional weight is calculated by multiplying the dimensions of a package, length by width by height, then dividing the product by 166. A package’s billable weight is the greater of the dimensional or actual weights. So, if you apply that formula to the current threshold, you’re left with a money-hungry 32-pound package. If that package only happens to contain, for example, a desk calendar, then it might be in a FedEx or UPS customer’s best interest to find a smaller box; or consider the financial benefit of encouraging their own customers to cozy up to their email calendars.

Of course, this apocalyptic example doesn’t exactly reflect the most feasible shipment, but it does make very clear the fact that shippers of large, lightweight goods had better get to brainstorming.

Below is a breakdown of similar worst-case scenarios across all zones:

ups-2015-dim-change-example

 

According to a May 7 report by the The Wall Street Journal, analysts think more than 30% of total shipments will be affected, and many weigh less than five pounds.

So, when determining how FedEx’s pricing change, and a potential UPS change, will impact your company’s bottom line, there are several key questions you should consider as you work to determine how the change will affect your business:

What role would a potential 2015 General Rate Increase (GRI) play in the announced increase?

It is important to consider that the rates contained within each carrier’s service guide likely will be at least a few percentage points higher by the time any dimensional weight changes are tossed in. Near the end of each calendar year, typically in between late October and early December, FedEx and UPS usually announce average published rate increases for most or all of their service offerings and service charges. While price changes for air and service charges are relatively straightforward, it is standard procedure for each carrier to refer to average cost hikes related to their respective ground service-level charges, which masks the fact that the price for the most common shipments increase at a disproportionate rate to relatively uncommon shipments, which plays in favor of the carrier.

How will contractual discounts factor into the equation?

High-volume shippers typically receive service-level discounts based on volume and package characteristics, meaning they pay less than published rates in exchange for the amount of business they provide to the carriers. When performing any type of financial impact analysis, it is important to factor these in when determining the true net effect of any dimensional weight pricing changes you have coming your way. For example, if your company currently receives a 20 percent discount on 1- to 5-pound ground shipments, and 25 percent off of 6- to 10-pounds, those discounts need to be included in your analysis. If you have an 18x12x7 (1,512 cubic inches) shipment that weighs three pounds, it will get billed at 10 if and when the change goes into effect. Make sure you subtract your respective discounts from the published rates for each shipment to ensure that you arrive at a true net change, as illustrated below in a breakdown reflecting costs across all zones for the example above:

2015-ups-dim-change-discounts

If UPS implements the same pricing changes, should I turn to regional carriers?

Upon the unveiling of the news, “regional carriers”, “USPS” and “Amazon” have shifted from mere companies to industry buzzwords. Regional carriers hang their hats on charging fewer accessorials and offering later pull times to customers, so it is only natural that shippers ask themselves whether shifting volume to these carriers would help them in the long run. And while that makes sense, it is important to look at the big picture. Hypothetically, such a seismic shift in the costs related to ground parcel networks offers regionals a window of opportunity to partner with major carriers to create network and/or service agreements with regional carriers – similar to what we saw with the introduction of FedEx SmartPost and UPS SurePost services. As grumblings over ever-increasing shipping costs grow, companies are (and should be) taking a harder look at the pros and cons of incorporating regionals into their parcel supply chains. Still, the only way for those regionals to shift the landscape, so to speak, is not to become competitors, but rather allies to FedEx and/or UPS. That would mean that, while regional carriers might provide short-term relief, the potential exists for partnerships, the likes of which FedEx and UPS have demonstrated their willingness to form, may lessen the financial impact at an undetermined point in the future.

What about Amazon?

Rumblings (and even some evidence to support the notion) abound that Amazon is hard at work, developing a logistics service to rival FedEx and UPS. Amazon’s growth, combined with UPS’s (Amazon’s primary parcel carrier) poor service performance last Christmas all but confirm that Amazon’s brass is following the changing landscape of the parcel shipping industry closely. And given the uproar generated by the dimension-based pricing models, it would seem logical that Amazon engineers are brainstorming a simpler, more shipper-friendly cost structure that would surpass necessary density-to-profitability ratios. Of course, what Amazon has in the works is of little solace to companies looking to dodge steep price increases within six months, but staying abreast to the company’s shipping-related announcements will put savvy businesses in prime position to take advantage if and when the opportunity arises.

Can a third-party parcel consultant help stop the bleeding?

Full disclosure: Brandon Staton, author and publisher of this article, is marketing and public relations manager for Transportation Impact and First Flight Solutions, third-party parcel consultants specializing in helping customers reduce parcel costs through carrier rate negotiation and parcel auditing.

A good parcel consultant can begin by helping you measure the net impact of dimensional weight increases related specifically to your business and its unique package characteristics and shipping trends. Before you can stop the bleeding, it is important to know two things: if you are even bleeding (i.e. will these cost increases actually impact your business), and if so, where is the cut; that is, which areas of your carrier agreement are driving costs up and profitability down? Third-party companies have made their mark in the industry by helping companies break aggregate, complex shipping data into discernable reports from which educated and effective decisions can be made. Often, companies assume that because the bulk of their shipments do not fall into a certain bucket (ground shipments subject to dimensional pricing in this case) that the impact will be minimal. Those assumptions can be costly. Since most parcel consultants are paid on a performance-based model, they are willing to thoroughly analyze your data at no cost, and in a fraction of the time that most companies could on their own. Therefore, the only real way to know whether hiring outside help is right for your company is to request a demonstration of their service portfolio and an explanation of their qualifications and business model.

It remains to be seen whether UPS will buck the trend of aligning its pricing models with its largest competitor, but companies that fail to prepare, as they say, are preparing to fail. Shipping is a numbers game; and the numbers point to one conclusion – a conclusion substantiated by the Bernstein findings. So while the news should come as no surprise, the net effect of the resulting cost increases could; even for companies that think they are well-prepared.

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