Case 6 The Air Express Industry: 40 Years of Expansion Charles W. L. Hill, The University of Washington via air. During the first half of the 1990s, the small pack- INTRODUCTION age express industry continued to grow at a healthy The small package express delivery industry is that seg- rate, with shipments expanding by slightly more than 2 ment of the broader postal and cargo industries that spe- 16% per annum. Despite this growth, the industry was cializes in rapid (normally 1–3 days) delivery of small hit by repeated rounds of price cutting as the three big packages (small packages are defined as those weighing private firms battled to capture major accounts. In addi- less than 150 lbs or having less than 165 inches in com- tion to price cutting, the big three also competed vigor- bined length and girth). The modern express delivery ously on the basis of technology, service offerings, and industry in the United States began with Fred Smith’s the global reach of their operations. By the late 1990s vision for Federal Express Company, which started and early 2000s the intensity of price competition in operations in 1973. Federal Express transformed the the industry had moderated, with a degree of pricing structure of the existing air cargo industry and paved discipline being maintained, despite the fact that the the way for rapid growth in the overnight package seg- growth rate for the industry slowed down. Between 1995 ment of that industry. A further impetus to the indus- and 2000, the industry grew at 9.8% per year. In 2001 try’s development was the 1977 deregulation of the U.S. the volume of express parcels shipped by air fell by air cargo industry. This deregulation allowed Federal 5.9%, partly due to an economic slowdown, and Express (and its emerging competitors) to buy large jets partly due to the aftereffects of the September 11 3 for the first time. The story of the industry during the terrorist attack on the United States. Growth picked up 1980s was one of rapid growth and new entry. Between again in 2002. Estimates suggest that the global market 1982 and 1989, small package express cargo shipments by for small package express delivery should continue to air in the United States grew at an annual average rate of grow by a little over 6% per annum between 2005 and 31%. In contrast, shipments of air freight and air mail 2025. Most of that growth, however, is forecasted to take grew at an annual rate of only 2.7%.1 This rapid growth place outside of the now mature North American mar- attracted new entrants such as United Parcel Service ket. Within the United States, the annual growth rate is 4 (UPS) and Airborne Freight (which operated under the predicted to match the growth in United States GDP. name Airborne Express). The entry of UPS triggered se- In North America, the biggest change to take place vere price cutting, which ultimately drove some of the in the 2000s was the 2003 entry of DHL with the ac- weaker competitors out of the market and touched off a quisition of Airborne Express for $1 billion. DHL is it- wave of consolidation in the industry. self owned by Deutsche Post World Net, formally the By the mid 1990s, the industry structure had stabi- German post office, which since privatization has been lized with four organizations —Federal Express, UPS, rapidly transforming itself into a global express mail Airborne Express, and the United States Postal Service — and logistics operation. Prior to 2003, DHL lacked a accounting for the vast majority U.S. express shipments strong presence in the all-important United States mar- ket. The acquisition of Airborne gave DHL a foothold in Copyright © Charles W.L. Hill. All rights reserved. the United States. DHL subsequently spent $1.5 billion C-92 84487_case-6_ptg01_hr_C092-C104.indd 92 22/10/13 4:39 PM Case 6 The Air Express Industry: 40 Years of Expansion C-93 trying to upgrade Airborne’s delivery network in a quest the airlines. They purchased cargo space from the airlines for market share. Despite heavy investments, DHL failed and retailed this space in small amounts. They dealt pri- to gain traction and after 5 years of losses, in 2009 it marily with small customers, providing pickup and deliv- exited the United States market. With the exit of DHL, ery services in most cities, either in their own trucks or the United States market looks increasingly like a duo- through contract agents. The U.S. Postal Service used air poly. In 2012, FedEx held onto 53% of the $15 billion service for transportation of long-distance letter mail and Overnight Express market, UPS accounted for 42% and air parcel post.7 the U.S. Postal Service (USPS) held 5% (although the USPS actually contracted out its express deliveries to FedEx). UPS dominated the $34 billion ground market for small packages in 2012, with a 60% share, followed THE FEDERAL EXPRESS by FedEx with 24% and the USPS with 16%.5 CONCEPT Founded by Fred Smith, Jr., Federal Express was incor- porated in 1971 and began operations in 1973. At that THE INDUSTRY BEFORE time, a significant proportion of small-package air freight FEDEX flew on commercial passenger flights. Smith believed that there were major differences between packages and In 1973, roughly 1.5 billion tons of freight were shipped passengers, and he was convinced that the two had to in the United States. Most of this freight was carried by be treated differently. Most passengers moved between surface transport, with air freight accounting for less major cities and wanted the convenience of daytime than 2% of the total.6 While shipment by air freight was flights. Cargo shippers preferred nighttime service to often quicker than shipment by surface freight, the high coincide with late-afternoon pickups and next-day delivery. cost of air freight had kept down demand. The typical Because small-package air freight was subservient to users of air freight at this time were suppliers of time- the requirements of passengers’ flight schedules, it was sensitive, high-priced goods, such as computer parts and often difficult for the major airlines to achieve next-day medical instruments, which were needed at dispersed lo- delivery of air freight. cations but which were too expensive for their customers Smith’s aim was to build a system that could achieve to hold as inventory. next-day delivery of small-package air freight (less The main cargo carriers in 1973 were major than 70 pounds). He set up Federal Express with his passenger airlines, which operated several all-cargo $8 million family inheritance and $90 million in venture planes and carried additional cargo in the holds of capital (the company’s name was changed to FedEx in their passenger planes, along with a handful of all- 1998). Federal Express established a hub-and-spoke route cargo airlines such as Flying Tiger. From 1973 onward, system, the first airline to do so. The hub of the system was the passenger airlines moved steadily away from all- Memphis, chosen for its good weather conditions, central cargo planes and began to concentrate cargo freight in location, and the fact that it was Smith’s hometown. The passenger planes. This change was a response to spokes were regular routes between Memphis and ship- increases in fuel costs, which made the operation of ping facilities at public airports in the cities serviced by many older cargo jets uneconomical. Federal Express. Every weeknight, aircraft would leave With regard to distribution of cargo to and from their home cities with a load of packages and fly down the airports, in 1973 about 20% of all air freight was delivered spokes to Memphis (often with one or two stops on to airports by the shipper and/or picked up by the con- the way). At Memphis, all packages were unloaded, sorted signee. The bulk of the remaining 80% was accounted for by destination, and reloaded. The aircraft then returned by three major intermediaries: (1) Air Cargo Incorporated, back to their home cities in the early hours of the morn- (2) freight forwarders, and (3) the U.S. Postal Service. Air ing. Packages were ferried to and from airports by Federal Cargo Incorporated was a trucking service, wholly owned Express couriers driving the company’s vans and working by 26 airlines, which performed pickup and delivery ser- to a tight schedule. Thus, from door to door, the package vice for the airlines’ direct customers. Freight forwarders was in Federal Express’s hands. This system guaranteed were trucking carriers who consolidated cargo going to that a package picked up from a customer in New York 84487_case-6_ptg01_hr_C092-C104.indd 93 22/10/13 4:39 PM C-94 Case 6 The Air Express Industry: 40 Years of Expansion at 5 p.m. would reach its final destination in Los Angeles been held artificially low by regulation. As a result, the (or any other major city) by noon the following day. It average yield (revenue per ton mile) on domestic air- enabled Federal Express to realize economies in sorting freight increased 10.6% in 1978 and 11.3% in 1979.9 and to utilize its air cargo capacity efficiently. Federal Freed from the constraints of regulation, Federal Ex- Express also pioneered the use of standard packaging with press immediately began to purchase larger jets and quickly an upper weight limit of 70 pounds and a maximum established itself as a major carrier of small-package air length plus girth of 108 inches.