"Tough love" or power grab? FedEx's shift to dimensional pricing is in eyes of the beholder

Depending on one's perspective, FedEx Corp.'s planned Jan. 1 switch to dimensional pricing on ground parcel shipments measuring less than three cubic feet is either another attempt to grab shippers by the short hairs or a rational move to price its surface capacity in line with an evolving traffic mix. The policy change could also wean customers off an addiction to excess packaging that adds unnecessary cube and cost to each delivery.

Because the announcement is only 10 days old, the debate is just taking shape. Yet two points are clear: The move is unprecedented—as of Jan. 1 all FedEx ground shipments will be priced based on their dimensions instead of their weight. But though the move is unprecedented, the objective isn't. Memphis-based FedEx and its chief rival, Atlanta-based UPS Inc., have tried for seven years to convince shippers to either tighten up their packaging or to fit more weight within the parcels they tender.

Since 2007, both have used the tool of volumetric division, where a parcel's cube is divided by a preset divisor, to price packages based not on their weight but on how much space they occupy on a delivery van. In January 2011, both shrunk their divisors to 166 from 194 to make it even costlier to tender lightweight, bulky parcels that take up a disproportionate share of van capacity and, according to the carriers, distort their pricing. Currently, however, shipments under the three cubic-feet threshold are exempt. As a result, a 5-pound parcel measuring less than three cubic feet is priced based on its weight.

FedEx's move changes the game. Take, for example, a one cubic foot box that measures 1,728 cubic inches, the sum of multiplying the shipment's height, weight, and length. Dividing that number by the divisor of 166 now in effect yields dimensional pricing of about 11 pounds, even if the parcel weighs less than that.

Extending the math to the three cubic-feet threshold only amplifies the magnitude of the change: Dividing 5,184 cubic inches by the 166 divisor yields a rate equal to that of a 36-pound shipment. Shippers generally pay the greater of the actual or dimensional weight.

To put it in ways a layperson could understand, come Jan. 1, a package of toilet paper ordered on Amazon.com that weighs 5 pounds could be priced as if it was a 20-pound shipment.

SHEDDING B2C WEIGHT?
Those affected by the shift have several choices: add heft to their packages so they can be priced by the weight, reduce the cubic dimensions of the parcels through more efficient packaging, pay the higher charges, minimize the damage through effective negotiation, or go elsewhere. Some choices are considered feasible. Others appear less so.

However, it is the last option that FedEx may have had in mind when developing its strategy. The explosive growth of e-commerce has pushed more business-to-consumer (B2C) shipments into FedEx's ground network than ever before. Most of those shipments consist of lightweight, bulky items. What's more, an e-commerce transaction often involves the delivery of only one item. By contrast, a typical business-to-business (B2B) delivery stop comprises multiple packages each weighing a decent amount, a more profitable scenario for a carrier.

Given that carriers price their delivery expenses on a per-stop basis, it isn't surprising B2C shipments have become an exercise in margin compression. The problem is amplified by a shipper's insistence to surround the product with Styrofoam popcorn, Bubble Wrap, or other types of padding that may or may not add protection but certainly add to cube. Jaris Briski, general manager of integrated parcel solutions for Pittsburgh-based third party logistics provider Genco, said he's concluded from numerous visits to shippers' facilities that "they are very generous" with additional packaging and that the FedEx move will force many to "take a serious look at their configurations."

The low-margin nature of B2C deliveries drove FedEx and UPS several years ago to partner with the U.S. Postal Service (USPS) to use the USPS' low-cost, universal delivery network to bring parcels mostly to residential destinations. (The FedEx-USPS alliance, known as "SmartPost," is exempt from the pricing change.) It could also explain why the FedEx move is aimed largely at the 1- to 10-pound weight range where e-commerce lives. Most B2C shipments weigh 5 pounds or less.

Rick Jones, president and CEO of Austin, Texas-based LSO (formerly Lone Star Overnight), a regional parcel carrier, reckons that FedEx wants to recalibrate its traffic mix so B2B shipments comprise more of its density. This, in turn, may lead to a shedding of B2C business as merchants that lack the volume leverage of a company like Amazon.com are effectively priced out of the FedEx system, he said.

Jones, who spent 22 years at UPS, said his old employer would likely follow FedEx's lead because it faces the same predicament. UPS has said it is studying the FedEx decision, but declined further comment.

It is difficult to quantify the volume of shipments that could be affected by the FedEx change, and the estimates get murkier if UPS, which handles three times the daily ground volumes, is thrown into the mix. According to consulting company SJ Consulting, which maintains a database of 100 million domestic parcels moved annually, 32 percent of that number have shipment characteristics that would make them vulnerable to the FedEx move. Within that subset, about 57 percent of shipments weigh 5 pounds or less, weight breaks that would face the steepest increase, according to Satish Jindel, SJ's president.

Jindel said his database may understate the impact, however. FedEx and UPS combined handle about 16 million ground parcels each shipping day. When that number is multiplied by 250 or so shipping days, the volume of affected packages "can go much higher" than the universe his company tracks, Jindel said. The change will add an estimated $186 million to FedEx's annual operating income without its FedEx Ground unit doing anything to change its operations, he forecast.

RATIONAL BEHAVIOR
Jindel said pundits who claim FedEx's actions smack of price gouging have little clue about the cost structure of its ground business. As more e-commerce flows into the system, the traffic mix will get lighter and bulkier. This will require the company to spend more on various types of equipment, notably larger delivery vans. Add to that the cube-busting bloat of extra packaging, and it is easy to see why FedEx believes it has no choice but to be properly compensated for carrying parcels that don't pay their way.

"This is not exploitation," he said. "This is a company that is adjusting to profound changes in its business."

Over the next seven months, many FedEx customers will have key decisions to make. Much depends on the course UPS takes. Presuming UPS follows suit, they can turn to the Postal Service, which does not employ dimensional pricing. However, USPS may not be able to handle an avalanche of new B2C business without increased capital investment in plant, facilities, and equipment, moves that could force it to take significant rate increases of its own.

Customers could also turn to the regional parcel carriers. Mark Magill, vice president of business development for Chandler, Ariz.-based OnTrac, a regional carrier that serves eight western states including all of California, said his company employs a more shipper-friendly volumetric divisor of 194. Magill said he uses that as a selling point, adding that he will go even higher if the customer is large enough. Jones of LSO, which uses the same divisor of 166 as FedEx and UPS, said the regionals could exempt shipments measuring one to two cubic feet from dimensional pricing; this would give a break to the many e-commerce shipments that cube out at such micro levels.

Customers could bargain for exemptions. Briski of Genco, which helps customers negotiate with the carriers, said he's begun advising clients on ways to leverage their contractual volumes to minimize the impact of the pricing change. It will be virtually impossible, however, to eliminate the impact, he said.

The next step, Briski said, will be to work with clients to modify their packaging. For decades, packaging sizes were basically uniform. The result was a lot of empty air that ended up being filled with useless stuff. But the world has changed. Today, packaging comes in all shapes and sizes. What's more, it can be customized, almost on the fly, to meet a shipper's individual needs.

As with so many circumstances, one person's misery is another's opportunity. "It's a good time to be in the packaging engineering business," said Jones of LSO.