The Postal Service rolls the delivery dice

The U.S. Postal Service (USPS) will face various tests on its path toward true parcel delivery legitimacy. One of its most important tests has already commenced.

On Aug. 15, the Postal Regulatory Commission, the body that rules on the agency's pricing actions, approved a USPS proposal to radically reduce rates on two of its "Priority Mail" one- to three-day delivery products for high-volume customers. The program rolled out on Sept. 7.

The rate cuts affect two Priority Mail services: Commercial Base, which carries no volume requirements and is available to customers that give parcels to USPS using specific methods of tender, and Commercial Plus, which requires that users have shipped at least 50,000 Priority Mail pieces in the prior year. The latter service is geared toward high-volume users like e-tailers, big business-to-business (B2B) shippers, and parcel consolidators that aggregate packages from multiple shippers and induct them deep into the USPS distribution network to get sizable bulk discounts.

In a statement issued in July disclosing its plans, USPS said Commercial Plus rates would decline, on average, by 2.9 percent. But the overall numbers are skewed because there are virtually no rate changes on parcels weighing up to three pounds. However, starting with the four-pound weight break, considered the "sweet spot" of parcel weight, rates begin to fall dramatically. For example, the new Commercial Plus rate for a five-pound parcel moving between 301 and 600 miles represents an 18.8-percent drop from prior levels, according to data from consultancy Shipware LLC. The rate for shipping a 10-pound parcel between 601 and 1,000 miles has dropped by 36 percent, according to the firm. The price of shipping a 15-pound parcel between 151 and 300 miles has fallen by nearly 48 percent, the firm said. The comparisons apply to B2B and business-to-consumer (B2C) traffic.

For parcels weighing up to 20 pounds, the tariff rates charged by UPS Inc., one of the post office's two main rivals, are now 11 to 56 percent higher than USPS's new Commercial Plus rate depending on the parcel's specific weight and distance shipped, according to Shipware. The UPS list price for a three-pound parcel moving under 300 miles is now almost 41 percent higher than the USPS Commercial Plus rates, the data show. The widest rate differentials occur in the lightweight bands where shipments tend to tilt toward B2C transactions. By contrast, USPS's new rates are much higher starting at shipments weighing seven pounds and that move over longer distances, the Shipware data show.

Unlike UPS and FedEx Corp., the post office's other main rival, USPS doesn't assess fuel surcharges or impose mandatory residential ground delivery surcharges. As a result, the price gap is more pronounced when these so-called accessorial fees are factored in, according to Shipware. For example, when fuel and residential delivery surcharges are included, the list rates charged by UPS and FedEx Ground, FedEx's ground delivery unit, are between 35.4 and 135.8 percent higher than the new USPS Commercial Plus rate for a package weighing 30 pounds or less and shipped up to 600 miles, the Shipware data show.

USPS did not make an executive available for an interview. In an e-mail, Katina Fields, a USPS spokeswoman, said the agency hopes to attract more business by cutting shipping prices.

NO NEW DIM WEIGHT CHARGES
At the same time it was rolling back rates, USPS said it would not implement any new dimensional weight pricing on its parcel shipments. By contrast, UPS and FedEx will soon begin assessing so-called dim weight charges on ground parcels measuring less than three cubic feet. Effective Jan. 1 for FedEx and Dec. 29 for UPS, rates on those packages will be based on their dimensions rather than weight. The result will be a significant increase in shipping costs for producers and merchants who tender lightweight but bulky parcels that occupy a disproportionate amount of space aboard a delivery vehicle. Most of the affected shipments are B2C products increasingly being ordered online.

USPS takes a bifurcated approach to Priority Mail pricing. A parcel weighing less than 20 pounds, measuring between 84 and 108 inches in combined length and girth, and moving under 600 miles is charged a "balloon" rate equal to the price of a 20-pound parcel. However, few Priority Mail pieces fit those dimensions.

For packages moving more than 600 miles, a piece that exceeds one cubic foot is subject to dimensional pricing. USPS uses a volumetric divisor of 194 to calculate dimensional weight, a more favorable formula for shippers than the divisor of 166 used by FedEx and UPS; as an example, a one-cubic-foot parcel measuring 1,728 cubic inches, when divided by 194, would yield a lower shipping charge than if divided by 166.

A source close to USPS said the agency had been aware for some time that FedEx and UPS planned to change their pricing schemes. In addition, the cuts in Priority Mail high-volume rates were planned long before FedEx and UPS made their respective announcements, according to the source.

Rick Jones, president and CEO of LSO (formerly Lone Star Overnight), a regional parcel carrier in Austin, Texas, said USPS's decision not to add dimensional pricing to its short-haul parcel deliveries reflects more its lack of infrastructure to measure each piece than a concerted effort to differentiate itself from the competition.

RISKS INVOLVED
The USPS strategy is not foolproof: FedEx and UPS may be willing to shed large numbers of B2C parcels that are marginally profitable on a per-stop basis; that's because many of those transactions involve one package per stop and rob carriers of the economies of scale that come with handling multiple packages per stop, which is the hallmark of B2B deliveries. A torrent of new B2C holiday traffic from former UPS and FedEx users could strain USPS's distribution network, forcing it to confront the same type of public relations disaster that befell UPS and to a lesser extent, FedEx, during last year's holidays, a fiasco that USPS was able to avoid. USPS, which by law must serve every U.S. address, also runs the risk of taking on the same uneconomical lightweight, high-cube packages that its rivals would be glad to be rid of. Jones of LSO said FedEx and UPS would love to purge their systems of much B2C traffic so they can reset their operations and focus more attention on B2B traffic, historically their bread and butter.

Jones, who spent 22 years with UPS before starting his own firm, said UPS generally discounts its published rates by at least 25 percent for big B2B customers. Those shippers are more likely to stay with UPS or FedEx because they demand a level of delivery sophistication they feel cannot be achieved with the post office, he said. In addition, B2B shippers are less price-sensitive than their B2C counterparts who angle for the lowest delivery cost to blunt the bottom-line hit of providing free shipping to their customers. That being said, USPS's new pricing is aimed in part at high-volume B2B accounts because it applies to parcels weighing up to 40 pounds, weight breaks that are normally associated with B2B transactions, Jones added.

CHANGES TO PACKAGE FLOW?
It remains to be seen how much business will flow USPS's way if FedEx and UPS customers feel the new dimensional pricing changes are untenable. The USPS rate cuts will have the biggest effect on parcels moving under 600 miles, which have become the ideal distance for deliveries as retailers and B2B shippers add density to their regional warehouse and distribution footprints to shorten transit times.

Those who follow the business said concerns about USPS's service issues are overblown. While some diversion may take place during peak season, it won't become a deluge, according to Jerry Hempstead, a former top parcel executive who now runs a consultancy bearing his name. Jones said USPS is unlikely to face delivery challenges from entities like parcel consolidators and big shippers like Amazon.com because those entities generally induct packages into the last node of the postal system before delivery to the customer, thus minimizing the risk of bottlenecks faced by users that tender parcels at the front end of the system. Mark S. Schoeman, president of The Colography Group Inc., a consultancy, said that USPS has demonstrated an ability to flex its system to handle surges in traffic and that it should be able to accommodate any holiday rush without dramatically adjusting its operations.

Rob Martinez, Shipware's president and CEO, said USPS will attract more packages because it offers a wide menu of reasonably priced services, and not because it isn't adopting a new form of dimensional pricing on short-haul ground shipments. Martinez added, though, that if USPS wants to sustain parcel growth, it must bring on larger vehicles and invest in advanced technologies to improve package flow, routing, and dispatch capabilities.

Joseph Corbett, USPS's CEO, said in a mid-August statement that the post office needs to spend up to $10 billion to upgrade its fleet, buy package sorting equipment, and make "necessary" infrastructure improvements.

USPS cannot afford to postpone these steps. Its "shipping and package" segment, while still accounting for a small piece of the agency's overall revenue mix, is one of the few parts of the business showing solid growth. Through the first nine months of its current fiscal year, which ends Sept. 30, revenue from the segment grew 9.7 percent and volumes increased 8.5 percent.

USPS reported a $2 billion net loss in the third quarter, weighed down considerably by a required $5.7 billion payment for prefunding retiree health benefits; USPS said in mid-August that it would be unable to make the payment by the Sept. 30 deadline unless Congress acts before then to eliminate the liability. At this writing, the issue remained unresolved.

"Package growth is the Postal Service's only hope to maintain solvency," said Martinez.