UPS Inc. has long faced challenges to optimize its vast U.S. surface transportation network. On one hand, it deals with traffic surges that put its network under stress and forces it to pay exorbitant rates to have others move its shipments. On the other, it struggles with empty miles and missed backhaul opportunities.
That could explain why the Atlanta-based giant was willing to spend $1.8 billion in cash and debt to acquire Chicago-based truckload and less-than-truckload (LTL) broker Coyote Logistics LLC. The deal, announced this morning, is the largest in UPS's 108-year history and the biggest pure brokerage deal ever. Beyond the headlines is the profound change the deal may bring to UPS's system by finally reducing the network variability that has bugged the company for decades.
For UPS, the deal has two parts: First, it adds an important arrow to its product quiver. UPS plans to stand back and let Coyote do its thing, which is to arrange transportation of more than 6,000 daily loads for shipper customers. UPS can now come to market with a portfolio that includes truckload brokerage, and can position itself as more of a lead logistics provider than it has in the past. Sources close to the deal said UPS's desire to boost its competitive position at the bidding table, or to compete with a company like C.H. Robinson Worldwide Inc., the nation's leading broker and a big third-party logistics provider, were not the primary drivers behind its purchase.
Others find that rationale hard to swallow. "Robinson needs to pay attention. They are no longer swinging the biggest bat," said Michael P. Regan, founder of TranzAct Technologies Inc., a consultancy and audit firm based in Elmhurst, Ill. Robinson was unavailable to comment. Regan said other freight brokers also should be concerned because Coyote now has the deepest pockets in U.S. transportation behind it. UPS generated $3.3 billion in free cash flow in the first half of 2015 and is on track this year to break the $60 billion annual-revenue barrier.
The problem of maintaining Coyote's freewheeling culture and keeping an organizational firewall between the two companies was not lost on UPS. In the statement announcing the deal, UPS said: "Coyote possesses significant industry knowledge, intellectual property, [and] employee talent, and has a strong company culture." Coyote will operate as a UPS subsidiary and will stay in its Chicago home base, and husband-and-wife cofounders Jeff and Marianne Silver will remain in charge for what appears to be an open-ended period, though there remains some question as to how long an entrepreneurial couple like the Silvers can comfortably coexist in UPS's bureaucracy.FILLING THE GAPS
The second, and perhaps most relevant, part of the deal is the role Coyote will play to help fill the gaps in UPS's road network. Each day, UPS moves tens of millions of parcels and freight across its ground system. In addition, shipments booked to move "air" freight often move on the ground, depending on the distance and the delivery windows. A network so large and complex inevitably suffers from the plague of "variability," where supply and demand are not always in proper alignment. The result can be less-than-optimal utilization of the company's fleet, at least by UPS's standards.
UPS has longstanding relationships with many truckload carriers to move shipments that, for whatever reason, can't go on its equipment. Those relationships will remain in place, and UPS will continue to be responsible for purchasing space. It also uses Coyote to broker shipments.
The plan under the acquisition is for Coyote to serve as an adviser of sorts, leveraging its expertise and technology to enhance truckload-shipment visibility for UPS, thus identifying new opportunities and reducing UPS's network variability. In effect, Coyote's goal is not to do UPS's job, but to help UPS do a better job. UPS CEO David Abney said in the statement that UPS expects to realize as much as $150 million a year of "annual operating synergies," ranging from better backhaul utilization to increased cross-selling opportunities.
Coyote has also helped behind the scenes to support UPS's capacity needs during prior holiday peak seasons, a period when demand goes on steroids and the pressure on UPS's system is immense. During the 2013 peak, when bad weather and an avalanche of last-minute shipments from e-tailing giant Amazon.com gummed up its air network, UPS paid dearly to reroute packages to truckload carriers for rush delivery. Chastened by the 2013 problems, UPS ramped up its operational spending for the 2014 peak, only to find that it overinvested for expected volumes that never materialized.
In January, Abney disclosed that the company would not meet its fourth-quarter earnings estimates due to the higher costs associated with the peak ramp-up. Abney also said at the time that UPS would implement "new pricing strategies" for the upcoming holiday cycle. That could mean the implementation of so-called surge pricing, similar to the system that ride-sharing firm Uber employs during its peak riding periods. If so, Coyote's skills and clout could allow UPS to push through surge pricing while keeping its line-haul rates in check, said Jett McCandless, founder and CEO of CarrierDirect LLC, a logistics consulting and sales company.
The emergence of UPS in a segment that it has largely avoided is likely to spark another wave of consolidation among brokers, who are unaccustomed to a company like this in their midst. The $50-billion-a-year business has a handful of big players, but is composed mostly of small companies, many of which are profitable but lack the resources to move up the ladder.
McCandless, who at 36 is one of the industry's "young turks," sees transportation and brokerage becoming "agnostic," with technology being the key differentiator. As a result, the next five years will witness major consolidation as the smaller companies, lacking the technology and robust carrier relationships, lose out to the large "one-stop shops" and are either acquired or fold their tents, said McCandless.
However, this cycle will beget another phase in years 6 through 10, as big players effectively become too big to adequately serve a broad shipper base, McCandless said. New, smaller niche providers will then step into the breach, pick up the slack, and expand the number of providers in the market, he predicted.