Days of wine, roses, and free third-party billing come to end as UPS slaps on new transaction fee

It's been standard practice in the parcel-shipping world for decades: A so-called third party, so named because it is neither a shipper nor receiver, uses a fulfillment house to store, pick, pack, and ship inventory. Carriers like UPS Inc. deliver the package and bill the third party, usually a merchant, for their services. Each third party has its own account number and its own set of pricing based on its unique shipping characteristics.

It's been a pretty good deal for everyone, except for the carrier. That's because large e-tailers with steep discounts would direct their fulfillment houses and so-called drop-ship vendors to use their third-party billing account numbers when their discounts were higher than those available to the actual shipper. While the carrier's cost of service didn't change because of the billing itself, its revenue would shrink because of the higher discounts the third party brought to the table.

Parcel carriers eager to win and keep business would offer third-party billing options knowing that discount cherry-picking existed, and that the risk of fraud was greater because a supplier could ship packages on behalf of its customer and to other consignees besides those that belonged to its customer. The third party would then receive its bill with shipping charges levied on transactions unrelated to it. UPS would be brought in, at its time and expense, to help resolve the conflicts.

Third-party billing was not a problem for carriers when it was a small part of the overall business. Today, however, third-party billing accounts for about 9 percent of UPS' and Memphis-based rival FedEx Corp.'s annual domestic revenues, due largely to the explosive growth of e-commerce transactions. At UPS alone, 11.64 percent of its shipments and 7.9 percent of its net charges are third-party billed, according to a source who asked not to be identified and who has access to much of the company's data. UPS moves more than 18 million pieces a day across its worldwide system.

In mid-October, UPS took action. The Atlanta-based giant imposed, effective Jan. 4, a 2.5-percent fee on all third-party billing services—the first time it has ever levied such a charge. FedEx does not have a similar fee, but given that the two companies frequently act in lockstep on pricing matters; that they have a virtual monopoly over B2B parcel traffic; and that there would be little visible downside for FedEx, no one would be surprised if it followed suit.

Susan L. Rosenberg, a UPS spokeswoman, said the new fee is designed to cover the overhead associated with managing these types of transactions, especially as e-commerce activity generates more of them. The current pricing structure underprices UPS' services in relation to the costs associated with providing them, said Rosenberg, noting that there is an "inappropriate level of volume discount" applied to a third-party billing transaction, and that UPS "incurs costs for which it may not be properly compensated."

Rosenberg said UPS always works to match incentive programs with a customer's shipping characteristics. She added, however, that "we're also going to get the percentage to cover overhead when it's a third party with smaller volume, where it costs us more to serve."

Those who will likely feel the most pain are small merchants who will now be forced to absorb a new charge on top of the carrier's regular annual rate increases. But any third party will likely sit up and take notice. Beyond trying to eliminate discount cherry-picking, the new charge is designed to modify customer behavior, according to Robert Persuit, director of business development of ShipMatrix, a unit of transport consultancy SJ Consulting. Persuit said UPS wants to migrate transactions away from third-party billing to a prepaid structure, where the fulfillment house become the payor and the merchant pays the house, thus eliminating UPS from any after-the-fact involvement. Persuit said prepaid billing is much simpler and less costly for UPS to understand and makes it easier for the carrier to quantify the costs of its service.

UPS CEO David P. Abney addressed the issue—albeit obliquely—during an Oct. 27 analyst call following UPS' announcement of its third-quarter results. In response to an analyst's query, Abney said the company wants to expand the third-party billing service in response to rising customer demand. Users benefit from "inventory handling and transportation savings associated with the service, as well as an ability for them to offer a broader line of products to both businesses and household consumers," he said.

Satish Jindel, head of SJ Consulting, said the charge is a cost-recovery initiative and not a way to wring profitable revenue out of UPS' customers. He said the current structure results in an "improper allocation of costs" for UPS because some are subsidizing the savings enjoyed by others.