USPS warns defection of three key customers could hurt package business

The U.S. Postal Service warned today that the multi-year growth of its shipping and package operations could be jeopardized if the three customers responsible for most of the business continue to expand their shipping capabilities and divert business from USPS.

USPS, which made the comments in a quarterly government filing that included its fiscal first-quarter results, did not identify the customers. However, they are believed to be Seattle-based Amazon.com Inc., Memphis-based FedEx Corp., and Atlanta-based UPS Inc.

The three are big users of a USPS service known as "Parcel Select," where companies induct packages deep into the postal system for last-mile deliveries to residences. In its 2016 fiscal year, about 2.5 billion packages moved under Parcel Select, according to consultancy SJ Consulting. Amazon, the largest user, tendered about 1 billion packages; FedEx, through its "SmartPost" product, proffers about 600 million; and UPS, through a similar product called "SurePost," moves about 275 million, based on SJ data. The balance came from an amalgam of customers, notably "parcel consolidators" that aggregate packages from multiple shippers for tender to USPS.

USPS prices the service cheaply, in part because it is already required by law to serve every U.S. address and P.O. box, and its letter carriers must serve the routes anyway. Parcel Select is extremely popular with FedEx and UPS customers selling into the business-to-consumer (B2C) channel. In addition, FedEx and UPS have long relied on Parcel Select to meet service commitments without the expense of deploying their own vehicles and drivers to residences.

Revenue for USPS' "parcel services" operation, which includes Parcel Select, rose 27.7 percent in the quarter compared to the prior-year period, while volume increased 18.2 percent year over year, USPS said. The quasi-governmental agency's shipping growth has been fueled by the continued surge in deliveries of goods ordered either online or via mobile devices. It has been a consistent bright spot in an otherwise difficult climate in which USPS' core first-class mail business continues to lose share to digital mail alternatives, a trend that is likely irreversible.

However, soaring e-commerce volumes have given FedEx and UPS the confidence that they can build the package density necessary to more cost-effectively handle shipments themselves rather than turn them over to USPS. FedEx and UPS don't generate much revenue from their current postal products relative to the rest of their portfolios, and must share what they bring in with USPS.

Today, about 35 percent of SurePost packages move on UPS' system, and that ratio is growing, according to Rob Martinez, president and CEO of Shipware LLC, a consultancy. Jerry Hempstead, head of a consultancy that bears his name, said UPS' drivers handle all SurePost parcels weighing more than 10 pounds, rather than offloading them to USPS.

UPS has built a network of about 8,000 U.S. "access points," commercial establishments in residential neighborhoods where packages are dropped off for customers to pick up on their way home. Customers enrolled in the company's "My Choice" service can redirect packages to drop-off locations among the designated access points. The network is also designed to consolidate multiple residential stops into one commercial stop, which improves UPS' capacity utilization and minimizes costly "not at home" delivery attempts, said Martinez.

In addition, UPS has expanded its "Synchronized Delivery Solutions" capability, which allows it to create "synthetic density" to speed up or slow down package deliveries so multiple packages get delivered at the same time, according to Martinez.

At FedEx, the level of diversion is nowhere near as high. However, the company has been working to consolidate traffic moving on its FedEx Ground, FedEx Home Delivery, and SmartPost services in an effort to improve density on its residential routes.

Amazon, the world's largest e-tailer, has made its intentions known, leasing up to 40 freighter aircraft, announcing plans to build an air hub in Cincinnati, and procuring thousands of truck trailers, all with the goal of taking more control of more of its supply chain. However, Satish Jindel, head of SJ Consulting, said it will be neither quick nor easy for Amazon to divert the massive volumes it tenders to USPS to its own network.

One way USPS can retain Amazon's business over the long haul is to impose surcharges on Parcel Select deliveries to locations outside densely populated urban and suburban areas, a practice FedEx and UPS have followed for years, Jindel said. USPS imposes no delivery surcharges, thus prices are the same regardless of distance. This keeps prices artificially elevated in urban areas, while subsidizing more labor-intensive deliveries to extended locales, according to Jindel. Amazon will eventually seek delivery alternatives to Parcel Select if it gets better pricing elsewhere, he said.

USPS said it handled about 800 million parcels during its peak holiday period, from Thanksgiving to New Year's. Shipping and package revenue, about half of which comes from USPS' Priority Mail one- to three-day deliveries, rose to $5.4 billion in the fiscal quarter, from $4.7 billion. Volume rose to 1.6 billion parcels from 1.44 billion, USPS said.

The "Shipping and Packages" business accounted for 28 percent of USPS' total quarterly revenue, it said. Though high by historical standards, it is still less than the 36-percent share generated by first-class mail, USPS' most profitable product. What's more, the shipping unit accounted for just 4 percent of total volume in the quarter.

Because the costs associated with handling parcels are greater than the expense of moving first-class mail, USPS would need to generate $2 in shipping and package revenue to replace the contribution from each $1 of lost first-class mail revenue, it said, citing fiscal 2016 estimates.