FedEx Ground’s Remarkable Ride to the Top
Over the last 15 years, FedEx Ground has grown from nothing, into being widely viewed as the preeminent ground courier transportation provider. This success is largely attributable to the unique operating decisions the company has made.
Introduction
When Federal Express Corporation (let “FedEx” represent the corporation) merged with Roadway Package System in 2000, the FedEx Ground business unit (let “FedExG” represent the Ground business unit) was created. Prior to this, FedEx was known for premium overnight air courier services (Express), but recognized an opportunity to compete at the bottom of the market with ground services (Ground) as well.
By 2002, FedExG had captured 14%[i] market share in the USA and by 2015, FedExG had reached 32.5%[ii] market share. Nearly all of this growth came directly from taking share from the industry incumbent United Parcel Service (UPS). FedEx was able to do this by segregating its Express and Ground businesses and then closely aligning each business’ value proposition to its own unique operating model. UPS on the other hand, has continued to run Express and Ground through the same operation.
Value Proposition
FedExG has a simple value proposition; they will move a package from one point to another for a better price than anyone else. They will also move it more quickly than anyone else can on the ground. FedExG fulfills this value by making business decisions that are specific to the Ground business unit, and by optimizing a flexible operating model.
Operating Model
FedEx’s approach is interesting because it is opposite to what every other transportation provider has done. FedEx already had a network of infrastructure that covered the entire USA, yet as they built out the Ground business, they did it with a whole new labor force and physical network. If a customer ships one package with FedEx Express and one with FedExG, FedEx will go so far as to send two separate trucks to the 
customer for pick-up. FedEx allows each business unit to manage its operating network in a way that best meets customer needs – facilities are rarely combined. The result is that FedEx may have an Express facility in an expensive downtown location, and a Ground terminal in a cheaper industrial setting. UPS combines facilities into one location that tries to meet the needs of two very different sets of customers (premium service versus value).
The courier business is correlated with GDP growth and trade flows, but also has large seasonal fluctuations, especially over the holidays. FedExG deals with this variability by outsourcing line-haul trucking, pick-up, and delivery to independent contractors. These contractors own a specific group of postal codes and are paid per piece handled. UPS on the other hand, has a unionized workforce of employees who are paid by the hour. This allows FedExG to keep costs variable on a daily basis, whereas costs end up semi-fixed in the UPS environment. FedExG’s contractors also buy their own trucks, pay maintenance, fuel, and insurance. FedExG’s contractors are thus incentivized to take better care of their trucks and are more conscientious in regards to fuel consumption. In addition, FedExG avoids paying these drivers benefits or vacation pay.
Contrary to what may be thought, FedExG drivers are not being taken advantage of in this model. When they are not working for FedExG they can leverage their assets to transport goods on behalf of other carriers. If they work efficiently, they may earn great sums of money (many earn over $1M/year[iii]). Not every driver is successful though, and this has led to some disgruntled drivers and court claims.[iv]
An additional benefit of drivers owning their own routes and getting paid per piece is that they are incentivized to provide better service. If a UPS driver loses business on her route, she will just be provided with a larger route. A FedExG driver will fight to maintain business and even refer new customers to the sales team in order to increase the revenue on his fixed route.
Results
Consequently, this model results in FedExG paying drivers a mere $1.88 for a single-piece delivery and $2.48 for a single-piece pick-up. This is more than 40% lower than UPS Ground’s cost.[v] The cost savings on labor propagates additional benefits for FedExG. FedExG can price lower than UPS, allowing them to increase volume in a business that benefits from economies of scale. FedExG has used proceeds from this success to invest in automated sorting facilities, which further lowers cost. FedExG has also steered profits into investments to improve transit times. The cheapest Ground carrier is now also the carrier with the fastest service.
Figure 1 – FedExG vs UPS Ground Transit Times[vi]
Since FedExG was created in 2000, FedEx has significantly outperformed UPS. A large part of this success is due to the Ground business’s consistent growth and profitability as cost conscious businesses continue to switch away from Express services.
Figure 2 – FedEx vs UPS Share Price since 2000
The Path Forward
When building volume in new markets, FedExG is highly selective in choosing the lanes[vii] it wishes to serve. FedExG will drive density in certain profitable lanes to drive costs down and then expand on a strong base. For example, the price that a customer will be charged to ship a 16 lb piece from Toronto to Montreal is $13.91, compared to $39.50 for Purolator, the Canadian market leader[viii].
In conclusion, FedEx has successfully split Ground operations from Express and pursued an operating model focused on matching the Ground business’ low-cost value proposition. The result of these unique and strategic decisions is that FedExG has positioned itself to completely dominate the Ground courier market.
[i] http://money.cnn.com/magazines/business2/business2_archive/2003/10/01/349456/
[ii] http://marketrealist.com/2015/06/fedex-ground-segment/
[iii] http://triblive.com/business/2223183-74/fedex-ground-contractors-company-delivery-business-employees-contractor-drivers-deliveries#ixzz3tUwKe7J3
[iv] http://www.bizjournals.com/sanfrancisco/morning_call/2015/06/fedex-settlement-drivers-independent-contractors.html
[v] Based on interviews with former UPS and FedEx employees combined with Financial Statement analysis
[vi] http://investors.fedex.com/company-overview/fedex-ground/competitive-position/
[vii] Lane: A specific point to point route (e.g. Toronto to Montreal is a lane).
[viii] Quotes from Purolator.com and FedEx.com
Interesting to see how they out competed UPS via a more aligned operating model.
What do you think of the risk posed by Amazon, have been a boon to them so far but the client concentration and risk of disintermediation must be high?
I have actually spent a lot of time thinking about that. Right now a lot of the disruption of the courier industry is in the B2C space, but longer-term companies like UPS and FedEx could be in trouble; if Amazon gains scale, why not go B2B? It will really depend on how much customers value same-day shipping. Same-day, if demand by customers, could lead to company’s redesigning their distribution networks and potentially cutting FedEx/UPS out.
Yeah – This really is an interesting time in this industry. On the B2C point, obviously Amazon is the large threat here, but other large retailers could hurt FedEx’s business as well. If you look at Walmart and Target, one of the advantages they have over Amazon is that they have thousands of physical store locations throughout the country. Currently, both of these companies are trying to turn the backrooms in some of these stores into Distribution Centers for their online business so that they can profitably ship products from their stores to the guests’ homes. This online inventory would be shipped on the same trucks to the stores as the inventory that is being placed on the floor, so it would be a very small incremental cost to ship this online inventory to the store. If Target and Walmart can fulfill online orders, even same day orders as they are currently testing this capability, out of a few hundred stores and cut down the transit time to the guests’s homes, that will significantly reduce the cost of shipping online orders for these companies. I used Walmart and Target as examples, but I know many other retailers are trying to develop this capability as well. If these retailers are successful, it will be interesting to see how much business they take away from a company like FedEx and how FedEx would respond.
Yeah that’s a great point, it definitely takes a lot of FedEx’s value prop away if the majority of B2C moves become within-city.
Interesting example of how divisional operating models align with specific business models within a company. With the importance of B2C transportation growing given online shopping tailwinds, this service will only continue to scale and reach additional operating efficiences. If FedEx has found a competitive advantage vs. UPS it will be interesting to see if it’s sustainable and how UPS responds. Can UPS just replicate the operating model or are they too invested already in its current infrastructure…?
UPS may or may not be in too deep… The number one problem is their union though.
Great write-up. I think it’s important to note that the benefits of FedExG’s independent contractor model go beyond variable vs. fixed costs. UPS is paying its union employees for healthcare, taxes, and 401k while FedExG is completely off the hook for those benefits. Based on that difference alone, I would guess that the cost of a FedExG driver is at least 30-40% less than a UPS employee, even if the parcel load were even. I’m guessing that FedExG will face a lot of pressure to continue to distance themselves from their IC’s for them to maintain that label – as FedExG has less control of their drivers and can’t tell them how and when to deliver packages, will that eventually break the operating model? Is there a point where you would rather employ them than lose a certain level of control? Will be interesting to watch.
You are certainly correct on the cost stand point. It seems that “control” is not a huge issue so far – service is exceptional (based on all the bench-marking studies I have seen), but the ICs are rebelling in some areas.
Did you see this:
http://www.logisticsmgmt.com/article/fedex_agrees_to_pay_228_million_to_settle_long_running_calif._independent_c
What was most interesting is that FedExG was able to maintain efficiency while not owning the trucks/drivers. One would imagine that for a company that derives its profits from running complex logistics, it would be important to own their distribution infrastructure to avoid overlap etc. However, it sounds like a distribution network that is in essence self regulated is better fit for the complexity of the delivery business. In a way, reminds me of the Uber model.