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Why FedEx is flying high
Frederick Smith, the taciturn ex-Marine who runs Federal Express, has recently been winning most battles against his competitors-and he's still got a few moves that he hasn't shown yet.
Fortune
November 10, 1997
During one of his two combat tours in Vietnam, Federal Express CEO Frederick Smith got a quick lesson in survival from a crusty Marine sergeant. "Lieutenant," the sergeant told Smith, "there's only three things you gotta remember: shoot, move, and communicate." Smith quickly warmed to that advice, which served him well on the battlefield-and since then in building his business. Just recently he pulled the trigger on a merger with $2.7 billion Caliber System, a trucking company whose RPS subsidiary is second in ground shipments only to United Parcel Service; he glided into the void left by last summer's 15-day UPS strike, luring droves of new customers to FedEx's fleet; and he continues to maintain such a bond with his workers that his company's esprit has become a competitive advantage. It adds up to the sort of slick maneuvering that Wall Street amply rewards these days-FedEx's share price is up nearly 70% in a year, to about $76.
The stock run-up signals the possibility that FedEx may at last have figured out how to make money out of its globe-girdling networks of planes and trucks, after years of puny profit margins that haven't risen above 3.2%; until this year the stock had been a dog for a decade. That's one reason Smith, 53, a stolid man who betrays little interest in idle conversation, wanted RPS. The new holding company, called FDX, will grow faster than FedEx could alone. RPS's fleet of 13,500 trucks will aid FedEx's ability to compete with UPS, because both companies move nonexpress parcels primarily by ground when they don't absolutely, positively have to arrive by the next day. The deal also promises to make FDX more profitable, because ground fleets are cheaper to operate than Memphis-based FedEx's combined system of 590 airplanes and 38,500 vehicles. Approval of the merger welled up from Wall Street, where several analysts, looking beyond FedEx's meager earnings of $361 million on revenues of $11.5 billion last fiscal year, have issued buy recommendations. "The acquisition is an excellent strategic move," says John Pincavage of SBC Warburg Dillon Read.
It was also another shot across the bow of Atlanta-based UPS. Big Brown, a $22 billion colossus, had assured customers that last summer's strike would never happen. UPS management is still mollifying angry clients, who may now be even more inclined to switch to FedEx because it can offer a wider range of services. Morgan Stanley analyst Kevin Murphy estimates that FedEx has already grabbed about two percentage points of market share away from UPS, widening its command of the express transportation market to more than 43% (see chart).
Worse for UPS, its labor problems aren't over. While Smith's pilots are a contented bunch, UPS's are spoiling for another fight, and they recently rejected a management proposal by a fearsomely large margin. Michael Erickson, vice president of Air Freight Management Services in Portland, Ore., which advises clients on how to negotiate favorable deals, reports: "Before the strike our customers usually chose a shipper by price, and UPS often won. But today many are afraid of another strike, so they're sending business elsewhere."
Smith, unlike most entrepreneurs, has proven a durable manager. His hands-on, detail-oriented leadership has shaped every facet of corporate strategy. For all his visibility, however, Smith remains a private man, serious, and oddly devoid of spontaneity. He speaks in a flat monotone tinged with Southern drawl, and he reveals little about his personal life other than the basics: He was born into a wealthy Memphis family, has fathered ten children in two marriages, and has compiled a fortune worth more than $700 million. The only glimpse behind his stoic presence in a recent FORTUNE interview was a poignant reference to combat: "I wanted to do something productive after blowing so many things up."
There's no denying Smith's role as father of a new industry. By starting his express-transportation
business in 1971, he ignited an explosion of demand that continues to shoot off new-business sparks. FedEx's initial delivery service began modestly with small packages and documents, but today the world is addicted to shipping all manner of goods around the globe swiftly and reliably. Containers in the bellies of the company's MD11s and A300s circle the globe with items essential and frivolous-Maine lobsters, Japanese cherries, Hawaiian flowers, medicines, heart monitors, contact lenses, surgical scalpels, tennis shoes, circuitboards, fresh blood, tractor parts, auto bumpers, European fragrances, Swiss watch parts. Says Smith, momentarily approaching a boast: "We are the clipper ships of the computer age."
Smith figured out two decades ago that FedEx was in the information business, so he stressed that knowledge about cargo's origin, present whereabouts, destination, estimated time of arrival, price, and cost of shipment was as important as its safe delivery. He has therefore insisted that a network of state-of-the-art information systems-a sophisticated melange of laser scanners, bar codes, software, and electronic connections-be erected alongside the air and vehicle networks.
Technology, of course, can be and is replicated by competitors. But Boston consultant Michael Treacy estimates that FedEx is so far ahead of the pack that it would take UPS and others at least one year to catch up. The company has installed computer terminals at 100,000 customers and given proprietary software to another 650,000, so today shippers label 60% of their own packages. FedEx just receives electronic notification to pick up, then ships and delivers. "We have learned to do business without phone calls or paperwork and with fewer people," chief information officer Dennis Jones notes.
The bad news is that feeding three costly networks-air, ground, and infotech-is extravagantly expensive. FedEx spends between $2 billion and $2.5 billion every year. At times the interest and depreciation charges from these hefty investments have come close to obliterating profits. Since 1993 return on revenues has ranged from less than 1% to today's 3.1%. Smith's aim is to fatten those profit margins to a still anemic 6%, more in line with the 5% level UPS maintains. That's a realistic goal if the company continues to manage its average "yield" properly. Yield, defined as average revenue per package, dropped scarily from 1991 through 1995 from a high of $17.33 to $14.62. Only dazzling growth in volume, which saw average daily shipments more than double, to 2.7 million, kept profits inching upward. But in 1996 yields began turning around. By last May the figure had grown 49 cents, to $15.11.
Two efforts apparently account for the uptick. First, FedEx discovered that its advanced infotech systems contain a mother lode of information about the profitability of each client. The company knows which customers create how much profit-and which actually end up costing FedEx money. Result: Salesmen began confronting unprofitable customers, and have either dropped them or won price increases. So far FedEx has closed accounts that shipped 150,000 packages a day. Last summer FedEx also introduced a new system of pricing packages according to the distance they travel. So far, says chief financial officer Alan Graf, "I believe that distance-based pricing has had a positive effect on yield, though it's hard to tell because the UPS strike distorted the first fiscal quarter's numbers."
Like many successful entrepreneurs, Smith regards Wall Street with bemusement and doesn't worry about what he has apparently concluded he cannot control. "I don't spend a lot of time thinking about the stock," he admits, expressing dismay at market windfalls to companies with few assets and no earnings. Besides, the stock is finally doing fine without his focusing on the ticker.
Employee loyalty at FedEx is unquantifiable and undeniable. Visitors to the company's Memphis headquarters, familiar with the conventional wisdom that corporate fealty is dead, can only be taken aback by cheerleading employees who describe their blood as "purple" (from the dominant logo color). Smith works hard at instilling loyalty because he believes "it makes good, hard-headed business sense."
One technique is to ensure that employees are fairly treated, so FedEx managers are elaborately trained and monitored. After a manager takes over a job, he or she is evaluated annually by bosses and workers. If assessments fall below a preordained numerical rating for several consecutive years, the manager is often replaced.
The CEO appears to have built a strong competitive weapon by harnessing workers' enthusiasm, which paid off during the UPS strike. After the company was swamped with 800,000 extra packages a day, thousands of employees voluntarily poured into the hubs a little before midnight-on weekdays this was after working a regular job-to sort the mountain of extra packages for several hours. Their toil demonstrated a dedication beyond any slogans. When the strike had ended, Smith congratulated them in 11 full-page newspaper ads that ended with the salute: "Bravo Zulu!" The military phrase is prized because employees learn during training that it is the highest compliment: "Job well done, your performance rose above and beyond the call of duty." Smith also ordered special bonuses.
To achieve new gains, Smith must continue to energize workers, preserve the present upward momentum in yields and profit margins, and exploit new opportunities. Three trends are playing nicely into his hands: globalization, corporate drives to cut inventory and logistics costs, and the rise of Internet commerce. Smith recognizes their cumulative potential when he acknowledges, "We think the planets are lined up."
GLOBALIZATION. Over the next ten years the world express-transportation market should explode from today's $12 billion to more than $150 billion. That's because companies are scrambling to establish overseas arms to grab their share of the world's expanding wealth. Because most manufacturers have shifted to just-in-time inventory practices, expensive parts must be shipped all over the world. Smith is overjoyed that Honda and Toyota are planning new plants in the U.S.
In Asia the company owns many exclusive cargo-route authorities, including the sole routes into and out of China, so it is well positioned to take advantage of burgeoning commerce. It recently built a hub at Subic Bay in the Philippines and completed a new facility in Taiwan. The best news is that FedEx's foreign operations are profitable. In fact, international earnings are growing so fast that CFO Graf predicts that in five years they'll exceed domestic contributions.
COST CUTTING. A lot of companies want to cut massive costs tied up in inventory, but the effort requires a radical redesign of processes. This is a lucrative market for FedEx, and to capture more of the sophisticated business, the company is training salespeople as consultants capable of examining processes and suggesting new ideas. A successful partnership has been established with California-based Temic Semiconductor, a $1 billion unit of Daimler-Benz. Several years ago Temic formed a joint venture with FedEx that closed eight warehouses and set up one global center at the facility in Subic Bay. Today, after a customer places an order with Temic, he receives a confirmation within 30 seconds. Notice is sent electronically to the manufacturing facility, which makes and sends the product to Subic Bay, where FedEx receives it and ships it to the customer. In Asia orders can be received within eight hours; it takes 48 hours for them to reach U.S. and European destinations. For Temic, the results have been outstanding: The company saves $5.5 million a year.
INTERNET COMMERCE: Smith compares the Web with technological advances like undersea telecom cables and intercontinental planes because "it allows you to sit anywhere on the planet and buy or sell anything." Like most people, he has no idea whether Web commerce will take off in three, nine, or 15 years, but whenever it happens, he wants FedEx to be ready to take a fat share of the delivery business it generates. Today the company partners with a few pioneers, like a $200 million seller of computers, peripherals, and parts called Sun Data. Sales vice president Mark Metz opened a Website catalogue with FedEx software six months ago and says he's "thrilled" with the response. His expectations have all been exceeded: The catalogue costs less than a paper one, Internet sales are increasing at a rate of 10% a month, the catalogue business has gone from losing money to earning twice its 1997 budget, and 90% of his Internet customers are new, many from overseas spots like Ukraine, Venezuela, and Pakistan.
Virtual business makes sense to a visionary like Smith. He concedes that he has no idea how current trends will affect his company over the next five years. "We've made huge investments in our networks, and now that bow wave has passed," he muses. "We think we have a good chance of harvesting a lot of that investment." Of course, his chances improve if he continues to shoot, move, and communicate as well as he has in the past. |
