No wonder that Smith likes to say this. It is, after all, a good line and it reflects FedEx's view of a worldwide need for a guaranteed express delivery system to act as a conduit for the ever-increasing use of just-in-time (JIT) manufacturing techniques. More importantly, it evokes Smith's view of the leading role being played by FedEx in helping the world evolve into a global marketplace. For its trouble, FedEx is destined to get a premium for the service provided, offsetting the diminished yields at home resulting from strong competition.
No doubt, big ideas can beget big rewards: FedEx is almost as close as the airline industry can get to a well-oiled, money-making machine, and has shown a consistent ability to turn in annual operating margins of close to 8 per cent over the past decade. In 1994, operating income jumped 41 per cent, most of the growth coming from the domestic market. But in its year ended 31 May 1995, domestic results were actually down $95 million and yields declined 5 per cent. FedEx nonetheless made record net profits of $297.6 million, helped by the international system's $126 million profit - its first ever.
But big ideas can also produce big problems. In the past nine years, FedEx has turned in two net losses, each primarily the result of large-scale initiatives gone awry: a 1987 loss of $65.5 million resulted from the failure of the pre-fax revolution ZapMail initiative; and 1992's $113.8 million loss was the end result of a failed effort to launch a US-like hub-and-spoke delivery system in Europe. That year was the nadir of the company's international expansion, when non-domestic operations chalked up $600 million in losses, the bulk of it Europe-related.
Now, three years later, FedEx is once again betting heavily that the international arena will ensure the company's profits run continues: in Asia, in particular, the September launch of AsiaOne, an intra-regional express delivery network, should guarantee FedEx a presence in a region which is tipped to see express delivery volumes grow by at least 25 per cent annually for the foreseeable future. The recent agreement to purchase Evergreen International Airlines' all-cargo route authorities to China adds to the potential.
So far, so good: 1995's 11 per cent gain in operating profits was due in large part to the performance in Asia. In the first quarter ending 31 August, international - or primarily intercontinental - business produced a $24 million operating profit.
But is FedEx basing too much of its future growth in a region that is prone to political instability or could turn protectionist at a moment's notice? And does demand for FedEx's express product really exist in Asia?
FedEx's international aspirations should be examined alongside its domestic operations. The company's home market is hardly a disaster: close to 70 per cent of FedEx's revenue is generated in the US and the market produced operating income of $465 million in 1995. Nonetheless, 13 years of head-to-head competition with United Parcel Service has, in the past five years, been exacerbated by competition from other entities such as Airborne, the US Post Office and, increasingly, trucking companies. Like a true commodity, pricing now drives volume.
In 1994, the movement of US freight was an $18.5 billion industry. Within that, FedEx has maintained a dominant share - roughly 59 per cent - of the $8.5 billion express overnight market compared to UPS' 36 per cent, according to figures from Arlington, Virginia-based MergeGlobal Inc. 'We have been able to keep our leadership in the express business despite the onslaught of a very able competitor,' Smith says.
Unfortunately for FedEx, the US market has become less infatuated with overnight delivery as new, less time-sensitive products have proliferated. The heated battle between FedEx and UPS has resulted in a duplication of product lines between the two operators, so that each offers same day service, overnight priority, 8-am deliver, 10-am delivery, afternoon delivery, two-day and three-day delivery. Smith says the product simply cannot be segmented any further.
According to Renee Shaker at Moody's Investor Service, 'priority overnight' has dropped from providing 59 per cent of FedEx's revenues in 1990 to 35 per cent in its 1995 financial year. This is compounded by the fact that overnight priority delivery gives the company, in general, a 30 per cent premium over two-day delivery products which now make up a larger percentage of overall volume.
Competition has also seen significant bouts of discounting. The result for FedEx has been a yield decline that decreased the average revenue per package by more than $2 between 1992 and 1995.
The only saving grace is that the effects of the yield decline have been minimised by tremendous volume growth. At the same time, FedEx has cut costs and raised productivity. Unit costs have fallen from $13.16 in 1992 to $11.99 in financial year 1994/95, as a result of the B727 fleet retirement, operations auto- mation and the transfer of technology from the customer service staff to the customer, via software that lets individual shippers track their package without burdening FedEx with queries. Shaker believes that the software has produced customer goodwill by providing more personal control over shipments. The added benefit is that UPS was far behind in initiating its own tracking software.
However UPS is a powerhouse in the US and has benefits of scale over FedEx and better cost distribution from a delivery system that is 20 per cent pure truck-to-truck. 'FedEx has an asset mismatch; the aircraft that they have invested in are critical to an overnight operation, but when it shifts to two-to-three day service, UPS has an appropriate mix of [delivery] assets,' says Brian Clancy, a director of MergeGlobal .
Smith sees more reliance on ground transport as a result of the deregulation of intra-state trucking in the US last January, and says FedEx will rejig its system to allow for more, cheaper truck deliveries. And, he adds, in the past two quarters yield diminishment has actually slowed to a rate of 2 to 3 per cent in the domestic market. This is largely a result of FedEx using new yield management systems that have helped manage the basic variables of the business: price, weight per shipment and traffic mix.
Though FedEx officials believe that the US freight and express market has not yet fully matured, they also think the growth market for the premium express volume lies in the intercontinental arena. Using the US market as its base, FedEx needs the global markets to address not only the asset-use question raised by Clancy, but also to reestablish its premium core business.
And, as business trends continue their global pace, FedEx must have worldwide coverage to remain competitive at home. 'The sectors that we serve are the globalising industries,' Smith says. 'Our US markets will grow faster than the rate of the GNP, but not nearly at the rate of the intercontinental business, which is twice as much for us. In five years, I'm sure our international revenue will be greater than today's total of 30 per cent. It will probably be 40 or 50 per cent.'
If AsiaOne comes off as hoped, that revenue will come from increased high yield 'priority' package and freight traffic in Asia. The international sector's profitability - all regions except Latin America posted operating profits - has come from better pricing of the express product, says Smith.
Package yields saw a 3 per cent increase in international yield in 1995, averaging $40.28. Efforts to manage capacity in the freight sector have been successful to a point, though Smith says it is an imperative to 'move' shippers into the realm of express delivery by limiting availability for the airport-to-airport freight product.
Joseph McCarty, formerly FedEx senior vice president of Asia and now heading up the company's new Latin America division, hopes AsiaOne will see the 50-50 volume split of express versus traditional freight in Asia change to a 70-30 split in favour of express. 'IXF [international express freight] is really the boom part of the market for us in Asia,' he says. 'Over time, the poundage represented by traditional freight will decline. It will be a deliberate attempt to manage it that way,' adds Smith.
The hope is that AsiaOne will firmly establish the long-foundering international system which began in 1989 with the purchase of Flying Tigers and its rights to and beyond Japan. More recently, FedEx has established what will become the main hub at Subic Bay in the Philippines. The system will eventually be comprised of transshipment hubs in Singapore, Taipei and Bangkok, and is currently being fed by fifth freedom services from Japan and direct services from the US.
Perhaps surprisingly, Smith does not consider Hong Kong more than a significant spoke, primarily because of issues regarding self-handling. Taipei, if similar aeropolitical 'doing business' issues can be worked out, could be 'equal to if not greater than Subic Bay' in size of operations, McCarty says.
Smith describes the importance of the revenue stream from AsiaOne, in descending order, as transpacific, intra-Asia, Asia-Europe. AsiaOne is first and foremost a feeder operation for the transpacific flights currently being operated with five A300s out of Anchorage and Oakland, with two more scheduled to be added in 1996. MD11s and DC10s comprise an intra-Asia fleet that connects 11 commercial centres in the region. Overnight service is offered between Seoul, Tokyo, Osaka, Taipei, Hong Kong, Kaohsiung, Bangkok, Manila, Penang, Kuala Lumpur and Singapore. The former Evergreen China authorities include Beijing and Shanghai, though by early November only two of four weekly service rights had been obtained.
Clancy sees more upside for AsiaOne than FedEx experienced when it tried in Europe where, in the end, trucking won out: 'Geographic distance is longer, there is, obviously, no truck competition between islands.' But other factors clearly do cause some concerns. In Europe the latent demand never really materialised and despite Asia's tremendous growth potential, there is always a danger the high yield demand could be lower than projected. Shaker at Moody's is cautiously optimistic about FedEx's chances in the region: 'I just wonder if FedEx is ahead of the rest of the world on this,' she reflects.
Certainly, bilateral negotiators in the US wonder about this issue too. FedEx has waged a long-running war of attrition on the bilateral front with almost every country to be affected by AsiaOne in order to set up the intra-Asian operation. For now the company seems to have won: Hong Kong has liberalised cargo fifth freedom rights, the Philippines have opened up cargo as a concession for delaying open skies negotiations with the US on the passenger front, and, most strikingly, Japan and the US are in the process of negotiating complete liberalisation for cargo rights, after FedEx made an application to serve Subic Bay from Osaka and was initially denied. Yet only 11th hour negotiations and threats of renounced bilaterals and trade sanctions, got FedEx seven extra beyond frequencies from Japan.
Smith is proud of FedEx's success in getting what it needed but the real test will come if and when the US and Japan work out a complete liberalisation package. This would go a long way to demonstrate that AsiaOne will not become a feather in the wind of trade warfare.
But even if a US-Japan cargo agreement emerges, there are few assurances that Asia is moving toward a liberalised environment. There is friction in: Bangkok, where FedEx operates once a week under the renounced Thai-US bilateral; China, where of the four weekly services purchased from Evergreen, two are being held hostage to China's complaints over US fifth freedom rights from Japan; and Taiwan, where hopes for a second trans-shipment centre for the carrier are being flummoxed because of Taipei's refusal to grant FedEx self-handling of its cargo. Says one Washington transportation official: 'in this region, there is never a sure thing. FedEx could find that one day Japan simply decides to shut its doors.'
So far, however, the potential of the region is far outweighing the risk, particulary when the competitive presence of DHL and TNT so far remains minimal. The next step could be to build an AsiaOne-like system in South America, where FedEx has a comparatively small presence, and McCarty says feasibility studies are being conducted on a large transshipment hub in the northern cone of South America.
If successful, FedEx could well become a significant part of the trade fabric that is increasingly binding the world's economies. 'We are the primary transport mode for the industries that will be the growth engines of the world economy,' says Smith, once again thinking big.
Source: Airline Business
