FedEx Price Update Delivers Sour Note to Online Shoppers

FedEx has given Internet shoppers a (nearly) free ride for years -- but that's about to change. Read on to find out how -- and how much it's going to hurt.

May 17, 2014 at 7:00AM

We have it from no less an authority than Shakespeare that "a rose, by any other name, would still smell as sweet." But delivering a box of roses to your sweetheart via FedEx (NYSE:FDX)? Soon, that's going to cost you a bundle.

Photo: The Motley Fool.

By now, you've probably heard the news: FedEx is changing how it charges for delivery of light weight, but large size, packages to your home or business. Dubbed "dimension-based pricing," FedEx's pricing scheme isn't exactly a new idea in the shipping business. But how FedEx plans to use the scheme here in the U.S. is. And it's directly relevant to you both as a consumer -- and also as an investor.

What dimension-based pricing is
Here's how FedEx describes the plan:

"Effective January 1, 2015, FedEx Ground will apply dimensional weight pricing to all shipments. Currently, FedEx Ground applies dimensional weight pricing only to packages measuring three cubic feet or greater."

Now before we go any further, a quick math review is probably in order. Three cubic feet is the volume occupied by three boxes, each 12 inches on a side. Mathematically, it works out to 12 x 12 x 12 (for one box) x 3 boxes total -- 5,184 cubic inches in all.

Now back to our originally scheduled programming:

"This change will align the FedEx Ground dimensional weight pricing with FedEx Express by applying it to all packages. Dimensional weight pricing is a common industry practice that sets the transportation price based on package volume -- the amount of space a package occupies in relation to its actual weight."

Got all that? FedEx is saying that it used to charge for delivery of most items based on weight. This was a simple pricing scheme, and it worked fine so long as the assumption that "the bigger the box, the greater the weight" held true. But now that consumers have begun ordering bigger boxes of lightweight items from online e-tailers such as (NASDAQ:AMZN) and Staples (NASDAQ:SPLS) -- the Nos. 1 and 2 Internet e-tailers, respectively -- FedEx's old pricing system has begun to break down.

And so FedEx is changing it.

What it means to shoppers
What does this mean to you as a consumer? Let's use a couple of examples to illustrate.

Say you want to order two items on One is a big box of Charmin Basic Toilet Paper. Forty double rolls to a box, it sells for $25.33 with free shipping via Amazon Prime. Amazon estimates this package at 8.9 pounds shipped, and measuring 3,196.5 cubic inches (21.9 x 8.9 x 16.4 inches). That's below FedEx's 5,184 cubic inch-cutoff point, and so the box is now subject to the new pricing regime:

FedEx's Dimensional weight calculator transforms an 8.9-lb. box of toilet paper into a 23.0 lb. box. Source: FedEx.

Say now you also want to buy a box of 10 Duracell "D" flashlight batteries. It costs $14.96, and also ships free with Prime. Order three of these puppies, and they'll ship to you at 9.6 pounds total (about 8% heavier than the Charmin). However, being more dense than paper, the three boxes of batteries, combined, will occupy just 5% the space of the case -- 155 cubic inches.

Sometimes, you just can't win. Space-efficient, but heavy batteries get priced by weight. Source: FedEx.

Result: If Amazon were to use FedEx for shipping these two packages (Amazon more usually ships its own merchandise via UPS or USPS, but third parties on may also use FedEx), FedEx would price the Charmin by volume, but the batteries by weight.

What it means for investors
For consumers, the implications of FedEx's new pricing system are clear: Pretty much everything's about to start costing more. From roses to toilet paper to batteries, if FedEx can charge you more by weight, they'll do that. And if they can charge you more by volume, then they'll do that instead. But what does all this mean for investors?

Well, for FedEx shareholders, this is obviously good news. The company has found a new way to make more money for doing the same amount of work it was doing before. Revenues will rise, and profits, too -- and presumably, the share price will follow. (In fact, since announcing the new pricing scheme two weeks ago, FedEx shares are up close to 2%).

UPS (NYSE:UPS) shareholders have enjoyed about a 3.5% gain since FedEx broke the bad news to its customers -- and this only stands to reason. On the one hand, UPS may decide to sit tight on its own pricing system, and benefit from customer defections from FedEx to Big Brown. Alternatively, UPS may decide to mimic FedEx's pricing move -- the two companies do tend to raise their prices in lockstep -- and this would mean bigger revenues and profits for UPS as well. Heads, UPS wins. Tails, UPS doesn't lose from FedEx's pricing switcheroo.

Does anybody lose?
Should UPS elect to follow FedEx's lead, this could be bad news for e-tailers such as Amazon and Staples. Both companies offer their customers free shipping on purchases of sufficient dollar value (and in Amazon's case, for Amazon Prime members on purchases of almost any size). And because Amazon and Staples mainly absorb shipping costs themselves, they've got a lot to lose from FedEx's pricing move.

Both companies presently prefer to use UPS for their package deliveries, true, and so they won't feel an immediate impact from a shift in pricing by UPS' rival. But they'll lose leverage in pricing negotiations with UPS for sure, because a threat to switch their business to FedEx will ring increasingly hollow now that FedEx costs more. And if UPS does follow FedEx's lead, then Amazon and Staples will have a tough choice to make: Eat the extra cost, or pass it on to consumers -- potentially losing customers as a result.

The moral of this story? It's good to be a shipping duopoly. FedEx's decision to switch to dimension-based pricing is good news for FedEx investors, and probably good news for UPS as well. It's only bad news for the companies' customers -- Amazon, Staples, and... you.

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Rich Smith has no position in any stocks mentioned. The Motley Fool recommends, FedEx, and United Parcel Service. The Motley Fool owns shares of and Staples. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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