Can United Parcel Service's New Pricing Strategy Deliver More Profits?

After much deliberation, United Parcel Service has finally made a big change in the pricing of its core ground business. This could mean big gains for the company.

Jul 5, 2014 at 2:07PM

United Parcel Service (NYSE:UPS) is America's biggest player in the $32 billion ground package delivery market. The company has recently revised the pricing structure of its ground delivery business, and it's announced that it would now consider the size of the parcel, and ot just weight, when charging customers. The decision was not surprising, as archrival FedEx (NYSE:FDX) made a similar announcement in May. How does this change affect United Parcel Service's future revenue and earnings prospects? Will volumes suffer because of this change? Let's find out.

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Source: United Parcel Service.

Volume could remain strong
Both United Parcel and FedEx have already implemented this new pricing approach in their express delivery services.

In the ground segment, parcels to be delivered within the U.S. and Canada have been priced only on the basis of weight. But beginning in 2015, the pricing will also depend on the size of boxes. This change will force shippers to pack goods more tightly to avoid using larger boxes that would be more expensive to ship.

Industry experts think this move could be profitable for the courier companies, even if intelligent packing lowers delivery volumes, better pricing could compensate for it.

And even if there's some impact on the volumes due to the new pricing policy, the online retailing boom, especially in holiday seasons, could continue the momentum.

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Source: Wikimedia Commons.

United Parcel Service delivered 16.9 million packages per day in 2013, reflecting a 4% growth year over year. The improvement was largely due to increasing online sales, a trend that is expected to continue in the years to come. According to data published by Forrester Research, online sales in the U.S. could touch $279 billion by 2015, up from $176 billion in 2010. The research also says that the growing preference for Web shopping will continue to drive double-digit online retail growth in the U.S. for another five years.

Earnings could get a boost
UPS is witnessing a decline in overall revenue per package as more customers opt for cheaper low-end services. The company's total average revenue per package grew 4.2% in 2010 and 5.7% in 2011, respectively. But revenue per parcel remained flat in 2012 before dipping 0.6% in 2013. This had a negative impact on total revenue, though higher volumes from increasing online sales made for the shortfall. The new pricing strategy will help offset some of the negative impact.

Small boxes that take up less space will enable the company to use its truck space more efficiently -- so more deliveries can be made using the same fleet, or a smaller fleet may be deployed for the same number of deliveries. Either scenario would lower fuel, maintenance, and similar costs and improve margins. United Parcel Service owns the largest fleet for domestic deliveries. It had 103,000 vehicles in 2013, compared with only 47,500 vehicles for FedEx, and stands to be a bigger beneficiary of this new strategy. 

In a company press release, Executive Vice President and Chief Commercial Officer Alan Gershenhorn said "UPS has been researching the potential expansion of dimensional-weight pricing for a number of years because it enables us to more appropriately align rates with costs which are influenced by both the size and weight of packages."

According to Citigroup analyst Christian Wetherbee, the new pricing strategy could have a 2% to 3% impact on UPS earnings per share in 2015.

Better customer services
The new pricing approach could help United Parcel Service serve its customers better.

The company got a lot of unwanted attention in the 2013 holiday season when it failed to deliver some parcels on time. Online sales are typically higher in the holiday seasons, but volume shot up abnormally between Nov. 1 and Dec. 15 on account of the severe cold. To deliver the parcels, United Parcel Service had to hire additional contract workers, planes, and fleet of trucks. This increased operating expenses, which affected the company's fourth-quarter results. FedEx, too, had similar troubles that hit its third-quarter results. This new pricing strategy could enable both companies to better use their resources and provide better prices, which in turn could fetch more orders.

Parting thoughts
The new pricing strategy could give United Parcel Service's revenue and earnings a boost. Revenue per parcel would improve, while operating costs would come down because of the efficiency gain. And this could be achieved without sacrificing volume. Since FedEx has made a similar move, and the two companies have an effective market duopoly, customers would have no choice but to accept the new pricing structure. All these factors are expected to solidifying UPS' business growth and improve profitability.

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ICRA Online has no position in any stocks mentioned. The Motley Fool recommends FedEx and United Parcel Service. 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.

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