The coming rate hikes at UPS (NYSE:UPS) and FedEx (NYSE:FDX) represent a threat to the free shipping policies we've seen retailers expand exponentially, but a rate cut the U.S. Postal Service just won might give it a competitive advantage the delivery giants won't be able to overcome.
In May FedEx announced it will begin using dimensional weight pricing to calculate rates on packages less than three cubic feet, and a month later UPS followed suit. Because both bricks-and-mortar retailers and their online brethren are increasingly shipping items that take up more real estate inside their delivery trucks, the carriers will start charging not only for how much a package weighs, but also for its size relative to its weight.
Dimensional weight pricing isn't really new as both have used it for ground delivery services, as have air freighters and truck carriers, and the post office even adopted it a few years ago in what it called "Shape-Based Pricing."
A lump of coal
While the rate hikes won't affect shipping policies for the coming Christmas holiday, since they go into effect right around the new year, they will play a big role in package returns however.
Rising costs made it necessary for the carriers to raise their rates, something even Amazon.com (NASDAQ:AMZN) was forced to consider as it raised the price of its Prime membership program from $70 to $99, a service which, among other things, includes free shipping on thousands upon thousands of products.
Exceedingly high demand for low-cost shipping services helped fuel the debacle surrounding shipments last Christmas. UPS was so overwhelmed that it was unable to deliver all of its packages by the holiday while FedEx was also hard-pressed to keep up. The fallout was that Amazon ended up having to refund shipping costs to irate customers and hand out $20 gift certificates. Earlier this year it announced plans for its own "last mile" delivery service so as not to be beholden to someone else's schedule.
So it's curious that the Postal Service applied for -- and ultimately won -- a rate cut just weeks after its rivals announced their pricing increases. The postal service will drop rates between 30% and 50% in weight categories that are used the most by e-commerce sites, a move FedEx called a bald-face attempt to aggressively gain market share among Internet retailers, and the Postal Regulatory Commission's acquiescence means it can no longer be trusted to ensure equity.
"The time has come to reinforce, indeed to rethink, the Commission's role in protecting fair competition in package distribution services," FedEx said in its comments to the PRC on the USPS's proposal.
UPS essentially agreed, saying the post office was hiking rates where it had a monopoly on delivery -- namely, first-class mail -- to be able to cut them where there was competition, effectively using the one to subsidize the other.
The Postal Service is a money-losing business. Even though it raised rates in January on an emergency basis, it still lost $2 billion in the second fiscal quarter, more than double the $740 million it lost in the year ago period. It lost $5 billion in 2013.
It blames the losses on a congressional requirement it prefund 75 years worth of retirement benefits for its workers over a 10-year period, but the General Accounting Office disputes that charge, and ignores that unfunded pension liabilities are a huge ticking time bomb in corporate America. It's no less so where taxpayers are backstopping the liability.
The real problem is the lucrative pensions and benefits enjoyed by postal workers. Even the USPS's own inspector general found the service spent a bigger percentage of its personnel costs on pensions (12%) than did either private companies (3.7%) or even state or local governments (9.4%).
This is important because the way the USPS is being run allows it to gain a competitive advantage over private businesses. Indeed, even Amazon is using the innate pricing advantages of the post office to deliver packages on Sundays -- business that could otherwise be going to FedEx, UPS, or other private carriers.
The Big Two carriers are also being pressured by the likes of Google and eBay, who are testing their own delivery services, not to mention smaller regional players that are grabbing customers like Walgreen and Avon who are looking for cheap, fast options for getting packages to customers.
Moreover, retailers from Wal-Mart to Target are relying more on their own stores located close to customers to ship goods rather than from distribution centers that may be located some distance away, even in other states. And the ship-to-store phenomenon has become a way for retailers to keep customers not only coming back, but also spending more when they enter the store to pick up their item.
While the rate hikes threaten consumers ability to get a good deal on shipping -- maybe not this Christmas but certainly next year -- it also represents a threat to FedEx and UPS themselves, who not only face more competition but an unlevel playing field as well.
[Editor's note: Corrected Postal Rate Commission to read Postal Regulatory Commission.]
Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, eBay, FedEx, Google (C shares), and United Parcel Service. The Motley Fool owns shares of Amazon.com, eBay, and Google (C shares). 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.