UPS (NYSE:UPS) took the Boy Scouts "Be prepared" motto to heart this past Christmas. In an effort to avoiding bungling holiday deliveries like it did a year ago, the package delivery leader hired 95,000 new workers and invested $675 million in infrastructure improvements.
And according to the shipment data trackers at ShipMatrix, it paid off. Both UPS and rival FedEx delivered 99% of their express packages on time as promised on Dec. 22 and Dec. 23, largely meeting consumer expectations. Last year their on-time record was in the low-90% range, a woefully inadequate result that left Internet retailer Amazon.com refunding shipping costs to irate customers.
But the investments came at a cost. While UPS had sufficient manpower and support during peak load times, there was a lot of downtime otherwise, leading to inefficiencies, lower productivity, and higher expenses.
Those higher costs caused UPS to report fourth-quarter earnings that came in lower than Wall Street's expectations, and full-year profits of $4.75 fell well short of its own previous guidance of $4.90-$5.00 per share. While admitting its performance was disappointing, it promised to do things differently this year and said it would impose surcharges on deliveries to residences during peak periods.
"Going forward, we will reduce operating costs and implement new pricing strategies during peak season," said UPS CEO David Abney.
Because the cost of delivering a package to a residence is higher than to an office, which tends to get more deliveries, UPS will be marking up the cost for retailers who ship packages to a home during its busiest periods.
That sounds like something ride-share service Uber does during its peak demand periods: raise its rates as demand rises. But it also suffers a tremendous backlash when it occurs, and UPS may be opening itself up to the same kind of pushback -- or worse -- from retailers: They could take their business to the competition.
The perils of ignoring Economics 101
Supply and demand is a simple concept that naturally regulates the price of goods and services based on their relative demand and scarcity. The problem occurs when there is a dramatic spike in demand that suddenly throws supply out of whack. Prices often skyrocket, at least initially.
When demand for Uber's cars gets out of kilter with the supply available, such as on New Year's Eve, its busiest night of the year, Uber's algorithm kicks in and implements "surge pricing" that can result in prices doubling, tripling, or even rising as much as 10 times higher than the regular rate.
As Uber explains on its website, "[R]ates increase to get more cars on the road and ensure reliability during the busiest times. When enough cars are on the road, prices go back down to normal levels." The price hikes serve as an incentive for more Uber drivers to come out to meet the demand, but that hasn't stopped the ride-share service from coming under attack for allegedly gouging its customers.
The high cost of doing business
UPS might not be accused of price gouging, but retailers may still balk at paying the higher rates. They're already facing higher shipping costs this year as new dimensional weight pricing plans from both UPS and FedEx took effect in January, and new, higher surcharges when they're fighting for every sale could be the tipping point if they have to bear the costs themselves instead of passing them along to customers for fear of losing a sale.
Both carriers last year warned retailers before the holidays not to make overly ambitious promises to customers to capture last-minute online sales. Along with generous free shipping offers, retailers were guaranteeing delivery on orders placed right up to the day before Christmas Eve, and UPS and FedEx wanted to dampen expectations.
According to the National Retail Federation, holiday sales rose 4.4% to $616 billion in November and December 2014, and UPS said it handled 34 million packages on its peak day, Dec. 23, up from 31 million in 2013.
The Postal Service is ready to step up
The winner in all this could be the U.S. Postal Service, which is positioning itself as a reliable, trustworthy alternative to UPS and FedEx. As part of its effort, the Postal Service has done the following:
- Begun delivering packages on Sundays.
- Won a controversial rate cut in the exact weight categories that are used the most by e-commerce sites.
- Delivered a record 28.2 million packages on Dec. 22, its busiest day of the year, a 10.5% increase from 2013.
UPS thus finds itself in a bit of a bind. If it doesn't raise prices high enough this year, it doesn't fix its problem. Raise them too high, and retailers could flee to the competition. Like Uber, it's in an untenable position, and UPS' stock reflects the uncertainty over whether it can successfully thread this needle.
UPS' shares tumbled after the earnings preannouncement and are down 12% from the 52-week high it hit last month when it was believed a busy Christmas season was going to benefit its business. The actual financial report issued yesterday delivered no new financial surprises, but the carrier maintained its priority is all about "protecting the brand."
What the earnings miss reveals instead is that UPS is still on a steep learning curve for responding to the overwhelming growth potential of e-commerce, which represents nearly half of its business. CEO Abney said e-commerce is expected to outpace global GDP growth by fourfold and cross-border e-commerce by as much as seven times.
That kind of growth is putting UPS on a course for a bigger clash with retailers this year, who may just bolt for the competition, wrecking the company's earnings once more in 2016.
Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, FedEx, and United Parcel Service. The Motley Fool owns shares of Amazon.com. 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.