FedEx Has More to Worry About Than Tariffs and a Freight Slump | Company Business News

(Bloomberg Opinion) — FedEx Corp. reported on Tuesday that it was able to increase margins in its fiscal fourth quarter on flat revenue thanks to cost cuts even amid a lingering freight recession, a tariff war and new rules that dried up so-called de minimis shipments from China.The stock still got dinged in after-hours trading because the company’s first-quarter earnings-per-share forecast fell short of analysts’ estimates. The company punted on providing a forecast for the coming year, and that makes sense given all the uncertainty around tariffs, trade and the economy.

Of course, that’s all short-term noise compared with the huge task that lies ahead to complete the transformation plan that Raj Subramaniam announced soon after taking over as chief executive officer in June 2022. The company will ramp efforts over the next two years to combine its two distinct delivery networks —  Express and Ground — which carries much more risk than $4 billion of cost cuts that Subramaniam promised and delivered.

The achievements of the transformation — the cost cuts, the combination of units under one FedEx and the preparation to spin off the less-than-truckload unit — have been overshadowed by weak demand over the last three years as the market cooled from pandemic highs. Bullish investors are betting that margins will increase significantly when demand returns.

The transformation, though, won’t be complete until the company combines its networks, a move that’s expected to reap $2 billion of additional savings and efficiencies. These structural changes were needed because FedEx had reached a crossroads in its storied history.  The trend of free trade and globalization that allowed FedEx to expand so quickly in early years is now under siege. E-commerce brought more package volume but at lower profit margins. Amazon.com Inc., while not a direct pickup and delivery competitor, raised consumer expectations for delivery speed and the mythical “free shipping.” The supply-chain snags during the pandemic compelled large retailers to seek out more delivery options, increasing competition.

Fred Smith, the legendary founder of FedEx who died at age 80 on Saturday, saw these changes coming and handpicked Subramaniam to come up with a bold plan to deal with the new market realities.Subramaniam’s first order of business was to reduce the size of the freight airline to match demand and rationalize the use of planes. Low-priority cargo now goes in the belly of commercial airliners while overnight packages are flown by FedEx’s best planes. The trade winds that once blew only in the direction of more growth are now swirling around ominously and threatening to shift in the opposite direction as the US tries to recover manufacturing capabilities and undercut China’s increasing dominance of whole sectors of industry. Local production for local consumption now makes more sense when factoring in the carbon spewed by jet engines that carry goods halfway around the world.Also putting FedEx at the crossroads is the recognition that it’s inefficient to operate two distinct delivery networks. Smith had defended having an original express network that employs drivers and owns the trucks and a separate ground network that depends on contractors who own the trucks and hire the drivers for last-mile deliveries.The contractor model was nimble and made it impossible to unionize drivers. This appealed to Smith, who saw firsthand how the Teamsters pushed up wages at United Parcel Service Inc. Because the Express network was part of FedEx’s cargo airline, it fell under rules of the Railroad Labor Act, which makes it extremely difficult to call strikes. The Teamsters never attempted to organize Express drivers.

Subramaniam wants the efficiency that UPS gains from its unified network and IT platform. It’s unclear if this move will make FedEx susceptible to union organization. The Teamsters for now are more interested in organizing Amazon workers, giving FedEx cover for many years.

What’s even more unclear is whether the contractor model can ever be as efficient as a company that owns the trucks and employs the drivers directly, as UPS does. FedEx executives have been dropping hints that its unified network will combine contractors who handle most of the delivery volume with drivers on the company payroll who cover time-definite deliveries — all working out of the same facilities.

Under the contractor model, there are disconnects between FedEx and the drivers, the vehicles, maintenance and the handoff of packages to the drivers from the sorting centers. These disconnects create inefficiencies and negative incentives. A FedEx manager of a sorting facility is more concerned with getting the packages out the door than having them loaded correctly in the contractor’s truck. If the driver takes longer because the packages aren’t loaded properly, that’s the contractor’s problem, not the facility manager’s.  

This strategy also requires a complex, fine-tuned model for calculating how much to pay a contractor for each delivery. This calculation takes into account variables such as the mileage between deliveries, how many packages are left at each stop and the area’s traffic patterns. If the calculations are off, then a good contractor can lose money or FedEx could be overpaying a contractor, which is less frequent. Now FedEx may add to the equation the time-definite deliveries for Express packages.

There’s also an issue of scale. If a contractor is too small, costs for everything from maintenance to tires are higher. Small contractors have a much harder time dealing with contingencies, such as having two drivers call in sick on the same day. On the other hand, large contractors have more negotiating leverage over FedEx and can represent a systemic risk if they go bust. When contractors fail, whether large or small, it becomes more difficult for FedEx to recruit new ones.

During the pandemic, a large contractor created a problem for FedEx by organizing fellow contractors to demand more pay because of soaring costs. FedEx ended up terminating its relationship with this contractor, and the dispute is now in arbitration.

Smith is one of those rare business leaders who will go down in history as having transformed an industry. He was a gambler, and he loved aircraft. It now seems only natural that he would start a cargo airline, betting on delivery speed and globalization to great success. Subramaniam is now transforming the business to meet today’s business environment, and overcoming the challenges to get Network 2.0 right will be a key to that success.

More From Bloomberg Opinion:

This column reflects the personal views of the author and does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Thomas Black is a Bloomberg Opinion columnist writing about the industrial and transportation sectors. He was previously a Bloomberg News reporter covering logistics, manufacturing and private aviation.

More stories like this are available on bloomberg.com/opinion