How Reforms Could Turn U.S. Postal Service Into Threat for UPS and FedEx

A parked USPS van in Colorado

The chronically beleaguered U.S. Postal Service may be headed for a refresh, courtesy of major reforms proposed in Congress.

But UPS and FedEx might not like the reformed agency that will ultimately emerge from the process.

A Morgan Stanley report this month suggests that a streamlined, flexible USPS could pose a threat to the two private logistics behemoths, particularly in e-commerce delivery services.

“This is clearly a time of fast-moving, secular developments in the logistics/last mile parcel delivery space, but all signs point to increased — not reduced — competition,” according to the report.

At the moment, however, USPS is spectacularly unhealthy.

Last year, the agency posted a $5.6-billion net loss, despite having moved 154 billion pieces of mail and collected $71.4 billion in revenue.

Those figures are “grim,” analysts wrote. But the 2017 outlook is “particularly dire,” they said.

If current trends hold and USPS continues to fund pension and healthcare requirements, the agency will end up with less than $3 billion in operating cash by mid-October. That’s enough to run the system for just 10 days.

“There is no question that the USPS is a financially unviable entity as it stands and the good/bad news is that this needs to be comprehensively addressed imminently to prevent a crisis,” analysts wrote.

Congress seems poised to step in. The Republican majority in both houses bodes well for a postal reform bill, HR 756, proposed in January by Rep. Jason Chaffetz, R-Utah.

The legislation targets USPS’ substantial healthcare liabilities and seeks to improve its operational flexibility and potentially raise postage prices. It would also partially restore an exigent surcharge that allowed the agency to collect $4.6 billion in rate surcharges before the provision was rolled back in April.

USPS management expects the bill to help shave $26 billion off the agency’s costs while optimizing its revenue potential. All four major postal employee unions support the legislation.

“I’m willing to invest political capital – we have a number of stakeholders who are here as we are looking to truly save the Postal Service as we know it,” said Rep. Mark Meadows, R-N.C., at a February hearing by the House Committee on Oversight and Government Reform.

Meadows chairs the committee’s subcommittee on government operations. Chaffetz, the bill’s sponsor, chairs the overarching committee.

The reforms are a bit of a gamble, because USPS faces many headwinds. Its high-margin first-class mail business is sliding, while its low-margin package business is on the upswing, putting more pressure on its solvency. Its fleet of delivery vehicles is outdated.

But with some help, Morgan Stanley analysts believe a sleeker USPS could put UPS and FedEx on the defensive.

“We believe a healthier, nimbler USPS with incremental pricing on its non-package mail business and higher capex that drives better service could actually become a stronger force to be reckoned with in the e-commerce space, especially in rural areas where an in-house logistics network at an e-commerce giant might not reach,” analysts wrote.

In the past, UPS and FedEx have pushed for postal reform in the hopes that a stronger agency would raise costs for its services, thus elevating prices across the industry.

Morgan Stanley analysts argue that this may not be the case.

USPS is operationally profitable. Its first-class mail revenue is declining more slowly year-over-year than forecasts projected. It has made $14 billion in cost reductions since 2008. In September, it awarded contracts to six suppliers to build prototypes of next-generation USPS delivery vehicles to potentially add to its fleet.

The agency’s net income certainly isn’t impressive, but it demonstrates that the core operations aren’t necessarily in disarray. The primary financial culprit is retiree healthcare benefit spending — if Congress can clean that up, USPS wouldn’t need to institute price hikes, Morgan Stanley analysts wrote.

And even if the agency decides to charge more for its services, it likely won’t target e-commerce parcel delivery, analysts wrote.

USPS considers packages to fall into a business category it dubs competitive products. That sector isn’t subject to a government-imposed price cap that affects USPS’ “market dominant products” category.

The argument, according to Morgan Stanley, is that if USPS wanted to raise parcel delivery prices, it would have done so already because Congress doesn’t restrict such increases. If anything, a reformed USPS would lower prices for package services while boosting stamp prices.

“That should be easier and have a much more positive impact, and we think stamp prices are too low, not package prices,” said David G. Ross, an analyst with Stifel Financial Corp.

Besides, Morgan Stanley analysts wrote, it’s not like USPS would hike package prices to a level that would justify UPS and FedEx following suit.

Currently, USPS’ competitive products are priced at $4 a unit, compared with $8 at UPS and FedEx Ground, Morgan Stanley found. So a 50 percent increase at USPS would still put the price 25 percent below the private competitors’.

Currently, UPS and FedEx can command a premium over USPS for package pricing because of superior technology and service, Ross said. But customers accustomed to cheap delivery could revolt if prices rise more, according to Morgan Stanley.

Such a move might actually benefit e-commerce behemoths such as Amazon and Walmart, who could rely more on in-house logistics and cheaper last-mile services. And smaller bricks-and-mortar retailers could adopt an omnichannel strategy, shipping from stores using local delivery and abandoning FedEx and UPS.

Congressional legislation could “infuse greater innovation” into the Postal Service even as it works to “provide greater product and pricing flexibility,” said Brian J. Wagner, president of the National Association of Postal Supervisors, in a February letter to Chaffetz.

Still, Ross is skeptical that such government efforts will significantly shake up the industry pecking order. USPS leads the business-to-consumer delivery market by a wide margin, often partnering with FedEx SmartPost and UPS SurePost. Meanwhile, FedEx and UPS hold the advantage in sortation and last-mile delivery, he said.

FedEx and UPS also invest billions of dollars annually into new, expanded and automated facilities that can accommodate growing demand for e-commerce delivery, Ross said. The companies also pour funds into improvements to their delivery services, networks and customer service.

“This massive investment just continues to widen the gap over what the USPS can provide,” he said. “Reform at the USPS will be focused more on the financials than on the operations, so we don’t expect the competitive landscape to change much,” he said.

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