July 1, 2023

UPS may find it hard to pass along higher labor costs


There is no doubt that UPS Inc.’s labor costs will rise once the Teamsters union ratifies the next five-year contract, which at this writing is still being negotiated. And there is little doubt that UPS will do what it can to recoup what could be a significant increase in its expense tab. 

It already is doing so, according to Steven Bergan, president of GLS, a Western regional carrier that recently expanded to four East Coast and Midwest markets with individual partners. “UPS is out being equally aggressive about using their volume rebate programs to demand volumes and threaten customers with major rate increases despite shippers looking to diversify in the event of a UPS (NYSE: UPS) strike,” Bergan said. Parcel customers typically get rebates based on volume tenders; conversely, they can lose those rebates if they divert certain volume levels elsewhere.

“It’s a bit heavy-handed in my opinion that a shipper’s parcel vendor would have the guts to go in to a customer, threaten major rate increases if volume gets pulled away, even when that same parcel vendor may not show up next week due to a strike, and there’s zero the shipper can recover if and when that happens,” Bergan said. In addition, UPS is “using this positioning to set up for next year’s rate increases and volume commitment demands,” he said.

Taking up rates and other fees in the belief that the marketplace will absorb them is not a wise assumption, said Josh Dunham, co-founder and CEO of the Reveel Group, a consultancy.

“With the slowing economy and the rate increases shippers have sustained over the last few years, shippers are at a crossroads where they are looking to other avenues of saving money. We’ve never experienced a time where shippers have been more open to multisourcing from regional carriers and others,” he said.

One example is SurePost, a product that UPS operates in conjunction with the U.S. Postal Service in which UPS tenders low-weight, nonurgent parcels to the Postal Service for last-mile delivery. Under tentative agreements already reached, the size of UPS SurePost packages eligible for handoff to the Postal Service will be reduced. In addition, UPS agreed that 50% of all SurePost parcels will be redirected to UPS by the end of the next contract, up from 42% currently. Both agreements are likely to push more of those parcels on to UPS package cars.

However, Josh Taylor, senior director of professional services for consultancy Shipware LLC, said that insourcing a higher percentage of SurePost packages will hurt UPS’s SurePost profitability. “They are outsourcing those packages today to the USPS because it is cheaper and more efficient than having the Teamsters deliver them,” Taylor said.

SurePost is often more expensive (and slower) than comparable services at postal expeditors like DHL eCommerce, OSM Worldwide and others. Any extraordinary rate increase UPS tries to pass along will drive more shippers into the arms of their competitors, potentially increasing UPS’s internal costs not just for SurePost, but for all residential deliveries,” Taylor said.

“UPS has been unwilling to sacrifice margins under [CEO] Carol Tomé. She likes to make the point that price is determined by what the customer is willing to pay,” Taylor said. “We should expect UPS to return to the same playbook and attempt to raise SurePost rates to avoid any margin loss, but SurePost service is different than Air/Ground and increasing rates could easily spiral out of control.”

John Haber, chief strategy officer at Transportation Insight Holding Co., said that shippers are extremely cost-sensitive in the current market environment, “and if UPS becomes drastically more expensive than other options, then they will risk losing customers. There is still a lack of full-scale competition in the U.S. small parcel market, and some shippers may not have other options — UPS may be able to raise rates for these customers without impunity. However, I don’t see this across all customers.”

“What could be problematic,” Haber said, “is if other carriers follow suit with UPS and follow their lead on pricing increases. With the soft economy weighing on parcel providers and volume levels, the only way to achieve profitability goals is through either increasing revenue-per-piece yields or via cost-cutting measures.”

Branden Burt, director of parcel operations for TransImpact LLC, said he expects UPS to honor contracts as they are constructed. However, “I’d suspect UPS to pull revenue levers” such as raising delivery and fuel surcharges to existing customers, Burt said. “The revenue levers are more easily passed to the end consumers.”

Dean Maciuba, managing director, U.S. operations for Crossroads Parcel Consulting, listed four reasons why UPS will be constrained in its rate actions. First, demand has largely dried up due to the slowing economy. Second, rival FedEx Corp., (NYSE: FDX) already a lower-cost, largely nonunion carrier, is in the process of taking billions of dollars of costs out of its business. Thus, it can more profitably offer service at lower rates than UPS, making it harder for UPS to raise rates, Maciuba said. Third, the proliferation of smaller but lower-cost options like regional carriers.

Fourth, the continued growth of forward stocking micro-fulfillment distribution solutions will negatively impact parcel carrier volume moving forward. This will impair scale and negatively impact the cost of handling packages. “Historically, UPS has profitably managed and leveraged scale better than any other parcel carrier,” Maciuba said. “UPS may have to lower rates to hold on to the scale necessary to drive margin.”

“Given the demand being soft at present and likely to remain that way for rest of 2023, it will be hard to push higher rates and surcharges to cover the change in labor cost with the new contract,” said Satish Jindel, president of ShipMatrix Inc., a transportation consulting firm.

Instead, Jindel said he expects UPS to increase its penetration of small to midsize business accounts which generally provide a higher yield, make offers that make it attractive for small shippers to drop off packages at UPS locations and don’t require a pickup, and faster rollout of productivity-enhancing technology initiatives. Jindel also would like to see UPS build more density for residential deliveries by promoting one-day-a-week deliveries for multiple items rather than five items ordered on different days of the week to be delivered on five different days.

Given UPS’s history of offsetting bottom-line contract hits, some see little trouble in the company being able to afford wage increases and remain profitable. Amit Mehrotra, analyst at Deutsche Bank, said in a mid-May note that “we see little risk that prospective wage inflation will “derail the profitable growth story” at UPS, and that the company’s shares should outperform strongly if and when a work stoppage is averted, which Mehrotra expected will be the case.


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