Federal Express Corporation
Federal Express Corporation
Sale: $7.69 billion
Stock Exchanges: New York Toronto Boston Midwest Pacific
Federal Express Corporation specializes in overnight delivery of high-priority packages, documents, and heavy freight. The company created the overnight air-express industry virtually singlehandedly in the 1970s, although it now faces increasing competition. Federal’s mastery of logistics enables it to act as a moving warehouse for many corporate customers and to track packages during the shipping process. It operates in 147 countries, and serves all of the United States.
Federal Express was founded in Memphis, Tennessee, by 28-year-old Frederick W. Smith in 1971. Smith originally outlined his idea for an overnight delivery service in a term paper he wrote for a Yale University economics class. Smith felt that air freight had different needs than air passenger service and that a company that specialized in air freight, rather than making it an add-on to passenger service, would find an unfilled niche. He thought speed was more important than cost and that it was essential for a company to reach smaller cities. His strategy was to ship all packages through a single hub, and to own his own aircraft. Aircraft ownership freed Federal from commercial-airline schedules and shipping regulations. The single hub allowed the tight control that got packages to their destinations overnight. He chose Memphis as his hub because of its central location and its modern airport that bad weather rarely closed.
Smith used a $4 million inheritance from his father, and raised $91 million in venture capital to get his idea off the ground. In 1973 Federal Express began service in 25 cities with a fleet of 14 Dassault Falcon—relatively small—aircraft and 389 employees. The planes collected packages from airports every night, and brought them to Memphis where they were immediately sorted. They were then flown to another airport and delivered to their destination by Federal Express trucks by the next morning.
Smith’s idea was costly because it required creating an entire system before the company’s first day of business. Federal Express began advertising and direct-mail campaigns in 1975, which were also expensive. The company lost $29 million in its first 26 months of operation. It had $43.5 million in sales in 1975 but lost $11.5 million. Smith’s investors considered removing him from control of the company, but company president Arthur Bass backed Smith. Bass improved delivery schedules and Federal’s volume climbed, making it profitable. By late 1976 Federal was carrying an average of 19,000 packages a night, and at the end of the year the company was $3.6 million in the black.
In 1977 company profits hit $8 million on sales of $110 million. The company had 31,000 regular customers, including IBM and the U.S. Air Force, which used it to ship spare parts. It also shipped blood, organs for transplant, drugs, and other items needing swift transport. Federal serviced 75 airports and 130 cities. The major airlines gave Federal stiff competition on heavily traveled passenger routes, but there was virtually no competition on routes between smaller cities. Its principal competitor, Emery Air Freight, used commercial airlines to ship its packages, giving Federal an important time advantage.
Deregulation of the airline industry in 1977 gave the still-struggling company an important boost. At the time of Federal’s startup, the U.S. airline industry was tightly regulated by the government. Federal Express had only managed to get into business through an exemption that allowed any company to enter the common carrier business if its payloads were under 7,500 pounds. The regulations, written in 1938 to protect passenger airlines, were holding back Federal’s growth. The company was forced to fly up to eight small Falcon jets side-by-side to bigger markets, when it could have used one larger jet and saved money. Smith led a legislative fight to end regulation, and a bill doing so was passed in 1977. Deregulation meant the company could fly anywhere in the United States anytime, and use larger aircraft like 727s, and later, DC-10s. Federal bought a fleet of used 727-100Cs. The Falcons were used to expand into small- and medium-sized markets.
In 1978 with its prospects looking solid, Federal went public, selling its first shares on the New York Stock Exchange. The move raised needed capital and gave the company’s backers a chance to make some of their investment back. Profits for 1979 were $21.4 million on sales of $258.5 million. By late 1980 Federal was well established and growing at about 40% a year. It had 6,700 employees and flew 65,000 packages a night to 89 cities. Its fleet included thirty-two Falcons, fifteen 727s, and five 737s. Explosive growth continued as a tidal wave of businesses switched to overnight service. Miniaturization of consumer electronics and scientific instruments meant ever-more small, valuable packages needing express shipment. Many U.S. companies were shifting to just-in-time inventories to keep prices down, lessen quality-control problems, and save money. As a result, companies more often needed emergency shipment of goods and parts, and Federal began billing itself as a “500-mile-an-hour warehouse.”
A decline in the reliability of the U.S. Postal Service caused many companies to switch to Federal Express for important packages. Courier-Paks were the fastest growing part of Federal’s business and accounted for about 40% of revenue. Courier-Paks, which are envelopes, boxes, or tubes used for important documents, photographs, blueprints, and other items cost $17 in 1980 for guaranteed overnight delivery. By mid-1980 the company had eight $24 million DC-10s on order or option from Continental Airlines, each capable of carrying 100,000 pounds of small packages. It had bought 23 more used 727s, and operated 2,000 delivery vans.
In mid-1981 Federal announced a new product that brought it into direct competition with the U.S. Postal Service for the first time: the overnight letter. The document-size cardboard envelope, containing up to two ounces, would be delivered overnight for $9.50 at that time.
By 1981 Federal Express had the largest sales of any U.S. air freight company, unseating competitors like Emery Air Freight, Airborne Freight, and Purolator Courier that had gone into business about 20 years before it. Federal’s competitors had shipped any size of package using regularly scheduled airlines, and had not stressed speed. Federal’s narrowly focused, speed-oriented service had won many of their customers. To compete Emery copied Federal’s strategy, buying its own planes, opening a small-package sorting center, and pushing overnight delivery. Airborne Freight also pushed into the small-package air express business. United Parcel Service of America (UPS), the leading package-shipper by truck, moved into the air-express business in 1981. The U.S. Postal Service began heavily marketing its own overnight-mail service when Federal’s Courier-Pak began eating into its revenues. The Postal Service’s overnight mail was about half the price of Federal’s but not as accessible in many locations. While Federal was the leader in the U.S. overnight package-delivery industry, DHL Worldwide Courier Express Network built a similar service overseas. DHL became a major competitor when Federal started building its own overseas network.
The increased competition put pressure on Federal’s niche, but its lead was large and its reputation excellent. In 1983 the company reached $1 billion in annual revenues—the first company in the United States to do so within ten years of its startup without mergers or acquisitions. In 1984 Federal made its first acquisition, Gelco Express, a Minneapolis, Minesota, package courier that served 84 countries. Federal, hoping to recreate its U.S. market dominance overseas, made further acquisitions in Britain, the Netherlands, and the United Arab Emirates. UPS also began building an overseas system.
By the late 1970s Smith realized that up to 15% of Courier-Pak business was information that eventually might be digitally transmitted as telephone and computer technology improved. He began developing an electronic-mail system, spending $100 million. In 1984 Federal launched ZapMail, a system for sending letters by fax machine and couriers. Federal promised ZapMail delivery within two hours. ZapMail had technology problems from its beginning. Fax machines broke down frequently, light-toned originals would not transmit, and minor telephone-line disturbances interrupted transmissions. High-volume customers discovered it was less expensive to install their own fax machines. ZapMail cost $35 for documents up to five pages, plus $1.00 for each additional page. It also faced competition from the electronic-mail system of MCI Communications. ZapMail was still losing money in 1986 when Federal abandoned the system, taking a $340 million charge against earnings. The 1,300 employees working on the ZapMail system were absorbed into the rest of the company.
In 1985 Federal took a major step in its attempt to expand its services to Europe, opening a European hub at the Brussels airport. Revenue reached $2 billion in 1985. In 1986 Federal opened sorting centers in Oakland, California, and in Newark, New Jersey, to more quickly handle shipments with nearby destinations. Federal’s hubs were becoming warehouses for its clients, storing parts until customers needed them, then shipping the parts overnight. IBM used Federal to store mainframe parts and get them quickly to malfunctioning computer systems. This trend coincided with a drop-off of Federal’s overnight mail volume, which was hurt by the spread of fax machines and the lower rates charged by competitors. Revenue for 1987 was $3.2 billion, while rival UPS collected about $1.7 billion from overnight delivery.
By 1988 Federal provided service to about 90 countries, claimed to ship about 50% of U.S. overnight packages, and had 54,000 employees. Increasing competition, however, led to a price war that lowered company profits from 16.9% of revenue in 1981 to 11% in 1987. Profits in 1988 were $188 million on revenue of $3.9 billion.
Expanding overseas proved tougher than Federal had anticipated, and the company’s international business lost $74 million between 1985 and 1989. In February 1989, hoping to build a global delivery system instantly, Federal bought Tiger International, Inc., particularly for its heavy-cargo airline, Flying Tiger Line, for $883 million. Before the acquisition, Federal had landing rights in five airports outside the United States: Montreal, Toronto, Brussels, London, and limited rights in Tokyo. Federal wanted the delivery routes Tiger had built over its 40-year history. They included landing rights in Paris and Frankfurt, three Japanese airports, and cities through east Asia and South America. Federal could use its own planes on these routes, not subcontract to other carriers, which the company had been doing in many countries. Tiger’s large fleet of long-range aircraft also gave Federal an important foothold in the heavy-freight business. In 1988 Tiger had twenty-two 747s, eleven 727s, and six DC-8s; 6,500 employees, and revenue of $1.4 billion. Many of Tiger’s planes needed quick repairs to meet U.S. government safety deadlines, however, leading to lower profits.
The purchase also increased Federal’s debt by nearly 250% to $2.1 billion, and put the company into a market that was more capital-intensive and cyclical than the small-package market. Owning Tiger put Federal into an awkward position-many of Tiger’s best customers were Federal’s competitors, and Federal feared it might lose many of them. The fears proved unfounded, although Tiger’s on-time record temporarily fell to 80% after the takeover, climbing to 96% by early 1990.
At the same time price wars continued with competitors, some of which made inroads into the overnight market. Earnings from UPS’s overnight service rose 63% between 1984 and 1988, and its revenues tripled. Federal had a 55% share of the U.S. overnight letter market and shipped 33% of U.S. overnight packages. It was clearly the leader in the express-delivery business, but its growth was slowing. Federal’s U.S. shipment volume grew 58% in 1984; 25% in 1988. The company compensated by pushing its higher-margin package service, which grew 53% from 1987 to 1989. Analysts estimated that packages provided 80% of Federal’s revenues and about 90% of its profits.
In April 1990 Federal raised its domestic prices, ending the seven-year price war. The U.S. air-freight industry was consolidating, and rival UPS had heavy capital expenses from its own overnight air service, giving Federal room to raise its prices. The company needed the extra profits, estimated at between $50 million and $75 million a year, to help pay for losses in its international business. Federal’s foreign operations lost $194 million in 1989 as it struggled to integrate Tiger and build a delivery system in Europe. Tiger was unionized but unstructured; Federal was non-union but bureaucratic. Several uneasy months passed while the two systems were unified and a pilot-seniority list was drawn up. Many industry analysts said that Federal had paid too much for Tiger. To help increase overseas tonnage, Federal began a one-, two-, and three-day service to large shippers between 25 cities worldwide and 85 cities in the United States.
Federal entered the 1990s with increasing competition in the U.S. market, but was maintaining its leading market share. UPS slowly was winning some of its customers by introducing volume discounts, which it had resisted for years. Federal’s foreign operations were troubled, and their losses dragged down Federal’s earnings. Federal’s sales rose from $5.2 billion in 1989 to $7.69 billion in fiscal 1991, but its operating income fell from $424 million in 1989 to $279 million in 1991. Industry analysts were divided over whether or how soon Federal would be able to make its foreign operations profitable. Smith argued that when Federal’s international volume increased, international service would become profitable. Some analysts, however, questioned how long Federal could accept international losses with $2.15 billion in long-term debt.
Federal Express Aviation Services; Federal Express International; Flying Tiger Line Inc.; Tiger Inter Modal Inc.; Tiger Trucking Subsidiary Inc.; Warren Transport Inc.
Flaherty, Robert J., “Breathing Under Water,” Forbes March 1, 1977; “Transportation,” Business Week, March 31, 1980; “Federal Express Background,” Federal Express corporate typescript, ; Foust, Dean, et al, “Mr. Smith Goes Global: He’s Putting Federal Express’ Future on The Line To Expand Overseas,” Business Week, February 13, 1989.
—Scott M. Lewis