USPS parcel growth slows as Amazon self-delivers more

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The report of the President’s Task Force on the Postal Service is overdue.  It was supposed to come out on August 10th, but for some reason the administration has delayed making it public, and there’s no word yet on when it will be released.

In the meantime, Amazon and other stakeholders in the Package Coalition aren’t waiting around to see what the Task Force has to say. They have already begun lobbying Congress to prevent a rate hike on parcels and to counter any move toward privatizing the nation’s postal system.

The Postal Service raises prices on shipping services every year.  Over the past ten years, rates on Priority Mail — which includes the popular Flat Rate Boxes — have gone up an average of 4.2 percent annually (as seen in this table shared with the PRC).  For Parcel Select — the low-cost, workshared Ground product that’s used for last-mile delivery by Amazon, FedEx (SmartPost), and UPS (SurePost) — rates have gone up an average of 6 percent a year.

The concern now is that a much bigger hike could be in the offing.  Thanks to a Citigroup report and Trump’s tweets, there’s now a widespread — and totally mistaken — belief that the Postal Service is undercharging Amazon by $1.50 per package.  Parcel Select currently averages about $2.15 per piece. A $1.50 increase would represent a 70 percent rate hike.

The undercharge argument has been fueled by UPS, which for years has been making the case with the Postal Regulatory Commission and federal courts that the Postal Service is competing unfairly by using market-dominant products (letters and flats) to subsidize competitive products (mostly parcels), which allows the Postal Service to charge below market rates on packages.  The claim has gotten little traction with the PRC and courts, but UPS has been persistent, and it may be about to take one of its appeals to the Supreme Court.

Whatever the Task Force recommends, there is one major constraint on just how much the Postal Service can charge to deliver parcels.  It’s called the marketplace.

According to the rate system set up in 2006 by the Postal Accountability and Enhancement Act, price increases on market-dominant products are limited by the consumer price index, while increases on competitive products are constrained by the marketplace.  And when it comes to parcels, the marketplace provides plenty of competition — not just UPS and FedEx, but also regional shipping companies, local couriers, and retailers themselves.

In a recent conference call with journalists about the Postal Service’s third quarter financial report, Postmaster General Megan Brennan focused on just this issue: “We operate in a highly competitive delivery marketplace,” said Brennan.  “We’ve got established players and a variety of startups, so we compete for business every day.”

Joe Corbett, the Postal Service’s chief financial officer, pointed out that new entrants to the package business could make it difficult for the agency to see the same rate of growth it’s been enjoying.

“We expect growth to continue,” said Corbett, “but we think that the years of double-digit growth are going to be difficult to get back to, given the level of competition.”  

 

The growth of Parcel Select

For the past few years, competitive products have seen significant increases in volumes and revenues.  From 2012 to 2017, revenues increased by 82 percent, with average annual growth rates of 14 percent. Total volumes doubled, from 2.5 billion pieces to 5 billion, with average growth of 22 percent.

For the first three quarters of FY 2018, competitive revenues are up about 12.5 percent — somewhat less than during the previous five years — and volumes are up 10.8 percent — well below the average rate of the previous five years.

The evidence for a slowdown in growth becomes more apparent when one focuses on Parcel Select.

Here’s a table showing volumes for Parcel Select, volumes for all other shipping services (Express, Priority, International, etc.), and volumes for competitive products as a whole.  (A more detailed table is here, and links to the Revenue, Piece & Weight (RPW) reports from which the numbers come are here; a table with revenues is here.)

Since 2014, the non-Parcel Select products have been growing at single-digit rates, while Parcel Select volumes have grown an average of about 21 percent a year.  The double-digit growth of competitive products overall is due almost entirely to the dramatic success of Parcel Select.

Here’s a chart based on that table.  It illustrates how the growth of competitive product volumes is due mostly to Parcel Select.  (Hover over bars for exact numbers.)

Chart by Visualizer

The rapid growth of Parcel Select may be coming to an end, however, as one can infer from the quarterly RPW reports.  Here’s a chart showing the percentage change in Parcel Select volumes, quarter to quarter, with each quarter compared to the same quarter the previous year.  (Hover over graph line for exact numbers.)

Chart by Visualizer

 

The Postal Service’s Negotiated Service Agreements with Amazon, FedEx, and UPS got started in 2012 and 2013, and for a while there, Parcel Select was experiencing triple-digit growth, which explains the big spike in the graph.

Now here’s another graph based on the same data, but focusing on 2014 to 2018.

Chart by Visualizer

 

During 2015 and 2016, the growth rate of Parcel Select was about 26 percent.  Then it slowed to about 18 percent in FY 2017.  For the first three quarters of FY 2018, Parcel Select volumes are up 7.7 percent over the same period in 2017.  The first quarter of 2018 was up 9.7 percent over the same quarter last year; the second quarter was up 5.3 percent, and the third quarter, 7.8 percent.  Overall, the trend line is clearly downward.

It looks like FY 2018 will end with Parcel Select volumes increasing by about 7 or 8 percent — less than half the growth rate of the previous year, and about a third of the growth rate of FY 2015 and 2016.   It appears that the future growth of Parcel Select may be similar to the growth rates of UPS and FedEx Ground, which over the past five years have been averaging 4 and 6 percent, respectively.

Since Parcel Select now accounts for more than half of competitive volumes, as its growth slows, so will the growth of competitive products as a whole.

That’s why USPS CFO Corbett said that the “the years of double-digit growth are going to be difficult to get back to, given the level of competition.”

 

Delivery options

Amazon is the Postal Service’s biggest customer, and it probably accounts for about 40 percent of Parcel Select volumes, maybe more.  The Postal Service delivers about 45 percent of Amazon’s domestic shipments, or perhaps as much as 60 percent.

When it comes to last-mile delivery, though, Amazon has many other options.  In addition to the Postal Service, Amazon can use UPS and FedEx, which have been delivering about 35 or 40 percent of Amazon’s domestic shipments.

Amazon can also do deliveries itself, using its own employees.  It can hire Uber-like independent contractors through its Flex program.  It can establish partnerships with regional carriers, many of which, like LaserShip, OnTrac, and Scoobeez, also use independent contractors.  Now Amazon is setting up franchise operations through its new Delivery Service Partner program, in which entrepreneurs can create instant start-up delivery companies, perhaps also using contract workers.

In many respects, these independent contractors resemble Amazon employees, and at least three of the carriers have ended up in court with workers claiming that they should be getting all the benefits of regular employees.  As described in court documents, these independent contractors sometimes get special training from Amazon, deliver exclusively for Amazon, and work directly out of Amazon warehouses.

The independent contractor system keeps labor costs way down.  Workers earn about $15 to $20 an hour, maybe more on a good day, maybe less after expenses like vehicle costs.  (According to the attorney representing contract workers in the Scoobeez case, couriers were sometimes earning just $7 an hour after expenses.)  Plus, with contract workers, there’s no cost for overtime, holiday pay, healthcare, and retirement plans.

These self-delivery options obviously save on Amazon’s shipping costs.  When it delivers itself or through one of its regional partners, Amazon’s costs are probably competitive with Parcel Select. They also give Amazon leverage when it negotiates contracts with the Postal Service, UPS, and FedEx.

In the short term, a USPS rate hike on parcels would mean a larger profit margin per piece.  The cost coverage in 2017 on Ground (basically Parcel Select) was 176 percent, meaning the revenue covered 100 percent of the expenses incurred for delivery (attributable costs), with 76 percent going toward institutional  costs (i.e., costs shared in common by all products).  That’s better than for other competitive products and about the same as market-dominant products overall.

The Postal Service might like an even better markup, but a price increase would also drive postal business to FedEx and UPS — which is why UPS has been pushing for changes in how the Postal Service allocates costs.  More profit per piece, but fewer pieces: it’s hard to predict how things would come out for the Postal Service’s bottom line.

The long-term impact of raising prices, however, could be much more significant. Amazon would be more motivated to pick up the pace on developing its own self-delivery network, and the Postal Service would lose business not just to UPS and FedEx but also to Amazon and its partners.

There are signs that this is already happening.  Not only is the growth rate of the Postal Service’s package business slowing down, but the growth of Amazon’s self-delivery capacity appears to be quickening.

 

Who’s delivering all those packages?

According to Amazon’s 8-K financial report for the second quarter of 2018 (which ended June 30), for the first six months of the fiscal year, revenues were $104 billion, compared to $74 billion for the same period last year, an increase of 40 percent.  That’s comparable to increases of the past few years, so there appears to be no letup in Amazon’s growth.

Amazon’s end-to-end shipping costs include expenses for sortation, transportation, and outbound delivery by the Postal Service and private carriers.  These costs have been going up at about 34 percent a year.  Here’s a chart showing this growth.  (To see the chart with all the numbers, visit it on Statista.com.)

Amazon’s shipping costs 2011-2017. Source: Statista.com

Amazon does not report volume numbers, so turning these costs into volumes and prices requires some guesswork, but Deutsche Bank has developed a useful hypothetical scenario, and we’ve done our own analysis as well.  (For details, see this previous post and this follow-up post about the Deutsche Post analysis.)

Amazon’s total shipping costs in FY 2017 were $21.7 billion worldwide.  Using a rough average for end-to-end shipping costs per package of $5 (Deutsche Bank’s estimate) to $6 (our estimate), $21.7 billion in costs translates to around 3.6 to 4.3 billion packages.  Based on the proportion of domestic to international revenues Amazon reports in the 10-Ks, one can figure that about two-thirds of the volume are domestic — 2.4 to 2.9 billion packages in FY 2017.

At the current growth rate (about 34 percent so far in FY 2018), Amazon’s shipping costs could increase from $21.7 billion in 2017 to nearly $29 billion in 2018, an increase of about $7.3 billion in costs worldwide and nearly $5 billion domestically.

At an average of $5 to $6 per package, this increase in costs represents 800 million to one billion more domestic packages in FY 2018 than in 2017.

Who’s delivering all those additional packages?  Obviously, the Postal Service, UPS, and FedEx are delivering a lot of them, but Amazon and its regional shipping partners may be delivering even more.

 

Self-delivery picks up

If, as suggested by the first three quarters, Parcel Select volumes end up increasing about 8 percent in FY 2018, it would mean an increase from about 2.8 billion pieces in FY 2017 to 3.02 billion in FY 2018 — about 220 million more pieces.

According to its 10-K report, in FY 2018 (its fiscal year has ended), FedEx delivered 2.1 billion Ground packages, an increase of about 5.6 percent over 2017 — about 110 million more packages.  UPS Ground handled about 3.5 billion packages in 2017, and it looks as though volumes will go up by 4 percent, as they did last year — an increase of 125 million packages.

(Just an aside: The President just asked the SEC to consider ending required quarterly reports, which would make an analysis like this difficult.)

Ground volumes for both UPS and FedEx will thus increase about 235 million pieces in 2018.  Add that to the Parcel Select increase, and we’re looking at about 450 million additional Ground parcels.

About half, maybe even 60 percent, of USPS Ground volumes are Amazon packages, and maybe 20 percent of the Ground volumes of UPS and FedEx are Amazon’s.  It’s possible that a larger proportion of these 450 million packages are Amazon’s.  In fact, for the sake of this analysis, let’s say that almost all of them are Amazon’s.

If Amazon is shipping 800 million or even a billion more domestic parcels than last year, and 400 million are being delivered by the Postal Service, UPS, and FedEx, it would leave 400 to 600 million more pieces being self-delivered by Amazon and its regional partners.

And that’s on top of what Amazon may have self-delivered in 2017.  Our analysis estimated 400 million packages. Amazon and its partners may thus be delivering as many as a billion packages in 2018.

Amazon’s total domestic shipping costs in FY 2018 will probably be something like $20 billion (about two-thirds of worldwide costs of $29 billion).  At $5 to $6 per piece for end-to-end shipping costs, that represents about 3.3 to 4 billion domestic shipments.  Amazon and its partners could be delivering at least one-fourth of them.

That’s a lot more than other recent estimates for 2016 and 2017, which range from 10 percent to 17 percent.

In 2013, Amazon and its regional partners probably delivered something on the order of 100 million packages.  Now Amazon and its partners may be delivering ten times that many.

Amazon is a long way from being able to deliver all of its packages — if that’s even one of its ambitions — but it’s making progress.

 

A trip down the Congo

The Postal Service is well aware of the threat posed by Amazon’s growing capacity to deliver its own parcels.

In June 2017, the USPS Office of Inspector General published a report entitled “Play to Win: Competition in Last-Mile Parcel Delivery.”

As the OIG explains, because of the changing nature of e-commerce and customer expectations about rapid delivery, in recent years “new, smaller, flexible, and technologically-advanced parcel delivery firms began to enter the market to take advantage of the new growth.”  In addition, a few large retailers have used their purchasing power to keep delivery prices low, and recently, “despite low delivery prices, these large retailers have begun to venture into self-delivery.”

The OIG asked John Panzar, a world-renowned expert on postal economics, to provide a theoretical model of this modern parcel market.  Panzer’s analysis is not entirely “theoretical,” however.  The main large retailer in his model is called “Congo,” and the rival shippers of “the post” are called the “Federal Parcel Service” (“FPS”) and “United Express” (“UX”).

Panzar’s analysis “shows that large parcel delivery companies are threatened by more than competition amongst each other — their real battle is over package volumes under the threat of self-delivery by large retailers.”

Panzer comes to this conclusion: “In this more evolved parcel market, the post needs to seek out a price that exceeds unit cost and is not only lower than the competitors’ prices but also low enough to discourage the retailer from self-delivery.”

In other words, the Postal Service has to price Parcel Select in such a way that it not only covers attributable costs (as required by law) and beats out UPS and FedEx, but that also discourages Amazon and other big retailers from further expansion into self-delivery.

The original cover of the OIG report, “Play to Win”

The Panzar study has gotten a thorough going-over by another heavyweight in postal economics, J. Gregory Sidak, in an article entitled “Why Should the Postal Service Deter Amazon’s Competitive Entry into Last-Mile Parcel Delivery?” (Criterion Journal on Innovation, 2017).

Sidak, it may be noted, has submitted testimony to the PRC on behalf of UPS, while Panzar has submitted testimony on behalf of Amazon.

Sidak criticizes nearly every aspect of Panzar’s analysis, starting with the fact that the original cover of the OIG report showed delivery trucks with Panzar’s “ersatz” company names as well as altered logos, whereas the cover in the final report shows a “sanitized” version with the trucks in all white without logos.

Sidak’s main argument is that the Postal Service is illegally using its monopoly powers to expand its parcel business and wrongfully adopting a pricing strategy that is partly designed to deter Amazon from doing more last-mile delivery on its own.

If deterring Amazon is one of the Postal Service’s goal, it doesn’t seem to be working.  As this analysis has shown, Amazon appears to be reducing its dependence on Parcel Select and increasing its efforts to self-deliver more.

In any case, the articles by Panzar and Sidak are definitely interesting reading, and they show that the legal, logistic, and economic issues involved with postal pricing are extremely complex.  It will be interesting to see if the report by the President’s Task Force on the Postal Service displays any understanding of these complexities.

(Photo: Amazon van)