The Issue: DHL Turns to Rival UPS

DHL Express entered the U.S. aiming to shake up the UPS-FedEx duopoly. After losing billions, it hatched a new plan: hold hands with UPS

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Shortly after DHL Express was purchased in 2002 by privatized German postal service Deutsche Post World Net (DPWGN.F), the yellow-clad global delivery service launched an ambitious assault on United Parcel Service (UPS) and Federal Express (now officially FedEx) (FDX), the two mainstays of the U.S. express-delivery market. DHL acquired Seattle-based Airborne, the third-largest player, for a little more than $1 billion in 2003. And DHL made explicit appeals to customers of the more established competitors with marketing slogans such as "Yellow. It's the new Brown": a challenge to UPS' highly recognizable brown trucks.

DHL has made impressive strides in the past six years. It raised awareness of its brand. It built an impressive air and ground network covering the U.S. And it made a significant impact on the market's dynamics. "We've created a third choice which was not there before, a real threat to the competition," says John Mullen, chief executive of DHL's global business.

Perhaps more important for DHL—a global giant with a presence in some 225 countries—the expansion represented a bigger footprint in the U.S.—the largest market in the industry by far.

DHL's "Financial Pain"

But going head-to-head with the go-everywhere, do-everything models of UPS and FedEx proved costly. "They are so strong we have to maintain almost a similar scale of network to them, but with only 6% or 7% market share," admits Mullen. "Hence the reason for financial pain." DHL's U.S. business lost $3 billion over the past four years, according to a Dow Jones report, while market share never surpassed 10%.

Much of the losses stem from DHL's low load rate, or inability to fill planes to capacity. "The problem has been that DHL wasn't flying full. If the plane isn't full you can't just say 'I'm sorry those packages are going to be delayed for a day or two until we fill up the plane,'" says Doug Caldwell, executive vice-president of ParcelPool.com, an Orem (Utah) logistics provider. "I've heard some numbers that suggest that they were well under 70% of capacity." By contrast, UPS and FedEx will typically fill planes to around 80% to 85% of capacity. For every light load DHL flew, it lost money in labor and fuel costs.

The skyrocketing cost of fuel itself has become an impediment to DHL's growth in the U.S. in two ways. "It's keeping market growth down because as the fuel surcharges climb to these exorbitant rates, customers are looking to go from air service to ground service. And it increases air costs at the same time," says Caldwell.

The Struggle To Be Global

Deutsche Post shareholders grew impatient. Personnel changes did little to appease: Four different leaders have been hired for DHL's top U.S. post in the past four years (including Mullen, who was promoted to lead DHL's global operations in 2006).

In recent years, the company began to mull a more drastic shift in strategy. The most obvious option was to sell the unit completely. "The easiest decision would have been just pack up and go home," says CEO Mullen. "The markets would have applauded us, because they [would have seen] the loss eradicated straight away."

But that move, management decided, would deliver a severe blow to the company's attempts to bill itself as a global player. Explains Mullen, "We're a global network. Every country in the network trades with every other country every day. And the U.S. is the largest, most important market in the world. If we say to our U.S. customers that we want your volume in Asia, but we can't help you in your home country, are we going to get the volumes in Asia? We think probably not."

A Big Win for Brown

In May, Deutsche Post announced a compromise solution, which would allow it to both retain its presence in the U.S. and slash costs. The company said it had begun talks to outsource all of DHL's airlift operations in the U.S. to a new partner. DHL plans to deliver, pick up, and track all cargo to and from the aircraft as usual. "The customer doesn't actually see a difference at all," says Mullen. That is, unless they pay attention to the color of the partner's planes: UPS brown.

DHL plans to pay UPS $1 billion annually to deliver its air freight, which DHL expects will help it to reduce annual losses from an expected $1.3 billion this year to $300 million by 2011—and put it back on the road to profitability in the U.S. As part of the restructuring, it will cut about 17% of its ground delivery routes and implement a new management structure that holds one person accountable for both sales and operations in each of four regions in the U.S.

For UPS, it's a huge win. "UPS had a very sophisticated network in the U.S. with [excess] capacity. And [with this deal] they better utilize that capacity," says Mullen.

Winner, Losers, and Questions

For Wilmington (Ohio) ABX Air (ATSG)—the company DHL spun off from Airborne to operate a majority of its yellow-painted aircraft—the deal will likely mean the loss of more than 6,000 jobs.

But while clear winners and losers have emerged, other aspects of the deal are more opaque. Will the substantial cost-cutting help DHL become a more competitive force in the tough U.S. market? What pressure will a DHL-UPS partnership put on prices across the market? And how will the alliance play out in international markets such as Europe and Asia, where DHL has more of the upper hand in the rivalry?

For the insight of experts and those close to the deal, read "The Analysis: DHL Saves Face."

MacMillan is a staff writer for BusinessWeek.com in New York.