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Big Brown's New Bag


For years, the bane of most Ford dealers was the auto maker's Rube Goldberg-like system for getting cars from factory to showroom. Cars could take as long as a month to arrive -- that is, when they weren't lost along the way. And Ford Motor Co. (F) was not always able to tell its dealers exactly what was coming, or even what was in inventory at the nearest rail yards. "We'd lose track of whole trainloads of cars," recalls Jerry Reynolds, owner of Prestige Ford in Garland, Tex. "It was crazy."

But three years ago, Ford handed its byzantine distribution network to an unlikely source for an overhaul: United Parcel Service Inc. (UPS). In a joint venture with the carmaker, UPS engineers, with input from Reynolds and other dealers, redesigned Ford's entire North American delivery network, streamlining everything from the route cars take from the factory to how they're processed at regional sorting hubs. Ultimately, UPS deployed a tracking system similar to the one it uses to monitor 13.8 million packages daily -- right down to slapping bar codes on the windshields of the 4 million cars rolling out of Ford's 19 North American plants each year and onto railcars.

The result: UPS has cut the time it takes autos to arrive at dealer lots by 40%, to 10 days on average. That saves Ford millions in working capital each year and makes it easy for its 6,500 dealers to track down the models most in demand. (General Motors Corp., by contrast, uses a proprietary online system for distribution; Chrysler Corp. (DCX) contracts with Union Pacific Corp.) "It was the most amazing transformation I had ever seen," marvels Reynolds. "My last comment to UPS was: 'Can you get us spare parts like this?' "

Welcome to the new UPS. Ever since its humble beginnings in 1907 as a Seattle messenger service, the real story about UPS is how this traditionally insular and conservative enterprise has managed to reinvent itself time and again to keep growing. No matter how fearful the next step might have seemed, UPS took it. Back when the telephone became a household staple, founder James E. Casey remade his messenger service into a home delivery business for retailers. When Americans began buying cars and driving their purchases home, UPS reinvented itself again, fighting scores of legal battles so that its fleet could compete with the U.S. Postal Service.

Those moves have helped make UPS into the colossus it is today. Last year, Big Brown earned $2.9 billion on $33.5 billion in revenues. And its stock, at about $74, has outperformed the market since the company went public in November, 1999. Since then, UPS shares have generated total shareholder returns of 21%, compared with a negative 12% return for the Standard & Poor's (MHP) 500-stock index.

FAST-FLOWING STREAM

TO KEEP UP THE momentum, UPS is undergoing its latest makeover. With its U.S. delivery business maturing, the company has been working feverishly to transform itself into a logistics expert. Last year, that end of the business accounted for $2.1 billion in revenues, or just 6% of the UPS total. But analysts believe logistics could provide a potentially huge new revenue stream -- up to 20% of future growth by some estimates. Simply put, UPS wants to leverage decades of experience managing its own global delivery network to serve as the traffic manager for Corporate America's sprawling distribution networks -- doing everything from scheduling the planes, trains, and ships on which goods move to owning and managing companies' distribution centers and warehouses. Just as important, says UPS, is that its strategy should also generate additional delivery business for its ubiquitous brown trucks and private air fleet. The pitch to customers: Let us manage the supply chain, while you focus on core marketing and product development. That way, says CEO Michael L. Eskew, 55, UPS can help companies "improve their cash flow, their customer service, and their productivity."

The shift in focus is not without risks for UPS. Contract logistics is historically a lower-margin business than package delivery. Analysts estimate that the company's operating margins in logistics are only 5% overall. Although large-scale consulting contracts can be quite profitable, bread-and-butter work like freight-forwarding, managing warehouses, or order fulfillment can earn as little as 2%. Margins on the company's core delivery business, on the other hand, hover around 15%. "The dilemma with logistics is that it offers high revenue growth, but if you aren't careful, minimal profit growth," warns Morgan Stanley (JPM) analyst James Valentine.

Some big rivals question whether UPS can generate enough additional delivery business to justify its foray into logistics. "The contract logistics business is fundamentally low margin," says FedEx Corp. (FDX) Chairman Frederick W. Smith. "And I'm not sure the fundamental premise -- that it will result in you getting more profitable small-shipment business -- is correct."

OUTRUNNING THE TRUCKS

BUT UPS MAINTAINS it is already seeing such a payoff. Indeed, some analysts estimate that in 2003 UPS used logistics to snag an extra $2 billion in shipping volume. UPS execs also maintain that because logistics is far less capital-intensive than the delivery business -- with its heavy investments in trucks, airplanes, technology, and real estate -- logistics has a high return on investment. And they contend that the margins will improve as the business grows.

For now, UPS is taking on more and more contracts where its brown trucks aren't involved -- or where they come into play only at the end of the journey. Consider its deal with Birkenstock Footprint Sandals Inc. UPS contracts with ocean carriers to get shoes made in Germany across the Atlantic to New Jersey ports, instead of routing them through the Panama Canal to the shoemaker's California warehouses. Each incoming shipment is whisked away to a UPS distribution hub and, within hours, to retailers (table, page 54). By handing over its keys to UPS, Birkenstock has cut the time it takes to get shoes to stores by half, to just three weeks. "Our spring fashion merchandise shipped 100% on time -- and it was the first time in history I've been able to say that," says Birkenstock's chief operating officer, Gene Kunde.

ONLINE ORDERS

IN FACT, THERE SEEM to be few tasks UPS won't undertake to embed itself with customers. For Jockey International Inc., UPS not only manages a warehouse but also handles Internet order fulfillment. Apparel bought on the Jockey Web site is boxed for shipping by UPS warehouse staffers and delivered by UPS drivers. And if there's a problem, calls are handled by UPS phone reps. Big Brown also handles laptop repairs for Toshiba America (TOSBF), installs X-ray machines in Europe for Philips Medical Systems, and dresses Teddy bears for TeddyCrafters.

The UPS move is partly defensive. Today a growing breed of consultants uses sophisticated computer programs to help corporate clients negotiate aggressive shipping discounts. And shipping rivals such as Deutsche Post, with its DHL unit, are aggressively moving into logistics. In recent years, DHL and FedEx have nibbled away at the UPS domestic ground business -- since 1998, its market share has shrunk from 57.7% to 56.9%. "We had a legitimate fear of becoming a commodity and having other providers deal with our customers," says James P. Kelly, who retired as the CEO of UPS in 2001 but remains a director. "If we didn't do it, someone else was going to."

Logistics represents a personal crusade of sorts for Eskew. A UPS careerist, he began formulating such a move several years ago when he served as head of strategic planning. But it wasn't until a management retreat in early 2002, where senior executives were pondering whether the company needed to expand into manufacturing or some other field to sustain its long-term growth, that Eskew convinced them that logistics was the answer. But doing it well, cautioned Eskew, would force UPS to reinvent itself yet again. "We can play a significant role [in logistics], but we will have to change ourselves," he said.

Since the year 2000, UPS has spent more than $1 billion to buy 25 companies involved in freight-forwarding, customs clearance, finance, and other logistics services. Eskew pulled some rising UPS stars from its mainstay delivery operations and on to his new supply-chain team. And in a departure from the cautious UPS culture, Eskew pushed managers to take risks -- counseling that failure wasn't irreparable as long as you "fail quick and fail small."

To its credit, UPS has learned how to keep those small failures from getting bigger. According to former executives, a UPS deal to acquire San Francisco's Fritz Cos., a freight forwarder that contracts with various carriers to help companies move goods, didn't go smoothly. After Fritz's entrepreneurial staffers clashed with by-the-book UPS managers, many left. That led to the defection of key customers like giant Costco Wholesale Corp. (COST). But in time, UPS stabilized Fritz's operations, installed some of its own managers, and lured back clients: Costco began using UPS freight-forwarding again earlier this year.

Eskew can now turn his attention to convincing the rest of Corporate America that UPS isn't just about parcels anymore: It's the missing link that can make their supply chains stronger. And if that pitch also helps UPS lock up their shipping business, so much the better.

By Dean Foust in Atlanta


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