Companies & Industries

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

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."

Partnering with a competitor may help DHL salvage its business reputation in the U.S.

Anytime a company joins hands with a rival, it's bound to raise concerns. And yet "co-opetition"—the sharing of resources amongst competitors—has a successful track record in dozens of industries, from shipping to financial services to telecommunications. DHL's proposal to outsource its air shipments to UPS (UPS) is likely to benefit both companies, and it may also set a precedent for similar partnerships in the express delivery market, according to industry analysts.

"I think it's a brilliant stroke for both DHL and UPS," says Doug Caldwell, executive vice-president of ParcelPool.com, an Orem (Utah) logistics provider. He believes the extra freight from DHL customers will help UPS fill its planes to near-capacity, building efficiency and ultimately lowering costs.

To be sure, it's not the first such move in the industry. In 2000, Federal Express (FDX) forged a long-term agreement to carry U.S. Postal Service packages through its air network. In return, FedEx placed drop-off boxes in some 38,000 retail postal outlets across the country. The deal currently being negotiated between DHL and UPS is similar, but it would be the first of its kind between two private players.

"With fuel prices unlikely to ever come back down materially and with ever-increasing costs of maintaining these networks, it makes sense that you will see competitive sharing arrangements around the world," says John Mullen, CEO of DHL's global business. "It makes sense anywhere where you can generate productivity and a better use of assets."

Going Greener

It could also be an environmentally beneficial move, according to Jim LeRose, principal of logistics consultancy Agile Network. "If you share capacity, you are reducing the amount of planes, cars, and trucks that go to the same places—so perhaps this is a twist on a [green initiative] as well," he says.

Many critics believe the deal is a win for DHL customers because of the strong reputation of UPS. "You're going to be moving from essentially a DHL air network to a UPS air network, and there's really nobody better operationally than UPS," says Caldwell. "They run on time, they sort on time—they're very efficient."

It's less clear what effect the arrangement will have on prices across the industry. "DHL was a downside pressure on the market," says Dan O'Rourke, editor of trade magazine Parcel. "It was another major carrier, so that kept some pressure on the other major private carriers. Obviously that pressure has dwindled quite a bit now."

The clearest beneficiaries of the deal are shareholders of Deutsche Post World Net, DHL's German parent, who have suffered billions of dollars in losses while DHL waited to make a major strategy shift in the U.S. "This stops the bleeding as far as their situation in the U.S.," says ParcelPool.com's Caldwell. "The question has been up until now whether DHL is even going to be able to maintain a presence in the U.S. market, much less expand it. If they perform the transition well, it's possible that they could increase their market share in the future."

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

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