Why United Parcel Service and FedEx Corporation Are Hiking Prices

Prices are going up. Around the time of the company's first-quarter 2017 results in late September,FedEx Corporation (NYSE: FDX) followed rival United Parcel Service, Inc (NYSE: UPS) in hiking selected shipping rates by 4.9% -- a rate far in excess of inflation. What's going on? What does it mean for investors in both stocks? And what can customers expect from pricing in the future?

UPS and FedEx are taking action to encourage e-commerce customers to package efficiently and maximize yield from bulky packages. Image source: UPS.

Why prices are going up

The pricing increases will grab the headlines, but in reality they are part of a series of actions both companies have been taking to maximize profitability. In short, FedEx and UPS need to take these measures because they are seeing margin pressure as a result of burgeoning e-commerce delivery growth. That pressure shows up in different ways.

  • The need to expand capacity to deal with increased costs brings about higher operational costs -- at least initially eating into gross profitmargins.
  • E-commerce demand during peak season is putting pressure on both companies to have the right capacity in place at the right time -- UPS in particular has had issues with this subject.
  • E-commerce vendors are packaging inefficiently and increasingly shipping large, difficult-to-deliver items, such as trampolines or gym equipment.

This gross margin pressure has beendiscussed has been noted previously here on Fool.com. A quick look at operating margin at both companies -- in the reported segments with strongest exposure to e-commerce -- graphically shows the pressures.

Data source: Company presentations. Year-over-year growth. BP = basis points, where 100 BP = 1%. UPS figures use adjusted operating income. FedEx's quarters are adjusted to fit UPS' quarters.

Both companiesneed to respond to these pressures.

What FedEx and UPS are doing

Theyhave implemented the following:

  • In 2015, both companies expanded the usage of dimensional-weight pricing, whereby packages are priced by dimensions as well as weight, therefore encouraging more efficient packaging.
  • On June 1,2016, FedEx adjusted the package length at which an additional handling surcharge would be applied -- it's now 48 inches, from 60 inches previously for FedEx ground.
  • UPS announced the same change to its additional handling surcharge for all air, international, and UPS SurePost packages. UPS also increased surcharges for oversized packages and selected residential deliveries.
  • FedEx express rates will rise 3.9%, with ground and freight rates rising 4.9% -- all effective on Jan. 2,2017.
  • UPS ground, air, and international service rates will increase 4.9%, effectiveDec. 26, 2016.

What it all means

Add all these measures together, and it's clear that both companies are trying to influence customer behavior with packaging and to maximize profitability rather than simply chase volume. The latter is a key point because much of the narrative around Amazon.com's(NASDAQ: AMZN) expanding its delivery network centers on the potential for it to eat the lunch of UPS and FedEx.

However, if both companies are happy to raise prices, then it implies they are willing to sacrifice volume on the altar of profitmargins. It's not the action of two companies who fear the competitive onslaught from Amazon, and it calls into question the seemingly never-ending speculation over Amazon's threat.

A quick look at revenue per piece (also called yield) growthcompared to volume growth in each company's ground operationsshows how both companies have seen stronger growth in volumes (largely due to e-commerce)but falling growth rates in yield.

First, FedEx:

Data source: FedEx.

And now UPS:

Data source:UPS.

Clearly, hiking prices will help both companies increase yield rate growth in the future. In short, both companies are trying to maximize profitability rather than just chase volume growth and fight off Amazon.

Looking ahead

For consumers, it's obviously not good news to see higher rates. However, for investors, it's good news. The evidence is that UPS and FedEx have struggled to deal with managing profitabilityin the face of strong e-commerce delivery growth. The measures taken are in response to the pressures that both these huge companies are feeling on their profitmargins. Given the strength of e-commerce delivery demand, seems likely that these costs will be more than accepted by the consumer - which is fantastic news for investors.

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Lee Samaha has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com and FedEx. The Motley Fool recommends United Parcel Service. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.