Airborne Teaching Note and

Summary Slides
MGT 525 Competitive Strategy
Florian Ederer

1
 Economics of Express Mail Industry
• Two major patterns
– Grim industry especially if small player serving large business
customers (perennial single-digit operating margin in E2,5,6)
• Low ROE (below S&P median 13%-14%) of FedEx and Airborne
• UPS ROE better, ground duopoly with USPS, UPS air operations would
lose money
• Even worse for smaller companies (e.g., Purolator, Emery)
– Fierce head-to-head competition between FedEx and UPS
• 70% market share
• Pushed out smaller competitors
• Economies of Scale
– Large fixed costs relative to marginal costs
• Hub facilities ($860m), air and truck fleet, IT costs ($3bn 1990-95)
• Per unit costs decline over time
– Shifting AC curves (higher FC, lower MC), FedEx now large

2
 FedEx vs UPS

• Initial positioning different

– UPS: Taylorist, ground, manual, domestic
– FedEx: empowerment, air, IT, international
– Historical convergence except for culture and UPS
ground, non-express operation
• FedEx later purchases RPS
• Consequences of competitive convergence
– Decreasing horizontal & vertical differentiation!
– High FC relative to MC leads to intense rivalry
– Even stronger incentives to invest given rivalry

3
 Airborne’s Position

• Analysis Roadmap
– Industry vs Airborne’s position
– Qualitative vs quantitative analysis of Airborne
– Interconnected set of choices of Airborne
– Activities influence recommendations
• Airborne has outperformed FedEx in 1997
– 20% cost advantage

4
 Porter’s Generic Strategies

Perception by Customer Low Cost Position

Industrywide Differentiation/Benefit Cost Leadership

Particular Segment Focus

• Don’t get stuck in the middle

5
Airborne vs FedEx

6
 Cost – Quality Frontier
• movements along the frontier can
be challenging
• multiple viable positions within an
industry
• informs pricing and product
FedEx decisions
Quality

Inefficient
firm
Airborne

1/Cost

7
 Airborne Customers
• Large volume vs business customers?
– But Airborne stopped serving catalog retailers
• Ideal Customer
– Steady volume
– Major metropolitan areas
– Large number of items per pickup/delivery
– Not requiring a lot of information
– A little more time-insensitive
• Niche has higher buyer power!
– Cost advantage for Airborne

8
 Airborne’s Activities
• Activity Table
– Columns: Airborne, Rivals, Airborne Rationale
– Rows: use of contractors, mix of truck and planes, plane
utilization, plane purchases
• How do these activities complement Airborne?
– Contractors: cheaper but less reliable
– Trucks: cheaper for short haul, important for distance
pricing
– Utilization: matches with steady customers
– Planes: Airborne lowers fixed costs instead of marginal costs
• Positive complementarities in cost reduction!
• What is Airborne’s cost curve relative to FedEx’s?

9
 Delivery
Exhibit 3: Estimated Cost Structure of Overnight Letter Delivery`
Airborne Express Cost Per
FEDEX Cost per unit
Item Unit
Pickup 10% savings for 65% handled by contractors
Labor 20% savings on labor for higher package density $1.09 $0.80
Fuel $0.07 $0.07
Maintenance and depreciation $0.21 $0.20
Subtotal $1.37 $1.07

Long-haul transport Airborne ships 15% more by truck, trucking 67% cheaper
Flight/trucking than air, Airborne has 85% aircraft utilization $2.44 $1.88
Hub labor Airborne has less automation so higher labor, lower $0.30
Hub depreciation depreciation $0.25 $0.55
Subtotal $2.99 $2.43

Delivery 10% savings on labor, maintenance, and depreciation for

Labor 65% of volume handled by contractors $1.64 $1.37
Fuel 10% savings on labor for higher package density $0.10 $0.10
Maintenance and depreciation $0.31 $0.29
Subtotal $2.05 $1.76

Advertising Airborne does not use advertising $0.22 $0.00

Sales 45% as many sales reps for 32% as much volume $0.21 $0.30

IT Lower investment, but spread over fewer units $0.54 $0.54

Customer service Comparable service $0.20 $0.20

Corporate overhead Spartan corporate operation $0.97 $0.58

Assume overhead/revenue of 8%
Total cost $8.55 $6.88

Margin $0.45 $0.32

Discounts for larger volume buyers
Price* 20% price discount $ 9.00 $ 7.20

10
 Details of Flight and Trucking Expenses
• Separate out flight/trucking for FedEx
– FedEx overall AC is $2.44 (Ex. 3)
– Trucking costs are 1/3 of flight costs (p. 11)
– FedEx ships 85% of volume by air, 15% by truck (p. 11)
– Z=AC per flown package for FedEx, then Z/3 per trucked package for FedEx
– 0.85*Z+0.15*Z/3=$2.44 so Z=$2.71, Z/3=$0.90
• Separate out FC/MC for flown FedEx page
– 80% of flight costs are fixed (p. 11)
– Typical FedEx plane flies 5,000 packages and 65% utilization (p. 11)
– FedEx plane capacity = 5,000/0.65=7,700 packages
– Cost of FedEx flight = 5,000*$2.71=$13,550
– FC of FedEx flight = 0.80*$13,550=$10,840
– MC flight cost per package for FedEx = 0.20*$2.71 = $0.54
• Calculate cost per unit for flown package for Airborne
– 80% utilization (p. 11)
– Number of packages per flight for Airborne = 0.80*7,7000 = 6,160
– Cost per unit for flown package = $10,840/6,160 + $0.54 = $2.30
• Calculate cost per unit for average package for Airborne
– Airborne ship 30% by truck, 70% by air (p. 11)
– Airborne flight- and trucking-related cost per unit = 0.30*$0.90 + 0.70*$2.30 = $1.88
• Airborne has $0.56 cost advantage ($0.29 from higher utilization, $0.27 from more trucking)

11
 Positioning
• What’s wrong with Exhibit 3?
– Representativeness
• FedEx customers are more diverse and demand higher quality
• Need to know what the costs are for Airborne “types”
– Marginal vs average costs
• Airborne has substituted FC for MC
• Delivery contractors, older aircraft, less automation
• MC matters for economic decisions
• Airborne very vulnerable in this segment
– Make niche unattractive
– Reduce costs further

12
 Good Habits for Relative Cost Analysis
• Choose simple unit of analysis
– What does the customer actually buy?
– Calculation in terms of % of revenue can confuse cost and price
differences
• Aggregate financial statements are dangerous
– Mix together products, manipulation, no easy comparison
– Sometimes you do not have anything else
– Ideally, complement with more fine-grained information
• Focus analysis on activities
– That account for a large portion of costs
– That are configured differently across firms
– Whose costs you do not know well
• Marginal costs and average costs
– MC relevant for pricing, AC for survival
• Cost analysis is only half of the story, WTP also matters

13
 Sustainability and “FedEx Lite”

• Intricate set of interwoven choices not easy to

imitate
– FedEx Lite might struggle on standalone basis
• Mismatches with FedEx mainstream
– “absolutely, positively overnight” pledge
– “almost certainly overnight” like Airborne
• No culture of frugality at FedEx
• Standardization obsession at FedEx and UPS

14
 Recommendations for Airborne

• Distance Pricing
– MC disadvantage exacerbated
– Lack of DP shifts shipment demand to long
distance
• Airborne survives by exploiting inflexibility
of competitors
• Drive down costs
– RPS partnership
– But RPS acquired by FedEx!

15
 Airborne Update
• Airborne faltered after 1999
– FedEx and UPS continued to raise standards and FC
– Meager profits until 2003
– DHL purchased Airborne for $1.2bn
• Strategy was not necessarily a failure
– Outperformed other small express companies
– Healthy purchase price
– Reasonable LR returns for shareholders
• DHL abandoned low cost strategy
– Heavy losses
– Discontinued all air and ground operations in US in 2008

16
 Conclusions and Takeaways

• Technique
– Relative cost analysis
• Concepts
– Competitive Advantage and Generic Strategies
– Logic of Airborne’s low cost position and link to the
economic dynamics of the industry
– Interactions between different activities to create
complementarities
– Cost-quality frontier (sometimes also called
quality-price value map)

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