Will FedEx Freight pull ahead as 'pure play' LTL?

Less-than-truckload (or LTL) freight is a common way to move shipments smaller than - you guessed it - a full truckload. Shippers use it to move smaller loads in a cost effective way, and carriers increase revenue by combining smaller shipments into one trip.

While some LTL carriers are “pure play,” meaning that they only offer LTL freight, others look at LTL as complimentary or an add-on to other logistics services.

Even when everything is going right - as it seems to be with FedEx Freight - it is hard to manage LTL in addition to other freight services. On June 26th, The Wall Street Journal reported that they are considering spinning off their Freight division into a standalone company in order to give it the opportunity to thrive.

For an in depth description of FedEx Freight’s role in the LTL market and how a spinoff would impact procurement’s negotiating leverage, read Will FedEx Freight hit the open road? on Art of Procurement.

Freight History Repeats Itself

Nearly all carriers think the same thing about LTL… at first. They think there will be an advantage associated with offering LTL in addition to other freight services. FedEx thought it would be a unique offering if they could bundle their LTL, Express, and Ground services.

Union Pacific and UPS had the same idea - and they bought the same company in an effort to achieve their vision.

In 1986, Union Pacific bought Overnite Transportation, an LTL carrier, for $1.2 Billion. In 1998, they sold the company for $550 Million, taking a loss of $650 Million on the deal.

In 2005, UPS bought Overnite for $1.25 Billion and rebranded them as UPS Freight. 15 years later, they sold them for $800 Million. UPS made it three years longer than Union Pacific and lost $200 Million less, but it was essentially the same idea and it had the same outcome.

As it turns out, small parcel and LTL (or cargo and LTL) are more different operationally than they seem. Trying to run a company with multiple classes of freight is like buying a toaster that also has a radio and a can opener in it. None of them work as well as you would like.

LTL is a capital intensive business with small margins. These operations have to be run right and tight.?

In my research, I came across an excellent article from HulkApps, a site for Shopify merchants, that sums up the decision Union Pacific and UPS already made and that FedEx has to make now: “At the heart of this assessment lies the future of integrated logistics services. While streamlined operations under a unified umbrella can offer certain economies of scale, distinct business units focused solely on their market segments can often outperform due to specialized focus and agility. FedEx's forthcoming decision will provide valuable insights into which model might hold more promise in the evolving logistics landscape.”

It was a good decision for UPS to spin off their freight unit in 2021, and it looks like the right decision for FedEx to do the same now - although to allow it to thrive, not to protect the mothership.

How many pennies are left?

FedEx Freight is the largest LTL carrier in the nation by revenue. They reported over $10 Billion last year. In second place (from a revenue standpoint) is Old Dominion at $6.2 Billion. FedEx wins the LTL game hands down when revenue is the performance metric, but what about management efficiency?

FedEx Freight has an operating ratio of 80 percent. This means that it costs them 80 cents in operating expenses to generate one dollar of net sales. But Old Dominion has an operating ratio of 72 percent, a full 10 percent less than FedEx Freight. So while they may bring in less revenue than FedEx Freight, they keep more of it.

When UPS decided to sell their freight division, they had an operating ratio of 98 percent. After making one dollar and accounting for operating expenses, they had two whole pennies left in their hand. 80 and 72 percent operating margins are harder to achieve than it may look.

Nearly every article I read about the potential for a FedEx Freight spinoff mentioned the importance of being a “pure play” LTL company. If independence gives them the chance to streamline and focus, they may be able to bring their operating ratio closer to that of Old Dominion’s. Investors are already drooling at the prospect.

LTL Freight Trends

With FedEx, Union Pacific, and UPS having such different track records, there has to be more to the decision to shed LTL than efficiency. The additional variable is a larger shift in the freight market.?

Satish Jindel is the President of SJ Consulting and was an advisor to former FedEx CEO Fred Smith. In an article on The Loadstar, he points out that the potential benefits associated with acquiring LTL "are no longer a magnet.”?

Part of the reason behind this is how the rise of eCommerce has changed demand for freight. In the late 1990s when FedEx was building their LTL organization through acquisition, small parcel was predominantly B2B. Adding LTL made good business sense.?

Today however, small parcel is dominated by B2C volume. The synergies are no longer there: “now freight and parcel don’t bundle,” Jindel said.

There are other factors changing this equation as well.?

Amazon’s decision to ship more of their own volume has reduced the number of packages available to other carriers and altered their efficiency calculations. As reported by Freightwaves, “Last year [2023], excluding Amazon, the package market in the U.S. dropped by 2.4 million packages a day.”?

In addition, The Postal Service is moving their volume from FedEx to UPS, but losing them as a customer may actually help FedEx, because USPS has been moving more of their volume from air to ground, a lower margin form of freight.

Most commentators believe FedEx will spin off Freight, and a final decision is expected by the end of the year. The reality is, no one is big enough to buy them.

“No private equity firm is willing to invest in asset-based companies that are that big,” Jindal said. “Which venture capital firm would pay $50Billion for FedEx Freight, and what would it do with it?”?

Fortunately for Freight, it won’t be spun or sold off at a loss. Over the last two years, FedEx Freight has generated operating margins in excess of 20 percent, compared to 11.8 percent for FedEx Ground and 2 percent for FedEx Express.??

If FedEx Freight gets the opportunity to set out and compete as a “pure play” LTL operation, they might be able to close the efficiency gap between them and Old Dominion, making them dominant in revenue and management efficiency.

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