Were the seeds of disruption planted at UPS in 2020?

Are we seeing the pattern of disruption introduced in Clayton Christensen’s seminal book, The Innovators Dilemma, play out in the package delivery industry??The attached article is a snippet from Chapter 1 of my book, Organizational Velocity, posing the provocative question, “Do you want to live?”?A section of the chapter examines UPS's strategic choices in 2020 in the context of Christensen's theory of disruptive innovation and illuminates a fundamental question for all leaders - are we in business to maximize shareholder value now or to build long-term, self-renewing companies?

The Case of Big Brown

As a long-time UPS shareholder, I benefit from the company’s success. When UPS announced a new CEO on March 12, 2020, as the COVID-19 pandemic spread across the United States, I was expectantly optimistic. Carol Tomé seemed like a brilliant choice. She was the first CEO in UPS history who did not grow up in the famously promote-from-within company, although she had been a board member for many years while a CFO at Home Depot. Her first earnings call was a breath of fresh air. She talked about her vision, the need for more diversity, and revamping the archaic decision-making processes that had slowed down the company for years. I began to question whether I had retired from UPS too early!

“UPS will be better, not bigger,” she said.

The slogan seemed strategic: UPS would “sweat the assets” and focus on the higher-margin verticals, such as health care and small- to mid-sized businesses. She almost immediately raised rates as capacity tightened with the pandemic-driven increase in demand for e-commerce deliveries. She slashed capital expenditures and sold off a low-margin trucking business. Wall Street cheered, and UPS stock soared to an all-time high. I joined in the celebration.

But, I also cringed. Beneath the surface of her words lay the seeds of disruption: “Better, not bigger” and “sweat the assets” translate, roughly, to reduced investment and a focus on the highest return areas. On the surface, her language makes sense, but it’s not the path of a Forever Company, which makes decisions beyond its quarterly earnings and the tenure of its current leadership.

The risk of a “better, not bigger” strategy was familiar. This was the classic “Innovator’s Dilemma” outlined by Christensen in 1997. The “dilemma” is whether incumbents focus on existing high-margin segments that are a good match with current capabilities or invest in new capabilities required to capture an emerging, lower-margin part of the market. Christensen’s book features the infamous case study of mini-mills disrupting U.S. Steel in the 1970s. Fifty years later, a similar scenario is playing out in the package delivery business. Table 1.1 shows a side-by-side comparison of strategic moves by U.S. Steel in the 1970s and UPS in 2020 and early 2021.

Table 1.1 U.S. steel and UPS: Similar paths?

The convergence of broadband, GPS, ubiquitous smartphones, and artificial intelligence allowed Uber to launch an online ride-hailing service in 2009. Online food delivery companies like UberEATS and DoorDash soon followed. While pizza delivery had been in place for years, this new technology-enabled model allowed businesses to tap into a ready supply of delivery vehicles and drivers on an ad hoc basis. It was revolutionary. Deliveries were made within an hour, but they were also haphazard and low margin. Profitability was an aspiration.

Same-day delivery of fast food was a business that UPS and other incumbents had no interest in. It didn’t fit UPS’s efficient route-based network, and paying gig-workers for delivery would be an uphill battle with the Teamsters Union representing UPS drivers. UPS made the logical choice. They focused on current customers who placed a high value on an efficient global network and were willing to pay more for it.

Fast forward to 2020. E-commerce spikes, outstripping UPS delivery capacity. Retailers increasingly use their stores to fulfill online orders with deliveries that don’t need the celebrated national networks of UPS, FedEx, or the U.S. Post Office. Options proliferate in every locality, from contractors to gig-workers, for local pickup with local delivery. Upstarts like Postmates and DoorDash, which already had a solution for local delivery, rushed in to fill the void and expand their market. Subsequently, Uber purchased Postmates for $2.7 billion in July 2020. A few months later, DoorDash went public, valuing the company at $72 billion.

Meanwhile, as part of its “better, not bigger” strategy, UPS reduced capital expenditures and focused on improving service for high-margin albeit slower-growing segments like international and health care while actively shunning some faster-growing but lower-margin e-commerce segments. Delivery capacity was constrained, shipping rates increased, and the rapidly growing same-day local delivery market was ignored.

The disruption was on.

The ostensibly strategic decision to leave the lower-margin business to the startups and the also-rans seemed to be logical, even brilliant. The market value of UPS nearly doubled in the new CEO’s first year. But in this case, the logical thing to do may turn out to be the wrong thing. Recent history is replete with stories of companies abandoning lower-margin products and businesses and aggressive startups happily filling the void. The new entrants continually innovate their business models and processes to stay profitable in a low-margin market. Eventually, these upstarts saturate the low end of the market and move upmarket to displace the incumbents with a better value proposition. The pattern of disruptive innovation popularized by Christensen over 20 years ago has played out in dozens of industries, from entertainment and photography to print media and manufacturing. It is now prevalent in health care, education, financial services, and yes … package delivery. If the pattern is so well known, why does it continue? The answer lies in the motivations and mindsets of the leaders who wrestle with the innovator’s dilemma.

The question “Do you want to live?” is not merely rhetorical. It’s existential: “Am I, as a leader, willing to sacrifice the profitability of the company I lead today to increase its chances for survival in the future?”...