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Describe the competition in the overnight package delivery industry and the strategies by which these two firms

are meeting the competition. FedEx: - Innovation o Broke into air freight market through purchase of own fleet of planes Competitors typically used space available on commercial flights o Implemented hub-and-spoke distribution pattern (key innovation) - Operational leader (Malcolm Baldridge National Quality Award) - Absolutely, Positively Overnight - Company philosophy People-Service-Profit o Emphasis on customer service o Total quality management o Employee participation Reputation as good place to work, helped keep out unions - High capital investment to expand operations and services - Technological innovation Greater monitoring and control of customer ordering, package tracking and process UPS Dominant firm in industry until entry by FedEx Expanded capabilities to be able to deliver to any address in the world Emphasis on efficiency route monitoring and control Went public in 1982 to raise capital to compete in the overnight delivery market o Large scale acquisitions of planes, trucks to expand capabiltiies Expanded through acquisition o Purchased freight carrier to expand into Latin America o Purchased MBE to expand into retail packaging/shipping/mail services market High emphasis on being low cost provider Invested in IT, aircraft and facilities to support innovations, maintain quality and reduce costs

What are the enabling and inhibiting factors facing the two firms as they pursue their goals? Enabling Factors: FedEx: - Deregulation Enabled FedEx to enter market - Size Large enough to take advantage of economies of scale - Innovation Hub & Spoke, maintaining own plane fleet - Technology Tracking, monitoring - Operations Absolutely Positively Overnight, Awards - Employees Non-union, employees involved in process - Large portion of costs are fixed, so increases in revenue go directly to bottom line UPS: - Size Dominant firm in express package industry, economies of scale, existing worldwide presence - Technology Leader in logistics, route management - Finance AAA credit rating, ability to raise large amount of capital quickly - Efficiency Low cost leader, ability to compete on price

Inhibiting Factors: FedEx: - Financial BBB credit rating, lower ability to raise capital - Market Domestic market reached maturity, must expand overseas - Market Unable to compete in Europe - Concentration Primarily competes in air shipment/overnight market segment - Lack of skilled workforce in China - Overall Chinese business environment (Exh 11) UPS: - Deregulation Opened market to competitors - Complacency Older, established company, used to controlling market - Employees Unionized - Size Slower to respond, shift focus - Lack of skilled workforce in China - Overall Chinese business environment (Exh 11)

Do you think either firm can attain sustainable competitive advantage in this business? Yes, UPS is the more likely of the two to attain a sustainable competitive advantage: - Financial strength Ability to raise capital at lower costs - Largest firm in delivery market - Worldwide presence - Low cost leader- better ability to compete on price - More complete service offering Why did FedExs stock price outstrip UPSs during the initiation of talks over liberalized air cargo routes between the U.S. and China? Stock price is a forward looking measure Many valuation models base stock prices on discounted future cash flows Estimates of growth, applied to current cash flows, discounted to present Market viewed the liberalization of air cargo routes in China as more favorable to FedEx than to UPS. FedEx already had largest foreign presence in China - Twice as many flights to China 11 flights vs 6 - Served more cities within China than UPS - UPS predicted demand would outstrip its capacity

Assuming a perfectly efficient stock, how might one interpret a 14% increase in FedExs market value of equity? A 14% increase in FedExs market value of equity can be interpreted as an indication that the market believes that FedEx will experience increases in cash flows in the future. FedExs sustainable growth rate is higher than that of UPS (4.96% vs 2.95%), coupled with FedExs existing presence in China (nearly 2X the routs, plus service to more cities), and FedEx working to catch

up to UPS on operational efficiency (higher margins), the trend of FedExs ROA and Net Profit margin starting to increase versus UPSs starting to decline, could lead to the market believing that FedEx will experience higher growth vs UPS.

How have FedEx and UPS performed since the mid 1980s? Which firm is doing better?

FedEx has been improving in financial performance since the 1980s. After the early years, FedEx began to turn a profit and has gradually improved: Return on Equity:

35% 30% 25% 20% 15% 10% 5% 0% -5% -10% 1990 1992 1994 1996 1998 2000 2002 2004 UPS FedEx

FedEx began generating a positive ROE in 1993, versus UPS which has been generating a higher, positive, ROE over the same time period. Decomposing the ROE into its components provides some insights as to the differences in performance. Under the DuPont Formula, ROE can be expressed as the product of: Net Profit Margin X Asset Turnover X Equity Multiplier = Return on Equity This is a measure of the profitability of the firm, its utilization of assets and use of leverage as they relate to the return on equity.

Profit Margin
12% 10% 8% 6% 4% 2% 0% -2% -4% 1990 1992 1994 1996 1998 2000 2002 2004 UPS FedEx

UPS has a superior profit margin compared to FedEx. This is consistent with UPSs operational efficiency and cost controls. For every dollar in sales, more of those sales are available to shareholders.

Asset Turnover
2.00 1.80 1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 1990









In the case of asset utilization, FedEx appears to have caught up to and surpassed UPS. UPSs asset utilization appears to have diminished over time, while FedEx appears to be improving in this area.

Equity Multiplier
4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 1990 1992 1994 1996 1998 2000 2002 2004 UPS FedEx

The use of leverage magnifies returns (and losses) through the use of borrowing. FedEx has been reducing leverage over time while UPS has remained relatively stable, but trending downward in 2003. In this case, this appears to be a relative draw as both firms have a similar equity multiplier. Based on the DuPont equation, it appears that the source of UPSs superior returns is their higher net profit margin. This overwhelms any advantages that FedEx has with respect to asset utilization. Activity Measures First, average days sales outstanding:

Days in Receivables
60 50 40 30 20 10 0 1990 UPS FedEx








Here, there is a convergence. FedEx initially started out with a much higher number of days sales outstanding. UPS had a much lower number, by more than half. Over time, as competition has

increased, UPS has increased their DSO. This may be an indication that UPS has changed their credit terms to match FedEx to better compete with them. Working Capital Turnover

Working Capital Turnover

6,000 5,000 4,000 3,000 2,000 1,000 0 -1,000 -2,000 1990 1992 1994 1996 1998 2000 2002 2004 UPS FedEx

UPS initially had much better utilization of working capital. FedEx was negative, which indicates a very inefficient use of working capital in generating sales. These measures have also converged as competition heated up between the firms. As previously mentioned, total asset turnover favors FedEx over UPS. FedEx appears to be more efficient in utilizing its assets to generate sales. Fixed Asset Turnover did not vary significantly between the two companies and both appear to be approximately equally effective at using fixed assets to generate sales. Liquidity From a liquidity standpoint, UPS is in better shape than FedEx. The measures of liquidity (Current, Cash, Cash from Operations, and Defensive Interval ratios) place UPS ahead of FedEx.

Solvency Ratios

Debt to Equity
1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 1990 1992 1994 1996 1998 2000 2002 2004 UPS Fed Ex

The debt-to-equity ratios have converged. FedEx appears to have been reducing its debt relative to equity while UPS has been increased their ratio. This appears to be as a result of increased competition with FedEx and the expansions UPS undertook to compete with FedEx.

Times Interest Earned

40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 1990 1992 1994 1996 1998 2000 2002 2004 UPS Fed Ex

The Times Interest Earned ratio is an indication of a firms ability to service its interest bearing debt. UPS is far superior to FedEx in this respect. This is consistent with FedExs apparent heavier reliance on debt to finance its expansion.

Fixed Charge Coverage

40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 1990 1992 1994 1996 1998 2000 2002 2004 UPS Fed Ex

The Fixed Charge Coverage ratio adds lease payments to the TIE calculation. Based on this measure, it appears that FedEx also heavily relies upon leases. UPSs ratio is identical to its TIE ratio, indicating minimal use of leasing . From a solvency standpoint, UPS is in a much better position than FedEx. This is probably also a result of UPSs stronger credit ratings (and a component of their strong credit rating). Profitability

Net Profit Margin

12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% -2.00% -4.00% 1990 1992 1994 1996 1998 2000 2002 2004 FedEx UPS

As noted in the ROE breakdown, UPS has a higher net profit margin. Overall, UPS appears to be better at controlling costs. This is a significant source of their return on equity and return on assets.

Sales Growth
40.00% 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 0 2 4 6 8 10 12 FedEx UPS

FedEx has experience higher sales growth than UPS. FedExs sales have grown an average of 11.53% versus 7.32% for UPS.

Market Performance

Stock Price
80.00 70.00 60.00 50.00 40.00 30.00 20.00 10.00 1992 1994 1996 1998 2000 2002 2004 UPS FedEx

The stock prices of both firms have performed similarly. FedEx maintained a higher stock price until 1999 when UPS made stock available via public offering. Both have trended upward with UPS offering a higher level of growth.

Annual Return
300.00% 250.00% 200.00% 150.00% 100.00% 50.00% 0.00% -50.00% 1992 1994 1996 1998 2000 2002 2004 UPS FedEx S&P

The annual returns have been similar, with UPS posting a very high return in 1999 when their stock was offered via public offering. Both firms have outperformed the S&P 500 overall. The annualized rate of return for UPS is higher at 22.95% (including dividends) versus 18.21% for FedEx. Over the same time period, the S&P 500 returned 8.89%.

Earnings Per Share

3.00 2.50 2.00 1.50 1.00 0.50 1992 1994 1996 1998 2000 2002 2004 UPS FedEx

FedExs EPS initially overtook UPS in the early 90s. As competition increased and UPS responded to FedEx in the market, UPS briefly regained the lead in earnings per share.

P/E Ratio
100.00 90.00 80.00 70.00 60.00 50.00 40.00 30.00 20.00 10.00 1992 1994 1996 1998 2000 2002 2004


The P/E ratios of the firms are very similar. 1999 represents an abnormal year for UPS as this was when their stock was initially offered to the public.

5,000 4,000 3,000 2,000 1,000 (1,000) (2,000) (3,000) 1990 1992 1994 1996 1998 2000 2002 2004 FedEx - Ann UPS - Ann FedEx - Cumulative UPS - Cumulative

Economic value added (EVA) is an estimate of a firm's economic profit the value created in excess of the required return of the company's investors (being shareholders and debt holders). EVA is the profit earned by the firm less the cost of financing the firm's capital (WACC). FedEx has had a return on net assets will below its WACC and has not created value in excess of the required return. With the exception of 2003, FedEx has had negative EVA and a cumulative negative EVA. UPS on the other hand, has consistently added value and earned a return on net assets above its WACC.

80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 1990 1992 1994 1996 1998 2000 2002 2004 FedEx UPS

Market Value Added the difference between the book and market values of capital. This measure also favors UPS. For FedEx, the value added is positive, but is still substantially less than UPS. This is a reflection of both how management is performing and how the market in general is performing. Discuss the insights you derived from the two firms financial statement, financial ratios, stock price performance, and economic profit (EVA). Also, describe how EVA is estimated and its strengths and weaknesses as a measure of performance. Overall, UPS appears to be the more profitable of the two firms, creating more value for shareholders. FedEx appears to be more efficient in the utilization of its assets to generate a return where UPS has higher margins which more than offset FedExs efficiencies. FedEx appears to be destroying value for shareholders in not generating a return on assets above its cost of capital. For stock prices, the two firms have stock prices that are very close, but since UPS went public, they generally have a higher stock price. Economic Value Added can be calculated in two ways: EVA = (Actual Return Required Return) X Invested Capital, where Actual Return is the Return on Net Assets (Assets Current Liabilities) Required Return is the WACC Invested Capital = Book Value of Debt + Book Value of Equity (Net Assets) EVA = NOPAT X (WACC X Invested Capital), where NOPAT = Net Operating Profit After Taxes Strengths: - Based on a simple concept If the return earned is greater than expected, then value has been created - Incorporates both balance sheet and income statement measures to determine performance - Provides a simple metric to judge value created/destroyed by management decisions adding more capital, removing capital, increasing earnings, decreasing costs

Weaknesses: - Based on GAAP based accounting data may be fuzzy as to estimates of activity/current position - GAAP is historical based, not forward looking Does not completely incorporate increases/decreases in value from external influences - Based on single period, which may not hold true for future periods - Can be complicated to calculate with adjustments to GAAP data: o LIFO reserves o Implied interest on operating leases o Bad Debt reserves o Deferred taxes o Capitalized costs o Etc

If you had to identify one of these companies as excellent, which would you choose? On what basis? More generally, what is excellence in business? Excellence in business can be defined as in the Baldridge Performance Excellence Award (http://www.nist.gov/baldrige/publications/business_nonprofit_criteria.cfm): The Criteria are a set of questions about seven critical aspects of managing and performing as an organization: Leadership Strategic planning Customer focus Measurement, analysis, and knowledge management Workforce focus Operations focus Results Or by the 9 criteria from the EFQM Excellence Model (http://www.efqm.org/en/tabid/392/default.aspx): 1. 2. 3. 4. 5. 6. 7. 8. 9. Leadership Strategy People Partnerships & Resources Processes, Products and Services Customer Results People Results Society Results Business Results

In either case, excellence can be generally defined by leadership, strategy, customer focus, process management and results. Using these criteria, both companies would be defined as excellent. Each company has areas where they excel over the other:

FedEx: Customer focus Employee focus (people) Process management Leadership (defined the overnight delivery service market) UPS: Strategy Slow to respond, but has redefined themselves and started setting the tone for the market Process management Excels in logistics Business Results Better overall performance Based solely on business performance, UPS would be a clear winner in the category of excellence.