Why FedEx Is Gaining Ground By converting truck drivers into sales machines and bringing its ground-shipping tech into the 21st century, FedEx is giving UPS a run for its money.
By Kevin Kelleher

(Business 2.0) – It's late morning in San Francisco's South of Market district, and Ramon Umali quickly steers his green-and-violet Federal Express truck into a U-turn. One of his biggest customers--online adult-toy retailer MyPleasure.com--just rang his cell phone with a last-minute plea: Does he have room in his truck for 600 boxes of Aqua Arousers, Violet Raptures, and Kama Sutra Weekender Kits? And could he pick them up before 1 p.m.?

No problem! This is the new FedEx, able to turn on a dime--on the ground. And it's pulling customers away from its biggest ground-delivery rival, United Parcel Service. Its secret? Umali and the 14,000 other U.S. drivers for FedEx Ground don't work for Federal Express at all. Unlike the Teamster-backed drivers at UPS, FedEx Ground drivers work as independent contractors; they own and insure their own trucks, manage their schedules, and get paid by package volume, not by the clock. "I feel like this is my own business," says Umali, who sold his restaurant-supply company to become a self-employed driver for FedEx Ground.

Instead of making customers bend to its schedule, FedEx Ground does the opposite: It delivers on Saturday, in the evening, or by appointment. And because the drivers tend to live near their routes, customers like MyPleasure.com CEO Sandor Gardos can coax even more perks from them. During the holidays last year, Gardos says, "Ramon not only did two Saturday pickups, but he said, 'I don't usually pick up on Sunday, but I live nearby and can bring my truck by.' That blew me away."

UPS still hogs the ground-delivery roadway with a 71 percent market share. But FedEx Ground--which just a few years ago was a sideshow to its $16 billion global air-delivery business--hit 14 percent market share in 2002. With revenue growing at a 26 percent annual clip and operating profit surging (up 47 percent in the fiscal year that ended in May), it's on track to swipe another 7 percent of the market by 2007. UPS, by contrast, has lagged behind: Revenue for ground-package shipments grew a measly 0.2 percent in 2002, while overall U.S. operating profit fell 1 percent.

UPS claims it's unthreatened by FedEx's inroads. "We don't have a one-up attitude," spokeswoman Christine McManus says. "Competition is good for the customer--and good for us."

Competition didn't exist just a few years ago, when two corporate fiefdoms split the market: FedEx ruled the skies, UPS dominated the earth. (A third player, the government-run U.S. Postal Service, has seen its former dominance dwindle to around 10 percent.)

FedEx didn't enter the ground-delivery market by choice. Revenue growth in airborne delivery dropped from around 15 percent in 1998 to just 8 percent in 2000. Business documents that once filled FedEx jets were flying for free as e-mail. At the same time, the Net was driving new business to UPS: It was the shipper of choice for eBay and Amazon.com.

FedEx CEO Fred Smith saw his opening in 1997--during the 15-day Teamster strike by UPS workers. "He called to ask if I was interested in combining our companies," says FedEx Ground CEO Daniel Sullivan, who was then running RPS, a Pittsburgh-based ground-delivery firm that had become UPS's biggest rival, with annual revenues of $1.7 billion. In 1998, FedEx acquired RPS. Smith put Sullivan in charge of the division--rechristened FedEx Ground in 2000--and the new unit began to claw its way into UPS's market.

Sullivan boosted sales in ways that UPS's unionized workers couldn't. FedEx Ground drivers are paid in weekly "settlements" based on how many stops they make, the number of packages they handle, and the density of their delivery zones. Drivers also get monthly and annual bonuses. (A delivery rate below 98 percent kills the bonus, as does a single complaint.)

UPS drivers, by contrast, get job security and benefits (see box at left). That breeds loyalty, but not sales-driven road warriors like Umali. "If they take care of customers, they'll profit," says Donald Broughton, an analyst with A.G. Edwards. "They think it's their shot at the American dream."

Hiring independent drivers bought FedEx one advantage, but it couldn't capitalize on it without catching up to UPS in technology. Relying on its world-class air-routing tech, FedEx raced to add a ground logistics system with Terminator-like efficiency. In Woodbridge, N.J., the largest of 27 FedEx Ground shipping hubs, bar-scanned packages trundle along miles of conveyor belts without human contact. The machinery usually lets FedEx ship packages overnight as far as 400 miles away--a claim that UPS can't match. If customers are willing to forgo that 10:30 a.m. arrival offered by airborne service, they get a delivery for about a third of the price.

That's persuaded customers who once used UPS to switch. Last summer, when Amazon promised fast delivery of the new Harry Potter book, FedEx handled 400,000 copies on the first day of the book's release. In the biggest one-day shipment in e-commerce history, FedEx delivered 99.8 percent of the books on time. Most went out on Saturday, when UPS doesn't operate at full strength. "This was a complex event that required all kinds of new processes to make sure the books didn't arrive too early or too late," says Steve Kessel, Amazon vice president for books and music. "But it worked. We got lots of e-mails from parents saying kids were yelling, 'Here comes the FedEx man!'"

The growth at FedEx Ground is especially welcome in the company's bottom line. The division makes up 15 percent of FedEx's total revenue, but 34 percent of its operating income--put simply, it's a lot cheaper for FedEx to run trucks than jets. And its operating margin, at 14.5 percent, is more than triple that for air. That's one reason FedEx is betting big on ground facilities--it has committed $1.8 billion for 10 new high-tech hubs and the expansion of others--despite having been forced to offer voluntary retirement and severance packages to 14,000 workers due to a slowdown in the air business. Needless to say, Ramon Umali and his fellow Ground drivers weren't among them.

--KEVIN KELLEHER