The Battle for Value
Andrew Hall
Yo Yo Ma
Jerry Seinfeld
Team One
22nd May 2008
Contents
Objectives ..................................................................................................................................................... 1
Management Summary ................................................................................................................................ 1
Sustainable Competitive Advantage ............................................................................................................. 1
Enabling Factors....................................................................................................................................... 1
Inhibiting Factors ..................................................................................................................................... 2
Conclusion................................................................................................................................................ 2
Interpretation of the 14% Increase in FedEx’s Market Value of Equity........................................................ 2
FedEx and UPS share price and liberalized air cargo routes between the U.S. and China ...................... 3
Conclusion................................................................................................................................................ 3
UPS and FedEx Performance Since Early 1990’s ........................................................................................... 3
Financial Statement Analysis ................................................................................................................... 3
Ratio Analysis ........................................................................................................................................... 3
Activity Ratios ..................................................................................................................................... 3
Liquidity Ratios ................................................................................................................................... 4
Profitability Ratios .............................................................................................................................. 5
Growth ................................................................................................................................................ 5
Stock-Price Performance ......................................................................................................................... 6
Economic Value Added ............................................................................................................................ 6
Market Value Added ................................................................................................................................ 7
Conclusion................................................................................................................................................ 7
Excellence in Business ................................................................................................................................... 7
Conclusion................................................................................................................................................ 7
Appendices.................................................................................................................................................... 7
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Objectives
This report seeks to answer the following four questions about UPS and FedEx:
1. What are the enabling and inhibiting factors facing the two firms as they pursue their goals? Do
you think that either firm can attain a sustainable competitive advantage in this business?
2. Why did FedEx’s stock price outstrip UPS’s during the initiation of talks over liberalized air cargo
routes between the U.S. and China? Assuming a perfectly efficient stock market, how might one
interpret a 14% increase in FedEx’s market value of equity?
3. How have FedEx and UPS performed since the early 1990s? Which firm is doing better? Discuss
the insights you derived from the two firms’ financial statements, financial ratios, stock-price
performance, and economic profit (economic value added or EVA).
4. If you had to identify one of those companies as excellent, which company would you choose?
On what basis did you make your decision? More generally, what is excellence in business?
Management Summary
The enabling factors for the two firms are economies of scale, technological and operational excellence
and market dominance. The inhibiting factor for FedEx is financial weakness; for UPS it was the culture
of “resting on its laurels”. UPS has improved its culture and is mastering technology and operations.
FedEx needs to address profitability and thereby address its financial weakness. UPS is getting close to
having a sustainable competitive advantage in the business.
FedEx’s stock price outstripped UPS’s during the initiation of talks over liberalized air cargo routes
between the U.S. and China because the market viewed the increased cash flows to FedEx as being a
higher percentage increase than would be the increased cash flows to UPS and then impounded the
revised estimates of the cash flows into the share price.
UPS is doing much better than FedEx financially. FedEx is growing faster than UPS and is sacrificing
profitability for growth.
UPS is the firm that I would identify as excellent, based upon its financial performance and its growing
operational effectiveness. Excellence in business is to perform be excellent in all of the dimensions of a
business: Human Resource Management; Operations Management; Information Technology
Management, Marketing and Financial Management.
Sustainable Competitive Advantage
Enabling Factors
FedEx entered the market when it was deregulated. Further deregulation might lower the barriers to
entry and allow new competitors. FedEx’s innovations in using their own planes and a hub and spoke
design for their network allowed them to break into the market and innovation is a way of maintaining
barriers to entry in the market.
FedEx’s operational excellence through the use of Total Quality Management, Technology and flawless
execution is a barrier to the entry of competitors and this allowed them to see off competition from
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USPS. Operational excellence also allows them to be the lowest cost competitor and to post smaller
price increases than UPS.
Employee participation and a non union environment give FedEx advantages over UPS. Finally their
strength in the “Air Express Market” gives them economies of scale in this business and their heavy
investment in Asia mean that they are better placed than UPS to take advantage of the additional flights
to be made available by the new agreement.
In a market characterized by economies of scale, UPS’ size and strength in all sectors give it economies
of scale. UPS also has tremendous financial strength, enjoying a AAA bond rating and better financials
generally, see below, than FedEx. Their financial strength enables them to price cut to establish market
share and to deter competitors. UPS has also invested in technology and process to allow good
operational performance and deter competitors.
Inhibiting Factors
The main general factors inhibiting entry into this market are Economies of Scale and the presence of
UPS and FedEx. While there is some competition, Emery Air Freight and USPS, Emery does not have the
scale to compete effectively and USPS is unable to master the technology innovations or the operational
excellence of either UPS or FedEx.
The factors inhibiting FedEx are its relatively poor financial strength, evidenced by its BBB bond rating;
its withdrawal from the European market which suggests that operational excellence is not the only
criterion for success, and its concentration on one segment of the market – Air Express.
The factors which were inhibiting UPS’ success were its size and its age and signs of complacency and a
tendency towards “resting on its laurels”. In this respect the arrival of FedEx in the market place has
been good for UPS which has been forced to respond with innovation and operational improvements of
its own.
Conclusion
Both UPS and FedEx have the economies of scale needed to be fierce competitors in this market. Both
have sustainable competitive advantages, FedEx needs to develop financial strength to maintain and
improve its position.
Interpretation of the 14% Increase in FedEx’s Market Value of Equity
Under conditions of weak efficiency, a market is efficient if it factors past prices and trading volume into
the stock price and neither of these factors would explain the 14% increase in FedEx’s market value of
equity.
Under semi-strong market efficiency, in addition to prices and trading volume, the market is efficient if it
factors analysts’ recommendations and financial statement analysis into the stock price. No historical
analysis of the financial statements of FedEx is going to explain the 14% increase in FedEx’s market value
of equity.
Strong market efficiency assumes that all publicly known information as well as insider information is
factored into the stock price. In this case, news of the initiation of talks on liberalization of air cargo
routes between the U.S. and China will have been analyzed to identify the likely impacts on the future
cash flows from both FedEx and UPS. The 14% increase should reflect the market’s assessment of the
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present value of the incremental cash flows to FedEx that are likely to be derived from the liberalization
of air cargo routes between the U.S. and China.
FedEx and UPS share price and liberalized air cargo routes between the U.S.
and China
The agreement allows for five times as many commercial cargo flights overall, to and from any airport in
either country. With Air Cargo expanding currently at 30% a year and with the expectation that this
growth rate will continue for the next 5 years there are plenty of opportunities for UPS and FedEx to
benefit.
FedEx currently has 11 flights a week and services 220 cities in China and has been experiencing a 50%
per annum volume growth in business in China. It has invested heavily in Asia and so it is very well
placed to take advantage of the liberalization.
UPS currently has 6 flights a week and services 200 cities in China and it is less well established on the
ground and therefore potentially less well able to take advantage of the opportunity that liberalization
of the market represents.
With one hundred flights a week up for grabs, however, it may be the more financially able firm that will
be able to finance the additions to the fleet of cargo aircraft that will be needed. In this respect UPS is
better placed. The fact that UPS’ stock price percentage increase was not as great as that for FedEx may
reflect the differences in scale between the companies. Adding $100 in value to a $700 company adds
14.2% adding $100 to a $1,100 company adds 9.1%
Conclusion
The stock price is the PV of future cash flows to the stock. News which suggests that the cash flows will
be greater than previously thought will, in general, increase the stock price.
Market expects liberalization to increase the PV of FedEx’s future cash flows by a greater percentage
than the increase in UPS’s future cash flows
UPS and FedEx Performance Since Early 1990’s
Financial Statement Analysis
Financial statement analysis allows us to identify trends and to see the absolute size of the business.
The disadvantages of financial statement analysis include the fact that financial statements are historic
rather than predictive, the values are Book Values rather than Market Values and they are based on the
Generally Accepted Accounting Principles (GAAP) which allow, in practice, for a fair degree of latitude.
Ratio Analysis
Ratio Analysis allows scale to be removed from the analysis and for comparison with other similar firms.
Ratio analysis suffers from all the problems of Financial Statement Analysis, generally, since ratio
analysis is usually based on financial statements. Where market values are available they should be
incorporated into the calculation of ratios.
Activity Ratios
The activity ratios for FedEx are improving as those for UPS weakening
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Average days receivables outstanding are fairly constant for FedEx from 1992 to 2003 while the average
days receivables for UPS are increasing – see Figure 1. One explanation might be that UPS are
competing on credit terms?
Figure 1
Average Days Outstanding
60
55
50
45
40
UPS
35
FedEx
30
25
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
20
UPS has more working capital than FedEx. FedEx’s fixed asset turnover is marginally higher than that of
UPS. FedEx’s total asset turnover is higher than UPS’ total asset turnover – see Figure 2 – This might
point to FedEx making more use than UPS of leasing or rental of equipment.
Figure 2
Total Asset Turnover
2
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
UPS
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
FedEx
Liquidity Ratios
UPS is significantly more liquid than FedEx as is evidenced by the Current Ratios – see Figure 3
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Figure 3
Current Ratio
3
2.5
2
1.5
UPS
1
FedEx
0.5
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
0
Profitability Ratios
UPS is more profitable than FedEx on every measure including the net profit margin shown in Figure 4.
Figure 4
Net Profit Margin Percent
12
10
8
6
UPS
4
FedEx
2
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
-2
1992
0
-4
Growth
FedEx is growing more strongly than UPS on every measure other than Earnings per Share (EPS). This
can be attributed in part to the effects of the strike at UPS in August 1997.
Figure 5
Sales Growth Percentage
40
35
30
25
20
UPS
15
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2003
2002
2001
2000
1999
1996
1995
1994
1993
0
FedEx
1998
5
UPS
Strike
Aug
1997
1997
10
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On earnings per share, UPS grew more significantly more strongly than FedEx between 1999 and 2003
although FedEx’s growth in EPS was greater than that for UPS between 1993 and 2003 – see Figure 6.
Figure 6
Earnings Per Share
Compound Annual Growth Rate
1993-2003
1999-2003
UPS
13.89%
34.30%
FedEx
27.54%
6.98%
So, UPS is performing significantly better in the generation of earnings per share and this is reflected in
the longer term stock-price performance of UPS
Stock-Price Performance
Fed Ex saw a 22% gain compared to UPS’ 14% gain between June 2003 and June 2004. In the longer
term, UPS has given stock holders better returns – 551% between 1993 and 2003 – as compared with
FedEx’s stock holder returns of 373% for the same time period – Case Exhibit 8. Both have performed
very much better than the S&P 500 index which showed cumulative compound annual returns of 155%
in that period.
Some of the difference in the returns is reflected in the growth in the share price, which was 23.2% per
annum compounding annually for UPS between 1993 and 2003, and 20.2% for FedEx. In addition, UPS
paid cash dividends where FedEx did not.
Economic Value Added
According to Case Exhibit 9, FedEx destroyed value each year from 1992 to 2002 and created $170
million of value in 2003 for a cumulative loss in value of $2,252 between 1992 and 2003. UPS also
destroyed value between 1992 and 1996, but it created value between 1997 and 2003 – Case Exhibit 10.
Figure 7 shows the annual EVA for each firm.
Figure 7
Economic Value Added
$ Millions
1,500
1,000
500
UPS
FedEx
0
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2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
-500
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Economic Value Added suffers from a number of weaknesses: it relies on GAAP and accounting values
and so it is a historic, rather than a predictive measurement. It ignores strategic option values that
derive from competencies such as the mastery of special skills and technologies, and the established
presence in markets.
Market Value Added
Market Value Added is calculated by subtracting the book value of the firm’s capital from the market
value of the firm’s capital and measures the markets’ perceptions of the firm’s value added. UPS has
been much more successful in creating Market Value than FedEx, particularly since the strike in 1997, as
can be seen from Figure 8 which shows the annual Market Value Added amounts for FedEx, from Case
Exhibit 9, and for UPS, from Case Exhibit 10.
Figure 8
Market Value Added
$ Billions
80
70
60
50
40
30
20
10
0
UPS
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
FedEx
Conclusion
UPS financial performance is excellent and stronger, in most areas, than FedEx’s financial performance.
UPS. Both have performed better than the S&P 500 index. The Economic Value Added by UPS exceeds
the EVA from FedEx, but the Market Value Added for each is positive, because the market is predictive,
valuing the firm on future cash flow expectations rather than historical values.
Excellence in Business
UPS is financially excellent and it is achieving operational excellence to become a truly excellent
business. FedEx entered the market after UPS and has been very successful, growing strongly to
become second only to UPS in the market. FedEx’s operational excellence is yet to be matched with
financial excellence although FedEx’s finances are improving.
Conclusion
On balance one has to favor UPS, although one should not count FedEx out.
Appendices
None
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