For the last 40 years, transportation industry, as we know it, has been quite dull and boring. Carriers would move the freight from point A to point B and generally that would be the end of their contractual relationship with the customer. They competed with one another on price and delivery reliability (or with attempt to reach “99.9% on-time-performance”, in the industry parlance). And customers accepted it as norm. After deregulation of 1980, anyone could start a business with no more than a driver’s license and 3-months lease payment on a truck, so customers were never short of options for the same offering.
Source: IPUMS-CPS/ University Of Minnesota
Credit: Quoctrung Bui/NPR
Although since then a number of advancements took place (such as tracking, software integrations, and visibility and optimization tools), for the most part players still compete on the same basis. Having spent an early part of my career in customer research, I learnt that 60% of all small package delivery business was won and lost on price; that number was even higher when it came to LTL (carriers that serve customers who do not have enough freight to contract the whole trailer) and full-load truckers. A recent study looked into returns on capital for each segment of the transportation industry. Between the years of 2006 and 2016, the industry as a whole achieved only 6.3% ROIC, 2% less than needed to meet the cost of capital. Inability to meet cost of capital is the first of many indications that the industry’s product is a commodity. By definition, it is undifferentiated.
So what?
Being in the commodity business is dangerous. For one, the firm’s fate is entirely defined by the external forces: price is determined by short-term demand and supply, growth is strictly defined by ability to reduce the cost, and unless the firm controls large portion of the market, it is easily replaceable.
Differentiation, on the other hand, practically or artificially reduces the options for customers. Many people believe that differentiation is about being better than competition. While it is not incorrect, differentiation is about solving customers’ needs, irritations and desires that other providers do not understand or simply ignore. Ultimate objective of differentiation is to create a perception for a customer (or segment of customers) that they have no other choice. In other words, the goal is to build a monopolistic position in customers’ mind. From economics 101, monopolistic position means that the supplier makes all choices about quantity of production and desired profitability. Nirvana of capitalism.
Let’s look at the following example. Every customer values reliable and cost-efficient service. Nonetheless, an auto dealership will value early morning delivery far more than a general auto parts retailer. Ability to fix customer’s car on the day of means that the dealer can get paid faster; for general parts retailer, however, there is no guarantee that the part would be sold the same day, so AM delivery doesn’t matter as much. Both are retail establishments, but alas with different needs. Most transportation companies understand this and offer both regular and AM service but only Cardinal Courier understands that a) mechanic may not always be there at 7am to accept the shipment and b) accepting shipment is a distraction. So Cardinal installed the vaults at customers’ sites. Whether they deliver at 5am or 7am, customer always knows that by 8am, their shipment will be there. Typical couriers such as UPS/FedEx will guarantee AM delivery, much like Cardinal would, but uncertainty of courier’s arrival time leaves customers with Cardinal as the only option (they would otherwise have to keep staff on site overnight to accept the shipment). If Cardinal simply promised 8am delivery, then it’d be very much one of the four options available to the customer. By installing vaults, however, Cardinal gave the mechanic the freedom to run the business as desired and in the process limited his/her choice to one. The less providers can meet intimate needs like this, the less likely the customer will be in control of setting the price. Coke and Pepsi will always be made of the same ingredients, but to those who can taste the difference in fizz, no matter the price, Coke will always be the only option.
FedEx was arguably among the first in the industry who successfully carved out a large segment with under-served need. Its founder, Fred Smith, introduced two new variables to the equation: delivery speed, and shipment visibility. He understood that customers valued information just as much as every other aspect of the delivery cycle. FedEx uncovered a segment of customers who couldn’t plan their production cycles well. Availability of overnight delivery across the country gave these customers opportunity to win business with no structural changes to their supply chains. Technology gave them opportunity to be proactive and to plan production based on up-to-date delivery times. In all fairness, UPS tried offering air the service two decades earlier, but Smith’s focus on technology was groundbreaking and made all the difference.
Since 1970s, UPS and most other carriers adopted tracking and other best practices introduced at FedEx. As a result, today again customers buy a relatively undifferentiated product, with decisions often defined by price. So how could players in the industry become differentiated? Changes in regulation and purchasing patterns have created opportunities that firms in the industry have not seen in years.
Temperature-Controlled Transportation for Healthcare Industry
In 2011, new regulations by FDA, Health Canada and EU Commission required all pharmaceutical manufacturers ensure that their products are transported in the temperature-controlled environment. Pharma companies weren’t happy but agencies held firm.
Several years in, majority of the pharma customers solved the problem in one of the two ways. For international and bulk moves, large manufacturers contract autonomous containers such as Envirotainer or ColdBox. They also rely on truckers such as Skelton Trucklines, Bio Pharma Logistics and Tribe Transportation. For their last mile deliveries to pharmacies they rely on packaging and overnight delivery by FedEx, UPS and Purolator. Occasionally, they outsource final mile to wholesalers’ 3PL arms. Smaller pharma manufacturers had to follow the other route. Most of them had to give up their logistics entirely to wholesalers such as McKesson, AmerisourceBergen and Cardinal Health. While a number of these manufacturers would prefer to retain control over distribution, compliance and handling costs are much higher than the cut that wholesalers take.
While on the surface, things are dandy, in reality most pharma customers quietly gripe about the situation. Packaging is an expensive option, not just because of packaging itself, but because of specifics required to actually ship the product to final customer. To prepare the shipment, shipper has to condition heat/cool packs in the fridge/shelf 48 hours in advance. Doing so requires not only labour, but real estate at the distribution center, as well as investment in fridges. Because packaging is made of insulated material, final shipment becomes double the size and weight of the actual product.
Note: Illustrative only. AeroSafe’s packaging is one of the most advanced solutions on the market with among the highest R-values (measure of thermal resistance per inch), making it lighter and thinner than styrofoam, typically used for packaging.
With dim-weight being a new reality, delivery cost is automatically doubled. In addition, if shipment is sent nationally, shipper has to send it via air, rather than ground (~2x the cost) and account for any missed connections, as most packaging is valid only for 48 hours. Finally, most shippers have no-Friday shipping policy if they do not have guarantee that the product would be delivered next day, thus missing out on sales.
While the problem is evident, few in the industry made the move to address it effectively. For UPS and FedEx it simply doesn’t make sense to invest in hundreds facilities and hundreds of thousands of vehicles across the country just because 10% of customers require temperature controlled transportation. It also doesn’t make sense to segregate the networks, given eCommerce represents far bigger opportunity for both. Most other courier and LTL providers are too small to be meaningful. For those who are able to crack this problem, rewards can be substantial. For instance, in Canada, ATS Healthcare built $200M+ business specifically around pharma. Today it generates mid-teen EBIT margins, double the industry average. Skelton Trucklines is another provider that achieved sustained success in this area.
Construction Sites and Milk-Runs
As North American oil and gas production continues ramping up, the need for critical parts delivered to oilfields will continue to grow. The same is applicable to construction sites. Today, most transportation providers deliver to the site entrance, but never cross the line due to hard hat, steel-toe boots and vest requirements. Drivers are also expected to be trained on safety procedures. Most industrial shippers see significant value in deliveries made directly to the site section where receiver is located. They also place an emphasis on having one company doing final mile delivery on behalf of every provider that brings parts and supplies to the site (known as “milk-run”, where construction site becomes an independent delivery route, with each section representing a delivery stop). Not only it reduces the need to send staff to pick up deliveries at the receiving dock, but it also allows to plan better, knowing that all shipments would be consolidated and dropped off at once at designated time, without disrupting the construction process. Most carriers consider this need not worth the foregone driver productivity, but if done right, this is one of few opportunities to truly differentiate with the construction and industrial shippers.
White Glove Home Delivery
When e-Commerce was born, it was mostly left to small low-value items. As consumers became more comfortable buying online, the order size and the average value of goods purchased online invariably kept climbing. Over the last 3 years retailers of home durables such as fridges, dishwashers, and entertainment systems joined the party. The problem they faced and often still do today is that neither UPS, nor FedEx have the desire or capability to deliver packages with length of more than 108 inches. Their conveyor belts and sorting systems simply aren’t designed to handle items this large.
The duo would often direct their customers to their LTL offering, which tends to be more expensive and designed for industrial customers (i.e. business hours only, delivery to the porch only, tailgate requirement, no advance notifications or delivery window for the receiver). Naturally, for most consumers this delivery experience is terrible. They would have to take days off work only to find that delivery would be made on another day. They’d also have to find someone to help them carry the fridges/dishwashers inside. Needless to say, they’d only buy from retailers who could address these pain points.
While there are several providers who offer “white-glove” home delivery, only XPO built a true national offering. They employed technology for arranging appointment with the receiver. Their drivers are now more technicians than drivers, as they offer full installation and testing services for TVs, entertainment systems, etc. Organic growth of 10%+ annually followed. As UPS finally realized that its own customers are now shifting their business to XPO, it started exploring partnership options. Success in this segment will require more than just ability to deliver to residences. For carriers that can capitalize on the needs of white-goods retailers, much like XPO did, the opportunity to build a strong differentiating position still exists.
Differentiation is Hard
So if there are so many opportunities, why so few take advantage of them? It’s hard to find a business in any industry that would say they don’t want to be differentiated. In reality, most firms either don’t know how to or have a hard time overcoming the hurdles necessary to become differentiated. Differentiation, requires deliberate effort and often takes combination of intuition, true understanding of customers, resources to develop the offering that no one else can replicate, and most importantly hard choices when it comes to internal alignment. I will cover these and some other aspects of this topic in more detail in my next post.