Out Of the Box

By Sally B. Donnelly/Elizabethtown

Harold Erickson knows his pet food. Every week he doles out thousands of pounds of Royal Canin therapeutic chow for every kind of pet, from aged Afghans to plump Persians. After Hurricane Charley blew through Florida late last summer, the former Army sergeant knew work might get hectic. He had no idea. On Aug. 16, French-based Royal Canin called with an urgent order, and within the hour Erickson, 46, and his co-workers mixed, packed and shipped a whopping 500 lbs. of premium dog and cat food--which can cost up to $30 per 16-lb. bag--to panicked pet owners in the Sunshine State.

But more surprising than what Erickson and his peers at a nondescript warehouse in Elizabethtown, Ky., accomplished that day is who they work for: United Parcel Service. Isn't UPS, universally known as Big Brown, a package-delivery company? Yes--and no. Sure, the bulk of the Atlanta-based company's $33 billion in revenue still comes from moving boxes from one place to another. But the company is rapidly expanding into something called supply-chain management, helping hundreds of clients like Royal Canin not only move products from place to place but also store, assemble and repair goods, even interact with customers, all without the client company's having to get involved. Such insourcing of clients' operations--work that traditionally was done in-house or was farmed out to dozens of different suppliers, shippers, customs clearers and technology experts--is one of UPS's fastest-growing businesses.

Why is UPS plunging into its clients' business? Chief executive Mike Eskew saw an opportunity: "Customers wanted one throat to choke when the pressure was on to deliver. We offered them UPS's throat," he says. UPS already dominates small-package ground delivery in the U.S., handling 13.7 million packages daily and moving items worth 6% of the U.S. GDP every 24 hours. By leveraging its operational efficiency, UPS is attacking what Eskew estimates might become a $3 trillion market--not only taking on smaller, European-based logistics firms like Exel and TNT but also fending off competitive pressure from Belgium-based DHL, which is making an aggressive push into the U.S. Over the past few years, UPS has spent more than $1 billion acquiring 25 companies (from a bank to freight forwarders) to become a logistics jack-of-all-trades. Just last month the company agreed to buy Menlo Worldwide Forwarding, which boasts more than $1 billion in annual revenue. "This is a big deal," says transportation analyst Brian Clancy of MergeGlobal. "It makes them a freight-forwarding powerhouse."

UPS is betting that companies like sports-apparel giant Nike will incorporate its service into their business. Already, every couple of hours Nike sends a batch of orders from Nike.com to a UPS facility in Kentucky. Within minutes a UPS employee using a state-of-the-art radio-frequency bar-code reader, grabs the item--usually made in Asia and delivered directly to UPS--off the shelf. The product, often a pair of Nike's famous shoes, is then quality checked by another UPS employee, carefully packed and sent out the door within 24 hours. "While Nike is researching how to make a better product or looking for another Michael Jordan, we're handling this side of the business," says Dale Helton, a UPS supervisor.

Other UPS employees are filling custom orders for TeddyCrafters teddy bears (dressing them in farmer's outfits or fire fighter's uniforms) or putting together kits of accessories for Nikon cameras. If a Toshiba laptop under warranty needs fixing in the U.S., the damaged product never touches Toshiba. It is shipped (usually from a UPS store) to UPS's Kentucky hub, where a UPS worker evaluates the problem, takes from nearby shelves whatever new Toshiba parts are required, repairs it and then returns the refurbished item--within 24 hours on average.

Since 1996, UPS has built--and filled--2 million sq. ft. of warehouse space right outside the fence at Louisville International Airport. That expansion, combined with UPS's impressive technology (750,000 packages move through another Louisville facility every night), has helped persuade hundreds of new customers to sign on. "The key advantage for UPS is that they are an operations company," says Clancy. "Their whole culture is about operational execution." The TV shopping network HSN was using six different companies to get its products to buyers before it signed on with UPS in November 2003. "We wanted to improve the customer experience," says HSN executive vice president Mark Ethier, who says UPS has done just that with reliability and speed. Package delivery time has been cut by two days on average. How much money is HSN saving? Ethier laughs. "We didn't do this to save money on shipping, and we're not," he says. "But the customers are pleased."

At the same time, UPS's supply-chain expansion is not without risks. The profitability of that business today, with operating margins of roughly 5%, is well below that of UPS's core small-package delivery, at 14%. CEO Eskew's bet is that margins will widen as the business grows--and, perhaps more important, that supply-chain operations will enable UPS to draw in and retain customers for its traditional shipping business. Just last month UPS reported strong earnings for the supply-chain group, which saw a 10% increase in revenue, to $591 million, in the third quarter of 2004.

While FedEx CEO Fred Smith has publicly expressed doubt that margins in the nontransportation side of the business can be improved enough to make it worthwhile for the long haul, Eskew's UPS is forging ahead. The company is spending more than $100 million on an ad campaign (with the awkward slogan "Synchronizing commerce") and has even changed its hallowed corporate charter to reflect the new mind-set: "For 93 years UPS wanted to be 'the best package-delivery company in the world,'" notes UPS spokesman Norman Black. "But now our purpose is to 'enable global commerce.'"

The supply-chain group's distinct operations account for just 6% of UPS revenues, though UPS executives say they expect it to grow to several billion dollars' worth by 2007. Much of that growth will come from overseas, mainly China. Last quarter, in fact, UPS's export volume in China grew 129% over the previous three-month period. "The globe is shrinking," says Kurt Kuehn, UPS senior vice president for worldwide sales. "Companies of any size have to be able to manage global enterprises. That's UPS's core competency."

In the meantime, Harold Erickson is on the job. He spent much of his 22 years in the military organizing and shipping vital supplies like ammo and armor to thousands of soldiers all over the world. Though he recognizes that his current shipments for UPS clearly don't have that life-or-death urgency, Erickson knows what the customer expects. That's why UPS has an on-time delivery rate that's better than 99% for Royal Canin's upscale pet food. Erickson admits, "I was surprised that UPS did this sort of thing." If Eskew has his way, people won't be surprised much longer. --With reporting by Greg Fulton/Atlanta

With reporting by Greg Fulton/Atlanta