Growth in a Lower-Margin Business

E-commerce is changing how business is done in a variety of industries. The fact that more commerce is moving online is having a big impact on the shipping business. After all, someone has to ship all those goods that we buy on the web.

UPS is been greatly affected by these changes. A recent Wall Street Journal article, “At UPS, E-Commerce Boom Proves a Heavy Lift” (9/12/14) discusses the changes. Here’s a link to that article:

http://imarketreports.com/at-ups-e-commerce-boom-proves-a-heavy-lift.html

Consider these points:

·            Net income last year (2013) was the highest ever at UPS. However, profit margins on U.S. deliveries have been flat for 3 years.

·            E-Commerce sales are growing rapidly. In the second quarter of 2014, 5.9% of all retail sales in the U.S. came from e-commerce. E-commerce vendors, led by Amazon, have introduced free shipping as a way to gain market share. Because Amazon is such a large UPS customer, they can pressure UPS to lower their shipping prices.

·            The E-Commerce trend requires the typical UPS driver to make more frequent stops to deliver smaller packages. The shift requires more time and fuel expense- which both increase UPS’s costs.

So, if you’re UPS and you’re facing pricing pressure from customers like Amazon, how do you cut costs? Well, here are few things they are implementing:

·            Specialized packaging: UPS will introduce pricing that will encourage customers to use boxes that fit the items being shipped. If UPS can use the room on their trucks more effectively, they fit more boxes in a given truck. That reduces the need for a driver to return to a warehouse to load more boxes- saving time and fuel costs.

·            Know where you’re going: UPS is also investing in a route-optimization system. The program will map out the best ways to pick up and deliver packages.

A Sales Mix Issue:

What’s going on at UPS can also be viewed as a sales mix issue. Sales mix considers the dollar amount of sales you generate for a group of products. Managers need an apples-to-apples comparison of each product’s profitability. Each product has a different sales price, so management needs a tool to compare profit levels.

There are several ways to make this comparison:

·            Profit margin as a percentage: Profit margin is defined as (Net Income)/ (Sales). If a $100 sale generates a $15 profit, the profit margin percentage is ($15)/($100), or 15%. To increase total company profit, the manager can attempt to sell more of the product that generates a higher profit margin percentage.

·            Contribution margin per unit: Contribution margin is defined as (sales – variable cost). Contribution margin is the dollar amount you have to cover fixed costs and generate a profit. A second way to analyze sales mix is to review contribution margin per unit sold. Assuming that all sales incur fixed costs, this analysis only considers variable costs and sales revenue. The product with the higher contribution margin per unit is more profitable. A manager can shift sales toward those more profitable products.

The UPS problem is that industry trends are pushing the firm to take on more E-Commerce business. This business is less profitable than other product lines. UPS is attempting to lower costs on E-Commerce business. Another part of their strategy will likely be to increase sales other business lines that are more profitable.

Here's my podcast on this topic:

http://accountingaccidentally.podbean.com/e/growth-in-a-lower-margin-business/

For blog and article writing, tutoring and speaking on investments and finance, contact me here:

Ken Boyd

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