Passengers, Packages: The Paradox of Air Transport

Paul Goldberger’s article Situation Terminal in the April 21, 2008 issue of The New Yorker magazine reminds us that “Airports are essentially machines for processing people, airplanes, automobiles, cargo and baggage.” He also notes the most recent example of the huge impact passenger baggage handling has on airport operations:

… Terminal 5, an eight-billion-dollar structure that was supposed to transform Heathrow from a congested tangle into a place that would thrill passengers with the joy of air travel, all but shut down on its opening day, when a computerized baggage system malfunctioned (p. 132).

In my last post in this series, Luggage Forward Flying: How to Restore Passenger Confidence and Carrier Profitability, I proposed a radical solution to the baggage handling problem: Removing baggage from the passenger air transport system by shifting it to the express shippers’ transport system:

Suppose all the major carriers were to enter into a partnership with FedEx (NYSE: FDX), UPS (NYSE: UPS), DHL and the other shippers with Luggage Forward operating as the corner stone in a worldwide baggage handling solution. This would remove passenger baggage handling from airports and passenger carriers altogether.

I also reviewed nine of the operational issues associated with that proposal. These nine don't need repeating as they are more-or-less easy hurdles to clear in such a massive change in passenger baggage handling. That post concluded with three deal-breaker questions. Two of these are the focus of this post: (1) Do the package carriers have the capacity to handle the additional volume and (2) Are the scale economies associated with passenger carriers bundling Luggage Forward into their reservation system sufficient to produce affordable shipping rates?

THE PARADOX

The top ten U.S. passenger carriers had a combined market cap of $20.38 billion on April 25, 2008. The top two U.S. package carriers, FedEx and UPS, had a market cap of $104.19 billion. Here’s the paradox of air transportation: Why do investors reward U.S. package carriers with five times the value they assign to passenger carriers? It's not because of revenue differences: American Airlines (NYSE: AMR) had a value/revenue ratio of 0.08 in 2007 compared with a UPS ratio of 1.50.

A LITTLE PERSPECTIVE

On Thursday I ordered a new HP Laser Jet P2015 printer from Amazon.com (NASDAQGS: AMZN). The retail price was $449. I paid just $289.99. The next-day Amazon Prime delivery charge for this 28.9 pound package on UPS was $3.99. Based on this rate significant scale economies must exist in AMZN’s agreement with UPS as a result of huge shipping volumes.

My printer was picked up at the Amazon facility in Dallas TX at 8:53 on Thursday evening. The next morning I called the UPS toll-free number to ask for a delivery time. The local station called me back within the hour to say that the driver would deliver my package at 1:30 PM on Friday. He actually delivered it at 1:25 PM.

Think about this. Passengers must do a large share of the work in baggage handling: getting the bag to the airport, checking it in, waiting at the baggage carrousel after landing, carrying it to ground transportation and then to the hotel. So passenger carriers could eliminate the need for both paid and unpaid baggage handlers.

AMZN in partnership with UPS can ship that 30 pound printer overnight for $4. If I’m willing to have my bag picked up at 8:30 the night before my trip and delivered to my hotel at 1:30 the next day, why can’t ARM, in partnership with Luggage Forward and UPS, ship my 30 pound bag for the same $4? With virtually no risk if loss or late delivery.

NO OBVIOUS ANSWER

Both passenger and package carriers are subject to the same forces. As Joseph Weisenthal said in a recent post Airline-In-A-Box:

Few businesses have as many variables and challenges as airlines. They are capital-intensive. Competition is fierce. Airlines are fossil fuel dependent and often at the mercy of fuel price volatility. Operations are labor intensive and subject to government control and political influence. And a lot depends on the weather.

It's true that both passenger airlines and package carriers are capital intensive. In 2007 FDX and UPS had capital intensity ratios of $0.68 and $0.79 respectively. The two largest passenger carriers, AMR and United Airlines (NASDAQGS: UAUA), had capital intensity ratio of $0.80 and $0.83 respectively.

The packages carriers have far less exposure to fuel price volatility than passenger carriers because they rely on indexed fuel surcharges. In 2007 FDX and UPS fuel costs as a percent of revenues were 10% and 6% respectively. AMR and UAUA had fuel costs of 29% and 25% respectively. One might wonder why the passenger carriers don’t also relay on indexed fuel surcharges. Today David Enke posted an interesting answer to this question in To Hedge or Not to Hedge.

The package carriers actually are more labor intensive than the passenger carriers. In 2007 FDX and UPS posted labor intensity ratios of 39.0% and 63.9% respectively. The two largest passenger carriers, AMR and UAUA, had labor intensity ratios of 29.5% and 21.2% respectively. Southwest Airlines (NYSE: LUV) had half the revenues of United but operated with a labor intensity ratio of 32.6%.

The number of employees per aircraft is a more telling indicator of the package carriers labor intensity. In 2007 FDX and UPS had 432 and 1,587 employees per aircraft respectively. The top two passenger carriers, AMR and UAUA, had 131 and 138 employees per aircraft.

Of course, all the extra people per plane employed by package carriers are required to make sure packages are picked-up and arrive on time. For example, in 2007 UPS had:

• 4,647UPS Stores®
• 1,306 Mail Boxes Etc.®
• 1,000 UPS Customer Centers
• 17,000 Authorized outlets
• 40,000 UPS Drop Boxes
• 1,800 Operating Facilities
• 93,637 package cars, vans, tractors, motorcycles
• 268 jet aircraft and
• 311 Chartered Aircraft

Maybe this is why UPS was able to offer next-day delivery at 1:30 PM!

PACKAGE CARRIER CAPACITY

It’s impossible to calculate what the industry calls the “letter/box” ratio without inside knowledge of package carrier operations. This ratio tells if the package carriers have the capacity to take on passenger baggage delivery. I asked an industry source to give me an opinion on this. Here’s what he reported in an email:

I don’t know their Letter/Box ratio but according to the UPS Q1 2008 earnings report, they shipped an average of 15.1 Million packages per day. I know FedEx moves less packages than UPS. I’ve been told that UPS has a smaller Letter/Box ratio than FedEx.

I know that there are approximately 2 Million emplaned passengers (DOT Stat) per day in the US and they average about 2 bags each. So, we’re talking about 4 Million pieces of luggage per day in the US. My guess is that the carriers can handle that type of increase. I think it is safe to assume the shippers are not operating at capacity and they could handle a 10-20% increase.

It looks like package carriers could scale up to handle passenger baggage. And based on the AMZN/UPS shipping rate of $4 per bag it seems reasonable to think an affordable express shipping charge could be built into the air fares of passenger reservations systems.

BECAUSE PACKAGES CAN’T WALK

The American Consumer Satisfaction Index [ACSI] was created by Professor Claes Fornell of the Ross Business School at the University of Michigan. The ACSI measures customer satisfaction for over 200 companies in 43 industries. Both passenger and package airlines are included.

FedEx and UPS have had ACSI customer satisfaction scores around 80% in each of the last ten years. In the same period AMR and UAUA have barely broken 60% customer satisfaction barrier. It’s been shown that higher ACSI consumer satisfaction scores are associated with significantly higher shareholder returns.

Some will say high customer satisfaction with express shippers is “because packages can’t walk.” The carriers must do everything with very little customer involvement. Of course that’s true. But it’s also true that almost everything express carriers do is dedicated to delivering packages on time. That’s their specialty.

Wouldn’t it improve consumer satisfaction if passenger carriers took baggage out of their equation? And specialized in transporting passengers? In economics this is called the “division of labor.” An idea famously created by Adam Smith in The Wealth of Nations using "the trade of the pin-maker" as an example. What do you think?

Comments

[sckarolek:]

Hello, interesting opinions, thanks for sharing. Re: Amazon Prime, you've conveniently left out the $75 you paid to join. I think Amazon rolls the dice on this betting that some will get more than $75 worth of shipping and some will get less than $75 worth of shipping but they will be able to invest the aggregate $75 membership fees and operate off of the investment profits.

History seems to indicate that when Bezos rolls the dice on investment issues, he isn't wrong very often.

2008 Apr 28 09:27 AM

[Victor Cook:]

Sckarolek,

Thanks for the reminder about the cost of Amazon Prime. I use the service so often it seems virtually free.

Rolling the dice is in the nature of membership clubs. My son's monther in law belongs to Costco. When we go shopping she rolls out two baskets full of so much stuff it probably pays for her membership in a single trip.

2008 Apr 28 10:27 AM

[JMike49:]

As has been previously pointed out, Amazon Prime skews the whole arguement.

The average person shipping a 30 lb. package will pay a heck of a lot more than $4 for next day shipping. I have shipped many packages and have had many packages shipped to me. In my experience, I would venture a guess that the average person would pay somewhere in the neighborhood of $70-90 to ship a 30 lb suitcase overnight. One can expect approximately half that amount for 3 day service.

Having said that, the concept is still a valid one, albeit at a higher cost to the consumer than the article would lead one to believe.

2008 Apr 28 12:16 PM

[Frequent Tr...:]

Southwest Airlines has already begun utilizing FEDEX for delivery of late/delayed bags. I had this happen recently and was pleased with the next day delivery. I must assume that Southwest gets a preferred rate for this service and this rate could certainly be passed along to the passenger if they decided to utilize the service for regular pickup and delivery. Certainly this would reduce the number of employees needed per aircraft. This would also shift the liability for loss and damage to the shipper and away from the carrier. Sounds like a win-win solution to a ever-increasing problem.

2008 Apr 28 10:32 PM

[Airline Pilot:]

If it worked, this concept would mean happier passengers, more revenue for cargo carriers, more room for cargo revenue in the bellies of passenger airliners and fuel savings for the passenger carriers due to lighter aircraft. Lastly, it would provide greater flexibility in 'tankering' fuel . . . that's when we choose to take on significantly more fuel than is needed, in order to buy more where it's cheapest.
Great stuff, but it doesn't seem feasible. Have you been through an airport security line lately? What I see as I pass through about 20 times a month is a widespread lack of preparedness on the part of the travelling public. "What bags can I take onboard?" "What items can't I take through security?" Joe & Jane Traveler don't seem to plan their packing very well. For example, people are still putting prescription meds in their checked bags. This express shipping concept would require that passengers planned ahead for what they'd be carrying with them and what would be shipped . . . not likely. Not on a widespread basis, anyway.

2008 Apr 29 09:07 AM

[Cookie Monster:]

Interesting, but off the mark IMHO. The real difference between passengers & their bags and boxes going air freight is the attention people demand for which they are unwilling to pay. People want to be pampered, they want their call drinks, they want wonderful food, they want executive waiting areas, they want wheelchair accessability, they want their 10-year olds to be able to travel alone, they want internet access throughout their travels, they want boarding music and movies in-flight. Boxes don't require any of this. In addition, while there are many air freight companies, there are really two powerhouses: FedEx and UPS. Congress and the public seem comfortable with this, yet anytime there seems to be a real chance of consolidating the airline industry down to 3 or four powerhouse carriers who might have a chance to become stable and profitable, there is a hue and cry from Washington about loss of service to remote areas and rising costs. As long as the government won't let carriers really compete (and some lose!) the entire industry will remain stuck. As long as carriers attempt to sell transportation as some sort of "Air Spa" they'll have to produce the personal treatment they have lead people to expect.

Passengers can't expect to pay air freight rates for their own transportation and then demand hot towels, lay-flat seats and hot fudge sundaes. Companies can't advertise the glamour and then compete on minimum cost. The Government can't claim that this is a competitive market when they won't get their hands off the competition.

Other than the above, it's really simple.

2008 Apr 29 12:29 PM

[Victor Cook:]

JMike49,

Actually you’re way off on the UPS average person shipping cost.

I just priced a 30 lb. package on UPS. If I shipped it by regular Next Day Air from New Orleans to Dallas in a Large UPS box with a declared value of $300 it would cost me $142.50. Shipped by Next Day Super Saver with no declared value it would be $134.16.

Can the difference between the single shipper UPS retail fares and the Amazon Prime cost of $3.99 be driven by volume discounts? Maybe. See my latest post.

2008 May 12 05:42 PM

[Victor Cook:]

Frequent Traveler,

I wasn’t aware the Southwest Airlines used FEDEX to deliver late/delayed bags. You also make a good case for some of the advantages of express delivery of passenger luggage. Thanks for your comments.

~V

2008 May 12 06:19 PM

[Victor Cook:]

Airline Pilot,

Excellent points! Especially the requirement that passengers must plan ahead for what they'd be carrying with them and what would be shipped. I travel a lot too and you’re right, many travelers are unprepared.

Planning ahead is a lot to ask of the ones who are unprepared. But there’s an upside that even the most careless traveler will notice: they don’t have to carry their bags to the airport, lug them into the check in line, then wait for them by the carrousel at their destination, lug them out to a vehicle, into their hotel and go through the whole thing on the return trip. Maybe the relief from these chores and knowing their bags would be picked up and returned to their home would be enough to it motivate careless travelers to plan ahead.

Here’s another possibility. What about providing passengers with standardized, re-usable “air valise” containers in small, medium and large sizes to pack their belongings? This would remind travelers that they had to plan ahead. It would also make it a lot easier for package shippers to handle the cargo.

Thanks for your comments.

~V

2008 May 12 06:21 PM

[Victor Cook:]

Cookie Monster,

“People want to be pampered.”

Yes, that’s my point. Let the box specialists move the boxes and the passenger specialists pamper the passengers!

“While there are many air freight companies, there are really two powerhouses: FedEx and UPS.”

Actually there are three: you forgot the biggest one of all DHL.

“… anytime there seems to be a real chance of consolidating the airline industry down to 3 or four powerhouse carriers who might have a chance to become stable and profitable, there is a hue and cry from Washington about loss of service to remote areas and rising costs.”

The package carriers did not consolidate down to 3 or four. They created the business to diminish the government monopoly and expanded up from 1 to 3 or 4 companies.

“Passengers can't expect to pay air freight rates for their own transportation and then demand hot towels, lay-flat seats and hot fudge sundaes. Do you any idea of what air freight rates might be if the package carriers managed all the “free” checked baggage?”

Well, that’s really good question! I try to shed a little light on the it in my latest post: Charting a Demand Curve Without Any Data." If you have some additional data to add that would be great!

Thanks for your comments.

~V

2008 May 12 06:32 PM

[Sacandaga:]

This is one of the nuttiest ideas I've ever heard.
For one thing, the average passenger that checks luggage (only about 60% of all air passengers) is never going to be willing to 1) pack far enough ahead of time to get it picked up by an express company, or 2) be willing to have it deposited at their destination unprotected, or have some stranger sign for it. Keep in mind that many people don't go immediately to a hotel from the airport, so someone is going to have to take responsibility for securing their luggage when it arrives, which may be many hours before you claim it.

Also, what makes you think that passenger airlines can easily fill their luggage compartments with profitable cargo? Their space-available cargo services are filled mostly with mail, and there is less and less mail in the system these days.

Just because Heathrow had day one problems, it doesn't mean that managing airport luggage sorting is beyond the reach of modern technology. The biggest obstacle to efficiency is the spot checking and scanning that Homeland Security now requires, not the coding and routing itself.

Face it -- people want their luggage to travel with them. They will never believe they are better off having lots of additional people handle and store it over a completely separate system on a separate schedule. And the purported cost savings will quickly turn into cost overrruns worse than anything happening in the current passenger system.

2008 May 13 04:33 PM

[Victor Cook:]

Sallfham,

“… only about 60% of all air passengers check their bags.” This is very useful statistic. Please give me reference.

“… who is going to have to take responsibility for securing their luggage when it arrives?” You may be out of step with the times on this one. Here’s the latest information I could find on baggage security at airports:

“Do you remember some airports before 9/11 had those “security” people who checked your luggage claim checks against the bags you were taking with you? Where are they now? Who is watching out for your luggage until you claim it at the carousel? The answer is NOONE is watching out for your luggage”

“ … what makes you think that passenger airlines can easily fill their luggage compartments with profitable cargo?” A comment by a senior operations manager at a legacy carrier that I quoted in an earlier post in this series.

“Just because Heathrow had day one problems, it doesn't mean that managing airport luggage sorting is beyond the reach of modern technology.” The Heathrow reference was just a lead in to my post on the problems with checked baggage, not a condemnation of modern technology.

“The biggest obstacle to efficiency is the spot checking and scanning that Homeland Security now requires, not the coding and routing itself.” Exactly! That’s another reason to remove luggage from the passenger transport system.

“Face it -- people want their luggage to travel with them.” I believe that you want your luggage to travel with you, but I’m not sure that you represent the traveling population.

Thanks for your comments.

~V

2008 May 14 09:34 AM