Reference no: EM131248866

Federal Express: Tiger International Acquisition11

What has become one of America's great success stories began operations almost two decades ago in Memphis, Tennessee. At that time, those who knew of Fred Smith's idea did not realize that his small company was about to revolutionize the aircargo industry.

In 1972, the Civil Aeronautics Board ruled that operators flying aircraft with an "all-up" weight of less than 75,000 pounds could be classified as an "air taxi" and would not be required to obtain a certificate of "public convenience and necessity" to operate. This made it possible for Federal Express (FedEx) to penetrate the heavily entrenched air-freight industry. FedEx ordered a fleet of 33 Dassault Falcon fan-jets in 1972 and commenced operations a year later. On April 17, 1973, the company delivered 18 packages, becoming the first to offer nationwide overnight delivery.
One of FedEx's fundamental principles was use of the hub-and-spoke system, in which all packages were flown to Memphis first, sorted during the night, and then shipped to their destinations the following morning. This system allowed FedEx to serve a large number of cities with a minimum number of aircraft. It also provided tight control and efficiency of ground operations and soon became increasingly important as package-tracking systems were installed.
During the first two years of operations, FedEx lost money, but revenues surpassed the $5 billion mark in fiscal year 1989, partly because of the acquisition of Tiger International.
As Table 14.3shows, FedEx began global expansion in 1984, when it purchased Gelco International. FedEx followed that expansion with its first scheduled flight to Europe in 1985, and it established a European headquarters in Brussels, Belgium, that same year.

Domestic operations were expanded as well. In 1986, regional hubs were established in Oakland, California, and in Newark, New Jersey. In 1987, a sorting facility was opened in

Indianapolis, and Honolulu was chosen for the Far East headquarters. That same year, FedEx was granted the rights to a small-cargo route to Japan, and the following year the company was making regularly scheduled flights to Asia.
International expansion did not result in immediate international success, however. In Asia, its planes were flying at half their capacity because of treaty restrictions, and a lack of backup planes in its South American operations jeopardized guaranteed delivery when regular aircraft were grounded. Even worse, many managers of the companies acquired in Europe had quit.
As a solution to these international bottlenecks, FedEx made a dramatic move in December of 1988, announcing plans to purchase Tiger International, the parent company of Flying Tigers, the world's largest heavy-cargo airline. The purchase price was about $880 million.

This action catapulted FedEx to the forefront of the international cargo market, giving it landing rights in 21 additional countries; however, the addition of Tigers was not without challenges. For example, the leveraged acquisition more than doubled FedEx's long-term debt, to approximately $2 billion. Moreover, FedEx had bought into the business of delivering heavy cargo, much of which was not sent overnight, which represented a significant departure from FedEx's traditional market niche. One of the largest dilemmas facing FedEx following the merger was how to integrate the two workforces.
MAJOR PLAYERS IN THE DOMESTIC AIR-CARGO INDUSTRY
Federal Express is the nation's largest overnight carrier, with more than 40 percent of the domestic market. United Parcel Service (UPS), DHL (an international carrier based in Brussels), and a few other carriers account for the remaining market share. FedEx had revenues of $3.9 billion and a net income of $188 million in 1988. FedEx had lost approximately $74 million on its international business since 1985, however, prompting the carrier to purchase Tiger International. That acquisition, which gained U.S. government approval on January 31, 1989, gave FedEx a strong entry position into heavy cargo as well as access to 21 additional countries.

Price wars, which began with UPS's entry into the overnight business, have decreased FedEx's revenues per package by 15 percent since 1984. Another setback to FedEx was its $350 million loss on Zapmail, which it dropped in 1986. A document transmission service that relayed information via satellite, Zapmail was quickly made obsolete by facsimile machines.
FedEx does offer its customers several other benefits not matched by its competitors, however. For example, it offers a 1-hour "on-call" pickup service, and through use of its database information system, COSMOS, FedEx guarantees that it can locate any package in its possession within 30 minutes. FedEx has found that this type of customer security helps to ensure continued growth.

THE NATURE OF THE COMPETITION

The air-cargo industry has undergone a series of mergers resulting from the recent price wars that rocked the industry. Also, marketing alliances have been formed between domestic and foreign carriers to take better advantage of international trade and to create new routes and services (e.g., package tracking).
When UPS entered the overnight-package market in 1982, competition rose substantially, starting the series of price wars that have hurt all air-cargo players. FedEx's average revenue per package declined by 30.3 percent between 1983 and 1988.
Fortunately, it appears that the price-cutting strategy may have finally run its course. When UPS, which created the price wars, announced another price cut in October of 1988, its competitors refused to follow, and in January 1993, UPS announced its first price increase in almost six years, a 5 percent increase in charges for next-day service. Several factors such as continued overcapacity, low switching costs, and high exit barriers, however, will continue to make the air-cargo industry extremely competitive.

CONCLUSIONS ON THE AIR-CARGO ENVIRONMENT

Although the situation may be improving, intraindustry competition and rivalry remain the main deterrent to the air-cargo industry. With overcapacity in the industry, firms, desperate to fill planes, continue to realize declining yields on the packages they ship.

Moreover, passenger airlines are reentering the air-cargo market with increased vigor, which also does not help the capacity situation. All these factors are leading current players to consolidate their operations in hope of achieving increased economies of scale.

Technology is acting as both friend and foe of the aircargo industry. Facsimile machines have carved a large niche from the overnight-document segment; on the other hand, improved databases are enabling companies to provide their clients with another valuable service: improved tracking information on the status of important shipments.
Until now, the large number of shippers has enabled buyers to enjoy low rates, but because of their wide dispersion, buyers are not able to control effectively the air-cargo companies. Likewise, air-cargo companies continue to have an advantage over their suppliers. The ability to purchase older planes keeps firms less dependent on aircraft manufacturers, and a large, unskilled labor pool helps to keep hub labor costs down. A lack of available airport facilities, however, presents a serious problem to the commercial air-freight industry. Not only is the lack of landing slots a problem in the United States, but acquiring government-controlled access to crowded international hubs can present a formidable challenge.

WORLDWIDE DISTRIBUTION

As the globe continues to shrink and economies grow more interdependent, customers are demanding new services to facilitate revamped production processes. One of the most publicized is the just-in-time (JIT) system that many U.S. firms have borrowed from their Japanese competitors. JIT systems argue for elimination of the traditional inventory stockpiles common to manufacturing, including the raw material, workin-process, and finished-goods inventories. Without question, such a scheme relies on having the right part at the right place at the right time.
Air express has been able to play a reliable role in delivering these needed materials on time. FedEx and its competitors have succeeded in contracting with manufacturers to supply the needed logistical expertise to support its JIT framework. Essentially, the planes have become flying warehouses. As this area grows, the Tiger addition to FedEx should reap large yields with its ability to handle the heavier shipments that are associated with international manufacturing. For example, an increasing amount of parts made in Asia are being shipped to the United States for final assembly.

POWERSHIP

To facilitate further penetration into a customer's business, FedEx developed Powership, which is a program that locates terminals on a client's premises and, thus, enables FedEx to stay abreast of the firm's needs. In simplifying the daily shipping process, an automated program tracks shipments, provides pricing information, and prints invoices. Such a device helps to eliminate the administrative need of reconciling manifests with invoices. Currently, more than 7,000 of FedEx's highestvolume customers are integrated into the Powership system. At Federal Express, customer automation is expected to play an increasingly significant role. By tying technological innovations with reliable on-time delivery, FedEx is achieving its goal of getting closer to the customer.

CORPORATE CULTURE

Many believe that FedEx could not have grown to its current magnitude had it been forced to deal with the added pressure of negotiating with a unionized workforce. FedEx has never employed organized labor, although attempts at unionization have been made. In 1976, the International Association of Machinists and Aerospace Workers tried to organize the company's mechanics, who rejected the offer. Likewise, FedEx's pilots rejected an offer by the Airline Pilots Association during that same period. In 1978, the Teamsters attempted to organize the hub sorters but could not get enough signatures for a vote.
Despite an admirable human resource track record, the outlook for FedEx to continue its past performance is hazy. Because of the Tiger International acquisition, FedEx had to merge the unionized Flying Tigers workforce with its own union-free environment. Previously, the willingness of FedEx workers to go above and beyond in performing their duties had given the company a marked advantage over UPS, the nation's largest employer of United Brotherhood of Teamsters members. As the FedEx-Tiger merger progressed, however, many questions remained to be answered.

ACQUISITION OF TIGER INTERNATIONAL

In December 1988, FedEx announced its intent to purchase Flying Tigers, and in early 1989, more than 40 years of air-cargo experience were merged with FedEx. Besides giving FedEx entry into an additional 21 nations, the Tigers merger possessed several other advantages for the aggressive company. Almost overnight, FedEx became owner of the world's largest full-service, all-cargo airline, nearly three times the size of its nearest competitor. Because FedEx could use this large fleet on its newly acquired routes, it no longer would be forced into the position of contracting out to other freight carriers in markets not served previously.

The addition of heavy freight to the FedEx service mix was viewed as a boost to its traditional express package-delivery business. The merger fit in neatly with the company's plans to focus on the higher-margin box business while shifting away from document service. During the preceding two years, box shipments had increased by 53 percent, generating as much as 80 percent of revenues and an estimated 90 percent of profits.
On the downside, as noted earlier, the $2 billion debt that was incurred by the merger and the capital intensiveness of the heavy-cargo business made the company more vulnerable to economic swings. Although the merger meshed well into its plans, FedEx still was a newcomer to the heavy-cargo market.
Another hurdle was that many premerger Flying Tigers customers were competitors that used Tigers to reach markets where they, like FedEx, had no service or could not establish service.
Finally, FedEx had to integrate the 6,500 unionized Tigers workers into a union-free company. Although Flying Tigers was founded with much the same type of entrepreneurial spirit that was cherished at Federal Express, the carrier had seen its workforce become members of organized labor early in its existence
At the time of the merger, the Tigers union ties were severed. FedEx promised to find positions for all employees, but critics felt that the union background of Tigers workers would dilute the corporate culture at Federal Express. Whether FedEx could continue its success story appeared to hinge on its ability to impart its way of life to the Tigers workers, not vice versa.

Questions

1. Describe the growth strategy of Federal Express. How has this strategy differed from those of its competitors?

2. What risks are involved in the acquisition of Tiger International?

3. In addition to the question of merging FedEx and Flying Tigers pilots, what other problems could be anticipated in accomplishing this acquisition?

4. Suggest a plan of action that Fred Smith could have used to address the potential acquisition problems given in your answer to the previous question.