FedEx-Ups: The Battle for Value Summary Points

1. FedEx-Ups: The Battle for Value Summary Points Prof. Mike Vetsuypens SMU Cox School of Business

2. EVA=Economic Value Added • EVA=Net Operating Profit after tax (NOPAT) - WACCAT*CAPITAL Increase EVA by.… • a. Increasing Profits with same CAPITAL • b. Maintaining Profits but with less CAPITAL • c. Investing more if IRR>WACCAT • d. Exit an investment when IRR<WACCAT • e. Reducing the WACCAT (WACCAT=Weighted Average Cost of Capital after-tax) (IRR= Internal Rate of Return) (EVA is a registered trademark of Stern Stewart & Co.) Not obvious! Professor Mike Vetsuypens

3. EVA in practice: The case of CSX “EVA is anything but theoretical,”, says CSX CEO John Snow, who introduced the concept at his company in 1988. On the route from New Orleans to Jacksonville, 4 locomotives used to power trains at 28mph. But the trains arrived at midnight, long before they were unloaded onto trucks. Spurred by EVA, CSX decided to run the trains at 25mph with only 3 locomotives and arrive three hours later, but still in plenty of time to be unloaded at 4 or 5 am. The 3 locomotives also use some 25% less fuel than four. Shawn Tully, “The Real Key to Creating Wealth,” Fortune, September 20, 1993, p. 38. Professor Mike Vetsuypens

4. Is EVA a better measure than ROI or IRR? • If past ROI is high, you might avoid positive Net Present Value (NPV) investments if their ROI happens to be less than past ROI (‘starve the stars’) • If past ROI is low, you might accept negative NPV investments if their ROI happens to exceed past ROI (‘feed the dogs’) • EVA avoids these problems by charging each project’s risk-adjusted capital cost! (but so does NPV) Professor Mike Vetsuypens

5. Is EVA a better measure than EPS? • If you try to maximize EPS, you might… • Postpone killing a dying business to avoid write-offs (which lower Earnings) • Over-invest in declining businesses to raise Earnings (all it takes is IRR>after-tax cost of debt) • EVA corrects for these accounting distortions because it focuses on cash flows and includes a cost for equity capital (but so does NPV!) Professor Mike Vetsuypens

6. Add back to NOPAT: Deferred tax reserve LIFO reserve Goodwill amortization Warranty reserve, Bad debt reserve, Inventory Obsolescence reserve Etc…… WHY? To show true taxes paid To correct LIFO inventory understatement To create cash on cash ROI To avoid earnings manipulation Add back to CAPITAL: Cumulative deferred taxes Cumulative LIFO reserves Cumulative goodwill amortization Cumulative reserves for warranties, bad debt, obsolete inventory (“earnings is an opinion, cash flow is a fact”) EVA requires adjustments to GAAP financials Professor Mike Vetsuypens

7. Is EVA a better measure than DCF?(DCF=Discounted Cash Flow) • Technically, the two measures produce the SAME answer ! • NPV(FCF)=PV(FCF)-Investment -the full investment is charged upfront all at once -FCF<0 in early years if strong growth (see 2 examples below) -hard to pay bonuses on negative FCF • PV(EVA)=PV(NOPAT-Capital charge) -capital usage charged against annual NOPAT -EVA can be positive even with strong growth (see 2 examples) -can use annual EVA for bonuses Professor Mike Vetsuypens

8. Professor Mike Vetsuypens

9. Professor Mike Vetsuypens

10. How can we measure performance? Professor Mike Vetsuypens

11. Strategy Points: • The definition of excellence from a financial point of view can differ dramatically from the definition of excellence from an operational point of view • FedEx: invented customer logistical management, was innovative, entrepreneurial, an operational leader, won quality awards • UPS: was big, complacent, bureaucratic, follower, but became a tenacious adversary Professor Mike Vetsuypens

12. Strategy Points (2) • Wall Street has (to date) preferred UPS. Why? • FedEx’s innovations were costly, risky (some failed), and easy to imitate by deep-pocketed UPS • UPS’s strategy may be aimed at denying FedEx the financial performance needed to create positive EVA and attract capital needed to stay in the game (a war of attrition?) • Being operationally excellent is not enough! Companies must also earn competitive return on capital! • FedEx failed to build a sustainable competitive advantage Professor Mike Vetsuypens

13. Building Competitive Advantage Value to Customer Value Drivers allow firm to charge more: - Technology - Quality - Delivery - Breadth of Line - Service - Customization - Risk reduction etc… Price Firm Profit Cost Drivers allow firm to increase margins: - economies of scale/scope - learning curves - low input costs - organizational practices Cost Professor Mike Vetsuypens

14. Retaining Competitive Advantage Value to Customer Increasing Customer Retention: Fight Substitutes by - Raising value to customer - Lower Price - Lower Substitutes’ appeal (search costs/switching costs) Price Firm Profit Preventing Imitation of Resources and Capabilities - exercise property rights - dedicated assets - unique organization skills Cost Professor Mike Vetsuypens

15. Update: What has changed? • summer 1997: strike at UPS • 1997: FedEx Asia expansion hurt by “Asian Crisis” • November 1999: UPS IPO • The rise of the Internet: • will email supplant overnight delivery? • UPS dominates internet shopping delivery • 2003: Asia roars back, FedEx hub at Anchorage big success, biggest player in China, success of LTL freight (‘less-than-truckload’) • EVA at last: FDX outperforms SP500, UPS in 2001-2004 Professor Mike Vetsuypens

16. Professor Mike Vetsuypens