Dhl Case Analysis Essay Example

3rd degree discrimination came into use when setting prices for different markets with different elasticities. All the three types of price discrimination are excellent ways to increase profits. Theoretically speaking, price discrimination is preferred to uniform pricing. But there have also been some argument against price discrimination.

The first concern is from the Multinational Customers (MNCs). They've been demanding a consistent worldwide pricing structure for their own convenience when keeping track of costs. All of them are large customers with a monthly billing of over $15,000, which seem be quite intimidating at a glimpse. However, if we take a good look at the profile of DHL's USA customer base (Exhibit 8), we can see that the $15,001+ accounts only make up 10% of DHL profits in 1990, which is not as significant as we might think.

Also, DHL had only about 10 global contracts with MNCs, representing less than 1% of the revenue. Given these facts, the MNCs don't seems to be worth that much of attention. Price shouldn't be altered due to the pressure from MNCs. Instead, what DHL could do is to negotiate prices with MNCs seeking to cut deals, and agree upon customized prices that would satisfy both the customer and the company itself.

Another argument for uniform pricing is from within the company. Some top executives have suggested that a uniform pricing across regions could lead to better cost control. My view is that, a smarter pricing is way more important than cost reduction. Pricing is going to affect the company's profits most directly and effectively. Cost reduction is a time-consuming process which is best achieved by economies of scale and learning by doing.

The profit forgone in implementing uniform price is likely to outweigh the extra gain from cost reduction, hence we should choose price discrimination over uniform pricing. After all, profit is what truly matters.

Up to this point, there should be no doubt about price discrimination. But in order to enforce price discrimination, DHL should provide its sales force with right incentives and resources necessary to carry out the best price. It has came to my attention that some very significant loopholes exist in these aspects.

Compensation Structure At present, managers are being compensated based on the profit and loss (P;L) within their territories. The contribution of each local operation was calculated by subtracting local costs from revenue. This implies that, the P;L is calculated by deducting the cost incurred within their region from the revenue of that region. Revenue is recognized at the location where a shipment was originated.

This system is unreasonable in the sense that it did not consider the costs to other country operations of delivery and whether the selling price was sufficient to cover the cost of pickup, line haul, hub transfer, delivery, and headquarters overhead and management costs. Therefore, a region's revenue is not being matched with its costs. Its real cost should include all costs along the way of sending its documents or parcels to their destinations. For regions with higher incoming traffic, this system assigns a higher cost to it. The higher cost will distort management's incentive to maximize profit. If use MR=MC to calculate optimal price, the region's MC will become higher than its real MC, resulting in a higher price, and it is not the real profit maximizing price.

So,

in order to provide the incentive for management to carry out a price that maximize the profit, the cost accounting structure must be changed. The company must find out the cost at each step of the transporting, and then add them up to get the total MC of a certain route. This requires DHL to improve its accounting IT system – PRISM.

Problematic PRISM PRISM costs were based on historical data which had been consolidated and averaged. “ All profitability analyses had to be based on average costs due to the variability in costs associated with transporting a shipment.” This indicates that PRISM is using AC in determining costs. As analyzed above, using AC doesn't provide right incentives for setting prices. Unless we fix this shortcoming, optimal price cannot be achieved. Moreover, PRISM “could not consolidate the profits of a given customer across countries.” For a global express company whose 50 million out of 60 million shipments were cross-border shipments, this is a huge drawback.

To preform price discrimination, DHL would need to fix PRISM. The new PRISM should take into consideration all the detailed delivery, pickup, hub, and line haul cost of each possible route, and come up with an accurate marginal cost which is used in determining the price. With more detailed cost information, it should be able to provide profitability analyses for domestic as well as international shipments. Management could better control costs and implement price discrimination with such a system.

Price Setting Structure Another important issue is who should determine the prices. The three options are: centralized, decentralized, or hybrid approach. The present policy is decentralized, where country/regional managers primarily set all prices and

headquarters offer counsel and support. To enforce price discrimination, a centralized structure will not work out. For instance, 1st degree price discrimination requires negotiation with customers to find out their willingness to pay and set price accordingly. Sales reps must have some say in the price. 2nd and 3rd degree price discrimination both require deep investigation into the market, which could only be achieved through regional offices, hence price should be set by regional managers too.

After eliminating centralized structure, the choice could either be a decentralized structure or a hybrid structure. A hybrid structure is one that include multiple pricing committees composed of managers from both headquarters and regions and each responsible for setting prices for one or more specific industries. Decentralization will allow each country/region manager to charge the highest price their market could bear, thus maximizing profits. A hybrid approach may not offer as much incentive as decentralized structure for profit maximization, it could come in handy when trying to achieve other strategic goals.

A Possible Price War In the recent years, the express courier industry has undergone an age of booming. The number of competitors are rapidly increasing and multiplying, that the industry margins are cut thinner and thinner. Among them, the most formidable players are FedEx, TNT and UPS, owning a 7%, 18%, and 4% market share respectively, compared to the 44% market share owned by DHL. They have all been engaging a series of expansions.

FedEx, with many years of experiences in US domestic market, began to expand internationally through acquisitions and competitive pricing in late 1980s. Since 1987, FedEx has invested over $1 billion in 14 acquisitions across the globe. It

also acquired Tiger International to enter the international air freight business. This has further expanded its reach in document and parcel delivery. FedEx now owns its own aircraft fleet. The price was that FedEx's international operations has made losses of $43 million in 1989 and $194 million in 1990. These evidence shows that FedEx is now ready to fight for the international market.

TNT, which was historically mainly focusing on Europe, has decided to penetrate into the North American market by holding a 15% stake in Airborne Freight Corporation.

Through the wild acquisitions, those competitors, especially FedEx, are able to build up large excess capacity. In 1990, DHL planes on average flew 85% full, while FedEx and UPS planes on international routes were thought to be achieving only 60% capacity utilization. Given all these access capacities of FedEx, and the fierce environment of the industry, FedEx is possible to start a price war with DHL. If a price war is triggered, would DHL win or lose?

FedEx is operating with its own aircraft fleet. For DHL, however, 65% of its shipments were sent via scheduled airlines and only 35% via owned or leased aircraft. If FedEx starts a price war and lowers price, it could make up for the lost in marginal profit by the increase in quantity. Its 40% excess aircraft capacity will allow it to increase quantity without a significant raise in cost. DHL should try to match the price charged by DHL, but their planes may run out of capacity due to the increase in quantity. If this happens, DHL could either rent more commercial airplanes and incurring losses, or not matching FedEx's price therefore

losing market shares. Neither result is favorable for FedEx. With a disadvantage in excess capacity, DHL will be at a disadvantage in a price war. So it's better to avoid the war.

On the other hand, does FedEx really favor a price war right now? Its financial reports tell us that FedEx has had financial deficit for two consecutive years, which means FedEx is not in a very good condition to start a price war. Given the already thin industrial margin, engaging in a price war wouldn't be the best choice of FedEx.

So is there a way around the price war? DHL and FedEx are facing a prisoners' dilemma. If FedEx lowers prices, DHL would fight with it, and both of them would not be at their optimal state. With this in mind, DHL and FedEx might be able to cooperate and achieve a win-win situation. DHL could give FedEx the signal by raising its price a little, and see how FedEx reacts to it. If FedEx decides to cooperate, it will soon match the price listed by DHL, and both of the companies would achieve higher profits. If FedEx didn't cooperate, then a price war is unavoidable. However, I believe that FedEx is more likely to cooperate than to disregard.

To raise the overall price in order to signal FedEx, DHL needs a hybrid price structure

WPX There has been an emerging trend of growth in WPX. In 1989, industry revenues were split 75:25 between parcels and documents. The parcel sector grew 40%, while document sector grew 15%. In comparison,DHL's revenues were split 40:60 between parcels and documents. Its parcel sector grew by 28%, and document sector

grew by 14%. (See chart below.) This has clearly shown that, DHL is lagging behind in WPX.

In DHL, prices were often higher for parcels than for documents of equivalent weight. It is due to extra costs for customs, clearance, handling, packaging, and additional paperwork. Exhibit 9 is a list of published prices of the main competitors on selected routes. One number that really stands out is the parcel price – it is almost 4 times more expensive than what UPS charges, and 3 times more expensive than FedEx. Moreover, FedEx is charging the same price for WPX and DOX. These data indicates that there exists a significant gap between DHL and other competitors in WPX area.

The cost of WPX seems to be out of control. This is because DHL lacks the experience in handling WPX. UPS has historically been known as a parcel shipper. FedEx was able to “buy” some learning by doing through acquisitions of other companies. Like DHL, TNT also started late in parcel sector, and that's why both of DHL and TNT have the same high level of price for parcels.

To catch up on WPX, one option is to acquire learning-by-doing. DHL will have to lower its price for parcels to drive up demand, and through learning-by-doing, it could gradually become more efficient in parcel delivering. It is said that the parcel market is typically more price sensitive than the document market, therefore, lowering price is a seemingly affective way to acquire learning-by-doing. To coordinate price of WPX, a hybrid price setting structure is needed.

Another option is to copy what FedEx did – “purchase” learning-by-doing through acquisitions. It is a faster way

to pull up WPX. Some potential candidates could be airlines with experience in parcel shipping.