For 45-960: Sustainable Operations
By Afshan Rehman, Jess Kaplan, Mathew Polowitz, Paul Scherlek and David Yaffe
executive summary
FedEx, a Fortune 500 company, is one of the world’s largest delivery companies. When the case was written in 2005, the company had 250,000 employees in 220 countries, 6 million daily package deliveries, revenues nearing $30 billion, and around 70,000 vehicles in their fleet. Clearly, any decision the firm would make would have a substantial impact on revenues and the surrounding environment.
FedEx faced a problem at the time, as their historic fleet of vehicles were expensive to operate. Diesel fuel prices were rising and became one of the more unpredictable aspects of the company’s operating costs. Additionally, corporate entities, nonprofits, and government regulators were beginning to notice the negative impact that delivery vehicle emissions caused in the environment. Diesel exhaust was linked to several health problems including weakened immune systems and respiratory diseases.
With help from Environmental Defense (ED), a non-profit that partnered with large corporations to push them towards fair, non-partisan environmentally-friendly solutions that are able to achieve significant cost savings, FedEx was able to successfully navigate through the strategic sourcing initiative of an environmentally friendly fleet of delivery vehicles. ED identified the opportunity to reduce smog-causing pollution and worked behind the scenes to convince and lead FedEx through the process.
Because of the work done by ED, FedEx and Eaton, the supplier chosen for the project, received substantial publicity and awards for the project. FedEx successfully launched over 100 diesel-hybrid delivery vehicles on routes by 2006 and hit their key objectives by reducing emissions while also reducing their overall fuel consumption. The company also became a leader in the industry, with this project setting off a wave of similar projects throughout the trucking industry.
analysis of the problem
When Environmental Defense reached out to FedEx with the goal of exploring and opportunity to update its fleet, the suggestion was initially met with skepticism. In the early 1990’s, FedEx evaluated several alternative fuel technologies. This project involved deploying a fleet of over 100 vehicles, with mixed results in terms of vehicle and environmental performance, and infrastructure requirements. As a result, FedEx focused on making incremental improvements to its existing fleet, targeting improved fuel efficiency and lower environmental impact.
It was clear that the opportunity was ripe. Per Environmental Defense’s analysis, for every 10,000 FedEx delivery trucks converted to hybrids, nearly 2,000 tons of smog-causing pollution would be eliminated. Given a majority of FedEx routes required frequent stops, it appeared that there was a strong fit for hybrid technology in maximizing the advantages of regenerative braking.
As such, it seems interesting there were no alternatives for trucks on the market at this time. While the Toyota Prius and Honda Insight were widely available when Environmental Defense approached FedEx in 2000, these were smaller sedans geared toward individual consumers. One reason there were not alternatives may have been that these were both Asian producers; given many larger vehicles, like the W700-class series, were generally too big for city streets in Asia (and Europe), it was likely not yet enough demand in the U.S. for Toyota and Honda to create a larger hybrid vehicle.
This is made even more likely by the notion that, at this time, most government air-quality regulation targeting trucks focused on the engines, and not the entire vehicle. This meant that incremental changes to achieve minimum requirements were often taken, rather than a more costly fleet investment in new technologies. Once federal incentives for purchase of commercial hybrid vehicles were instated in 2005, there was a much stronger incentive - including tax credits to cover a significant portion of incremental costs - to invest in these new technologies.
measuring success
Environmental Defense
With the goal of reducing or eliminating environmental problems, ED will be most interested in the net environmental impact of the project. Success should be defined by a reduction in the consumption of fuel and output of exhaust gasses in the affected industry. ED will also be concerned about the environmental impact of the production, delivery, and the eventual disposal of the new vehicles. With that in mind, ED should consider this project a success if they are able to reduce fuel consumption and exhaust output without creating a negative environmental impact through production or disposal.
With the goal of reducing or eliminating environmental problems, ED will be most interested in the net environmental impact of the project. Success should be defined by a reduction in the consumption of fuel and output of exhaust gasses in the affected industry. ED will also be concerned about the environmental impact of the production, delivery, and the eventual disposal of the new vehicles. With that in mind, ED should consider this project a success if they are able to reduce fuel consumption and exhaust output without creating a negative environmental impact through production or disposal.
FedEx
FedEx’s primary concern is the financial and operational viability of the new Eaton trucks. FedEx is interested in reducing its exposure to the volatile oil market as well as the cost to operate their fleet overall. To measure the success of the project, FedEx should compare the net present value, payback periods, and tax impacts to the vehicles that will be replaced. Positive values indicate a financially viable project. As the vehicles are put into production and operations data such as maintenance costs, downtime, etc. is collected, FedEx should compare their real-life results to the test results. If the project is both financially and operationally viable, FedEx should consider the transition a success.
FedEx’s primary concern is the financial and operational viability of the new Eaton trucks. FedEx is interested in reducing its exposure to the volatile oil market as well as the cost to operate their fleet overall. To measure the success of the project, FedEx should compare the net present value, payback periods, and tax impacts to the vehicles that will be replaced. Positive values indicate a financially viable project. As the vehicles are put into production and operations data such as maintenance costs, downtime, etc. is collected, FedEx should compare their real-life results to the test results. If the project is both financially and operationally viable, FedEx should consider the transition a success.
Eaton
For Eaton, the success of their new vehicles will be defined by the project’s impact on their financials. Primarily, Eaton should be looking at revenue growth and cost reduction. Eaton should also attempt to measure the impact of any marketing that occurs as a result of this line. Some metrics to consider include change in the number of searches, unique users on their website, RFP growth, and brand awareness. If the project is financially viable and increases (or at least does not decrease) their marketing / sales figures, it should be considered a success.
For Eaton, the success of their new vehicles will be defined by the project’s impact on their financials. Primarily, Eaton should be looking at revenue growth and cost reduction. Eaton should also attempt to measure the impact of any marketing that occurs as a result of this line. Some metrics to consider include change in the number of searches, unique users on their website, RFP growth, and brand awareness. If the project is financially viable and increases (or at least does not decrease) their marketing / sales figures, it should be considered a success.
pricing hybrid trucks
As FedEx looks to acquire commercial hybrid vehicles to add to their fleet, cost becomes a major consideration. In 2005, the average cost for one of FedEx’s diesel delivery vehicles was around $40,000. We are also told in the case that FedEx’s typical lifespan for a diesel vehicle is around 10 years. With the hybrid vehicle, warranties had a 9-year lifespan. It would make sense that FedEx would like to recoup their investment on a hybrid vehicle within that time period.
With production of the hybrid delivery vehicle being so new, costs would be expected to remain high until scale can be achieved to achieve further costs savings along the value chain. FedEx should be willing to pay a premium on early versions of the delivery trucks now to help Eaton (or other suppliers) reach economies of scale. The expected price for a hybrid delivery vehicle would be $52,000 once mature production volumes were achieved, but to determine the maximum cost to pay, other considerations need to be taken into account. Hybrid vehicles would increase fuel efficiency by 57% over current diesel engines, resulting in significant cost savings for FedEx. Additionally, congress provides up to a $15,000 tax credit for purchase of commercial hybrid vehicles. For FedEx, the 57% improvement in fuel mileage means up to $6,000 in tax credits for this new hybrid delivery vehicle.
Environmental Defense calculated that for every 10,000 conventional delivery trucks that were replaced by hybrids, diesel fuel usage would be reduced by 6.5 million gallons per year. This allows us to determine that each hybrid vehicle will save around 650 gallons of fuel per year, or an estimated 6500 gallons over a ten-year life. At a projected $2.80/gallon, each purchased hybrid vehicle would save FedEx an additional $18,200. With these substantial cost savings plus the potential for free marketing through news coverage of this deal and the $6,000 tax credit, FedEx should be willing to pay around $26,000 more than they would for a traditional vehicle, or up to $66,000/vehicle once mature production volumes are achieved. This number should remain valid as long as all other variables are held constant, and could potentially be even larger if higher fuel prices are on the horizon. This $66,000 maximum figure is in line with Eaton’s public statement about hybrid vehicles being at a minimum 50% more expensive than conventional vehicles. It would not be unexpected for FedEx to be willing to pay slightly more for early versions of this vehicle, potentially up to $70 - 75,000, as Eaton scales production.
FedEx should contract with hybrid suppliers like Eaton to secure pricing at a discounted rate with the promise to purchase a certain number of vehicles by a certain date through bulk orders. This will allow Eaton (or other suppliers) to plan for future growth and reduce costs by achieving economies of scale faster than they would otherwise. It would not make sense for FedEx to petition for an exclusive contract with a supplier, as more business for the supplier would result in additional cost savings through shared fixed costs on production through as many customers as possible.
recommendations
To fully leverage the benefits from converting to a hybrid fleet, FedEx should start by optimising fleet routes to capture the advantages of a regenerative engine and electric engine starts. Because most hybrids are simply not as well suited for longer-haul routes, it is possible it makes sense to build new distribution centres to minimise these distances where strategically viable. Or, perhaps there are variations of hybrids that can be created leveraging the more complex CVT technology for a larger type of truck that is better suited for long haul deliveries.
Additionally, there will be a high degree of expertise required to ensure fleet performance is maintained at a high standard. FedEx will need to hire a range of technicians and mechanics familiar with hybrid vehicles to provide maintenance that will keep these trucks at optimal performance and increase fleet lifetime. Ideally, existing staff can be trained in the skills necessary to do so, leading to greater organisational efficiency overall.
Finally, there is a strong branding opportunity present for FedEx in this initiative. Where both Greenpeace and the U.S Environmental Protection Agency recognised the impact of this investment, FedEx can brand itself as “the more sustainable shipping option” in its direct-to-consumer advertising, which will also have the net benefit of forcing its competitors to shift to hybrid truck fleets.