Operating leverage – seasonal woes at UPS & Fedex

Apparently, logistics firms UPS and Fedex ran into a bit of bother during the pre-Christmas parcel rush – see this article on Forbes by Steve Banker.

The problem may be one of bad planning. Simply put, Steve Banker suggests both firms did not have enough capacity in terms of aircraft or parcel sorting at their highly automated distribution centres. While Banker talks about strategic planning, when I read his article I immediately thought about operating leverage – which would of course be part of the strategic planning.

Operating leverage can be simply defined as the percentage of fixed costs compared to total costs. If UPS or Fedex wants to add capacity, by either leasing aircraft or adding more automation, this will increase fixed costs and operating leverage worsens as these fixed costs affect profits. Alternatively, firms like UPS or Fedex could instead hire more temporary staff, which represents a variable cost. No doubt they do this, but from my limited knowledge it would seem Amazon have this well organised. Increasing variable costs does not affect operating leverage, and is thus preferable in the longer term.

Of course it may be that firms like UPS and Fedex actually need to increase capacity and thus fixed costs. But as Banker points out in the Forbes article, investing to cover short term seasonal capacity issues implies over or idle capacity at other times.