When up-and-coming Western and Southern entrepreneurs wanted to kickstart their wealth-building process in the mid-1800s, they turned their attention towards one lucrative source of income—mail transportation contracts from the United States government. In 1845, Congress created something called star routes, which awarded mail distribution networks automatically to the lowest bidder with no conditions except those affecting “celerity, certainty, and security.” Each of these terms was noted on receipts with a *, and the *** led to the star-route nomenclature.
It was a great way for a young entrepreneur to get some responsibility and a claim on a profit source that could climb correspondingly with effort.
The bold promise of the United States Post Office—the guaranteed delivery of mail—required a lot of private businessmen busting their butts to get the mail to a post office location. Remember that the United States didn’t even authorize the construction of a highway until 1956, so you would have to travel through forests and swamps—maybe even fight off some bears—before you reached your township’s post office. A popular dime-store novel story would feature a young protagonist striking riches after acquiring a mail distribution route and applying hustle and gumption to make deliveries quickly without any mail losses.
Business-minded Americans did well for themselves by experiencing a lucrative connection between effort expended and reward received. Societies are economically structured at their best when industrious individuals can most clearly identify a path—in this case, quite literally—that will enable them to make use of such industry.
When I studied the change in mail and package deliveries since these localize-it-yourself Civil War Era routes, I was struck by how it has largely been the story of four companies applying the same broad principles to establish an economic sector with oligopolistic overtones.
First, starting in the 1850s, you saw Wells Fargo stagecoaches enter the mail business to reach Western locations where the government’s postal service network had not yet been delivered. It charged high premiums to do so, and this created torrents of excess cash that enabled Henry Wells to establish banks in California.
Remember, Henry Wells was one of the founders of American Express in 1850, and they ruled the transfer of cash, gold, and valuables on the Northeast. They charged a very high price for doing so, but they were the only reliable option if you wanted to mail a chunk of your life savings to someone a few states away.
Henry Wells and William Fargo wanted to replicate this strategy in the rapidly industrializing Western states—particularly California—but the rest of the American Express Board resisted, so they established Wells & Fargo to be a California version of American Express.
During the Civil War and its aftermath, Wells Fargo used its mail routes to establish its banking business by integrating the two. Want faster shipping on your mail? Do your banking at Wells Fargo? Want to transfer a negotiable instrument quickly? Make sure the instrument is created at Wells Fargo, and it’ll get shipped for free.
This competitive advantage enabled the Wells Fargo banks to develop a massive customer account deposit base that briefly made the San Francisco Stock Exchange so powerful that it required efforts from no less than Jon Pierpont Morgan the man himself to subsidize prospective New York Stock Exchange participants to ward off competition.
Eventually, the government began to mimic Wells Fargo’s routes and charged a much lower price to do so, and Wells Fargo stopped investing into its delivery infrastructure and let its mailing business taper off to focus on its much more lucrative banking outfit.
Since Wells Fargo, there have been three principal entrants to the package and mail delivery space: UPS, FedEx, and Amazon.
It is interesting to me that the primary innovation in the transportation sector has come from speed of delivery rather than cost of delivery. This is understandable because the United States government has largely pegged the cost of package delivery at an artificially low rate to spur trade and the free flow of resources under a uniform system. After all, there is no reason for why you should pay the same postage cost shipping something to someone who lives five minutes away as shipping a letter to Anchorage, Alaska for the same rate.
If you have to compete with a business that loses billions of dollars per year in charging fifty cents or so with its cheapest delivery with proportionate increases as the package gets better, it doesn’t make sense for entrepreneurs to compete on price (although Amazon has tried to compete with its Amazon Prime delivery service that gives “free delivery”, it is really part of a subscription service and is reflected in Amazon’s fees on sales. For instance, you can’t avail yourself of Amazon Prime without engaging in some other transaction with Amazon that gives them an indirect transportation fee take.)
From an investment perspective, investing in the three major package transportation firms—UPS, FedEx, and Amazon—makes a lot of sense because they have vast distribution network that have been built over decades and would cost hundreds of billions of dollars to replicate. As an entrepreneur, there is no star route opportunity in the Western world—with the one exception of rural delivery—it would not surprise me if a “Fourth Firm” emerges some day that specializes in low population density delivery areas.
In some ways, this reminds me of my fondness for the beverage industry as a long-term investment. If you look at the major alcoholic and soda beverages that existed 50-150 years ago, it is largely the same brands that are relevant and profitable today. What distinguishes beverage brands from transportation industry players is the manner in which the competitive advantage is maintained.
With beverages, a cheaper or even better-tasting beverage might come along and you’d still stick with your beverage of choice due to habit, general familiarity, and the longstanding effectiveness of the advertising campaign that has surrounded it.
With transportation companies, no one uses UPS, FedEx, or Amazon because they love those companies as “brands”—they use them because they can deliver something quickly. If that is ever displaced, the “moat” can diminish rapidly. However, this risk is diminished by the fact that it would be really, really, really hard to build out a network that does it better (it is much more likely that one of the three existing giants gains market share at the expense of the others, and few people try to answer this question without applying recency bias to conclude that Amazon’s recent successes must continue forever.)
From an investor perspective, Amazon has always been difficult to analyze because its P/E multiple is obscene, and has always looked lofty even if you were charitable in your calculation of potential profits. There are case studies out there that support the proposition of “Just buy the damn stock and you’ll do well” and there are others that showcase excellent businesses performing poorly when bought at nosebleed valuations. My read on the data is that overpaying by a moderate amount can still deliver superior returns for excellent companies, but paying twice what a mature business is worth will drag your future returns. The art of investing is distinguishing in real time the one from the other.
There is an old saying: “You can get it Fast, Good, or Cheap. Pick two.” Considering that people for the past century have been non-negotiable in their insistence that packages get delivered without harm, that option is already chosen. In the transportation industry, UPS and FedEx have established themselves by trying to succeed on the “fast” element.
Amazon has tried to distinguish itself by delivering upon all three. Although it should be noted that Amazon Prime itself has not been a profit driver for the company—the costs of delivering costs vastly outstrip the price customers currently pay for their subscription—in a way, it has some similarities to the money losing story of paying $0.50 on a stamp to get something to Alaska. It just so happens that Amazon can afford to lose money in its right pocket because it has much more cash in its left one.
From an investment perspective, this is a sector of the economy that makes sense to invest in during recessions. All three businesses fell heavily in 2009, and for good reason. Shipments are economically sensitive, and that is why the stock prices tend to be especially hard hit during economic distress. If you are someone who wants 15% or greater returns for a ten year stretch, waiting to purchase these stocks is likely the right strategy.
As for figuring out which of the three transportation stocks to invest, it’s always been all about speed. Large-scale investments that build out the infrastructure with the purpose of faster delivery are something worthy of your close attention when studying this industry. I would much rather see UPS build out distribution networks that resulted in 5% earnings growth than repurchase stock in a manner that projected an 8% increase in immediate value because the caveat with the transportation sector is that you can never neglect speed.
In this regard, Amazon deserves to be commended. It has largely minimized stock repurchases and has focused unabashedly at improving the speed of its Amazon Prime delivery service. Experimenting with one-hour delivery in major metropolitan areas is wise. If it ever reaches a scale where it can be produced for the masses, history is on its side. The package delivery industry has always been lucrative at letting the messenger get a little something for itself if it delivers quicker than the next-best option.
Originally posted 2018-06-18 01:20:32.