The pandemic is painting a picture of a future in which residential deliveries dominate the parcel market—and it doesn’t look pretty for couriers.

(Bloomberg)—As Carol Tomé takes over as CEO of United Parcel Service Inc. on Monday, she inherits the Amazon dilemma: The same online shopping explosion that is increasing delivery volume also is squeezing profit margins.

How the former finance chief at Home Depot Inc. solves the conundrumwhich has been magnified by the coronavirus pandemicis likely to define her tenure at UPS. Prominent voices on Wall Street are already recommending that she reject some business from Amazon.com Inc., which is a significant customer as well as a burgeoning competitor.

“What she needs to do is take a very firm stance and say, ‘This is not going to work long term, you need to pay us more,’” said Cowen & Co. analyst Helane Becker. “If you say ‘No’ every once in a while, you probably wind up with a better relationship.”

Amazon, No. 1 in the 2020 Digital Commerce 360 Top 500, won’t be the only challenge for Tome. She’ll face tough negotiations with the Teamsters union, which represents about 290,000 UPS workers. And she’s walking into a workplace disrupted by the pandemic, with employee morale drained by a frenzied pace and concern over catching the virus. More than 70 employees tested positive for the virus at a facility in Germany.

The Amazon dilemma, though, will be a constant theme for Tomé. The pandemic is painting a picture of a future in which residential deliveries dominate the parcel marketand it doesn’t look pretty for couriers.

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By the end of March, the virus-induced lockdown caused residential packages to soar to 70% of UPS shipments from the usual 50-50 split with commercial parcels. Profit margins plummeted with the shift as drivers logged more miles and made more stops to deliver just one or two packages to each home. Businesses typically receive more packages per stop, spurring greater profit.

The new breakdown only accelerated a trend that was already underway. Amazon will probably account for at least 15% of UPS’s total sales this year, with a profit margin below 5%, Becker estimated. That’s less than half of UPS’s margin for operating profit last year.

Although Tomé (pronounced toh-MAY) is the first CEO to come from outside UPS’s management ranks in its 112-year history, she has been on the board since 2003, so she is familiar with the problem. Tomé’s two decades at Home Depot also gave her a view of Amazon’s force as a competitor, long before it became a focus at Atlanta-based UPS.

The online retailer is building its own delivery network and plans to compete for third-party packages to increase its network’s efficiency. When FedEx Corp. balked at Amazon’s terms for airborne service last year, the retailer declined to renew the contract. FedEx then walked away from its ground delivery deal as well. That sent more of Amazon’s business to UPSagain, boosting volume and lowering margins.

Beginning this week, UPS is raising prices on large-volume shippers by 30 cents a package after volume exceeds a certain level. Amazon’s bargaining power means it will probably negotiate less of an increase, said Glenn Gooding, president of IDrive Logistics, a consultant to the couriers’ customers.

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“UPS continues to hold tightly to that proverbial tail of the tiger called Amazon. They don’t want the teeth,” Gooding said. UPS declined to comment about Amazon’s rate, saying it doesn’t discuss individual customers.

Tomé, the first woman to run UPS, declined to be interviewed for this article and hasn’t spoken publicly since being named as the next CEO in March.

Two-tier wages

Beyond Amazon, Tomé also could face a challenge from the Teamsters union.

Departing CEO David Abney was able to establish a new class of drivers who are paid less than the existing ones. That contract, which was ratified despite a minority of membership support, expires in August 2023. Sean O’Brien, who is vying for leadership of the national union, wants to get rid of the new class, as well as block the company from using temporary holiday workers who deliver packages in their own vehicles.

“We’re going to be tougher, we’re going to be more prepared and we’re going to be less tolerant for any type of concessions,” O’Brien said in an interview. “It’s a proven fact that two-tier wage systems don’t work.”

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At Home Depot, Tomé helped drive the company’s transition from speedy expansion to healthy profitability. She took on other tough tasks, including trying to salvage the company’s doomed attempt to expand into China. She’s been praised by investors and analysts as smart, hard-charging, witty and gracious.

The Jackson, Wyoming, native also is known for her engaging public appearances. At the end of a simulated Home Depot cheer in a 2012 presentation to the University of Denver business school, where Tomé had earned her MBA, the cheer’s leader asked, “What are we going to do?” Tomé shouted back an answer about kicking the competition in the rear.

Data-driven

“In addition to being an excellent leader, she’s one of the nicest persons that I’ve met in this business,” said Seth Basham, a retail analyst with Wedbush Securities, who once traveled with Tomé on a Home Depot trip through Europe.

During her 18 years as chief financial officer of Home Depot, the retailer increased sales and profit margins at existing stores by rolling out new technology and wooing small contractors. Over her term, the retailer logged a total return on share price and dividends of about 575%, more than double what UPS garnered over the same period. Home Depot’s return on invested capital was 39% last year, near the top of the S&P 500 Index, and its operating profit margin was 14%, unusually strong among retailers.

“She has a reputation for data-driven answers about the business. People like the way she quantifies and explains what’s going on at Home Depot,” said Margaret Vitrano, a fund manager with ClearBridge LLC, which owns about $1.3 billion in UPS shares.

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“Our hope is that as CEO at UPS,” Vitrano said, “she’ll take some of the learning of how she helped create shareholder value at Home Depot and apply it to UPS.”

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