Big Brown boots up.

Internet companies are very hot now. That's nice. But maybe the biggest e-commerce player isn't Microsoft, Intel, AOL, Amazon, or the dot com de jour stock the punters are talking up.

While most companies are adapting to the Internet, UPS sees an opportunity to get a head start against industry, rivals, such as Federal Express, DHL, and the government-backed competitors - U.S. Postal Service (USPS) and the PTT's around the world - with which it competes. Last June, the Atlanta-based, privately held firm with approximate 1998 revenues of $25 billion launched Document Exchange, a service that zips documents via the Internet in seconds rather than relying on planes, trains, or the company's ubiquitous delivery vans. Until then, someone sending sensitive material had three options: Pay a delivery service, fax it, or use e-mail. The latter two lack confidentiality, and observers have noted that up to 30 percent of faxes must be resent.

FedEx and DHL already allow customers to track packages on the Internet. But UPS's entry into on-line services is the first step into the next level of e-commerce, says James P. Kelly, the company's chairman and CEO. Relying on software created by Tumbleweed Software and Net Dox, UPS uses encryption technology that gives customers with Web access a digital fingerprint so that only the sender and receiver know what is sent, who sent it, and when - unlike e-mail and materials sent over the Web. The price ranges from $1 to $10 - well below UPS's $12 minimum for package delivery. Is UPS crazy to cannibalize its core delivery business? Maybe. On the other hand, if analyst predictions that up to one-third of documents will be cyber-delivered by next year are correct, maybe it's not.

Big Brown, which has spent $9 billion on IT over the last decade, is beginning to rival Big Blue as a technology contender. Last year, it invested $1 billion on IT, more than it spends on vehicles and nearly as much as it spends on airplanes. (With the fleet of 271 aircraft UPS owns or has on order, plus the 300 it charters, it runs the 10th largest airline in the U.S.) Its global telecom network, which links a quarter of a million users in 70 international locations, makes UPS the largest user of cellular technology in the world. Currently, more than half of all shipment order information from customers comes into the company electronically. Considering that UPS deals with 1.6 million customers who ship 12.1 million packages and documents daily, that's saying something.

The company is also testing new technology that will enable drivers to transmit shipment information instantly to its mainframes. The backbone of all UPS's information services consists of two data centers with 14 mainframes and a global network called UPSnet. In fact, the company claims it operates the largest DB2 mainframe database in the world - larger than that of the U.S. Census Bureau. In the first quarter of 1999, UPS plans to roll out a new Internet service that will allow anyone with Web access to place a shipment order to send a package anywhere in the world.

But of all UPS's activities, its worldwide logistics unit (WWL), growing at an annual rate of 42 percent in revenue, is where the folks in Atlanta are training their high-tech guns. UPS is taking on the supply chain activities of many companies. It's given software-connecting data to leading ERP software firms, such as SAP, Oracle, and PeopleSoft, to create a seamless interface between a shipper's own system and UPS's network. WWL's latest entry is creating software for supply chain needs of specific industries, such as multiunit hospitals.

WWL already undertakes the outsourcing distribution of companies, including GNB Technologies, a manufacturer of lead acid batteries, and AlliedSignal's automotive products group, which makes Fram filters and Bendix and Autolite products. It's estimated that of about $1 trillion in inventory, up to half of that value can be freed up through better supply chain management. Although Kelly says there are no plans to do so, turning UPS's finance subsidiary [TABULAR DATA OMITTED] loose to finance inventory, credit guarantees, and other trade facilitation services suggests Big Brown has a GE Capital manque in its UPS capital unit.

What separates UPS from the garden variety supply chain vendors or e-commerce companies is scale. Big Brown's end-to-end delivery touches 6 percent of U.S. GDP - 99 percent of the businesses, 97 of the residences, and 100 percent of the Fortune 1000. Swimming in the data centers' 14 mainframes are precise numbers on value ordered by zip code and by household. By having perfect information about goods and services at hand, Big Brown reckons it could be the supply chain supplier of choice. No public utility, regional Bell company, cable or long distance phone company has anywhere near the same physical or virtual connectivity. Furthermore, Big Brown doesn't face the regulatory, financial, or infrastructural hurdles with which others must contend.

UPS's IT muscle notwithstanding, don't color e-commerce brown just yet. The company is still licking its wounds from price wars in Europe and the 1997 Teamster strike that left relations with the rank and file sensitive. Then there's the challenge from U.S. Postal Service. According to December 1998 figures from Zona Research, the USPS has a 35 percent share of the on-line delivery market as compared to UPS's 55 percent share. Covering a dozen countries, the USPS's global package link service (GPL) targets U.S. catalog retailers, offering expedited delivery at rates well below the industry average. For example, GPL's price for a 10-pound San Francisco-to-London package is $26.63 compared to $41.10 average from commercial carriers, leaving UPS management fuming over "sweetheart customs deals" and cost of capital "advantages no private sector company can match." Big Brown bled $1.3 billion in its international operations, principally in Europe, before breaking even last year.

The once-lethargic postal agencies in France, Germany, the Netherlands, and the U.K. have been freed by the advent of privatization and the launch of the single market. A revived Deutsche Post is not only slashing prices on freight rates and packages shipped in Germany, but also has a 24 percent equity stake in DHL International. Before DP is privatized in 2003, CEO Klaus Zumwinkel intends to make its Big Yellow as ubiquitous as Big Brown inside Europe. UPS insists that its European operations are profitable, but concedes that this is due to its worldwide and pan-European traffic. It's dropped its freight business and is no longer focused on domestic package service in countries like Germany. In the EU overall, it is behind DHL Worldwide but ahead of U.S. rival FedEx. Conversely, in China, UPS has partnered with SinoTrans, a local carrier, in its expanding operations now reaching 21 cities in that country.

Like his predecessors, Kelly, 55, has brown blood in his veins. After a brief stint as an accountant, the Jersey City, NJ, native joined UPS in 1964 as a delivery driver, after earning a B.A. from Rutgers and serving in the U.S. Navy. A year later, he was promoted and moved up through various operations positions before becoming SVP of labor relations in 1988. In 1991, he joined UPS's board and became EVP two years later, assuming the CEO post in January 1997. Over six feet tall, the physically imposing Kelly is naturally gregarious, but highly focused on "looking after [founder] Jim Casey's company." As he relates in the following interview in UPS's Atlanta headquarters, "the competition is blurring." It's also intensifying.

J.P. Donlon

NET DREAMS

For a while UPS has been playing catch up, but now that you've made some progress, what new frontiers do you have to break through? And to what degree is the Net precipitating who you are and what you want to do?

Right now we're being rewarded with additional business as a result of things we've done over the past 10 years, both in the technical area and other areas. And technology's continuing to push us. The change is far more rapid now than even five and 10 years ago. So how we position ourselves, make ourselves available to our customers, and embed ourselves in their technology solutions, is what will enable us to provide more information services for them. The supply chain is really three things - the movement of goods, information, and finances. We move goods pretty well, and we're doing a whole lot better in the information area.

The Net and electronic commerce in general is causing us all to rethink the entire business model, and certainly the supply chain as it relates to UPS. We've positioned ourselves well as leaders in e-commerce and certainly in our industry. We think our recently rolled out Document Exchange will provide opportunities.

With the logistics business new accounting for more than $1 billion of your sales, what do you see as its growth potential?

We expect our worldwide logistics group to do a little more than $1 billion and project about 40 percent growth for subsequent years. We're looking for ways to triple or quadruple that part of our business within a three-year period. Demand is enormous, and we expect it will increase tenfold in the next five or six years.

How does that growth rate compare to your core package delivery business?

Our Worldwide Express product is the product where we've had the most growth. We continue to have significant growth and improved share on our next-day business within the U.S. Our ground business growth is a smaller percentage, but is still a tremendously important part of our business, and our residential growth has been the most modest of the four.

Are you becoming by degrees a logistics or supply chain company?

We're becoming a logistics company because we have many customers who don't want to do certain things themselves any longer, customers who are saying, "I want to produce a product, and after that I want you to take care of it." So there are big, broad opportunities for a worldwide logistics group.

We heard firms saying they wanted to focus on their corebusiness and to partner with other companies that can provide quality services in other areas early on. We had the infrastructure in place in the U.S. to respond perhaps quicker than anyone else. Now we're building a global presence. When you think of logistics, you think of warehouses and racks, but what our customers are asking us to do - everything from repairing computers to site selection - is much deeper in the supply chain. In some cases, they want us to do their billing and handle inventory cycle times.

You mentioned $1 trillion worth of inventory in the nation's warehouses - and a target of reducing that to half a billion.

That figure refers to the industry overall and not just UPS. Customers don't want to tie up goods. It's about getting it from the end of the product cycle to market as quickly as you can, with as little time as possible spent sitting in warehouses around the world. We can do that by both doing some of those things for them and eliminating in-between steps. We have one customer who has us coordinate when they ship things from three different parts of the world - say Malaysia, Toronto, Belgium - so that they all get to the same place at the same time and don't have to stop anywhere in between.

That suggests you're getting into creating systems that dovetail with your own.

We want to be where our customers want us to be. If ERP systems are their business systems, we want to be embedded in those, able to provide information for them and to use that information to provide additional value-added services. The customer decides whether that involves a mainframe-to-mainframe connection; being embedded in every ERP that exists; or supplying them with software and hardware. We decided that we wouldn't have a proprietary system that our customers would have to use. We believe that's one of the most significant reasons we've had some success in that area.

Ultimately, will you be competing with the SAPs and PeopleSofts in devising or helping to devise these systems?

The environment we're in right now is moving and changing so quickly that the competition is blurring. But I don't anticipate we'll compete directly with them. I anticipate our being more deeply involved and providing information solutions for our customers. We've partnered with more than 2,000 different companies doing some of those things.

Our worldwide logistics group has created software that's customized based on individual customer needs. That's part of the reason why developing those broad supply chain solutions for customers isn't done overnight. It's a six- or a nine-month process - sometimes a year.

Several European countries don't want encrypted data crossing their borders. Is the encryption technology in UPS's Document Exchange product before its time, outside of nations like the U.S., Canada, Japan, and Australia, which don't have restrictions?

Government regulation is a deep, complicated issue. Ultimately, it has to allow trade to exist in a free fashion, and I don't believe pockets of the world will prevent people from trading electronically, so encryption and security issues will be dealt with and become level at some point in time.

What challenges do you face with Document Exchange?

Historically we usually put products, such as next-day air or Worldwide Express, in place for the long term. With technology products, you must be ready to change them real quick, to adapt, adjust, and understand customer needs and be looking for the next way to meet them and to get documents from Point A to Point B.

Over the past five or six years, you've invested heavily in growing your international business. What lessons did you learn and what would you have done differently in retrospect?

In retrospect, we should have known that in serving 200 countries in addition to our domestic operations and those in Canada and Germany, it was going to take time to integrate systems and different product offerings and to hone those things and get the kind of efficiency and service reliability that we provide here in the U.S.

[TABULAR DATA OMITTED]

Putting those together took more time than we anticipated. In Europe, the primary challenge now is the postal service - which is similar to the challenge we face in the U.S. There's a tremendous amount of consolidation being driven by postal services, some of which are going to be privatized in the coming years. Very few of us understand what privatization means and how subsidies will exist from first-class mail to package delivery.

We don't object to competition as long as the playing field is level. In the last four months, the Deutsche Post has made seven or eight acquisitions, among them DHL, in different EU countries, including the U.K. and France. So they're aggressively growing. We have a few complaints before the EU right now on that issue. If they were privatized and didn't receive cross-subsidies from first-class mail or monopoly services, it would solve our concern. Unfortunately, the timeframe to resolve some of those things is beyond what's reasonable.

It's like the U.S. Postal Service; you can't have it both ways. You can't be a monopoly and then use that monopoly power to compete against room-and-pop shops, UPS, or FedEx. It has to be one or the other. If some EU countries don't want that, then they have to be disallowed from doing it through monopoly classes.

Certainly the long-term solution in the U.S. is more oversight by the postal rate commission. We support the universal delivery of first-class mail. We don't support them extending into any business they want, selling Walt Disney T-shirts or however they compete with the private

MAIL FRAUD?

How do you view the USPS's Priority Mail ads that compare their rates to yours and FedEx's and mention that UPS doesn't deliver Saturdays?

We've responded on that to both the Postal Service and Congress. The ads compare apples and oranges. Theirs is a two- to four-day product with no guarantee and no tracking ability.

What's the status of UPS's operations in China and Asia?

We're operating with a partner in China - SinoTrans - and have express service in more cities than any of our competitors in China. So we're satisfied with our growth there. In Asia, even with the depressed economic conditions, we've had 10-12 percent growth for this past year. We're focused primarily on to-and-from Asia from North America, Europe, and Latin America. We have less of an intra-Asian infrastructure than some of our competitors, so we didn't get hurt within Asia to the extent some other companies did.

What are your strongest growth areas?

We expect good growth in our Worldwide Express delivery operation to and from 200 countries, and in the logistics group. E-commerce will provide us with opportunities beyond the current benefit we're deriving from being embedded in customers systems.

We still have double-digit growth in total air and next-day air products. Business-to-business is very important to us, and we're developing better models to reach the residential customer, which has the potential to grow as a result of e-commerce. Approximately $50 million of merchandise was purchased on the Web this Christmas season. If that's going to grow fivefold in the next two years and tenfold in the next four years, does it become significant when it's 2 or 3 percent?

There are questions about how quickly that will happen and precisely how it will happen. But it will happen. So we have to find better ways to move goods to residential customers.