Federal
Before Doordash, Uber, Deliveroo and Postmates, there was FedEx. Founded in 1971 by a 27-year-old Vietnam veteran with a monster inheritance, FedEx blitzscaled way before Reid Hoffman wrote the book. It’s now a $73 billion company, but in Roger Frock’s Changing How the World Does Business, we get FedEx’s story from Arkansas origins to 1978 IPO, as told by an early executive.
It’s not a perfect book, but there’s a lot of value in it; in this essay, I’ll pull out the most useful and interesting parts. First, I’ll give some detail on how FedEx grew during the 1970s. I’ll then dig into three themes: the name ‘Federal’ as a shibboleth, the interaction of military and personal relationships with regulation, and the importance of making ‘partners of lenders’. I’ll finish by sketching the character of Fred Smith, who remains president of FedEx in 2024.
Fred Smith had founder-market fit. After Yale, he cut his teeth with the Marines in Vietnam, and in 1969 joined Arkansas Aviation Sales. AAS was owned and operated by Fred’s stepfather, a retired Air Force colonel, but Fred was too ambitious to work for anyone else for long. Fortunately for Fred, his father had in 1944 set aside $14 million in a trust fund for Fred and his two sisters - that’s $270 million in 2024 dollars.
And so in 1970 Fred used part of that trust fund to buy control of AAS, building it into a business with a “reputation as a fast-response, low-cost corporate jet equipment and maintenance centre for local and itinerant general aviation aircraft, usually small propeller-driven planes operated by independent owners.”
Fred expanded AAS into corporate jet brokerage, a business which had obvious synergies with his spare parts and maintenance operation. But by 1971, the 27-year-old had grander ambitions: he wanted to use his experience in aviation to get into the freight industry himself.
Initially, Fred considered a courier service for bearer bonds - but found the required insurance prohibitively expensive. Next, Fred sought a partnership with the Federal Reserve to expedite interbank clearing. At the time, the Federal Reserve had 36 district banks, and had to clear physical checks between them - a process which took 10 days, costing $3 million per day in float. That partnership never materialised, so Fred came to focus on "small, time-critical items with substantial intrinsic or financial value... [especially] replacement parts for equipment installed in factories, offices, and medical facilities". Crucially, Fred had traded in exactly these kinds of spare parts at AAS; that background, combined with his aviation experience and ample funding, prepared him for FedEx.
The abortive Federal Reserve partnership had one important consequence: it showed Fred the potential importance of a hub-and-spoke model. The idea was to fly packages to a single central location for processing, rather than directly to their final destination. The potential efficiency of this model at scale was obvious, but it wasn’t employed by any incumbent air freight service - perhaps because the market, which grew 17% a year between 1965 and 1971, had not been big enough to support it. If Fred’s new company became the first hub-and-spoke air freight service, then at sufficient scale it would be able to unlock, for the first time, reliable overnight shipping.
The hub-and-spoke model can be counterintuitive: FedEx had to put a lot of effort into customer education:
In the early days, people had a difficult time understanding the concept of shipping through the hub. Diane, one of our customer service agents doing telemarketing at the time, was explaining to a prospect that our central sorting hub was the reason we were so reliable.
The prospect said, “You mean that if I ship a package from Milwaukee to Chicago, it has to go through Memphis?”
Diane responded, “Look, sir, if you don't tell your customer, we won't. It just will be there by noon tomorrow. Will that work?”
The prospect was quiet for a moment, apparently thinking over the merits of Diane's suggestion before answering, “OK, I'lI ship!”
The company was therefore a bet on market size - would there be enough package volume to support the expense of operating the network? In 1971, Fred brought in two sets of consultants - A.T. Kearney and the Aerospace Advanced Planning Group - to study that market. Not only did they uncover the 17% historic growth rate, but they also found that a network of 111 cities would cover 95% of US air freight movements, and that 90% of the nation's airliners were out of action between 10pm and 8am.
Today, it would be strange for a startup to hire consultants to scope out their business - especially at the earliest stages. The assumption would be that the founder has unique vision and insight that consultants couldn’t possibly share. In FedEx’s case, however, the genesis of the company wasn’t a contrarian insight (e.g. Airbnb) - but rather the application of an extraordinay force (Fred’s personality and trust fund) in the right place, in the right direction, at the right time. Netflix transitioned from mail to Internet delivery as soon as it became cheaper to do so; FedEx was born on a similar calculus.
Fred then hired those same consultants into his management team: Roger Frock (our esteemed author) and Fred Basch joined from Kearney, while Art Bass, Vince Fagan and Tucker Taylor joined from AAPG. Perhaps that recruiting success was a testament to Fred’s magnetic personality and messianic vision - consultants don’t often join their clients, especially clients based in Arkansas!
Basch was an important hire - he had spent 8 years at UPS before joining Kearney - and his first impression of Fred may have been representative.
He was more than impressive; he was captivating. I found myself hoping that somehow they would give me the opportunity to be part of the adventure.
FedEx was (is?) a classic network effects business. It had a cold start problem: it needed enough package volume to justify the cost of running its network. However, its business improved with each marginal customer, because it amortised the fixed costs of running the network over more shipments. Just like Instacart and DoorDash, FedEx would have to fundraise aggressively while simultaneously scaling operations.
Their first launch, in March 1973, was not a success. Having relocated their hub from Little Rock to Memphis, FedEx’s model suggested 30,000 packages on their first night. Management cautiously cut that forecast by an order of magnitude - only to be shocked when just six packages arrived for shipment that evening.
In response to this setback, Fred went into “Marine Corps boot camp mode”. Having assembled the entire management team, Fred made his resolve clear: “We are going to do it right this time. Failure is not an option.” With the March launch labelled a “system test”, FedEx prepared for a second launch in April 1973.
That night, 22 months from the date of incorporation, FedEx had about 100 employees and served a network of 25 cites with a fleet of six planes. Just getting to launch had cost them $25m (approximately $175m in 2024 money). They were “flat broke”.
On the first night of their second launch, FedEx generated 185 packages - better than six, to be sure, but a long way from the scale necessary to justify their investments. And so FedEx, like a 21st century startup, raised money across three private placements. Each of these were organised by Charlie Lea, an investment banker from New Court Securities who became chair of the board.
Nov 1973 - $24.5 million of equity from 23 investors, and a long-term loan of $27.5 million - the largest private placement in American history.
March 1974 - $6 million of equity, $5 million of debt, leaving Fred and the employees with just 19% of the company
September 1974 - $9 million total, from the Parisian Rothschilds as well as from existing investors.
According to legend, in July 1973 FedEx was so short of cash that Fred flew to Vegas with the company’s last five thousand dollars, and won $27k in order to pay a $24k jet fuel bill. This story has been very widely shared, , but I think it reflects pretty badly on you if that’s the only thing you take away from Changing How The World Does Business. The story doesn’t teach us anything about history or strategy or operations, and it doesn’t even seem plausible - even if FedEx was flat broke, I don’t think Fred personally was! If they had a liquidity crisis and needed $24k, I think he was good for it. It’s the worst kind of saccharine business-book nugget.
In the same period, package volume grew steadily: from 400 packages/day in May 1973, to 2,000 in September, to 3,000 in October, and 5,000 in December. By December 1974 FedEx had reached 10,000 packages/day, growing volume 20% quarter-on-quarter and serving 59 cities. However, FedEx was still losing a million dollars a month - not least because of the cost of jet fuel, which after the 1973 Yom Kippur War and subsequent OPEC oil embargo rose from eighteen cents per gallon to almost a dollar.
Frock’s book sadly doesn’t provide much detail about the glass-chewing battle for unit economics that must have occurred between 1973 and FedEx’s 1978 IPO; crucially, however, FedEx didn’t face the kind of well-funded competition that instant delivery saw before and during the pandemic. That speaks to the nascent venture and startup ecosystem of the time, but also to Fred’s singular positioning - almost nobody else was in a position to start the business he started.
As part of that struggle, however, FedEx must have continued to deploy operations research - there’s a great line in the book about using a HP 35 calculator for some of the trickier calculations involved in planning the network. To find the 25 cities for their initial network, FedEx looked for the SIC codes of industries producing small, time-critical items with substantial intrinsic or financial value, then checked employment statistics to find the standard metropolitan statistical areas in which those industries were to be found, and compared that with the cities that already had some of form of evening parcel service.
Those unit economics did ultimately turn positive. One assumes that the hub-spoke network helped, but the focus on small high-value packages was also crucial. In 1978, a United exec was shocked to find out that FedEx charged their customers an average of $3.60/lb - United’s abortive cargo service had only mustered $0.20.
FedEx raised $18.8 million in an April 1978 IPO - closing out their first chapter. With that, Frock’s book starts to peter out. The next chapter is titled “Mach 1 to Idle”, reflecting the management changes that Fred expected in his newly mature and structured corporation, and most of the rest of the book concerns the interpersonal dynamics between Fred and his original executive team. With that, I’ll end my narrative, and move on to three themes that are weaved throughout the book: shibboleths, regulation, and financing.
Shibboleths are the things that mark out the in-group to one another.
I once used the phrase “back of a fag packet” with a London underwriter - he excitedly interrupted to say me that he could tell I had family in the market, because that's exactly what they used to say back in the 90s. He told me that he once broked a £35 million facility on the back of a Post-it note, and had the note framed for his boss with a little sign saying “who the fuck needs a fucking contract.”
In that context, the phrase “back of a fag packet” was a shibboleth (not least because you apparently can’t say that in America), but names are often shibboleths too. McKinsey calls itself “the Firm;” people that worked at SAC Capital (the predecessor of Point72) call it : “sack”, while some people at D.E. Shaw and Company call it “DESCO” (rhymes with Tesco).
Throughout this essay I’ve used the ubiquitous name “FedEx”, but that word doesn’t appear in any of the quotes in the book. Instead, it seems that contemporaries used the abbreviation “Federal”, as seen here:
Debra Howse: “Federal had gender and racial equality and opportunity long before they became buzzwords.”
Charlie Lea: “[Fred Smith] was going to spend every cent of a significant net worth to make Federal a success.”
Tucker Taylor: “We were determined to make Federal work.”
Who knew!
I started this essay with Fred’s military service not just as a curiosity, but because it mattered. At risk of stating the obvious, Vietnam was a huge deal in the 1970s, and many of FedEx’s early hires were veterans. Both Art Bass and Vince Fagan - the AAPG consultants that Fred hired into his management team - were Marines. So was Mike Fitzgerald, a former UPS driver who rose to manage 1,000 of his former colleagues as VP Operations; Fred hired him to run field sales. The Director of Flight Operations was ex-Air Force, and from 1972 he ran a Little Rock flight school to train Vietnam veterans to become FedEx pilots.
Maybe this is unremarkable, because pretty much everyone in American aviation has and had a military background; as I write this, I’m on a United flight that supposedly has “cockpit representation from both the Air Force and the Marine Corps”. But the military connection feels important to the way that Fred assembled his team; and may have been critical to FedEx’s dealings with the Federal Government.
In 1970, aviation oversight in the United States came from two places: safety regulation from the FAA, and economic regulation from the Civil Board of Aviation, or CAB.
Since 1938, all air carriers had needed a “certificate of public convenience and necessity”, or CPCN; 23 carriers (including American, Delta and United) were grandfathered in, and they vigorously used the CAB to guard their position. Shocking though it might seem, FedEx’s proposed service would have been blocked by the CAB on the grounds that it was not “necessary”.
Air taxis - aircraft with fewer than 12 seats and less than 27,000lb takeoff weight - were exempt from these regulations. That was great news for FedEx - except that for reasons that aren’t fully clear to me, Fred Smith decided to buy his nascent company a fleet of Falcon 20s. To be sure, the Falcons were cheap - Pan Am had parked a fleet (flock? parliament? who knows) in the Arizona desert to weather a soft period in the jet market, but they nonetheless had a maximum takeoff weight of 28,660lb. That meant that FedEx would need a CPCN - and the CAB had never granted anyairline the specific version they would need. American, Delta, United - the incumbents operated a cartel.
Fortunately for Fred, in 1972 the CAB proposed a new CPCN exemption based on payload weight, which would permit air taxi operators to use planes with a payload of less than 7,500lb; Fred’s Falcons carried 6,500lb.
Counterintuitively, these liberal reforms were championed by the CAB and eagerly supported by FedEx, airplane manufacturers, and 12 other carriers. FedEx argued that the weight limit had been based on the 1936 DC-3; they ought to be updated in line with more powerful Falcons, introduced in 1963.
The reforms passed in September 1972 cleared the way for FedEx’s 1973 launch; but deregulation continued, resulting in November 1977 in HR 6010. This bill allowed FedEx and all other cargo airlines to “choose their own routes, set their own rates, and fly the planes that best suited their operating requirements”, liberating them from the oversight of the CAB. But without that early lobbying, FedEx would have been DOA.
1973 was not an easy year to be in the transportation industry: in October, OPEC launched a complete oil embargo that by January 1974 saw the price of oil quadruple. FedEx were desperately short of cash in any case, but Nixon’s Emergency Petroleum Allocation Act imposed fuel rationing. As of January 1974, airlines would be allocated fuel based on their 1972 consumption - which for FedEx was practically zero. As such. FedEx was allocated less than one million of the four million gallons they needed for 1974.
Fred went to meet with Howard Baker, the Republican senator for Tennessee, who arranged a meeting with the director of the federal Office of Oil and Gas, at which point, to quote Frock:
The director and Fred then began reminiscing about people they had known and lost in Vietnam. “It was clear that the director, a navy admiral, was very impressed with Fred.”
FedEx then submitted a new petition - without reference to Fred’s meeting - and were magically allocated 4.3 million gallons of jet fuel. They still needed someone to sell them the fuel - not easy in a time of queues at gas stations! - but fortunately, Charlie Lea’s nephew’s godfather, no less, was a former P-51 pilot who headed up general aviation sales at Exxon. Once again, Charlie brokered a deal to rescue FedEx, arranging delivery of millions of gallons of jet fuel.
FedEx is a story about operations research and engineering efficiency - but it’s also the story of an American business, and so relationships matter. When people can trade with anyone they want, they want to trade with their godson’s uncle, and they hate to see a fellow veteran’s business sputter out for want of fuel. Fred Smith - the Yale Marine with a trust-fund - had founder-market fit there too.
Charlie Lea had a clear goal when it came to FedEx’s financing: to make partners of the lenders. If the metaphorical cargo jet were to go down, Charlie wanted to make sure they came with it. As Keynes wrote in 1945, “Owe your banker £1,000 and you are at his mercy; owe him £1 million, and the position is reversed.” After the second, $11.5 million, private placement in March 1974, outside investors owned 81% of the company: Charlie’s goal had finally been realised.
But FedEx still needed more money - $9 million, to be precise. Much as growth equity these days often comes from the Middle East, Art Bass managed to get $3 million from the Rothschilds in Paris; but FedEx’s existing investors had to be bullied into providing the rest. As Charlie Lea recounted,
We were able to piece together that last round by convincing the banks to renew their loans and to defer principal and interest payments for a period of time. We finally explained to the banks that without their co-operation, planes would sit on the ground in Memphis and draw flies.
In today’s world of private credit, people like to talk about lender-on-lender violence: but FedEx was manipulating its capital stack back in the early 1970s.
That wasn’t the only time FedEx stiffed their lenders. FedEx funded the purchase of some of their early planes with debt collateralised by those same planes; but by May 1975, FedEx was defaulting on their interest payments. The CEO of the lender wanted his collateral back, but Art Bass explained that Federal’s Falcon 20s weren’t worth as much as the lender expected. If the lender wanted to resell them, they’d have to be refitted as passenger planes - and the private jet market was in a downturn. As such, he really ought to grant FedEx a reprieve. The exasperated CEO relented: “All right, I think I'll just give you enough rope to hang yourself.” FedEx needed more than a few of these gifts on the path to IPO.
Changing How the World Does Business presents one explanation of FedEx’s success: it was the result of the exceptional team they assembled. Fred Smith himself promulgated that opinion: as part of the Nov 1973 financing, FedEx gave every employee a bonus check, with a note from Fred saying: "Rome wasn't built in a day. It might have been if Federal Express employees had been in charge."
Indeed, Frock judged that:
Federal Express was not just a good idea - it was and still is about dedicated people... All of us struggled to help the company grow. We nudged it along with love, enthusiasm, passion, excitement and strength of will.
Nonetheless, Frock acknowledged that Fred was individually indispensable to the business. Discussing the critical 1973-4 period, he wrote that:
The epic struggle for financial viability fell squarely on his braod shoulders. The management group assisted by keeping the company moving forwards, but it was Fred's dedication, daring entrepreneurial spirit, and persuasive personality that carried us through those dark days.
Fred knew where his resilience came from: “No man on earth will ever know what I went through in 1973 and 1974, but it was nothing in comparison to Vietnam.” When he allied that resilience with his other advantages, the combination was formidable. For instance, Charlie Lea’s first impression of Fred in March 1973 was that:
Here was a young man who had just come out of Vietnam with a distinguished service record. He had put his own money into the company and was totally dedicated to it. Fred was the consummate entrepreneur type. There was no balance to him at the time, and he was going to spend every cent of a significant net worth to make Federal a success.
Fred’s single-minded intensity was maintained throughout the 1970s. One executive, recalling the frantic period between the March 1973 “system test” and second launch in April, said that:
Fred, back in those days, was bigger than life. I don't think too many people have pulled off anything more impressive. There was nobody like him. He had that knack of inspiring people to do things that they might not really feel comfortable doing.
We now associate this style of management - setting entirely unreasonable goals in order to take the team to another level - with Elon Musk, but Fred Smith was doing it back in the 1970s. Drawing on the Lone Ranger and his “jet jockey” training, Fred liked to say “kick the tires, light the fires; hi, ho paint, let's get where we ain’t!” As another executive recounted, “if Fred tells you a chicken can pull a freight train, your job is to hook 'em up.”
That damn-the-torpedoes attitude did well with the investors. After he closed the third private placement, Charlie Lea wrote Fred a letter:
We have just shot our wads between banks, investors, and oil companies; the next money that comes into this company has to come from the customers… If you are as successful in developing Federal Express as you were in convincing half the venture capitalists in America, we will all be very happy.
But Fred’s disregard for constraints also came with a persistent disregard for others. Right from his first meetings with Fred, Frock “intuitively felt that while he possessed great leadership potential, he apparently had little regard for the people around him.”
Fred controlled that disregard during FedEx’s rise - but after the IPO, he sidelined his original management team. The new public company required hierarchy and rigidity, not the decentralised power structure of a startup. As one FedEx exec had it:
Up to this time, we had been able to challenge Fred when he was wrong, and that did not fit well with his conception of a large public company. It did not make Fred warm and fuzzy to sit around a table with a bunch of guys he had drunk beer with, and who knew where some of the weaknesses were.
Of course, Roger Frock was part of the management team that Fred froze out; one detects a certain bitterness and ambivalence to Fred. That seems justified! Fred’s intensity and salesmanship was integral to FedEx’s success, and it made his early associates rich. But he that doesn’t mean he was a pleasure to work with.
It’s tough to get a consistent picture of anything from this book; Frock could have been more systematic about FedEx’s operations, more thoughtful about FedEx’s market opportunity and timing, and more nuanced about the causes of FedEx’s success. Not only does he skate through the late 1970s, we come out with an ambiguous interpretation of Fred’s character.
To be clear, I’ve also elided a few elements in writing this piece - most notably Fred’s fraud trial (he was acquitted), and his dethroning in favour of an Air Force general (he was reinstated). But I think that even if you don’t come away from Changing How the World Does Business with a grand theory of the great founder, or a detailed primer in late-20th century logistics, there’s enough meat on the bones to give you a sense of what it took to build a company like FedEx. The book presents a vignette of corporate America.
Kick the tires, light the fires; hi, ho paint, let's get where we ain’t!