The history of Federal Express Corp. has become a parable of sorts. Some feel that the significance of the company is that it created a $3-billion industry where none existed before, changing the way America does business and adding a new cliche -- "when it absolutely, positively has to be there overnight" -- to the language. Others say the significance is in showing how one man, Frederick W. Smith, could see trends in-the world, conceptualize a product that would capitalize on those trends, and motivate an untested work force to build a $1.2-billion empire. Some financiers say its success reminded the venture capital community that there was a world beyond high technology; others assert that the company shows the virtues of persistence with the right product in a growing market. Finally, a broad spectrum of observers claim that the history of modern venture capital would be drastrically different had the company failed. No matter how the story is told, however, it has assumed the status of myth.
The heart of that myth is the story of the company's genesis. In 1965, writing a paper for an economics course at Yale University, Smith proposed a new kind of freight service. The vicissitudes of piggy-backing air freight onto passenger service, he argued, created an opportunity for a company totally dedicated to small, time-sensitive air freight. Such a company would be freed from the shifting schedules of different airplanes that bedeviled the existing freight forwarders. Smith's professor pointed out the futility of the idea, given the regulatory climate and the hostility of the huge, entrenched airlines. He awarded Smith a "C" for his efforts.
Except for his persistence and willingness to bet the ranch, Frederick Smith is not an easy fit into the image of the entrepreneur. Prep school and Yale educated, Smith had the luxury of putting $8.5 million of family money into his start-up. It would be nowhere near enough. Starting an air-freight business carries with it the cash-gobbling entry barrier of having to operate a fleet of planes, hundreds of vehicles, scores of offices, and a vast sorting and distribution system -- costs that can digest an inheritance in a hurry. At one point, Smith met a payroll in part with $27,000 he won in blackjack. Apart from personal funds, his company would also consume $70 million in venture capital before it went into the black in late 1975 -- four years after starting out.
Not that Smith was unfamiliar with adversity. Although he suffered from a crippled hip in childhood, he had recovered sufficiently to enter the U.S. Marine Corps after graduation from college in 1966. He served two distinguished tours of duty in Vietnam, first as a platoon leader and then as a reconnaissance pilot.
While Smith could not convince his economics professor of the viability of his idea for a small package service, six years after he wrote his paper he would manage to convince the financial community. Smith spared no expense to prove that Federal Express could tap an unexplored and potentially huge market. He commissioned studies to back up his judgment, and at one point spent 10% of the company's net worth to prove that if Federal Express provided quality service, then that service would generate the customers. "We purchased the credibility we needed to entice capital sources," Smith has noted. Smith anticipated the explosion of commercial activity in the 1970s, as well as the trend in the airline industry to fly larger aircraft to fewer cities and to drop service to smaller cities. Then the United Parcel Service Inc. strike in 1974 and the collapse of REA Express Inc. gave Federal Express a chance to prove its mettle.
Even with a compelling story and the studies to back it up, however, Federal Express still nearly went under at several points during its infancy, and it is these perilous years that have made the company a cynosure for the venture capital community. Steve Birnbaum, a venture capitalist with the Santa Monica, Calif., office of Oxford Partners, notes that while Federal Express was consuming huge sums of venture capital, the venture capital market itself was in a profound depression. "We were having terrible times," he says. "In 1975, new capital was $10 million [against $3 billion in 1983], and the initial offering market in 1974-75 raised only $32 million [against $5.5 billion last year]. We were all sitting around saying how terrible the world was, and speculating on whether free enterprise itself was doomed."
Federal Express hung on by its teeth, constantly going back to banks, corporations, and venture capitalists for new loans and equity participations. Ultimately, over a dozen equity groups participated in three major rounds of financing. Through all the bad times, however, Smith earned the undying loyalty of those who worked for him. "He was a fantastic motivator of people," said Charles Tucker Morse, the company's first general counsel. "I have not worked since in a situation so intense and so free of politics."
In a venture capital market that was suicidally depressed, the amounts of money being consumed by Federal Express were enough to make the company a metaphor for an industry teetering on a ledge. But the drama was compounded by the number of times the financial community heard that this was the amount needed to get the company over the hump. Says Charles Lea, the venture capitalist who played a crucial role in arranging financing, "By any standards, there were a large number of financings. Coupled with this, there was the size of these financings. They were so much larger than anything else that they were difficult to deal with. Finally, there was the financial climate -- there was nowhere to turn to find money. Nobody had it." In his desperate search for money, Smith had to give up virtually all his equity in his company. (He eventually recaptured a substantial portion in later refinancings.) Thus, when the company announced that it was running in the black, it had a huge psychological impact.
"People said, 'I believe again,' " Birnbaum remembers. "They could see that even in those dark times there was a light at the end of the tunnel; that it was possible to get gains after all those years of work; that there was a reason to be in this business after all. In the same way that a bankruptcy might symbolize the end of a recession, this light at the end of the tunnel symbolized the end of our depression. Things have gotten stronger ever since."
What might have happened had Federal Express failed? The overnight-package industry might still have been born -- the concept Smith first expressed in his economics course seems, in retrospect, almost inevitable. But, according to Charles Lea, the venture capital market would be very different Amdahl [Corp.] had crashed, we would not have seen the ebullience in venture capital that we have seen. There still would be a venture capital market, but it would be much more modest." If nothing else, he notes, the success of Federal Express gave a lot of venture capitalists gains they could plough back into new ventures -- and a reason for doing so.