Thirteenth ACCC Regulatory Conference July 26 and 27, 2012
The Last Post: W(h)ither
physical communications?
Martin Cave Imperial College Business School &
UK Competition Commission
(The views expressed are those of the author alone.)
The basic proposition• There is an overwhelming chance that
demand for delivery of physical written or printed material to individual homes and
business premises will continue to decline.
• Yet it is a regulated ‘universal service’ business, held in high esteem.
• How can its decline be managed?
• What should be done with the postal service’s residual competitive business, particularly
fulfilment or delivery of physical goods?
Another declining business‐newspapers as an analogy
• Similar decline in demand as posts, for the same reason – digital substitution
• Past history of union control and resistance to technical change
• Response is reduced frequency and pagination and real price rises, as employment plummets and closures multiply
• Productivity improvements can mitigate but not defeat demand decline
• News organisations seek to monetise new digital forms of distribution
• Limited public outcry.
This is how industries decline under capitalism – canal transport, UK steel‐ making, etc –
without fanfare or regulatory involvement . But with the
postal service, governments and regulators get involved in service standards and pricing. How do they react? Do they put their heads in the
sand?
Agenda
1. Basic economics of postal services
2. The good (for the provider) years of monopoly
3. The quite good years of growing demand and incipient competition, ending in about 2007
4. The spiralling decline of demand since then, and regulatory responses
5. Regulation of related competitive services.
1. The basic economic features of postal services
• Discussion is confined to postal services, not to post offices or counters
• A standard value chain of separate activities with different cost characteristics
• Initially privately run, then nationalised and monopolised; in some places privatised
• Subject to a universal service obligation with ‘postalised’
pricing
• Has co‐existed with private courier and parcel services
Sources of demand
• Segmentation of the letters market in the UK :
‐
business to business – 27%
‐
business to residential – 59% (bills‐vulnerable)
‐
residential to business – 3%
‐
residential to residential – 11%
• 50 UK firms account for 40% of letter volumes; 88% of small businesses post every
day.
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The Postal Value Chain
Delivery (M) - 40-45% of costs
Outward sorting ( C)
Trunking ( C)
Inward sorting (C)
‘Workshare’ (C)
Collection (C/M)
Retailing (C)
2. The quiet life for the monopolist
• The Post Office as a government department, (including in the UK its small sibling,
telecommunications)
• No separation of operation and regulation• Classic public sector enterprise problems ‐
over‐employment, inefficiency, hostility to change, jealous of monopoly
• High levels of service (4 deliveries per day!)• Universal service easily covered via cross‐
subsidy.
3. Competitive challenges arise• Competition in posts followed competition in many other
regulated sectors –
beginning in the 1990s in the UK
• Why so late (or not at all)? Public satisfaction; low levels of household spending (about 50 pence per week); few
opportunities to unleash innovation; union opposition; no political support for change from left or (sentimental) right.
• Similar obstacles to privatisation, which has only been achieved in minority of countries, including Germany and the
Netherlands
• Conservative politician Heseltine tried but failed to privatise the Royal Mail in mid 1990s, defeated by left and right. (A key
issue ‐
would a privatised firm be allowed ‐
or required ‐
to keep the Queen’s head on stamps?)
European Postal Directives: the long road towards liberalisation in Europe
The 1997 Directive: defined and standardised the Universal Service Obligation (USO) and the Universal Service Provider
(USP); created a reserved area (a segment of postal services which is
reserved to those postal operators providing
universal services within national boundaries) of letters under 350 g; proposed independent regulation for postal services.
The 2002 Directive: reduced the reserved area to below 100g (most mail is < 25g; the European Commission wanted a 50g
limit); created an access regime; provided for competitors to contribute to the costs of the USO
The 2008 Directive: liberalised the whole market from 2011, with some derogations.
Unbundling the posts: the UK experience
• Creation of a regulator, Postcomm, in 2000
• Primary duty is maintenance of the ‘universal service’; secondary duties include the
promotion of competition etc.
• Postcomm’s strategy was to open up the market progressively, by granting limited licences, culminating in full liberalisation in
2006
• This was accompanied by mandating access to the incumbent’s delivery network
The form of competition• Is end‐to‐end competition for ‘basic service’
possible, or is access‐based competition inevitable?
• Mooted forms of competition have included:
‐
daily deliveries in easy‐to‐serve neighbourhoods
‐
large customers’
mail delivered to major cities on a rota basis
‐
tie in with other delivery network, eg of milk.
• None has yet worked. But Royal Mail wants to outlaw them.
Access Prices
• According to the 2nd
Postal Directive, access prices ‘should take account of the avoided costs, as
compared with the standard service…Any such tariffs shall also be available to private customers…’
• The meaning of this was disputed, but in the event a ‘retail minus’
pricing rule emerged for the delivery
network, designed to give initial entrants an appropriate level of ‘headroom’
to compete. Access
competition may have seemed more palatable to the incumbent than end‐to‐end competition.
The effects of competition
• Retail prices were set by Postcomm using a RPI‐X formula on 1st
and 2nd
class mail, based
from 2006 on a regulatory asset base (RAB)
• The trajectory of retail prices then determined access prices
• The ‘headroom’
(minus) was generous; competitors quickly gained a large share of
the business market: 39% of bulk mail by 2007/8.
Aggravating factors in the market place
• Efficiency targets were not met. Modernisation funds made available by the government were not spent as a result of
industrial strife. Levels of walk sorting and walk sequencing were (and are) pitifully low
• Quality targets were not met
• The Royal Mail uniquely does not pay VAT/GST (important for customers such as financial institutions which do not charge
VAT); this advantage is now under threat
• The pension deficit ballooned to £9bn, while RAB is £5bn.
• As a result, the taxpayers picked up the losses – a classic public sector soft budget constraint.
Dealing with universal service in a competitive world‐
the ‘death spiral’
story
• Entrants cherry pick ‘profitable’
business
• Incumbent’s average costs and prices rise
• More segments become potentially profitable to competitors
• Repeat, until the incumbent collapses
• Mitigated to date by a uniform and universally paid delivery access charge.
Universal service regulation
• European requirement is for 5 days per week delivery and collection
• UK requirement is for 6 days, high standard of service at average price
• Capitalised NPV of the Royal Mail switching from 6 to 5 day delivery was estimated at £3
billion (£300 m. per year)
Sharing the USO
• Why not create a fund and share the USO?
• This is permitted under European law
• However, it has perverse effects if deficit is based on inefficient costs
• Accordingly strong resistance to setting up a fund until the incumbent is certified as
efficient.
4. The crisis and response
• From 2007 to 2012, demand for postal services has fallen 20‐30% in many
jurisdictions ‐
less in Australia
• Cyclical effects are in play, but structural change (email substitution) is the major factor
• This threatens some postal operators with insolvency
The response in the UK
• The privatisation attempted by the Labour Govt. failed – thanks in part to Union planning
• The Coalition has passed an Act permitting it (which assume the pension deficit)
• Regulation has switched to Ofcom• Recognising that Universal Service is in peril,
Ofcom has fundamentally re‐regulated the sector
This involves• Controls removed from all services except 2nd
class
• 2nd
class mail price set at safeguard rate of 55p (indexed to CPI) for 7 years; for 2012, Royal Mail chooses 50p
• Further safeguard cap for large letters and small parcels
• Access mandated on ‘fair and reasonable’
terms, with prices based on a (non‐parsimonious) ex ante
margin squeeze test
• Monitoring of quality of service, affordability.
Why so radical a deregulation?
• The primary duty is the USO
• A risk analysis shows that continuing price regulation carries the risk of collapse of the USO
• Hence better to deregulate now, with an opportunity to re‐regulate later on
• [Privatisation goal may have played a part.]
Why not relax the universal service?
• ‘This is matter for Parliament’
• The Government is torn: relaxing the USO makes it easier to find a buyer for the RM; retaining the USO reduces the spotlight on an
unpopular privatisation
• The USO is kept intact, for now.
What does this example tell us about the future of posts?
The status quo in the UK (and possibly elsewhere) is unsustainable.
The principal levers to ensure survival are:a) efficiency improvements ( in some places hampered by
public ownership and perceived government responsibility for strikes)
b) price limits
c) restrictions on competition
d) the scope of the USO.
How much can each of these contribute?
How long will they take to operate?
Which are most/least politically acceptable?
What does this tell us about governance?• The government ideally should separate its policy
role from its ownership role, and also should not second‐guess the regulator
• This degree of self discipline was not shown in UK posts; unions went to the government round the backs of management and the regulator
• Maybe only privatisation can separate the government from micro‐responsibility and micro‐
management?
• How is this dealt with elsewhere?
5. Links with competitive services
• Decline in letters is accompanied by growth in packets/parcels
• Media fulfilment (audio, video, newspapers, books) subject to digital substitution
• Non‐media e‐commerce fulfilment growing quickly
How competitive is competitive ? UK data
• Parcels delivered to pillar boxes or post offices not competitive
• Express business services very competitive
• Deferred business services variable; Royal Mail strong in low weight items, subject to strong economy of scope with letter delivery,
especially in rural areas
• In the UK, little access competition
Regulatory issues • Single or dual till?• Reasons for favouring dual tills in airports: they are targeted at acknowledged sources of monopoly power
they minimise the distortions in markets where monopoly power is unproven or absent
they provide better investment incentives
• But in posts the scope for subsidies from monopoly services is limited
ACCC 2010/11 review of cross‐subsidy in Australia Post
• Reserved services not a source of cross‐ subsidy
• Non‐reserved services may be a source of cross‐subsidy
• ‘Australia Post may have a strong market position in certain non‐reserved areas (such as
the growing area of parcels).’
These services may subsidise letters.
• Is this single till necessary or desirable?
