Wednesday, July 7, 2010

The Exigent Rate Case: Rethinking Price Regulation

Yesterday the Postal Service proposed a major change in its rate structure through an exigent rate case.   The general and postal press have focused on 1) the rate increases themselves with particular attention to the impact on First Class single piece mail; and 2) the exigent process itself, a rate setting process that is being used for the first time. 

Mailers have organized a major effort to stop the changes through a new group the Affordable Mail Alliance.   With only 90 days to press their case mailers have a major challenge in their effort to argue that:
  1. the conditions necessary for invoking the exigent process had not been met; 
  2. the rate increases proposed are too large;  and
  3. the changes in individual rates result in rates that are not fair and reasonable and do not meet the pricing objectives in postal law.
Given the limited amount of time available for the proceeding, the level of discovery, expert testimony, and cross-examination in this proceeding will be limited.   While the procedural schedule is not yet out, the Commission will likely need around 20 to 30 days to review evidence and write its opinion which compresses the first nine months of a traditional rate case into a 60 to70 day period.

What makes the exigent rate increase particularly difficult for mailers and the Commission is that it represents more than just a simple across the board increase in rates.   The proposal represents a fairly bold rethinking of regulatory pricing and the economic thinking that guided postal pricing for nearly thirty years.  These new approach can be summarized in seven statements as follows:

  1. Divergence to electronic alternatives for single piece mail is not affected by stamp prices.   "The Postal Service does not believe that the erosion of single-piece mail through electronic diversion can be materially affected by limiting the growth of the stamp price." (Statement of James M Kiefer on Behalf of the United States Postal Service, July, 6, 2010, p. 15)  "As long as these forces [that encourage electronic payment] are in play, efforts to hold down the stamp price to "protect" the single piece customer will be unlikely to spur usage of single piece mail among users, for whom continence trumps the small impact of the postage savings." (Kiefer, p. 16)

    From a business standpoint, this means that the Postal Service cannot protect itself from the decline in single piece First Class mail by holding prices down.   Given that single piece mail is now declining at a faster rate than it did before the recession, the Postal Service's single piece rates today will increasingly be required to bear the costs associated with reducing the workforce that currently handles single piece mail at a rate far faster than the rate of normal attrition.  The public should expect that single piece rates will begin rising faster than other postal products to generate cash to cover these costs.
  2. The markets for single-piece and presorted First Class mail are different.   By separating the markets for single-piece and presorted First Class mail, the Postal Service presents a direct challenge to the theory behind workshare discounts as they are currently constructed. "Traditional workshare theory suggests that increasing presort First-Class Mail prices would simply cause customers to re-evaluate their decision to perform worksharing activities.  Essentially, the theory argues that if it costs less for a customer to presort mail than the postal discount, then they will do the sortation. Conversely, if it costs more to presort mail than the postal discount, then the customer will choose to tender unsorted mail to the Postal Service. While this argument may have been valid at the inception of the automation program, it ignores the realities of decisions that customers are making today. Much of today’s presort mail is generated not by physically sorting mail pieces but by using presorted mailing lists to produce the resulting mail in presort order. 

    Customers pay prices, not “discounts” and decide whether to mail or not to mail based on the total cost of mailing, including the postage paid (not just the price differential between single-piece and presort mail) and the costs of producing that mail. While at some level the size of the discount affects workshare decisions, the overall postage price affects the decision to mail or not to mail. If this price goes up substantially (because discounts are reduced) the decision to mail at all may be reconsidered." 
    (Kiefer, p. 18)

    The Postal Service carriers maintains the separation between individual and commercial users of First Class mail in its development of First class mail products regardless of shape and is clearly seen in the discussion of both letter and parcel rates.  

    The separation of individual and commercial mailers requires the Postal Regulatory Commission to overturn current precedent on First Class rates and worksharing discounts as applied in the Postal Regulatory Commission's 2009 Annual Compliance Determination.   The Postal Regulatory Commission will like spend some time deliberating this change but much of the public work on this issue has been completed as part of another proceeding, Docket No. RM2009-3.
  3. Pricing is still subject to the Postal Regulatory Commission's worksharing rules even if the Postal Service does not believe it makes sense.   Mr. Kiefer's statement has numerous sections on worksharing to deal with the Commission's approach to measuring traditional worksharing discounts.   The inconsistency between these sections and the Postal Service's thinking on separating single piece and pre-sorted First Class into two separate markets indicates that the Postal Service still must prepare its proposal to meet Commission precedent even if it believes that the precedent does not allow for postal prices to reflect market realities.  While the Postal Service may want to challenge worksharing precedent and law, the Postal Service is holding off that challenge until at least 2011.   
  4. Weight Categories for First Class Pre-sorted mail require rethinking.   The Postal Service has proposed allowing single piece First Class letters to hold 1.2 ounces and still pay a single ounce rate.   This allows more advertising inserts in letters, items that help make mail that normally is a business expense become a profit generating advertising opportunity.   The question that this change makes is: why 1.2 ounces?  As mailers and the Postal Service experiment with this proposed change, it is possible that the Postal Service may want to allow commercial mailers to send higher weights as long as the mailing meets automation requirements.
  5. Pricing should not reflect bad operating processes or short term economic challenges.  The prices proposed for Standard Flats and Periodicals both are more modest than traditional price setting rules would require.   The process for handling flats are currently in flux and the costs associated with moving them in one to two years should reflect a different operating process than the Postal Service now uses.  Also if the Postal Service, started an aggressive program to remove excess capacity through a new round of early retirements and a national distribution strategy for flats similar to what it did with the NDC's it may be possible to reduce costs even further.

    The Postal Service's rates also reflect a limited recognition that catalogs and magazines are struggling in the marketplace that sees significant reductions in consumer demand.   Magazines in particular have seen significant drops in ad pages that reduce the amount of postage a magazine pays per issue.    The recovering economy has seen some increase in the number of advertising pages sold that will increase the amount of revenue the Postal Service generates per magazine.
  6. Not all products that look the same compete in the same market.   The Postal Service in its press conference described two Standard Parcel markets.   The first is a product sample market that is a form of advertising and competes with other means of distributing product samples.    The second is fulfillment and includes the distribution of light weight parcels.   Physically, these items look very similar.  However, the value of the item to the sender is very different.   Samples are designed to generate sales so the postage price, combined with all other costs of producing the sample must product a positive return on the advertising expenditure.   Fulfillment parcels rates must allow the seller of the item to earn a profit on the sale including the item's cost as well as all other sales, marketing, and overhead costs associated with the sale.   The differences between the two markets are intuitive, proving this as part of a regulatory proceeding may not be. 
  7. The Postal Service's regulated parcel services, regardless of class, are offered in competitive markets.   The Postal Service with the exigent filing has begun the process of moving its parcel products into the competitive product category. This would allow it to offer all parcel services to commercial customers within contracts just like its competitors do and offer services to individuals based on rates contained in published tariffs.  The Postal Service at its press conference stated that it will propose moving Standard parcels to the competitive category this fall and is evaluating moving other products to this category as well.  

    The Postal Service's position in the parcel market is unique in that it both offers services directly to consumers and businesses and offers its delivery network to its competitors for delivering light weight items and items destined to the rural households.   All of the Postal Service's parcel products sold directly to shippers have private sector substitutes, although some are offered at prices that the private sector finds unprofitable and no private sector carrier offers a service that is price competitive. 

    The Postal Service's last mile delivery service competes with other firms that can offer last mile delivery as well as the employees and regular contractors of United Parcel Service and FedEx Ground.  The use of the Postal Service's last mile service reflects a classic make or buy decision that United Parcel Service and FedEx Ground that these companies constantly evaluate to ensure that they meet their profitability objectives.   The Postal Service ability to raise its prices for the last-mile delivery of light weight and rural parcels depends on price of its customer's alternatives. 
The seven items listed above should give the mailing community a lot to think about as they deal with the details of the Postal Service's proposal.   They all reflect long-term issues that go beyond the rates themselves.  For many stakeholders, including the Postal Rate Commission, postal unions, and many mailers, the changes reflect challenges to their long standing positions.  In 90 days we will see if the Postal Service has overcome the pull of precedent and traditional viewpoints or if a new era in postal pricing has begun.

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