Tuesday, June 21, 2011

The Death Spiral: Could it Be Driven By Service Quality as well as Costs

The previous post, "Businessweek fires the Postal Service," identified a  recent effort of a major mailer to switch to alternative delivery.   Previously, this blog has noted that Valassis has expanded its use of alternative delivery for saturation advertising in the post, "Is it time to Choose Alternative Delivery."  The Businessweek move may be more significant for four reasons:
  1. it represents the first time in over three decades that a non-saturation mailer has decided that alternative delivery is a better delivery option on a service basis for a large number of its recipients;
  2. it illustrates that the return on delivery costs is affected by service quality and is not just price driven; 
  3. it represents a shift of volume from the Postal Service's highest income recipients; and
  4. it illustrates why the the title of the last Congressional Hearing on the Postal Service, "Postal Infrastructure: How Much Can We Afford?" asked the wrong question.
Service Quality Matters

Businessweek illustrates that there for print to be competitive in the world of digital content, there is a minimum level of service quality that a print delivery service must meet to be competitive.   The earlier critical entry times, inconsistent delivery service, and the potential loss of Saturday delivery are all examples of service quality factors that make the printed Businessweek product delivered by the Postal Service less competitive than its other print competitors and digital content.

To the extent that financial challenges force cost cutting that affects service, the most service driven customers will leave.    This is no different from what happens with the railroads prior to bankruptcy as they delayed the capital investments to meet the needs of customers even though rates were held down by rate regulations by the Interstate Commerce Commission.

This is not to say that if the Postal Service charges 20 cents per delivery and the competition is $1 that the delivery firm will chose an alternative means of physical delivery.  It means that the print delivery customer may be willing to pay 25, 30 or 40 cents to get the service that they require for print delivery from any provider and decide to shift customers that cannot be served via print delivery at a reasonable price to its digital offerings.   

Businessweek also illustrates that service quality for "Periodical Mail" is not identical.   If Hot2C service is required by certain publications, then that is a very different product than standard processing of periodicals, and periodical mail requiring tighter delivery standards needs to be handled as a different product than those periodicals that do not need such service.  

Similar differentiation most likely exists among Standard mailers.   Many standard mailers have specific in-home dates that matter precisely.   Others have less concerns about when the mail piece arrives.    These two groups of Standard Mail customers should be treated as different classes of customers to ensure that they get the service that they require at a price that distinguish the levels of service.   

The mail product for customers with specific delivery dates should be shifted to a defined delivery day product with the delivery date scheduled in advance so that local managers can schedule employees to meet demand. In this way the Postal Service would compete directly with other advertising media that can promise specific delivery dates.   (This is very different from First Class Mail that has delivery standards but not scheduled delivery dates.)   The less time conscious Standard Mailers can continue to be viewed using the traditional view of Standard Mail as deferred mail

Return on Delivery Cost Matters

Businessweek's focus on service first, and cost second illustrates that what matters is the economic return of delivering a printed mail piece.   As noted above, the delivery price must include delivery on the day that ensures that the  mail piece has a positive return.   A Businessweek delivered on a Monday or Tuesday has a much lower return to Bloomberg than one delivered on Friday.   The content is less fresh and therefore the advertisements are less likely to be seen.  

Price does matter but if the weekly magazine does not arrive on Friday or Saturday, or the advertisement does not arrive before the sale, the election notice or campaign advertisement doe not arrive before the election its value to the sender is less or even zero.   Unless the Postal Service can ensure that its service quality meets the service needs of its commercial mailers, it will not provide a delivery service that makes print a competitive form of communications.   This will speed the shift of recipients to digital delivery regardless of the how low the Postal Service's rates are.

Cherry Picking of Customers

BusinessWeek's shift of subscribers illustrates the ultimate form of cherry picking.    It shifts customers from not just whole zip codes but from portions of zip codes.   In many ways, the shift may come very close to shifting volume from individual carrier routes to alternative delivery.

The problem for the Postal Service is that the loss of volume will occur at high income, high volume delivery stops.  These stops occur on routes where every stop now receives more volume per day on average and rarely if ever receives no mail.

While the Postal Service's and Postal Regulatory Commission's cost model estimate long run marginal costs associated with mail, they represent long-run marginal costs over all routes.  These models would suggest that the loss of Businessweek should be a net gain for the Postal Service as the cost of delivering periodicals are less than revenue.  

However, Businessweek is shifting volume from the Postal Service only on the highest income, highest mail volume routes.   As such, the loss of Businessweek will have minimal if any impact on delivery or transportation costs of the Postal Service and only affect processing and other non-capital related costs associated with handling the lost pieces.  As such, the loss of Businessweek will likely increase losses at the Postal Service rather than reduce them as the cost models would project.

Cherry picking of customers raise questions about the future of the Universal Service Obligation.   Clearly, alternative delivery will deliver to Potomac, Maryland, the Hamptons in New York, and Beverly Hills in California.  Those who live in more modest surrounding are less likely to see their print communications switch to an alternative print delivery service and instead they will be encouraged to shift to digital delivery.   

The problem of Cherry picking illustrates another problem facing the Postal Service, uniform pricing.   Once service issues are resolved, the Postal Service will need the freedom to charge different rates depending on the distribution of mail pieces sent by a commercial mailer.  The cost structure of handling Businessweek's periodicals is different than the cost structure of handling delivery of Time, Lucky, Christianity Today or ESPN Magazine due to differences in the distribution of recipients of these publications .    Regional pricing is used by Royal Mail, and shipper specific pricing is used by United Parcel Service, FedEx and all other delivery firms.  

Adjusting to cherry picking competitors is not only a Periodical Mail issue.  To survive, the Postal Service will have little choice than to price according the costs of individual commercial customers.   Continuation of uniform prices for commercial mailers is unsustainable if the Postal Service is to remain a self sufficient enterprise that provides universal service.

Postal Infrastructure and Its Customers

Over 90% of all mail is sent or received by businesses, governments or non-profit organizations.  These entities use mail because it provides a positive economic benefit to their enterprise.  If alternatives can provide a bigger impact at the same price, or the same impact at a lower price they will chose it.   The service problems facing Businessweek, illustrates that the Postal Service as an enterprise has to have the physical, information technology, human capital, and intellectual property assets to meet business needs or the customers that generate 90% of its revenue will go away.

The fact that decisions to invest in the Postal Service infrastructure need to reflect business decisions and not political decisions is well known.   Questions regarding location of mail processing and retail facilities using considerations other than whether the investment improves the return on the postage paid my the Postal Service's customers unless local, state, or federal government entities are willing to subsidize the Postal operation.

The question that The Subcommittee on Federal Workforce, U.S. Postal Service and Labor Policy asked, "Postal Infrastructure: How Much Can We Afford?"  focused on the political question.   It is also couched in a manner that one might ask about other government programs,  such as

  • How many national parks can we afford?
  • How much medical care can we afford to offer senior citizens or children? and
  • How much military spending can we afford to ensure that that the United States is safe?
The problem is for Businessweek and all other commercial mailers, the Postal Service, while a semi-government entity, is not a government entity to them.   It is instead a critical part of the print delivery supply chain.  Its ability to invest capital to create or buy the collection, processing, transportation, and delivery network that meets the print communications customer's needs will determine the ability of the rest of the supply chain to survive in the face of competition from traditional, digital and social media competition.

Creating a Postal Service that can meet these needs is going to require significant capital investments the scale of which are unknown.    The delivery fleet requires replacement at a cost of around $7 billion.   Additional expenditures are needed rather rapidly to:
  • replace processing equipment that may be reaching the end of its useful life just as delivery vehicles have and to meet the needs of processing strategies that minimizes the time that mail spends in processing plants to allow for longer times in trucks and other forms of transportation,
  • restructure the processing network beyond just consolidating plants to reflect that not all plants are the right size or in the right location to meet service needs of customers and operations of fast turn-around processing operations,
  • install information systems needed to modernize retail operations, integrate track and trace operations with that of FedEx, UPS, and other parcel carriers, implement mail scheduling for time definite mailing, and improve management of postal operations;
  • replace existing costing systems to allow for bottom-up costs and customer-based contract pricing for all commercial customers;
  • cover transition costs including, retirement incentives, severance costs, training costs, transfer costs associated with rightsizing and restructuring the workforce to reflect the operating and skill needs of a more customer-focused, flexible set of employees.
Before, the The Subcommittee on Federal Workforce or any other Congressional Committee moves forward, they need to look at what the Postal Service means to the businesses that depend on delivery of communications and parcels.   This inquiry will clearly show that for these firms the Postal Service needs to be a business first or what they now deposit in the mailstream will move to digital, mobile or physical alternatives.   Second, Congress needs to look at how uniform pricing encourages cherry-picking and will speed the death spiral rather than retard it.  Finally, Congress needs to look at the Postal Service's capital and cash needs from a business perspective.   Only after this is completed, will Congress have a clue as to whether the Postal Service has or will have the resources as a government entity to meet the business needs of its customers with a particular focus on determining whether resolving the retiree healthcare issues in the Postal Service's favor would give it the cash and capital resources necessary to meet the needs of its commercial customers whose business will determine if the Postal Service can remain self sufficient.

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