Sunday, August 28, 2011

Could First Class Mail Service Standard Be Maintained?

In a major effort to reduce costs to match projected revenue, the Postal Service has proposed eliminating overnight delivery of single-piece mail.   The Postal Service projects substantial cost savings that would come from eliminating full time positions and reducing its use of clerks and mailhandlers during periods when they would be paid a premium for nighttime work.  Support for the Postal Service's cost savings assertion comes from "Cost of Service Standards," a recent report of the Office of Inspector General - United States Postal Service (USPS-OIG).

While the "Cost of Service Standards," report illustrates that cutting service standards could save money, it also illustrates that current service standards could be saved by raising the price of single piece mail.  To estimate how much single piece mail would need to increase over the next ten years, I developed a simple model that suggests that the Postal Service cold maintain current First-class single piece service at rates that remain below the rates that foreign posts charge for similar service.  The model suggests that single-piece First Class mail could maintain current service standards if letter prices was raised to between 50 and 53.5 cents in 2012 and service could be maintained at current levels in 2020 if single piece letter rates were between 51 and 55 cents per letter.

Details of Analysis
The estimate of price increases is based on a simple trend forecast of single-piece letter and card volumes, the peak load cost estimates developed in "Cost of Service Standards." The model also includes a number of critical assumptions that would need to be modified in a more robust analysis of raising prices as an alternative to cutting service standards.  These assumptions include:
  1. The long-run inflation rate for Postal Service peak-load costs will be 2.19%, a rate equal to the current rate for the 10-year Treasury bill.  If labor or other costs rise faster than 2.19% annually, then the price increase would need to be higher.
  2. The Postal Service can adjust peak load costs proportionally with volume declines.  This assumption is not realistic as capital and maintenance costs will not decline proportionally with volume costs.   Also, reducing labor costs for single-piece mail will be difficult as reduced single-piece volumes can be dumped, culled, faced, cancelled and sorted at origin in less time which makes it exceedingly difficult to continue to use full-time clerks and mailhandlers to handle this mail.  Even the changes in the APWU contract that allow non-traditional full time assignments and an increase in part-time employees may not be sufficient to deal with such a rapid decline in work preparing and sorting single-piece mail at origin. 

    Finally, reduced volumes will increase some transportation costs as the cost of inter-facility truck transportation is less than 100% variable with volume and the decline in volumes may shift some volumes from truck to air transportation. The decline in volumes could reduce transportation costs if the Postal Service can reduce the time associated with taking raw single-piece mail and preparing it for dispatch by shifting some transportation from air to truck transportation.  Reducing time in sorting this mail requires higher levels of part-time labor and more sortation equipment than would be required if current critical dispatch times are maintained.
  3. Peak load costs per piece are the same for cards, letters, flats and parcels.  Peak load costs will vary depending on whether an item can be sorted using automation or manual sortation.  Single-piece letters and cards are more likely to avoid high-cost manual sortation than flats and parcels and therefore are likely to have a lower per-piece peak-load cost than flats or parcels. Therefore, the per-piece price increases listed below more than likely overestimate the increases associated with letters and cards and underestimate increases for single-piece First class flats and parcels.
  4. Users of single-piece First Class mail are insensitive to price changes.  The sensitivity to price changes, or price-elasticity, is different than the sensitivity to technological changes.   Users of a  product with technological alternatives may remain price inelastic even if they are very sensitive to the convenience of alternatives.  While the demand for buggy whips has dropped to nearly zero over the last century, those users of buggies, including carriage drivers in Central Park and the Amish may be relatively insensitive to price changes in the cost of buggy whips while nearly everyone else has abandoned them. 

    Single-piece mail is generally thought of as price-inelastic.  However, a major price increase could result in a greater price impact (i.e. reduced single piece volume) than what current models now estimate.
Single Piece Mail Volume Trend

Figure 1
Single Piece mail volumes are rapidly declining creating real stresses on controlling costs of handling this mail.  Between FY 2009 and 2010, single-piece First Class mail declined by 9.8% and through three quarters it has declined 9.4% from 2010 levels.  The decline in single-piece mail reflects the shift in bill payments and correspondence to electronic alternatives.   The chart illustrates that the Postal Service could be handling less than 40% of the volume of single-piece letters and cards that it does today.

Peak Load Costs
Peak load costs for 2010 are the estimates generated by Christensen and Associates for the USPS-OIG.  The upper bound represents the largest estimate in their report and includes all mail processing, transportation, and delivery costs that may be service related.  (Source: Bullet #1 in the Christensen executive summary)  The lower bound only reflects Mail Processing costs.  (Source: Page 3 of the USPS-OIG report) 
Figure 2 illustrates the change in peak-load costs over time using the assumptions detailed above.  The chart illustrates that peak load costs will likely decline as peak-load First Class single-piece volumes decline.

Figure 2
The rate of decline is dependent upon the assumptions listed above.  As the discussion on the assumptions show, cost related assumptions are more likely to be biased toward producing peak load costs that are lower in out years than illustrated in the chart.  The volume assumption produces a potential bias in the opposite direction as volume could decline faster than projected.

Increase in Single Piece Rates
Estimating an increase in single piece rates to cover peak-load costs was estimated by dividing estimated peak load costs by single piece volume.  The estimate for 2010 reflects 2010 volumes and Christensen Associates estimates of peak load costs.  Increases in other years reflect the impact of inflation and volume losses. For 2012, single piece rates would have to increase between 5 and 8.5 cents to keep current service standards.  Figure 3 illustrates the increases that could be required between now and 2020 to maintain current service standards.
Figure 3

Single Piece Letter Rates

Figure 4 illustrates prospective single-piece letter rates that would  allow the Postal Service to continue to offer service at current service standards.   The chart illustrates that the standard letter rate would need to rise to a level between 50 and 53.5 cents in 2012 to cover peak load costs and maintain current service standards.   The kink in the two lines in the chart reflects the fact that CPI related price increases are incorporated in 2010 and 2011 rates but not in rates for 2012 and beyond. These prices reflect both a 1 cent price increase due to the price cap that will reflect the cost increase that will occur even if service standards are reduced and a 5 to 8.5 cent increase needed to maintain current service standards.   
Figure 4

 Regulatory and Legal Constaints

The Postal Service will soon present its proposal to reduce service standards for single piece mail for review by the Postal Regulatory Commission.  The Commission will examine the cost, revenue and policy implications of the change.   Upon the completion of its review the Commission will issue a non-binding recommendation on whether the Postal Service should reduce service standards or not.

Instead of the proposal to reduce service standards for single-piece First Class mail, the Postal Service could have decided to present an alternative that would maintain current service standards but at higher rates.  However, to implement higher rates, the Postal Service would have to file the proceeding as an exigent rate case.  Given the difficulty that it had in the last exigent case, the Postal Service logically chose reducing service and costs rather than maintaining service and raising rates, even if that option makes more business sense.

Current service standards at current rates could still happen depending on what the Commission and/or Congress does.

The Commission could examine the Postal Service's proposal cutting First Class single-piece service standards and recommend higher prices rather than lower service standards.  In doing-so it would have to determine that the benefits of current service standards over reduced levels of service exceeded the differences in price that would be required to maintain existing service levels.   If it did that, it would be making a policy judgement based on its understanding of United States postal policy, thereby creating a new explicit component of the Postal Service's universal service obligation (USO).  In doing this, it would need to also indicate that if the Postal Service filed an exignent case that it would be favorably viewed using reasoning consistent with the information available and recent court cases.

Congress could get involved in the issue of service quality as a matter of policy.  If it did so, Congress would be adding an additional cost associated with the USO.  If Congress added a condition to the USO, then it would be appropriate for it to also allow the Postal Service to raise its prices to cover the additional cost of this new obligation.  Without an explicit permission to raise prices, Congress would force the Postal Service to use the exigent process to cover the additional costs created by the new specifications of the USO.

No comments: