FedEx Earnings - Implications for the USPS

FedEx's earnings announcement and conference provided some insights into the parcel market and the increasing integration of the Postal Services delivery network with the marketing and distribution capabilities of FedEx.   The comments relating to FedEx Smart Post seem to indicate that United Parcel Service and other carriers that compete in the market for delivering small parcels to households, whether by their own drivers or by the Postal Service may be losing market share to FedEx.

Here are the relevant excerpts:

 Parcel Volume

Dave Bronczek – President and CEO of FedEx Express from the Q & A

Well, Art, as Fred mentioned in his opening remarks, we expect a very solid peak season. It always gets a little cloudy after that with the key focal point being Chinese New Year. So, we're optimistic about going into the holiday period and I think we'll have strong performance both in our U.S. networks and international networks through the peak season, but it always gets a little cloudy after that with the important period being around Chinese New Year.

We do expect solid industrial production numbers for the calendar year 2010 and going into 2011 in the 4% to 5% range, and we expect a little bit of consumer spending pickup. Our numbers are around 1.5 in calendar year '10 and about 2.6 in calendar year '11. So those are numbers that we’re very comfortable with in terms of supporting our business levels. Obviously, we'll need to wait a little while after peak season to see what the remainder of the year looks like.

The Postal Service can expect an increase in parcels in the 4th quarter and beyond at least as much as large as what FedEx expects.  As will be shown below, the volume of parcels that the Postal Service delivers is tied to how many parcels FedEx and other similar firms feed to its delivery network.

Distribution Patterns

Alan Graf  - CFO from the Q and A

 Let me just add, particularly in the high-tech sector, our customers don't have any inventory. And what's happening, the market is coming to us as there's a disintermediation of intermediate distribution. Items are going directly from where they are manufactured to point of consumption, which is called International Priority Express, and that's what’s so exciting about the next few years around here is, that's going to continue, and with the reliability that we put up, there's no need to have an intermediate warehouse and there's no need to have a backlog of things that can go obsolete on the shelves and that's part of the excitement that we see around here.

In response to a question about inventory, Alan Graf highlights one of the challenges competing in the domestic home-delivery parcel market.   Inventory of items manufactured overseas, and in particular items that weigh less than ten pounds are no longer shipped to a domestic warehouse for shipping to the household customers.   As the retailer does not know where in the United States the sales will come from or for that matter, what color, size, and in the case of computers, the processor, specific amount of memory, size of hard drive, and other components that the customer plans to order, keeping inventory in the United States becomes quite expensive.  Given the difference in labor costs, it becomes cheaper to pay international air freight than to ship a basic model to the United States, and then modify it for individual orders.  

FedEx continues to deliver these items within its Express network and United Parcel Service delivers them within their standard network.   The Postal Service could enter the market for the delivery of foreign sourced retail sales for home delivery only if it offered a price competitive delivery service in conjunction with DHL or TNT or a foreign post that offered the same security as what FedEx and UPS offer (signature requirements and tracking service) at a competitive price for the total end to end transportation charge.  It could more easily offer a price competitive service that allowed for pick-up at a Post Office or automated kiosk in conjunction with any carrier for a price well below the cost of home delivery.


Parcel Prices:

Mike Glen - President and CEO of FedEx Services from the Q & A



We were pleased with the Domestic Express volume performance. It is also being driven by the high-tech high value added sector. But the particular point that I want to make here is about the strong yield management activities that are in place and we will continue going forward. That is our primary objective. While we want to continue to grow volume and expect that we will do that, our primary focus is on improving yields, at the domestic Express business as well as in Ground and certainly LTL. So, our primary focus is not on market share so much as opposed to continuing to improve yields.


Dave Bronczek – President and CEO of FedEx Express from the Q & A

This is Dave. I’ll just add to what Mike said, and I've mentioned this a couple of times before and we'll talk about it in a couple of weeks here. Yes, the volume is up 3% and yes, my yields are up 7% for an overall revenue increase of 10%, but again, the global network that FedEx Express is, the more international packages that end up in the United States in the inbound, or outbound part of my cycle drives more and more profits automatically. So, the more international packages that end up in my U.S. domestic trucks coupled with the yield improvement program that Mike just talked about is a significant profit driver for FedEx Express.

FeEx's increases in yield (average revenue per piece) reflect a concerted effort to raise the average rate that its customers pay.  While some of the increase in reflects an increase in weight and a higher proportion of international shipments for FedEx Express, it is clear that even in an economy with slow growth, FedEx is able to raise its prices for parcel delivery services.


Service Quality:

Fred Smith from opening statement

FedEx Ground continues to accelerate its network providing a clear speed advantage over the competition. Quite simply, FedEx Ground is faster to more U.S. locations than any other ground carrier.

Just since this last January, FedEx Ground has increased the speed of nearly 3,700 lanes. Since June 2003, FedEx Ground has accelerated its delivery times by one day or more in about 82,000 lanes. FedEx Ground now delivers more than half its volume of packages in two business days or less, and more than 80% in three days or less. FedEx Ground service levels are at all-time highs.

For the Postal Service, FedEx Ground's improved service standards pose a competitive threat to Priority Mail as for many origin destination pairs FedEx Ground rates are less than Priority Mail.   To the extent that United Parcel Service is also expanding the geographic area that has delivery in less than two or three days, they create a competitive advantage over Priority Mail.

Integration with the Postal Service Delivery Network:

 Mike Glenn - President and CEO of FedEx Services

I want to comment on one thing and caution you about looking at the Ground numbers in a vacuum. One of the strategic advantages that we have is SmartPost. SmartPost allows us to attack the residential lightweight business in a very efficient and profitable way. So rather than trying to steer that traffic into the Ground network and the Home network in particular, we steer that traffic into the SmartPost network.

So by definition, some of the growth potential that might otherwise go to Ground is going to SmartPost, and I think you can see the very strong performance we have there. So you have to look at our Ground strategy as an overall residential strategy, including SmartPost. We are very pleased with our ability to continue to have industry-leading growth rates and very strong yield improvement efforts at Ground, and I think that's based upon the combination of a great sales team that is armed with the tremendous value proposition and that's a formula for success.

Fred Smith from the Q & A

So, a good example of that is what Mike Glenn just talked to you about. If you really want to talk about the most cost-sensitive segment of the market, it is lightweight, low value-added retail items going to the home. There is no one that has the density that can compete with United States Postal Service. That's why several years ago, we came up with the strategy of developing a SmartPost service, and why it is growing at huge rates. So, we firmly believe that our strategy which has allowed us to pick-up in the commercial ground sector, what about 12 market share points...

Alan Graf - CFO from the opening statement

FedEx SmartPost average daily volumes grew 9% to $1.1 million as a result of gains in market share and the introduction of new service offerings. Yields at FedEx SmartPost increased 19% primarily due to lower postage costs as a result of increased deliveries to U.S. Postal Service, final destination facilities and higher fuel surcharges.

FedEx clearly sees its SmartPost service as a competitive advantage.   Given that it offers shippers in a highly price sensitive market very low parcel delivery rates a competitive service it increases what the Postal Service delivers.   Pricing this service to FedEx requires a great deal of understanding as to what FedEx is charging customers and what portion of that charge represents the Postal Service's part.   Trying to set this rate within a regulatory context is particularly difficult and raises a question as to whether the rate increases for the Postal Service's portion of the revenue from a parcel delivery shipment should reflect the ability of FedEx and similar carriers to raise prices for end to end service or some other standard.  

To the extent that regulated parcel services are primarily originated by FedEx and similar firms, then the value of the regulation to the shipper of regulated rates may be diminished by the benefits that FedEx and similar firms capture for themselves.

If UPS can do it why can't the USPS

In its conference call discussing its 2nd Quarter 2010 results,  UPS explained that the growth in its profitability this quarter reflected the fact that while volumes grew slightly, both labor hours and miles driven were down.    The decline in the use of labor and transportation assets reflected a more streamlined network than what existed a year earlier. The streamlining put downward pressure on the total work hours of its Teamster employees.

In addition to streamlining its network, the total complement and work hours of Teamster employees, UPS also made major strides in cutting layers of management by eliminating a significant portion of its district and regional management.   Elimination of middle management reflects the fact that UPS's standards based management approach and strong information technology platform allows fewer managers to manage more territory and employees effectively.

The Postal Service, even though it has reduced work hours and employees, has not been able to get ahead of the curve in streamlining either its facility or transportation network.  The Postal Service has not been as aggressive as financial conditions warrant in streamlining regional and area management.

Looking forward into 2011, the Postal Service expects that single piece First Class mail will decline by double digits from current levels and bulk First Class mail will decline by 6% further increasing over-capacity in its collection, mail preparation and origination sortation operations and may reduce demand for destination sortation capacity as well. 

No one knows how well the consolidation efforts now in the evaluation stage will work to reduce the over-capacity problem.  However, the public method projecting savings underestimate the benefits of plant consolidation because 1) they do not use volume forecasts which would identify the impact of declining First Class volumes on capacity needs; and 2) they do not use a net present value analysis that would show the impact over 2 to 5 years that would clearly show the value of early retirement incentives and some capital expenditures to speed the consolidation process and operating cost savings. 

In addition, consolidation efforts are limited due to three reasons:

1. the lack of capital that forces the Postal Service to use existing facilities that may not be ideally located for the most cost-efficient means of providing high quality service;
2. the lack of a employment plan that includes focused early retirement incentives and severance pay that would reduce head count more quickly than now occurs; and
3. full time job requirements which are increasingly difficult to justify given both declining originating volumes and the efficiency and service quality requirement that proportion of time that mail spends inside the walls of a processing plant decrease and the the time the mail spends in transit increases. 

 As both the shareholder and bondholder of the Postal Service, Congress needs to have a clearer understanding as to:

• the network that could optimally handle mail volume in 2020 while improving on or maintaining current service levels and how the constraints listed above prevent the Postal Service from having such a network;
• the additional costs that are imposed by the constraints identified above;
• the cost impact of not having such a network and the impact of those costs on postal prices and to a lesser extent on employee compensation; 
• the risks of not having such a network creates for the Postal Service's ability to pay its obligations to the treasury and be self-sufficient; and
• the impact of not having an efficient operating network on economic growth.

Additional Comments:

Retirement Liabilities:  I do recognize that the Postal Service has expenses for retiree benefit liabilities that no private sector company does in addition to having had its obligation for pension liabilities overstated.   However, even if these expenses were liabilities were removed from the balance sheet, the Postal Service would still face the challenge of dealing with flat or declining volumes total mail and declining First Class mail volumes which has created the need to adjust the sortation and transportation networks.     In order to be financially self-sufficient, the Postal Service has to move from behind the curve to ahead of the curve in its efforts to ensure that operating capacity fits the demand for mail.

Cuts in Management:   As one reader noted, the Postal Service has made some cuts in district and area management.   However,  UPS has made an even larger proportional cut in middle management than the Postal Service.   UPS made these cuts in order to deal with profitability challenges that exist due to competition from FedEx and slow growth in demand.   The Postal Service's profitability challenges are even greater which would suggest that further consolidation of area and district management may be warranted on top of its efforts to streamline its production operations.

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.

National Envelope Company Bankruptcy

The Wall Street Journal reported that the National Envelope Company, the largest envelope manufacturer in the United States filed for bankruptcy today. The bankruptcy filing indicated that the company had between $100 and $500 million in both assets and liabilities.  The company is family owned.

National Envelope Company is unlikely to cease operations under bankruptcy.   The bankruptcy proceeding will allow it to renegotiate existing contracts with employees  and vendors, renegotiate terms of loans, and renegotiate or terminate real estate leases that could not be completed outside of bankruptcy. 

National Envelope Company's bankruptcy follows a nearly two year process during which it has been consolidating operations.   During this period it has closed facilities, ended production, or curtailed production in:

• Chino, CA,
• Union, NJ,
• Long Island City, NY, and
• Houston, TX

The Houston TX closure represented the last step in the consolidation of three facilities in Texas into a new facility near Dallas.

National Envelope bankruptcy most likely represents an orderly way for it to deal with the need to reduce capacity at a pace faster than just waiting for existing capital and real estate leases to expire would allow.   It also allows some more flexibility in adjusting its workforce, that currently numbers around 3,000 employees.  However, there is no information yet available that would indicate that renegotiating union agreements, which may be permissible under bankruptcy, is anticipated.

The financial challenges that caused National Envelope to close these four facilities and now file for bankruptcy reflect the decline in the demand for mail and therefore the envelopes that National Envelope Company produces.  National Envelope is not alone in requiring significant consolidation of capacity.  The recent merger of Quad Graphics with Quebecor World Color will likely result in consolidation of printing operations of these two companies that will likely include some plant closures.   If the supplier's of the envelopes see the speedy consolidation of existing production facilities as critical to their survival as financially viable enterprises, it would seem that the Postal Service cannot delay its consolidation efforts either.  

What National Envelope Corporation's bankruptcy says to postal stakeholders is that mail volume declines, particularly in single-piece first class mail and flat shaped mail across all classes, may not allow the Postal Service to use painless ways to reduce capacity.   The decline in mail volume, combined with improvements in mail automation, means that the number of employees that the Postal Service needs is declining at a rate faster than the rate of attrition.   Similarly, the number of plants that the Postal Service needs may be declining faster than the rate that real estate leases are expiring.

The Postal Service could even find itself in the position, like National Envelope Company found itself in Texas, that it needed a new facility in a different location to replace a group of existing facilities that are no longer optimally located to provide efficient and timely service.  In this case the capital investment in a new optimally located facility could reduce both operating and transportation costs and creates the possibility of improving service previously served by the facilities that are replaced.

Unfortunately, the Postal Service does not have the ability to go through a pre-packaged bankruptcy process like National Envelope Company is likely about to begin. Nor will it have the financing needed to handle the transition costs to a move quickly to a smaller and more efficient mail-processing network that National Envelope Company will have so that it can streamline its current production network during its bankruptcy proceeding. 

It may be worthwhile now for the Postal Service to lay out the capital and transition costs necessary to reduce operating costs and consolidate its processing and transportation network.   This information could be quite valuable in trying to develop a case for restructuring the retirement expenses that the USPS-OIG has indicated should be adjusted.

The problem of capital and transition costs is illustrated in recent statements from Postal Service officials to mailers regarding the automated flat sortation and how a key constraint to fully taking advantage of the technology is availability of funds.    While flat volumes are down significantly, a streamlined flats sortation network modeled after the NDC network could handle bulk flats efficiently with the ability to automate sortation to the finest level that the technology allows at a lower cost to periodicals, catalogs, and other bulk flat mailers.  Such a network would allow mailers to reduce transportation costs by drop-shipping flats to fewer facilities that specialize in sorting flats using automation and then the finely sorted flats would be transported directly to delivery units, or transported to downstream plants for cross-dock movements onto transportation to delivery units.   A full explanation of the capital and transaction spending needed to put such a network in place should be demanded by flat-shaped mailers.  

The current problem with flats is just the canary in the coal mine.  The next product that will face an equivalent challenge will be single-piece mail and.   Single piece mail is declining now at above 10% year-to-year, a rate faster than what was seen before the recession.  This is different from nearly all other postal products which have seen volumes stabilize at 2009 levels and it does not seem unreasonable to believe that demand could rise from that low level as advertising spending across all modes begins to increase in 2010 and 2011.   

The problem with single-piece mail is two-fold.  First, it is highly profitable and its loss reduces contribution to overhead that must be generated elsewhere.   Second, its decline is far faster than the rate of retirement of employees that process single piece mail.    Therefore, the Postal Service will face continuing excess capacity of employees, and especially employees working on shifts handling originating single-piece mail unless it plans to reduce its workforce to reflect the decline in demand in the mail that has the greatest processing requirements. Similarly excess capacity will exist in facilities and possibly equipment.   Now is the time to plan the network for single-piece volume in 2015 and beyond.  A network planned geared for this change would go far to convince stakeholders and Congress that the Postal Service is serious in its efforts to manage its business which will be needed to get the changes in retirement obligations and postal labor law that the Postal Service wants.

Optimizing the Postal Service Network and 6-day Delivery

One of the benefits of the 6-day to 5-day proceeding is that it provides an enormous amount of data relevant for trying to understand the Postal Service's strategy to control costs.  A recent response by the Postal Service to an interrogatory by Douglas Carlson provides the first nationwide picture of the Postal Service's effort to consolidate sortation on Saturday among fewer facilities.

The Postal Service can consolidate sortation of collection mail that is collected on Saturday because it has at least 12 hours of time to transport the mail for sortation at a distant facility and get that mail back for final sortation at the destination facility.  The list of facilities that Douglas Carlson elicited from the Postal Service identifies 139 facilities that do not sort on Saturday.  A cursory look at the distance between facilities that sort mail only Monday through Friday and facilities that sort mail within that facility's territory on Saturday suggests that the Postal Service could be significantly more aggressive in consolidating sortation on its slowest day of the week.


The question as to how many facilities are needed to sort Saturday collection mail is determined by the time it takes to sort this mail, the available capacity in the canceling and originating sortation operations and the time it takes to transport the mail from one facility to another.  The Postal Service has shown that it can handle its service commitments by consolidating Saturday sortation at facilities more than 100 miles away from the facility that sorts the mail the other 5 days.  Examples include:

• Rapid City SD to Sioux Falls, SD - 348 miles
• Truth or Consequence, NM to Albuquerque, NM - 149 miles
• Green Bay, WI to Milwaukee, WI - 116 miles

If it is physically possible to consolidate sortation into a network that transports mail collected on Saturday 100 miles or more in South Dakota, New Mexico, and Wisconsin, then it should be possible to do the same in all other regions of the United States.  

Now this raises a second question is, "does it reduce cost of operations?"  Is the reduction of processing costs greater than the increase in transportation costs?  Given that the Postal Service can cost-justify consolidating operations from Rapid City to Sioux Falls and between Green Bay to Milwaukee, that I would expect that similar analysis in Pennsylvania might support consolidating all Saturday sortation in no more than three facilities in Pittsburgh, Harrisburg, and Philadelphia and it may even be possible to consolidate Saturday collection mail sortation in Pennsylvania in two facilities. Similar examples can be constructed in other states. 

What this means for the 6-day to 5-day proposal is that the Postal Service could most likely provide 6-day service using fewer facilities and at a lower cost than it does today.   Choosing to become more efficient has a major drawback for postal management; it creates more excess career employees.    Excessing these employees would have up-front costs in terms of retirement incentives and severance pay.   The Postal Service does not have the cash to cover these costs.  In addition to increasing immediate cash needs, excessing career employees create additional political headaches that the Postal Service does its best to avoid.

The possibility that facility consolidation could reduce the need to cut one day of delivery also creates a conundrum for postal labor.  Postal unions are all opponents of the 6-day to 5-day proposal, however, it is unlikely that their filings before the Postal Regulatory Commission will identify how the Postal Service could change its operations to reduce costs and union jobs if that was needed to keep 6-day delivery service.  In many ways, unions may find that 5-day delivery is preferable to consolidating the processing network as it minimizes the number of career jobs that are lost.

Of all stakeholders with an interest in the 6-day to 5-day proposal, clearly the Postal Service's customers have the most to lose by the less than aggressive strategy consolidating the operating network.   If 6-days of delivery are preferred by the postal market, it appears that the Postal Service did not act aggressively enough to reduce capacity and costs to keep 6-day delivery financially viable.   If the market is indifferent to 6-day or 5-day delivery, or if financial losses are so great that 6-day is unlikely to ever be financially viable, then customers still lose as the less than aggressive effort to consolidate facilities has resulted in higher costs that the Postal Service needs to recover through an exigent rate case it will file this summer.  

Congressional hearings are not a particularly good forum for analyzing the consolidation of the postal processing network and the impact of any consolidation strategy on postal costs and the rates that its customers pay.  Yet testimony from Michael Coughlin, and the Government Accountability Office indicted that such an analysis needs to be conducted by an independent entity.   It may be worthwhile for Congress to ask a government entity other than those that have previously provided testimony to the relevant committees to conduct such an analysis.  For example, the Department of Transportation and in particular the Volpe National Transportation System Center has the capability of managing such a study.  Such a study could help Congress evaluate all of the legislative changes that the Postal Service requests as well as whether GAO's proposal of a BRAC type commission is needed.

Should Voluntary Early Retirement Become the New Normal?

The Postal Reporter News Blog reported that the Postal Service is quietly announcing the introduction of a voluntary early retirement program in selected cities.  Voluntary early retirement programs allow employees to retire early but do not offer them a financial incentive to do so.  This program requires eligible employees to decide between now and May 21, 2010 with their retirement date occurring in June 2010.

Voluntary early retirement is the least expense method that the Postal Service has to convince excess employees to leave voluntarily and the least attractive method for employees who might consider retiring.    Because of the minimal cost of voluntary early retirement programs, it would make sense for the Postal Service to offer these programs every Spring prior to slower summer mailing season when demand for employees are lower and many of its processing consolidation actions take place.  

Early retirement can have significant financial penalties in the form of reduced pension and/or social security payments which is why incentives are often needed to get significant number of employees to retiree early.   However, even if the program only convinces employees thinking about retirement to retire 6-months or a year earlier, it will have the effect of reducing employment costs by moving normal attrition up by a few months. 

If Postal Reporter News is correct, the Postal Service's decision to offer voluntary early retirement only in selected cities, suggests that the program may exist to give employees that work in offices that are losing processing operations to other facilities or experiencing significant declines in volume the option to retire rather than accept reassignment at a facility that would require a long commute.   As there are no incentives, this year's voluntary early retirement program will likely only attract employees that are at or very close to normal retirement age or those eligible employees who use the next few months to find another private-sector job to supplement their CSRS or FERS retirement income. 

In cities where processing operations are being consolidated or declining volumes have created stand-by employees, the Postal Service should have within its workforce management arsenal the ability to offer incentives to employees only in those cities, as well as those cities where the processing operation is moving to.   Transferring employees to new facilities is not cost free as there are additional training costs to deal with each employee bumped by a transfer.  These costs, added to the wages that do not have to be paid, create a justification for the Postal Service to offer some early retirement incentive, although it is not clear if its additional costs are above or below the $15,000 that it offered last year to encourage retirement.   Postal unions may want to consider doing the analysis to figure out what the benefit is to the Postal Service of convincing someone to retire early.   The union should use this information to negotiate an addendum to their existing contracts to include a streamlined process for offering early retirement with incentives based on a value that makes financial sense for the Postal Service.  This would give employees some protection from reduced retirement benefits that voluntary early retirement does not offer and give the Postal Service an early retirement program that more closely meets its needs than the voluntary one that it now plans to use.  

Even without incentives, postal employees who are eligible for voluntary early retirement should take the time to see if early retirement from the Postal Service makes sense for them.  Potential early retirees could use the retirement income calculators available on the U.S. Geological Survey website to determine what their income would be after retirement. [The actual numbers should come from the Postal Service.]   This new program is coming at a time when most economists expect to see significant increases in available private-sector jobs which should make a job search now a lot easier than when the last voluntary early retirement program was offered.   With two months to look for a new job, postal employees eligible for the voluntary employment program have sufficient time to find new employment if they take an aggressive approach to seeking a new job.

Early retirees from the Postal Service have an advantage in seeking new employment as compared to non-retirees as their retiree health care and other benefits allow them to choose among a broader range of employment opportunities that include jobs that do not traditionally offer those benefits.   In addition, employees seeking to shift careers have a base income to cover expenses during while they are taking classes or getting necessary licenses (i.e. real estate, insurance, investment sales, etc.) as well as the health insurance that many changing careers do not have. 

Early retirees should not think that they are too old for school as demand for a number of professions that require two years or less of training is substantial.   Even in the current recession, individuals with two years of post-high school education had relatively low unemployment rates even as those with a high school education or less had trouble finding any work at all. 

Employees that learn that they are eligible for voluntary early retirement and want to consider looking for new jobs while they are considering the offer will find that the following books by Donald Asher would be helpful in finding a new job in the shortest amount of time.

The Overnight Resume, 3rd edition  - A new book that includes good advice for writing a resume for a career change including how to write a resume that is submitted and read electronically.

The Overnight Resume, 2004 edition - This is the older edition that can be bought on Amazon for less than $5 including delivery charge and is an absolute bargain.

The Overnight Job Change Strategy - While this book was written  17 years ago, the approach is still sound.   It explains clearly why personal contacts is the best way to find a private sector job.  IF you add e-mail to telephone contacts and substitute careerbuilder.com, monster.com and craigslist.org for want-adsthen the ideas are up to date.  At under $5 used on Amazon including shipping, it is a bargain.  (Used books are often library copies.)

The Foolproof Job Search Workbook -  This book is 15 years old but covers Donald Asher's approach to finding jobs.   Again add e-mail and substitute careerbuilder.com, monster.com and craigslist.org for want-ads and it the approach is up to date. At under $5 used on Amazon including shipping, it is a bargain. (Used books are often library copies.)

How to Get Any Job -  written for college students and those under 30 (read without mortgages and children) who are looking for a job or a career change.  Provides some insight into the impact of the web on job-seeking and explains why the web makes job searching harder not easier as it make it too easy for job seekers to apply.  Asher's approach here is similar to what he explains in his earlier books but with a focus on younger job-seekers.   It is worth reading to identify what has changed since his prior books were published.

Cracking the Hidden Job Market - this book will not be published until the fall of 2010 but is worth pre-ordering if you are considering a job change in the next year.  His current presentations to college students and alumni-associations summarizes the key points that will be included in this book.   It follows  the same approach used in his older books, The Overnight Job Change Strategy and The Foolproof Job Search Workbook but reflects the changes in technology since the mid 1990's and how they affect the process required to get an interview.

Understanding the Postal Regulatory Commission's Power.

In a number of previous posts, I indicated that the Annual Compliance Review had the potential to become a mini-rate case.  In her remarks before the Financial Services and General Government Subcommittee of the Senate Appropriations Committee, Postal Regulatory Commission Chairman Ruth Goldway laid out a view of the Postal Regulatory Commission that more than reinforces that view.

Chairman Goldway, in response to a question from Senator Durbin, noted that the PRC's opinion on the Postal Service's 5-day delivery proposal was advisory.  The PRC could not stop the Postal Service from implementing a service change that it advised against.   However she indicated that the Commission had the power to compel the Postal Service to reinstate service if it finds as part of the annual compliance review that the change results in the Postal Service no longer providing the universal service required by the law.

Her exact quote was:

Every year we have to make a report on whether the Postal Service has complied with the law and that means whether it [the Postal Service] has met its obligation to provide an efficient and fair level of universal service.  So if they don't take our advice on this [the 5-day delivery proposal] and at the end of the year they entered into an activity that we deem is less than universal service, we can find them out of compliance and require them to start up some new activity again.   But we could not tell them at the time of our advisory opinion what to do.

The PRC will issue its review of the Postal Service's 2009 Annual Compliance Report in the next few weeks.   This quote suggests that the Commission will assert that it has the power to compel the Postal Service to change any aspect of its rates or service in order to comply with the law. 

The Public Representative and others presented testimony in the annual compliance proceeding stating that Postal Service rates put it out of compliance with the law.   Given Chairman Goldway's understanding of the Commission's powers, the possibility exists that the Commission could concur with these assessments and require the Postal Service to adjust its rates upward to comply with the law.  

Mailers and the Postal Service appear likely to find an outcome in the PRC's review of the Annual Compliance Report to their liking only if the Commission does not find that the testimony arguing non-compliance was convincing or identifies a way to defer its power to compel Postal Service action.

Earlier Posts on this topic:

• Rethinking the Value of Postal Regulatory Policy
• Regulating the USPS into Financial Stability
• Re-regulating the Postal Service

Why the Postal Service Matters: FedEx Needs It

The financial data unveiled along with the FedEx earnings report that was announced yesterday revealed how closely tied the fortunes of FedEx and UPS are tied to the Postal Service.  FedEx is one of the Postal Service's largest suppliers.  It provides the postal service with a significant portion of the $2 billion spent on air domestic air transportation annually.   FedEx uses the Postal Service to deliver a significant portion of its light weight ground parcels.

While the size of the air transportation contract with the Postal Service is proprietary, FedEx reports its use of the Postal Service as a delivery supplier.  The following chart shows that FedEx's Ground delivery service has increasingly relied on the Postal Service to deliver parcels.  The shift to Postal Service delivery of ground parcels began in the fall of 2008 (FedEx's FY 2009 2nd quarter).

The shipments delivered by the Postal Service for FedEx Ground generally are 1) lighter weight than those that FedEx Ground delivers itself; and 2) more likely require delivery to a household address. FedEx Ground charged its customers less than $4 per shipment.  Of that the Postal Service received about $2 per shipment and FedEx Ground recorded the rest as its revenue. The most recent quarters for which the Postal Service and FedEx provided data had the Postal Service recording revenue of $1.92 per shipment and FedEx recording revenue of $1.59 per shipment.  Using the Postal Service to delivery lighter weight and home delivery shipments, allows FedEx to:

• Offer customers a delivery product with an attractive price.   With an average price running below $4, FedEx Smart Post offers a service that allows companies selling large quantities of light weight items on the web to offer those products at an attractive delivered price.
• Improve the profitability of its delivery contractors, and in particular home delivery contractors by increasing the average revenue per shipment they deliver.  By shifting low weight shipments to the Postal Service FedEx Ground increases the total revenue associated with all shipments delivered on a delivery route as low revenue items are removed from the contractor delivered network. This is most important for home delivery contractors who can deliver fewer shipments per day as the number of items delivered per stop and the distance between stops are greater than those routes in the same geographic area focused on commercial addresses.  It is hard to imagine any contractor able to cover his costs and earn a profit at $1.92 per shipment.
• Grow its parcel delivery business faster.   Volume growth requires increasing the capacity of the network and in particular delivery routes and delivery drivers.   The use of the Postal Service allows FedEx to better manage this growth and to ensure that its own network grows only as rapidly as heavier weight shipment volume grows.  Also, FedEx Ground would be less likely to invest in the marketing and distribution capacity required to accommodate growth if it had to use some of the $1.59 it now generates per shipment for profitably handling marketing and distribution of the lightweight parcel service to pay for delivery. 
• Grow its parcel delivery more profitably.   Even though FedEx Ground uses a contractor model, it is not immune to the economics associated with delivery networks.  Growing delivery network capacity to handle the growth in low revenue deliveries (i.e. light weight shipments that with rates of $4 or less) can create significant pressures on profit.  Paying the Postal Service around $2 per piece allows FedEx to earn a larger profit on light weight and home delivery shipments than it could if its contractors delivered the same item.

The recent growth in FedEx Ground's use of the Postal Service has contributed to FedEx Ground's gains in market share.  In it's most recent quarter FedEx Ground's daily originating shipment volume grew 13.9% year-to-year while United Parcel's daily ground parcel volume declined by 2.9%.   Clearly the ability of FedEx Ground to continue to grow its business and more than likely United Parcel Service find a way to stop the slide in market share will depend on the continuing existence of a reliable and competitively priced parcel delivery service that the Postal Service now offers.

Postal Service in Triage

Anyone who has ever been in an emergency room has had to deal with a triage nurse.   The triage nurse's job is to conduct an initial assessment of every patient that comes for emergency treatment and prioritize the patients based on the severity of their illness or injury.

Triage gets complicated when there is second door for patients that come in ambulances.   These patients skip the triage nurse and may have their first assessment by the emergency room nurse or physician.  This second door may allow a patient who is less sick than one who is driven to the emergency room to see a physician faster, or at least be placed on a gurney in an emergency room corridor.

Further complications exist in the case of natural disasters, mass-casualty accidents, and suicide bombings all of which may overwhelm the capacity of the medical facilities available.   Then the choices become even more daunting.   Instead of just choosing which patient can wait to be treated, the triage process may have to decide who is too injured to try to save and for those that it can save what organ/limb must be sacrificed for expediency in order to save even more lives given the available resources.   Medical care in Haiti following the earthquake was like this as limited facilities, supplies and medical personnel forced some horrific decisions to amputate limbs that could have been saved in a medical environment that was not so stressed.

The decision by the Postal Service to eliminate one day of delivery is equivalent to a decision that a business in triage makes.  Given the substantial losses, even discounting the retiree issues, the Postal Service had no choice but to find a way to cut costs faster than its current cost cutting efforts had produced.  Specifically, it needed to find a way to cut costs by between $2 and 4 billion above and beyond existing efforts in order to survive.

In its business triage, the Postal Service faced the question, "How can it cut costs in order to save the business without harming the brand and relationships with customers?"  The decision to eliminate one day of delivery is equivalent to an amputation.   It may save the business but it will create new challenges for it going forward.  Decision-makers had confidence in this decision because posts in other countries had made similar changes and their brand and customer relationships survived intact.

In the next year the Postal Regulatory Commission will review whether the Postal Service made the correct decision in its triage process, in the equivalent of a pre-amputation second opinion.   The focus of the PRC will likely be checking to see whether the cost savings projected are realistic and evaluating the likelihood that the impact on customers will be a form of business gangrene or benign.

One of the biggest challenges facing the PRC will be putting the decision to eliminate 5-day a week delivery into context.  The Postal Service made the decision to develop a 5-day a week proposal as part of a business triage process in the fall of 2008 that also generated some additional efforts to cut costs.  These included:

• Preparing a proposal to offer a Voluntary Early Retirement Offering;
• Preparing a case to close post offices;  
• Completing preparations to complete plant consolidation studies;
• More intensive efforts in carrier route evaluations; and
• Preparing a proposal for 5-day delivery.

The Voluntary early retirement offer had minimal impact. From this the Postal Service learned that it could not reduce its workforce quickly cost free. Within a few months an offer with financial incentives was introduced.

The PRC's evaluation of post office closures is nearing its end and the list of post offices that will be closed has shrunk from more than 3,000 to less than 200.   The potential cost savings has most likely shrunk as well.  The failure of the Postal Service to eliminate all of the corporate offices that it wanted reflects both the need to continue to provide service in the communities affected and the lack of a ready strategy to replace corporate offices to be closed with contract or franchised offices in those communities.  

Plant consolidation study announcements were publicized in earnest from the spring till fall of 2009.   These consolidations were chosen based on the knowledge and experience of local management.   A national strategy to restructure the bulk mail network was begun and then expedited after the initial efforts both improved service and reduced costs.   Even without PRC review, plant consolidation proposals take a full year to complete the entire process meaning that efforts begun in 2009 could not begin producing savings for a full year.

Walking Between the Law and Disaster

The Postal Regulatory Commission held its public forum on the Postal Service's Annual Compliance Review (ACR) yesterday.   The tenor of the discussion suggests that the Commission facing the challenge in this proceeding of walking the fine line between the law and disaster.

Simply put, the ACR proceeding raises two questions relating to the law.

• Did the Postal Service's ACR filing show that it complies with the requirements of 39 U.S. Code to 1) provide prompt, reliable, and efficient services to patrons in all areas[39 U.S.C. § 101 (a)] ; and 2) "to assure adequate revenues, including retained earnings, to maintain financial stability?" [39 U.S.C. § 3622(b)(5)].
  
• If it did not, what actions can or should the Postal Regulatory Commission take?

Did the Postal Service's ACR filing show that it complies with the requirements of 39 U.S. Code to 1) provide prompt, reliable, and efficient services to patrons in all areas; and 2) "to assure adequate revenues, including retained earnings, to maintain financial stability?

The first question  raises the question about both service quality and postal finances.   As service quality in transportation firms often depends on both efficient operations and financial strength focusing on the financial issues raised by this question is sufficient for understanding the challenge facing the PRC.

During the public forum no party other than the Public Representative directly indicated that they understood that the Postal Service did not generate sufficient revenue in 2009 to maintain financial stability.  Most parties requested that the PRC take the long view in looking at the question of financial stability.  This focus hinted that most parties believe that the Postal Service's business plan did provide service at a sufficiently efficient level to ensure that current rate levels generated adequate revenues to cover operating and legislatively mandated costs and generate retained earnings sufficient to maintain financial stability.

This sentiment is consistent with the public statements of the Postal Service's CFO Joe Corbett who stated in an interview with the Federal Times, "We will need [some assistance from Congress] or we will have difficulty paying all of our obligations this year. And going into next year, we might not have enough cash to operate. ... We are dangerously close to running out of cash."

If the Postal Service is insolvent, as the Federal Times headline implies, then by definition the Postal Service is not sufficiently efficient and does not generate sufficient revenue to maintain financial stability.    While the pension and retiree health care issues affect the question of financial stability the PRC is faced with the challenge of making a determination on this issue prior to any action by Congress.  Furthermore, the Postal Service has numerous other operating and market challenges that threaten its financial stability that go beyond its retiree benefit issues.

Given the information available to the Commission, both on the record and in the public domain,  it may have little choice but to come to the same conclusion that CFO Corbett and the Government Accountability Office have drawn, that it is not now a financially stable enterprise.   This question then forces it to address the second question listed above.  

What actions can or should the Postal Regulatory Commission take?

The Public Representative has presented a serious, but highly unpopular proposal to deal with the issue of financial stability.  It proposed that the Commission order the Postal Service institute rate increases in 2010 and 2011 that would cumulatively raise rates between a 6.3% and 21.2%.   The public representative noted that these increases would only return the Postal Service to break even.  In a recent post, I noted that a more realistic proposal that included retained earnings could raise rates between  25% and 42.6%.


The prospect of such large rate increases, clearly have large mailers concerned and created a conundrum for the Commission.  Large rate increases raise the possibility that large rate increases now would accelerate the diversion of mail to digital alternatives, worsening the prospects of financial stability in 2011 and beyond.   (Further study is needed to understand how rates, convenience of recipients, or communication cost-effectiveness drive the switch to digital delivery.)

Commissioner Dan Blair, in his comments raised procedural concerns that the ACR review could turn into a mini rate case.   His concerns reflect the intent of the PAEA to generally eliminate the traditional processes of setting postal rates.

So what options do he and other Commissioner's have if they join the consensus that the Postal Service is nearly insolvent?  It is this question that inspired the title of this post, "walking the line between the law and disaster."

In my view, the Commission can walk this line if it focuses less on the obvious, the Postal Service's near insolvency. Instead, it should use the ACR Review to advance a framework for discussing the options available to make the Postal Service a financially stable enterprise.   Then, the Commission would provide the Postal Service, postal stakeholders, and Congress a method to understand the financial impact of current law and how that law may need to change to create a financially stable enterprise.  To that end, I would suggest that parties to the proceeding and the  Commission focus on answering or at least asking the following questions.

• What financial goals indicate financial stability for the Postal Service?   We know that a financially insolvent Postal Service cannot pay its bills. We know that accounting break-even does not produce financial stability under any financial management theory. We do not know what financial goals a financially stable Postal Service should have, if accounting break-even is no longer appropriate.  Nearly all foreign posts have addressed this question first in examining reform of their postal policy.   Postal policy in the United States has never addressed this question.
  
• What level of retained earnings is sufficient?   Under the Postal Reorganization Act, accounting break-even was considered sufficient.  The 3-year rate cycle, combined by actions of Congress resulted in the Postal Service having almost no retained earnings.  In the near term, the Postal Service will soon need to end deferment of capital projects and maintenance, and improving operating efficiency will require capital expenditures to reduce the number of facilities and locate these facilities in locations that promote both cost efficiency and better service quality, transition costs to reduce the workforce at a rate at least equal to the impact of new technology and reduced mail volumes.   All of these actions cost money and there is no information on how much it would or could cost or the level of earnings necessary to implement these plans.
  
• What impact do restrictions on capital have on postal efficiency and service quality?   Currently capital spending is limited to what cash is available. The ability of any enterprise to rightsize its operations in the face of changing demand depends on the capital available to restructure its operations and provide incentives for excess employees to leave.  Showing how capital constraints are linked to cost efficiency and service quality could provide Congress with a better understanding as to how serious the current situation truly is.  

In focusing on these questions, the Commission can provide postal stakeholders with a greater understanding of the problems that the Postal Service faces without making these problems worse through imposing significant rate increases.  In this way, the PRC will use its authority in a way that forces Congress, the Postal Service and the Obama administration to seriously discuss the financial details of what it will take to ensure that the Postal Service is a financially stable enterprise far beyond 2010.

Closing the USPS' Income Gap

The Public Representative performed a service for postal stakeholders in their estimates of the required rate increases to return the Postal Service to break even by 2011 under various estimates of the Postal Service’s retiree obligations. These estimates represent the worst case scenarios for mailers as they assume that the return to break even could only come from increases in rates.

Unfortunately for mailers, the Public Representatives estimates of rate increases are not enough to return the Postal Service to self sufficiency. Simply put, the break even goal for 2011, a goal that guided rate cases under the Postal Reorganization Act, is not sufficient to ensure a financially viable Postal Service. A more realistic goal would include these two parameters:

• A target for cash flow that is sufficient to fund capital expenditures, working capital, transition costs of a shrinking network and workforce and potential dividends and taxes or payments in lieu of taxes.
• An EBITDA (earnings before interest, taxes, depreciation and amortization) and an interest expense ratio such that a government guarantee would not be required to raise capital in the debt markets, even if private capital is not employed.The Postal Service may need an EBITDA of between 10% and 15% in order to generate the targeted levels of cash flow.

These targets are independent of the business model employed. They reflect goals that are necessary for both governmental and corporate business models. As such stakeholders that believe that one type of business model or another will prevent job cuts, require fewer closures and relocations of postal plants, preserve the current model of providing retail service, or prevent near-term rate increases above the current rate cap constraints will likely be disappointed if their business model choice is selected by Congress.

So what would really happen to postage rates if the Public Representative used more realistic financial targets? Using the Office of Inspector General recommendations for financial relief, postage rates might need to rise at least 25% without more aggressive actions on restructuring the operating network or modernizing the retail model. Without relief, postage rates might need to rise by 40% or more. (Both of these estimates do not account for the impact of price increases on mail volume.) Not a pretty picture and one that no postal stakeholder believes would ensure a viable postal enterprise as vibrant as it is today.

Rethinking The Value of Postal Regulatory Policy

I have never been much of a fan of old regulatory process of setting postal prices.   The contradictions among the competing objectives of pricing policy in the law created a zero sum game that resulted in mailers and the Postal Service spending millions to litigate prices that could be set in a much less constrained litigious environment. 

Currently, the Postal Regulatory Commission is in the middle of a proceeding to see whether what the Postal Service presented in its Annual Compliance Report puts it out of compliance with requirements in postal law in regards to financial stability and requirements in regards to pricing workshare discounts.

As stated in previous posts, I agree that postal stakeholders, and in particular Congress, the Office of Management and Budget, and the U.S. Treasury acting as shareholder and creditor, need to know whether the Postal Service has a business plan, working under existing law, that will ensure financial stability.  If such a plan does not exist, then those parties representing the shareholder and creditor interests in the Postal Service need to see a set of alternative plans with hard numbers that would produce financial stability under alternatives that require changes in existing law.

While the PRC, with its knowledge of postal data and operations can provide assistance in this effort, its forte is not evaluating business plans.  Its strength is examining in a legalistic manner whether a particular plan follows regulatory precedent in meeting the objectives of postal law.

The problem with the PRC's attempt to evaluate the Postal Service's business plans is seen in the language that the parties use to discuss the issues that the PRC's review of the Annual Compliance Review generates.    The first paragraph of the summary of the Comments of Time Warner on Issues raised in Commission Information Request No. 1 illustrates this point.

In these comments, we explain why Time Warner believes that § 3622(b)(5) does not, and cannot, raise  an issue of "compliance" within the meaning of § 3653(b).We review Time Warner's previous comments on the scope of § 3653(b) and the Commission's discussion of those comments, and we conclude that the Commission has as yet made no statement responsive to the two major points of our analysis: (1) that it is impossible to make a determination of Postal Service noncompliance with the "objectives" and "factors" of § 3622(b) and (c) because those factors and objectives are not addressed to the Postal Service but to the Commission, relating to the Commission's design of a new ratemaking system; and (2) that it is impossible to make a determination of Postal Service noncompliance with the "objectives" and "factors" of § 3622(b) and (c) because a set of nine mutually competing "objectives," "each of which [is required] to be applied in conjunction with the others" (§ 3622(b)) and fourteen mutually competing "factors," which are required only to be "take[n] into account" in designing the new system (§ 3622(c)) are not conceptually susceptible to a "determination of noncompliance" (unless all that is meant by "noncompliance" is that they are disregarded completely).

Remember, this language is the first paragraph of the summary of document presented in a proceeding designed to look at what is necessary to make the Postal Service a financially stable business. I cannot imagine anything being further from the language of business than what Time Warner's lawyers wrote in that paragraph and leads me to two questions. 

• How did we get here?
• How and when do we stop spending our time and resources in activities that do not ensure that mailers continue to use the Postal Service to advance economic activity?

Taking Advantage of Regulated Rates

The Globe and Mail today has an article that indicates that Canadian mailers are taking advantage of lower Postal Service rates to mail letters and parcels across Canada.

"For a small but growing number of this country's eBay vendors, the cheapest path across Canada lies through the heart of America.  Canadians are showing up in increasing numbers at U.S. Postal Service outlets with parcels and letters destined for other provinces – and, in at least one case, a neighbouring town."

Later in the article, it is clear why this is happening, the rates for the Postal Service's money-losing Media Mail service are so low, it is worth it for Canadians to drive to the United States to ship books, records, CD's and DVD's.   

“If I didn't ship through the States, I'd probably have to lay all my staff off for sure and just run the store, my wife and I,” said Gary Nerman, whose Nerman's Books and Collectibles in Winnipeg employs three people. “It would probably cut our sales down by 80 per cent, 90 per cent.”

Every week, Mr. Nerman drives an hour south to Pembina, N.D., usually with between 90 and 130 books to ship. The savings are dramatic. In the U.S., a special media rate allows him to ship, say, a Stephen King hardcover to Los Angeles for less than $3. From Canada, it would cost about $10. (It's also substantially cheaper and faster to ship to Europe or Australia, through the U.S.)

Canada Post operates under financial goals and pricing strategies approved by its Board of Directors.  These financial goals have generally prevented Canada Post from offering any service below costs.   I know of only one exception.  This was an unaddressed advertising mail service that was stopped over a decade ago after objections from newspapers and others that delivered unaddressed mail prompted an external review demanded by Parliament that clearly showed that prices were both below cost and a bad business decision.  Since then, Canada Post financial management has has more power to oversee prices proposed by marketing staff to ensure that business is profitable.

The financial returns of Canada Post since the unaddressed product was dropped have been positive.  Recent changes that employ more realistic financial objectives, will ensure that Canada Post remains profitable even as many mailers switch from print to digital delivery. 

The experience with the money losing unaddressed mail profit did not change the minimal price regulation in Canadian Postal Policy.   Canada Post announces price changes on an annual basis with an opportunity for public comment.   There is no regulatory body to check costs or whether prices meet objectives of postal-policy.  More importantly for a product like Media Mail, there is no pricing objective that favors mail based on content, so shipping a book in Canada is priced no different than shipping other parcels.

The volume of mail similar to what the Globe and Mail described is likely small.    But given the Postal Service's operating losses, how long can management, the Postal Regulatory Commission, and Congress allow these pricing aberrations to continue?

Could the Budget Kill Efforts to Save the Postal Service?

In the next few days, President Obama will deliver the State of the Union Address and reveal the 2011 budget.   White House spokesman have already announced that the budget will include a freeze in discretionary spending in fiscal years 2011 through 2014.    The spending freeze creates an additional barrier on top of the normal budget scoring process to efforts to find a solution to the Postal Service's financial problems.   

The budget scoring process put the retiree health care payment schedule in place in order for the Postal Accountability and Enhancement Act (PAEA) to pass.   The budget scoring process derailed the normal legislative process as a method to deal with the Postal Service's financial problems last year.   The relief that was granted was included in last-minute legislation that did not require budget scoring.

The relief that Congress granted last year did not solve the long term problems of the Postal Service.   Congress will soon see a report from the Government Accountability Office (GAO) on potential business models and regulatory frameworks that could offer long term solutions.   It is unclear whether the GAO's mandate will cover key financial questions regarding the Postal Service's true liabilities for CSRS pensions, retiree health care benefits, and workers compensation payments which affect the viability of all business modes that the GAO is likely to consider.


The Problem with the retiree health care liability was studied by both the USPS - Office of Inspector General (USPS-OIG), and the Postal Regulatory Commission (PRC) and both studies recommended lower payment schedules than the current schedule.   Choosing either the USPS-OIG or the PRC schedules would reduce the Postal Service's payment to Office of Personnel Management (OPM) and in the budget scoring process would require cost savings in non-postal programs or other payments from the Postal Service for the change to be budget neutral.

A new report from the USPS-OIG, The Postal Service's Share of CSRS Pension Responsibility, creates even more budgetary problems if the results are accepted.   This report indicates that the Postal Service has overpaid its liability by $58.7 billion more than previously estimated.   If this overpayment is transferred to cover the Postal Service's retiree health care liability, the Postal Service's obligation for retiree health care costs would be even smaller.   Again, the primary obstacle to accepting the USPS-OIG analysis is the Congressional budget scoring process.

Fixing retiree and other liabilities was critical in postal reform efforts outside the United States.   In these countries, legislatures realized that a viable national postal operator and universal service required that the postal operator not be burdened with retiree obligations at levels that would force layoffs or price increases. 

The Postal Service and nearly all stakeholders realize that the first step to solving the Postal Service's problems will involve recognizing that 1) retiree payments reflect actual obligations and 2) the payment schedule for this actual obligation should follow private sector standards for funding retiree obligations.  The National Association of Letter Carrier's Fact Sheet presents the arguments that stakeholders will make before Congress over the coming month. 

Given budget scoring, these arguments will fall on deaf ears unless stakeholders can find ways to replace the "funds" that fixing the pension and retiree health care obligations creates.   Failure in the effort to find a fix will force the Postal Service to raise rates substantially, make cuts in service beyond eliminating Saturday, and reduce the workforce faster than it has proposed to date.   

Is there a solution?  Is there a solution using a governmental business model?   My paper, Examination of Postal Business Models, tried to answer these questions in assessing potential business models and concluded that there is a solution and governmental business models did not offer one.   It is time for others looking at Postal business models, and in particular those stakeholders that want to retain a governmental model to explain how their model can solve the problem of Postal liabilities and get the changes that they envision passed by Congress. 

Regulating the USPS into Financial Stability

In a previous post, "Re-Regulating the Postal Service?", I noted that the Postal Regulatory Commission's (PRC) interest in examining the Postal Service's FY 2009 Annual Compliance Report represents the potential for a mini rate case.    Now that the PRC has chosen to proceed, this has happened.   In addition, the PRC has chosen to enter uncharted territory, examination of the Postal Service's financial and business plans by asking whether the Postal Service generated sufficient revenue in 2009 "to assure adequate revenues, including retained earnings, to maintain financial stability." [39 U.S.C. § 3622(b)(5)]

Overhanging all of the specific areas of inquiring discussed below, postal stakeholders face a concern that hangs over the entire proceeding.   If the PRC find the Postal Service to not be in compliance with any of the ratemaking rules included in 39 U.S.C. § 3622, can it force the Postal Service to file an exigent rate case to put it in compliance?

The Mini Rate Case

The scope of the PRC's mini rate case will likely focus on the following three areas:

• The rates charged for products that the Postal Service's FY 2009 Annual Compliance Report showed had attributable costs greater than revenue.
• The size of worksharing discounts.
• Computational and typing errors in the Compliance Report and accompanying workpapers.   

The first two areas could have a significant impact on mailers that now generate at least 63% of the revenue and 79% of the volume of the services covered by price regulations.

Products With Revenue Below Attributable Costs

 The Following products had revenue below attributable costs.

• Inbound single-piece international mail
• Standard flats
• Standard parcels and non-machinable flats
• All Periodical Class products
• Single Piece Parcel Post
• Bound Printed Matter Parcels
• Media Mail/Library Rate parcels

The list of products includes mostly flat and parcel shaped products.   The list includes products that have costs that are difficult to measure because the total volume handled is so low.

To the extent that the Postal Service and mailers want to address this question, they may want to address the following two questions.

• How relevant are 2009 costs for 2010 and beyond given that the handling of flats and parcels as the processing and transportation technology networks handling this mail will be different in 2010 and beyond from the networks used in 2009?  
  
• Are sampling systems capable of accurately measuring the costs of low volume products?   

The Size of Worksharing Discounts

Most of the questions contained in the Chairman's Information Request #1 focus on whether the Postal Service's worksharing discounts comply with 39 U.S.C. § 3622(e)(2).  This section sets the rules for the specific rates for all mailers sending more than 500 pieces at a time, mailers for whom 80% of the money spent on mail is spent in competitive markets for services required before the mail is handled is tendered to the Postal Service.   This section requires that worksharing discounts be no greater than cost savings with four rather limited exceptions.

1. The discount is associated with a new postal service, a change to an existing postal service, or with a new work share initiative related to an existing postal service or the discount necessary to induce mailer behavior that furthers the economically efficient operation of the Postal Service and the portion of the discount in excess of the cost that the Postal Service avoids as a result of the workshare activity will be phased out over a limited period of time.
2. The amount of the discount above costs avoided is necessary to mitigate rate shock; and will be phased out over time.
3. The discount is provided in connection with subclasses of mail consisting exclusively of mail matter of educational, cultural, scientific, or informational value.
4. Reduction or elimination of the discount would impede the efficient operation of the Postal Service. 

These exceptions indicate that the PAEA does not favor the use of market-based, or non-cost based rates for customers shipping more than 500 items at time with the exception of discounts that have a very short duration like a sale.    The section also enshrines differences in rates for editorial content in periodicals from the advertising content.   Only the last exception, "reduction or elimination of discounts that would impede the efficient operation of the Postal Service," provides a crack that might let the light of market-based into the process.

The PAEA does provide some limitation to a strict cost based approach in 39 U.S.C. § 3622(e)(3), but again the language in appears to focus on enshrining the rate relationships that existed when the PAEA was passed, and protecting the rates of single-piece mailers.  The language requires that the Postal Service prove that 1) raising rates that are lower than cost differences may indicate would reduce the volume of the products that use the product and lower the Postal Service's net income; 2) the rates do not increase rates of products that do not use the discount.   

In answering the PRC's questions on worksharing discounts, the Postal Service and mailers need to go beyond answering the computational issues, and illustrate the value of market based rates using the exceptions and limitations as the basis for their argument.

Determination of Rates Necessary for Financial Stability

In raising the question of whether rates are sufficient for financial stability, the Commission addresses the question of financial targets and financial plans.  The Commission's asked the Postal Service to "provide the Postal Service’s current plans to achieve financial stability in FY 2010 and beyond under the Postal Accountability and Enhancement Act (PAEA) to enable it to meet its principal responsibilities" in Commission Information Request No. 1.

In the old regulatory process, the question of financial targets was set in the revenue requirement.   Once the rules were set in the first few rate proceedings, the PRC's limited its analysis to checking that the Postal Service's calculations were correct.   The PRC rarely if ever questioned whether the revenue requirement generated sufficient cash to make the capital investments necessary to streamline mail operations and reduce operating costs or to reduce the postal workforce at a pace commensurate with the introduction of automation and streamlined operating and delivery networks.  

Questions of "sufficient financial returns" never were addressed.  Mailers had no interest in raising the issue, as their concern was keeping rates down, not maintaining a financially viable Postal Service.   In many ways, the PRC also tended to focus on ways to reduce the revenue requirement, even if the reductions were minuscule and based only in errors in calculation or changes in economic forecasts during the course of the 9 month rate proceeding.   

I have raised the issue of self sufficiency, a number of times in this blog and in my paper, Examination of Potential Postal Business Models.   In that paper I stated: "Given the outsized operating losses in 2008, 2009, and most likely in 2010 and the elimination of cash available for anything but absolutely critical capital spending, there are substantive questions about whether the current postal business model and regulatory framework can ever generate sufficient levels of cash to ensure long-term postal financial self sufficiency."   Postal forecasts of revenue and volume indicate that these questions could remain through the middle of this decade.

In that paper, I further noted that postal operators outside of the United States have real financial return objectives.    Postal policy in these countries understands that universal service requires that the postal operator earn a financial return that will sustain the business.   To meet this financial objective, postal policy in these countries grants the postal operators sufficient commercial freedom to manage all aspects of the business to meet these objectives and provide universal service.   In addition, postal operators manage the business under standard business, and tax law, and employment and labor law similar to what private sector firms operate under.

Most recently, the Canadian government re-evaluated Canada Post's financial objectives and set higher targets to allow for the modernization that is necessary there.  The re-evaluation has led to higher rates on postal products, and increases of 2 cents each year from 2010 to 2012 for single piece mail.

Congress cannot act on future business models unless it has an independent assessment of the financial plan of the Postal Service under both the current law and the changes in law that it has proposed in testimony to Congress and in its paper, Assessment of U.S. Postal Service Business Model.   It is not clear whether a formal regulatory process will provide that assessment in a format that is useful for advancing postal policy changes in Congress that will ensure the Postal Service's financial stability.   Given the reluctance of postal stakeholders to suggest changes in the business model that could improve financial viability of the Postal Service without increasing rates, as well as the cost of producing those studies, the PRC will have little information on the record on alternative business plans that could meet the PAEA's financial goals.

Mailers and the Postal Service have additional immediate concerns about potential actions that the PRC could take if it determines that the Postal Service is not in compliance with postal law.   The Commission's powers and authority once such a non-compliance determination is made is unknown.   As such, much of the discussion at hearings and in documents filed with the PRC will focus on defining its authority and not the changes needed to make the Postal Service financially viable and the business model and regulatory framework that will allow that to happen.