An Opportunity for Mail in the Decline of Local Media

In recent days, a number of news articles focused on financial troubles across all media modes that depend on advertisers for most if not all of their revenue. While all advertising media are suffering, the economic downturn plus a switch to Internet-based media has pushed print media, and in particular daily newspapers, toward bankruptcy.

As the largest deliverer of print advertising, the question arises: Is the Postal Service facing the same fate, or is there an opportunity in the decline of a direct competitor?

The answer to this question requires that six questions be answered.

1. What are newspapters doing to cope with change that affects the market for advertising?
2. How do these changes affect the competitive position of postal delivered advertising and in particular what gaps in advertiser needs are the changes creating that postal delivered advertising could meet?
3. How well do existing mail-delivered advertising vehicles fill in the gaps that the changes in the newspaper industry create?
4. Could new mail-delivered advertising vehicles fill in these gaps in a way that these new vehicles will have a higher value to the recipient than traditional advertising vehicles?
5. Does the Postal Service have operating processes and rate structures that will allow the creation of these new advertising vehicles especially when many of these vehicles may not fit the traditional definitions that define existing mail classes and sub-classes?
6. Can the regulatory process handle the creation of new Postal products for which any forecast of revenue and volume would be speculative?
   

Right now the greatest opportunities may exist in those markets where newspaper home delivery is threatened. For example, Detroit's two dailies are talking about ending daily home delivery and only delivering three days a week. Similar opportunities exist in communities with the highest proportion of young, internet-savvy residents where daily newspaper delivery has not taken hold. Now is the time to start developing plans for this new vehicle so that it can launch when the economic and advertising recovery comes in 2009 or 2010

Hard Times

The Postal Service is now beginning to tell its stakeholders the extent of the hard times that it faces. In a notice to members, APWU President Burrus provides some financial details that were not presented at the Board of Governors meeting. The information he provides along with my comments in italics is as follows:

• The Postal Service experienced a 12 percent reduction in mail volume during some unspecified time period. [Most likely this figure represents an early estimate of volume for the 4th quarter. If true it means that mail volume has truly dropped precipitously as in the 3rd quarter volume was only down by 5.5% over last year. ]
  
  
• The Postal Service's expected loss in 2008 will be around $2.3 billion. [This is about $1 billion less than the estimate that I generated in my last post but still a substantial number. The difference reflects the fact that I was not able to identify all of the one time charges and accounting credits that will occur]
  
  
• There are no prospects that increases in mail volume or for productivity improvements will be sufficient to offset losses. Increasing postage rates, beyond what is permitted under the rate cap, is not an option either as large price increases would hasten the substitution of electronic alternatives for mail. [With these comments, President Burrus is preparing APWU membership of the prospect for significant changes in postal operations beyond productivity improvements within a single facility.]
  
  
• Postal Service employees may experience layoffs in the next fiscal year. [The layoffs would come from the 16,000 employees have less than 6 years of service. The layoffs would further reduce Postal Service head count beyond what the hiring freeze and the early retirement program will generate.]
  
  
• The Postal Service will have losses in 2009 of around $2 billion. [The projection of a $2 billion loss is most likely , the Postal Service's best projection for FY 2009 even with the hiring freeze, the early retirement program and the layoffs that President Burrus is hinting at.]
  
  
• To cover losses, the Postal Service will have to borrow around $5 billion. [If the business cycle recovers in FY 2010, the Postal Service will need to still hold down costs then to pay back the debt.]
  

President Burrus closes his note linking the Postal Service's financial challenges with the upcoming election and the impact that the election could have on the prospect for postal privatization. While I am less convinced than President Burres that postal privatization is in the offing, I do agree with him that the next administration will likely examine "the future role of government in providing postal services."

Filling in the Gaps

At the Board of Governor’s meeting on Wednesday, September 24, Postal Service’s CFO Harold Glen Walker provided only a limited picture of the Postal Service’s current and near term and financial condition. He did not present as expected either a forecast of a projected loss for the remainder of the fiscal year, nor did he present an integrated financial plan for FY 2009 as was expected from the agenda e-mailed to the press. His only clear statement on finances was that the “4^th quarter decline has occurred at an accelerating rate.” The postal community needs more information than that, and this post will provide an analysis that hopes to fill in the gap in public information that was left behind at the conclusion of the meeting.

In particular this post and the ones that will follow, I will provide:

• an updated forecast of the Postal Service’s loss for FY 2008;
• an examination of the economic and business trends that will drive revenue and costs in the remainder of the fiscal year and next fiscal year;
• the challenge of doing any forecasting in today's economic environment;
  
• some thoughts on strategic planning; and
  
• a preliminary forecast for FY 2009.

The fourth quarter is clearly one of the most difficult periods that the Postal Service has faced in its history. The release of the Postal Service's revenue and expenses accounts through August shows that the Postal Service's loss so far this year is how challenging this period is. So far this quarter, revenue is$11.850 billion and expenses are $13.025 billion, producing a two month loss of $1.176 billion.

The loss so far in the fourth quarter is driven by a 4.7% decline in revenue, a 1.3% increase in expenses, and a $329 million workers compensation adjustment. Extrapolating this trend through September would result in a quarterly loss of $2.168 billion and a fiscal year loss of $3.326 billion.

The increase in expenses in these two months appear likely to continue through the remainder of the quarter. During the 4th quarter, COLA payments raised labor costs. Changes in energy prices raised expenses by over $140 million as noted in transportation, gasoline, natural gas, heating oil, and electricity accounts. Given that much of the increase in energy prices happened after the beginning of 2008, this increase in cost will clearly continue through the remainder of the quarter. The Postal Service will be able to cut the projected deficit on the expense side only if they can make substantial reductions in work hours, reduce contracted and postal transportation, or have accounting adjustments that affect final expense totals.

The decline in revenue raises some serious questions about the near term business prospects of the Postal Service, particularly since it raised rates just a few months ago. The decline in revenue potentially reflects two trends that were not present previous. First, the decline in revenue most likely reflects a volume decline that is greater than the 4.7% decline in revenue given the increase in rates. Second, the decline in revenue most likely indicates that both long term trends and the economic downturn are having a greater impact on the Postal Service's products that generate more revenue-per-piece than others.

Looking at the revenue figures in more detail does provide some hints as to which products are driving the revenue decline. In particular the revenue data shows that:

• Revenue from those payment categories most likely to represent single-piece First Class mail declined by 6.75% or $158 million. This includes revenue from stamps, other than precanceled stamps, PC Postage, and low speed meters. The decline in revenue here is only marginally larger than the decline in single piece revenue in the third quarter (5.6%). During that quarter, single piece mail volume declined by 9.8%. This fourth quarter will likely show the first double-digit decline in single piece mail volume. As the downward trend in single-piece mail volume, that presents a faster decline in each subsequent year, began almost a decade ago, the decline in First Class Single Class mail is unlikely to return when the economy returns.
  
  
• The 7.3% or $242 million decline in revenue in Standard Mail permit and pre-cancelled stamp revenue in the 4th quarter shows the intense impact of of the economy on revenue sources linked to advertising. Regular Standard Mail permit revenue declined by 7.4% and Non-profit Standard Mail permit revenue declined by 5.9%. Both of these products saw declines in permit revenue greater than that experienced by the Postal Service as whole. In the 3rd quarter, standard regular mail volumes were down by 6.8% and non-profit volumes rose by 2.9%. In the 4th quarter, the Postal Service may be seeing large single-digit or double-digit declines in regular Standard mail volume and single-digit declines in non-profit mail volumes. The Postal Service will get a small bump in non-profit mail in September from the election but much of the election effect will occur in the next fiscal year.
  
  
• All other postal products do not appear to be as adversely affected by the economy or long-term secular trends. However, the impact of the economy on periodical revenue may be delayed due to advertising page commitments for July and August may have been made before the depth of the downturn was as clear. The Postal Service may be seeing problems in periodical revenue in the next fiscal year.

Given that the economy has slowed further in September, with the greatest impact occurring in the mail intensive financial service businesses, the Postal Service is unlikely to report better revenue trends in its 4th quarter RPW report based on one additional month of data. Therefore, extrapolating the year-to-year change in revenue feels like a reasonable assumpt ion without further data.

If the Postal Service's projected loss is even close to the $3.3 billion that an extrapolation would suggest, then the sooner the Postal Service begins to prepare its stakeholders for the end-of-the-year reports the better. Holding back on bad news is unlikely to make life any stakeholder including Postal unions and their leaders, employees, mailers, Congress, and Postal Regulatory Commission.
Service

Oct 1, 2008 Correction: Since this observation was posted, I have learned that the Postal Service has told its unions, and management associations that it expects its losses for the year will be $2.3 billion, $1 billion less than what is projected in the observation above. I take the Postal Service's statement to be authoritative and all future observations will use this figure. The difference most likely represents one time expenses or accounting adjustments to either revenue or expenses that I did not account for. I should have noted that possibility in the original post.

The APWU reported that the Postal Service has stated that mail volume decline by 12%, most likely in the 4th quarter. This would match the revenue decline identified above. Combining the volume decline with the revenue decline really highlights that the slowdown in the economy is hitting the Postal Service particularly hard.

Why Lehman Brothers and Merril Lynch Matters ot the CEP Industry

The seriousness of today's financial news is broadcast across the top of all of the world's newspapers, at the top of Internet news sites and is the lead story on all broadcast newscasts. The headline in today's Wall Street Journal succinctly describes the situation, "Crisis on Wall Street as Lehman Totters, Merrill is Sold , AIG Seeks to Raise Cash" In the first paragraph, the Wall Street Journal states that "the American financial system was shaken to its core" by these events that developed yesterday.

The financial crisis may represent the greatest since 1929. More recent financial collapses of savings and loans, Mexico, Long Term Capital, and the Russian Ruble all pale in size. As this is not a financial blog, I will not comment as to what it means to your investments including your home, and savings in 401-K's, IRA's or equivalent retirement savings accounts. What is clear is that a lot of large banks, insurance companies, and other corporate and public institutions hold significant quantities of assets that have values well below what is currently on the balance sheet and will need to sell assets or seek infusions of cash to meet their obligations to their customers, policyholders and pensioners. Also, equity investors and lending institutions of all types will be more risk adverse than they were. This will will result in tighter capital markets in the near term.

So, what does this mean the courier, express and postal industry?

• The immediate impact of crisis will be some job losses in the financial sector that will slow growth in regional economies most heavily dependent on this industry. (e.g. New York, London, etc) CEP business tied to those markets will suffer.
  
  
• Tighter investment capital will act as a brake on the economy. It will make it more difficult for businesses and individuals to gain capital to do everything from buy a set of tires on credit to expand a factor to meet customer demand. Less credit-worthy businesses may even find their normal sources of operating credit drying up. A slower economy means less volume. FedEx's recent announcement on its current quarter's earnings highlighted the impact of a slower economy on volume. Postal operators should see a similar impact on revenue generated by their more economically sensitive products including parcels, advertising and periodicals.
  
  
• Well capitalized and cash generating CEP competitors, may try to provide alternative financing arrangements to lock customers into a broader relationship of financial and transportation services. UPS's recent announcement that it will use it UPS Capital unit to lend to small exporters, illustrates this trend. Other CEP competitors that have home markets that can generate substantial cash, may also enter this market.
  
  
• Certain costs of the CEP business may drop due to the slowing economy. Lower fuel prices will reduce the expense of delivering letters and parcels. Lower demand for transportation capacity in general may reduce the cost of capacity bought on the spot market. The industry should be cautious that, in the near-term, some of the lower fuel prices may reflect an oversold commodities market as financial institutions unload positions in oil and gas futures to raise cash.
  
  
• The lower fuel costs will have a side benefit of higher margins for companies that charge fuel surcharges in that the decline if fuel prices is occurring at a faster rate than the companies are reducing the surcharges. Fedex noted that affect in announcing higher earnings than projected in its current quarter. A similar impact will be felt by UPS.
  
  
• Capital spending among all CEP firms will slow. Every quarterly announcement from publicly traded firm will announce a delay in capital investments for the foreseeable future.
  
  
• CEP firms, and in particular postal operations facing faltering finances due to the slow economy will find their path to improved finances more difficult. Those administrations that are planning reductions in headcounts, retail offices, or capital spending may take a second look to see if further reductions can be made. Those administrations that have not begun the process will begin the process.
  
  
• Consolidation of letter and parcel sortation operations into fewer, more automated facilities will occur among both public sector and private sector firms. Plant consolidations at national posts, both public and private, in their home markets will likely receive significant political attention given the impact on jobs in a slow economy. Consolidations happening in the private sector and by national posts outside of their home market will receive little if any negative political attention. UPS's recent opening of a new ground terminal in Louisville, Kentucky consolidated sortation that was done elsewhere in Louisville, as well as in Lexington, Ky., Cincinnati and Sharonville, Ohio. The opening was attended by Louisville's mayor and the city named the day in commemoration of the opening.
  
  
• To the extent that regulatory restrictions do not restrain competitive responses, incumbent operators may begin to expand and accelerate counter-moves to new entrants in upstream, downstream, and end-to end markets to use excess capacity in more efficient automated facilities to recapture market share.
  

Royal Mail: Is There a Future?

The more that I read about Royal Mail, the more I wonder whether it is following the fate of the Penn Central Railroad. For those readers outside of the United States or too young to remember, the Penn Central Railroad was the railroad formed by the merger of the Pennsylvania and New York Central Railroads in 1968. Only two years after the merger was approved by the Federal regulator, the Penn Central went bankrupt in the largest corporate bankruptcy ever recorded.

As railroad customers, including freight, commuter rail, and intercity passenger customers, could not afford the liquidation of the railroad, the Penn Central along with other failing northeast bankrupt railroads were taken over by the U.S. government to form Conrail. The essential commuter passenger service was stripped from the railroad and transferred to state transit authorities that run them to this day. The intercity passenger service became the core of Amtrak's northeast corridor.

I bring up the Penn Central, not to talk about ancient history but to focus on how bad management, government policy, and overbearing and misguided industry regulation can cause a business to fail and fail rather quickly. Furthermore, the possibility of the break-up of Royal mail between the letter mail and parcel businesses seems to follow the break-up of the Penn Central between a for profit, freight railroad, Conrail, and a subsidized universal service provider of passenger commuter and inter-city passenger service (Amtrak, New Jersey Transit, and SEPTA commuter rail among others).

Given Royal Mail's current financial problems, and the difficulty that management, regulators, and government policy makers have in making changes quickly, maybe a break-up as part of a privatization effort is inevitable. The question is: is it advisable or can other actions provide a more secure future for universal service and the future of Royal Mail employees? For those concerned about the future of Royal Mail, or for the matter any other troubled posts, I would recommend two books on the Penn Central that may provide a lesson for those trying to find a way out of (or maybe a way not to get into) trouble. They are: "The Wreck of the Penn Central," by Joseph R. Daughen and Peter Binzen and "The Fallen Colossus: The Great Crash of the Penn Central," by Robert Sobel. The first is written by two journalists who covered the story of the Penn Central Bankruptcy. The second is written by one of America's greatest business historians.

What is clear from looking at the global postal industry, that not all posts have followed the same path as Royal Mail. Different management, regulatory, and government policy models exist in other countries that first transition their public postal operators to corporatization and in some cases privatization prior to introducing increased competition. Furthermore, in most of these countries the level of regulation is less intensive and government policy appears to have a lower priority on introducing competition and a higher priority on giving the Post the opportunity and freedom to develop a plan for competition that can succeed. It should be noted that the United States reflects a completely different model from what has been follwed in the rest of the world in that corporatization was only gingerly introduced in stages along with tight price regulation, and upstream competition was introduced from the dawn of automation which allowed the mailing industry to grow without the U.S. Postal Service having to make the capital or human investments necessary to accommodate the mail growth that the lower costs of automation allowed. Now the question in the United States is how does the U.S. Postal Service and the industry adapt to severe over capacity (especially if you combine the capacity of the private sector and the Postal Service), a new lighter regular regime and another small step toward corporatization.

Given the challenges that face the industry, regardless of the change model chosen, there are like to be just as many paths to failure as paths to success. But how can failure be avoided? The answer may be to observe what works and what does not in the industry and in the general business community. Just as the greatest generals study military history to avoid the mistakes of previous generations, so should today's postal executives and policy makers study business history to do the same. To start, I would would begin with some magnificient failures as described in"When Giants Stumble: Classic Business Blunders and How to Avoid Them" by Robert Sobel. Readers of this blog are invited to recommend in thier comments other books and articles that could help the postal industry choose a successful path.

Why Weight Matters

Most of the attention to date has been on the decline in both Postal volume and revenue. However, to fully understand the drivers of revenue change, one needs to look at the average weight of a mail piece, which is the best publicly available proxy for the changing mix of mail handled. The changing mix primarily reflects three influences: 1) the Postal Service's increasing specialization as the carrier of light weight parcels, 2) the switch away from hard copy delivery for longer documents, manuals and brochures with the increasingly improving ability of the Internet to deliver high quality images and longer documents to more recipients; and 3) the slowdown in the market for all advertising.

A recent report by Morgan Stanley looked at the Postal Service's Priority and Express Mail volume numbers in drawing its conclusion that DHL, FedEx, UPS, will face increased competitive pressure from a Postal Service now that the USPS can offer both competitive service and contract terms. What Morgan Stanley missed is that the Postal Service's parcel products serve a different segment of the parcel market, specializing in lighter weight parcels, where its private sector competitors dominate in the delivery of parcels over 5 pounds, and especially smaller parcels for delivery to households. The average weight of Express Mail is under a pound, Priority Mail is under 2 pounds and Parcel Post is now just over 4 pounds. The Postal Service's advantage in delivering light weight packages is illustrated by UPS's decision to sell USPS delivery under its brand name at prices nearly twice what the Postal Service charges for the same level of service. The extent that DHL, FedEx and UPS and others have exploited the Postal Service's delivery network and Parcel Select price structure for light weight parcels can be seen in the decline in the average weight of Parcel Post (the vast majority being sold as Parcel Select) dropping from 5.17 pounds in the 3rd quarter of FY2003 to 4.1 pounds in 2008.

The Internet can deliver full sheet (8 1/2 x 11), brochures, manuals, and many other documents through attachments to e-mails, websites, and downloads of pdf files. Over the past 5 years the breadth of recipients with access to high speed Internet services has expended the Internet delivery network to include nearly all businesses and business locations and an increasing percentage of households. As such, documents that would have been sent as Priority Mail based on the weight of the item, now can be delivered electronically. The decline in the document delivery market can be seen in the increase in the average weight of Priority Mail which has seen a 7.5% in average weight (a gain of over 2 ounces) since 1993. As the volume of documents delivered via Priority Mail continues to decline until the volume reaches a new post high-speed Internet equilibrium, the Postal Service will see its Priority Mail document business contract and its Priority mail parcel business increase in prominance.

The Internet has also had an impact on how mailers use standard mail. The expansion of high speed access has allowed catalog merchants to improve the usability of their on-line presence with better color, animation, and images. As such, the need to delivery full catalogs and large format brochures has decreased as customers use the Internet to get the information that would have been delivered by mail. The Postal Service encouraged this switch through its introduction of shape based rates that increased the cost of flat-shaped mail at a greater rate than letter-shaped mail. So over the the past 5 years, the average weight of standard mail has declined by nearly 11%. (This trend may have been exacerbated by political mailings that rarely used heavy mail pieces.)

The final influence, the decline in advertising reflects more transitory changes in the economy. As the economy has shrunk, advertisers have cut back on advertising modes and mail is no exception. While some of this cut back results in fewer pieces being sent, an additional impact occurs as mailers reduce the weight of their mail pieces. In the past year, periodicals have seen a 5.7% decline in average weight reflecting a decline in advertising pages. This single-year decline is greater than the five year decline, suggesting that periodical average piece weight could increase once the advertising budgets begin to grow again.

While the declining advertising market may have had some impact on the amount of material printed and mailed per Standard Mail piece, the statistics do not show an obvious trend. Clearly catalog merchants are continuing to reduce page counts and mail piece size. However, a switch from other advertising modes to mail may be mitigating the the reported decline in average mail piece weight.

Now how does a decline in average mail piece weight affect the bottom lines of the Postal Service and mailers. Clearly, for the Postal Service, this trend means that revenue declines faster than volume (discounting for the impact of rate increases). For the future, the Postal Service will find it more difficult to determine what portion of a revenue increase should come from the lowest weight increment and what portion should come from weight related charges. Mailers may find that traditional relationships between mailing cost and piece volume verses mail piece weight will be changing as the Postal Service needs to meet its revenue needs from a new mix of lighter weight letters, flats and Parcel Post parcels and heavier weight Priority Mail.

$2 Billion Confirmation and Other Odds and Ends

1) Today, the Associated Press reported that Postmaster General Jack Potter told the National Association of Postmasters that the Postal Service will lose 2 billion this year. The readers of this blog knew that was going to happen two weeks ago. Now the question is: how long will it take for the Postal Service to clearly lay out its challenges in FY2009?

2) One of the Comments to this blog suggested that the Postal Service could generate more revenue by reducing its automation discounts. As has been said on this blog before, the drop in single piece volume increases available capacity for originating mail sortation. This capacity could be used for a new product that does just that. Such a product would require only clean, trayed, metered or permit mail and would compete with presorters but would not affect the efforts of mailers that can sort and place barcodes on mail pieces during the printing process. As producers of large volumes of bills and statements are both generally able to print barcodes and sort mail during printing of mail pieces and are tempted to encourage their recipients to switch to electronic delivery, any change in their discount would have to be thought through carefully to avoid losing more revenue from volume declines than is gained from the lower discount.

3) Over the past two months, the British Press has reported a potential UPS-TNT merger twice, and a FedEx-TNT merger once. These reports have resulted in TNT stock jumping on the Friday of the report and declining on Monday when the date of the supposed merger annoucement passes without an anouncement. One starts to wonder when investors will become spooked by a business that cries wolf and misses the "real" merger story when it comes along.

4) Please keep the comments coming. I read them all and will post anything that is not offensive or defamatory. I would appreciate comments in this blog reacting to what I say, especially if you can provide information on operating or marketing changes that relate to the post and provide information that other readers may want to have. To the extent that we can develop a dialog here, I think the entire courier, express, and postal community will benefit. Different points of view are appreciated including alternative ways of interpreting the data underlying in articles that I cite. Also, I would like you to include in your comments suggestions about topics that interest you that may need more focus in my research and observations.