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.

The Challenge of Cutting Costs

The Postal Service has begun a all-hands-on-deck effort to work its way through its financial challenges caused by the economic downturn. Nearly every day there is another story about how the Postal Service is changing operations in one community or another to reduce work hours. These changes have resulted in later mail delivery, elimination of Saturday mail holds for businesses and transfer of mail processing operations from one plant to another. Accompanying these articles, there are the expected quotes from local labor leaders about how the changes will reduce jobs in the community and weaken service quality.

As more of these articles appear, I believe that the postal community will see an important trend in postal management that bodes well for the health of the organization. These articles suggest that the Postal Service is beginning to take greater public relations risks in finding ways to reduce costs. By making changes that will generate some vocal individuals, businesses or organizations to use old and new media to draw attention to the potential downside of the change, the Postal Service indicates now that it has little choice but to take the heat that significant cost reduction will create.

The articles also suggest that the Postal Service is giving local managers significant flexibility to choose which cost reduction options they implement. In doing so, the Postal Service will have a wide range of cost reduction options implemented with just as wide a range of efforts made to minimize service disruptions and changes in customer satisfaction for each option implemented. The Postal Service has a significant learning opportunity if it chooses to use the actions of each local manager as a teaching opportunity with a focus on one question: "what could have been done better to ensure that service changes minimize the impact on consistent service quality, labor-management relations, public perception of the Postal Service, and customer satisfaction?" Compiling answers to that question after every cost reduction effort and making that information available to the next location thinking about implementing a similar effort on an ongoing basis through a wiki or internal operations improvement blog, while the changes are being implemented, will ensure that all others implementing a similar change or about to begin implementing a similar change will be able to continuously improve the implementation of operational change.

These articles also illustrate a challenge for postal labor as they begin dealing the numerous operating changes that will come in the near term. Even though the economy is weak, the Postal Service's financial difficulties may be sufficient to counter traditional arguments and political efforts to save jobs. Labor leaders may need to look for different approaches to help their members deal with the transition that is occurring. For example:

• Given that the Postal Service will likely want to reduce head counts at a higher rate in the rust belt then in the rest of the country, unions may want to begin developing programs with management that encourage or assist workers in transferring to faster growing regions.
  
• Labor leaders should also talk to their Canadian colleagues in the Canadian Union of Postal Workers (CUPW) about their efforts to develop proposal to compete with management efforts to outsource activities in order to develop work rules and other contract provisions that would allow the the Postal Service to cut costs by bringing work back in house.
• Labor leaders should also use their knowledge of postal operations to look at what what types of work processes, work rules, or wage levels would be needed for the Postal Service to profitably provide services that pre-sorters and other firms collecting, preparing, and transporting currently do. Then labor should work with management to both implement those changes and support introduction of the new higher revenue products that would compete with firms now doing these activities.

Finally, these articles illustrate a challenge now facing the mailing community. If the mailing community wants to keep mail affordable, then it must reinforce the Postal Service's efforts to explain its financial difficulties to mailers, local media, and local politicians so that the Postal Service can make the changes necessary to control costs.. This effort will need to explain why simple solutions, such as eliminating one day of delivery, will not meet the needs of either senders or recipients. The mailing community will also need to expand its focus on service quality and in particular service quality at the local level. The Postal Service will be implementing numerous changes to cut costs that will differ across the country. Mailer communication will be critical in identifying those changes that work and those that need to be reversed.

If all of these stakeholders, management, labor, and mailers become active participants in the transition to a more efficient, more consistent Postal Service, all can end up as winners. A focus by all stakeholders on both costs and service consistency, could improve the Postal Service's competitive position as the premier, measurable-impact, communication method. The future of the Postal Service depends on it.

Understanding The Outlook

The first inkling that the Postal Service faced difficult times was reported on this blog a little over a week ago. With the publication of the 3rd quarter 2008 10-Q, the Postal Service confirmed that the decline in volumes has already generated losses this year of 1.3 billion. More importantly the Postal Service provided some details of its outlook for the remainder of FY 2008 and all of FY 2009 that indicates that the Postal Service and the mailing industry face another tough year ahead of them.

Revenue Outlook

The Postal Service's revenue outlook is summed in this sentence: "We (the Postal Service) face a prolonged period of slow growth coupled with the threat of stagflation." The Postal Service's current volume forecast is now based on the assumption that 2008 FY GDP growth will be 2.1% and 2009 FY GDP growth will be 0.5% with a decline in GDP through the first two quarters of FY 2009.

The Postal Service expects that the 4th quarter of FY will see volume declines and revenue performance similar to what was seen in the 3rd Quarter. In that quarter volume declined by 5.5% and revenue declined by 2.4%. If a similar decline occurs in the fourth quarter, 4th quarter 2008 revenue will be $437 million below 2007 levels and volume would be $2.8 billion pieces below last year's levels. Withe these assumptions for the 4th quarter, FY 2008 revenue would total $75.265 billion, only 0.5% more than last year primarily due to the decline in volume.

The Postal Service did not provide a revenue forecast for FY 2009 but they provide some parameters that suggest that they expect that the volume declines that began in earnest in the 3rd quarter of 2008 will continue though at least the first two fiscal quarters of 2009. Furthermore, it is not clear if they see any improvement over current volume levels in the second half of FY 2009 without a robust turn around in the economy. Without completing more serious calculations, assuming that FY 2009 revenue would be no higher than what was generated in FY 2008 would seem a reasonable even if the Postal Service raises rates at the maximum levels permitted under the rate cap.

Expense Outlook

The Postal Service's comments on expenses suggests that making expense reductions neccessary to bring it back to break even will be difficult. While the Postal Service has reduced work hours in FY 2008 by 40 million work hours, increases in wage rates and fuel expenses has resulted in a 0.4% increase in expenses this year. The increase was even higher in the 3rd quarter which experienced a 0.94% increase in expenses. The Postal Service notes that COLA adjustments will raise 4th quarter expenses by $80-100 million, and even with the recent decline in fuel prices, the Postal Service will still see significantly higher expenses for fuel, electricity, and transportation services than in the 4th quarter of FY 2007. Given these headwinds, the Postal Service will do well to hold expenses to an increase just below what it experienced in the the 3rd quarter. Using a 0.8% increase over FY 2007, 4th quarter expenses would be $19.181 billion and full year expenses would be $77.534 billion.

Again the Postal Service does not provide a forecast for FY 2009 expenses but identifies that the employee COLA could increase costs by $1 billion. It is not clear whether this increase reflects the potential impact of normal attrition or the VERA. The Postal Service will also experience higher fuel, electricity, heating, and transportation costs through at least the first two quarters even if oil drops down to $100 a barrel. The Postal Service may see some relief in the third and fourth quarter as current oil price levels are below the highest levels of that period. Clearly, in order to bring its costs closer in line to revenues, the Postal Service will need to reduce work-hours in the first three quarters of FY 2009, including the impact of the VERA, by an amount exceeding the 40 million work hours that it achieved in FY 2008 along with cost savings in all other areas.

Net Income Outlook

The Postal Service did not provide a net income outlook. Through 3 quarters in 2008 its net loss is $1.1 billion. Based on the assumptions and estimates listed above, the Postal Service would appear likely to end the year was a loss of $2.269 billion. Even if the Postal Service was able to hold all expenses in the fourth quarter at FY 2007 levels, the FY loss would likely exceed $2 billion.

The outlook for net-income in FY 2009 would appear to be not much better. If revenue remains flat, the Postal Service would need to cut expenses by over $3 billion in FY2009 to break even. (The $2.3 billion loss in FY 2008 plus the increase in costs due to the COLA and difference in the fuel prices over FY 2008 in the first two quarters of FY 2009.) Such a large reduction in expenses is an ambitious goal. However, the Postal Service may have little choice but to seek to set a goal close to this amount to ensure that it will be in good shape financially when the economy improves in FY 2010.

Postage Rate Outlook

The Postal Service provides mailers with no indication of what future rate increases will be in the 10-Q. However, given the financial situation, mailers should assume that the Postal Service will raise rates by the maximum amount permitted by law for all products subject to the rate cap. At this moment the index is 3.7% but will likely be higher by the time the Postal Service proposes next year's rate increase. An average increase somewhat above 4% would seem to be a reasonable assumption for planning purposes. Given that cost of fuel is just beginning to trickle through into other prices, assuming that postage rates will rise another 4% in 2010 as well would seem to be a reasonable starting point.

While the CPI-U index provides information on the average rate increase, it does not say much about how individual products will be affected. Among the factors that may affect individual mailers are:

• The impact of the unitary postage rate for First Class single piece on the total increase from First Class mail and the automation and pre-sort discounts. The Postal Service may choose to not raise stamps 2 cents if by doing so it must raise discounts beyond what it believes is financial prudent.
• The additional ounce 1st Class rate adjustment may reflect the need to make the transition between First Class and Priority mail rates rational. If priority mail rates increase by more than the CPI-U then the additional ounce rate could be expected to rise by a larger percentage than the first ounce rate.
• Drop shipment discounts may be constrained by the CPI-U limitation. It is possible that discounts may not adequately reflect the rise in fuel costs thereby causing some drop-shipped mail to be transported by the Postal Service.
• Parcel rates under the price cap (e.g. single piece parcels, media mail, and bulk printed matter) could become a test case for exemption from the CPI-U limitation. These products have a higher transportation cost component than other mail products and the CPI-U limitation may force these rates to be below financially prudent level.

For competitive products, mailers should expect that the Postal Service will raise rates by a percentage equal or larger than what private sector carriers do in January. The Postal Service will likely take into account the impact of increases that have already been implemented by its competitors in the form of fuel surcharges when it raises rates next May. (Given that a substantial portion of the Postal Service's parcel business is first handled by FedEx or UPS, mailers may have seen the impact of the fuel surcharge on drop-shipment rates already.) The Postal Service's competitive product price increases could be constrained by the increase in rates for single piece parcels and the First Class additional ounce rates.

Legislative Changes Suggested by the Current Financial Challenges

This review of the current financial challenges facing the Postal Service suggests that it may need some relief from Congress in order to work its way through the current economic downturn. Specifically, two actions could ease the Postal Service's ability to hold rates below the cap and prevent its financial position from deteriorating over the next few years.

• Extend the period over which the Postal Service must fund its retiree health care obligations. An extension of the 10 year period to 15 or 20 years would reduce the hurdle required to ensure that revenue matches costs. This could prevent significant cuts in service or reductions in force that would otherwise be required
• Place all parcel rates under the competitive banner. By doing so, the Postal Service can ensure that its rates for all parcels remain remunerative and that rates for both individual and commercial customers remain both reasonable and competitive. This may mean that parcel rates will rise more than the cap in years when fuel and labor costs rise faster than CPI-U and will rise less than the cap in years that either competitive pressures are greater or cost pressures are less severe than they are now. Removing parcel rates from the regulated sector may be necessary to ensure that the Postal Service can offer universal access to its parcel delivery network to individual and small business customers.

Neither of these changes would require direct government outlays. The first one could have a budgetary impact that would have to be dealt with in the legislative process.

The impact of FSS? Changing the shape of Mail

The New York Times has reported that Rolling Stone, the largest circulation music magazine will be changing its format from a tabloid to a more standard magazine size. While the article focuses on the impact that the new format will have on newsstand sales, clearly Rolling Stone will reap large benefits in postage savings by using an automation compatible format. By changing its binding and paper stock, Rolling Stone will create a more attractive format for advertisers chasing after the young demographic of its readers. In addition, its new format will allow printers to use the same equipment and paper that they use to print other larger-circulation bound periodicals, creating the possibility that the new size may also save printing costs as well. One wonder's whether other shorter-run, tabloid-shaped periodicals and advertisers are now looking at printing and postage in a similar way and are considering changing their format to better fit the FSS and more commonly used printing and binding equipment.

With a circulation of over 1.4 million of which 1.2 million are delivered through the mail Rolling Stone was the largest circulation magazine that did not conform with the FSS automation specifications. Clearly such a major makeover was not a small undertaking and in all likelihood was many months in the making.

The new format no longer fits the rebel image of Rolling Stone that the tabloid format did so Rolling Stone management must have seen significant economic benefits from making the change. Now they have the challenge of selling the change to their readers and advertisers. The article in the New York Times is one of the magazine's forays in talking to advertisers. It's success over the next year may indicate how well the change was accepted.

UPDATE TNT - UPS Merger Rumor

Early Monday morning, Don Brutto, UPS President of International Business, put a kibosh on the story that it was negotiating to purchase TNT. In an interview with Reuters, he stated that a purchase of TNT would devalue UPS shares. He went on to state that UPS is looking for acquisitions in China with a goal of growing its headcount from 5,300 to 25,000 to reflect the demand that he says is there.

While Mr. Brutto's statement may accurately reflect UPS's current intentions, rumors of mergers between FedEx or UPS and TNT will continue to circulate given the synergies that a merger would produce both in Europe and Asia. What clearly is a stumbling block is determining a price that would be both attractive to stockholders of TNT and the acquiring firm. Any purchase of TNT would likely come at enterprise value multiple (EV/EBITDA) greater than that of the acquiring firm. In addition, European stock analysts have expressed opinions that the any acquiring price would be in excess of the $15 billion U.S. that was reported by the Sunday Telegraph.

Consolidation of the Package Delivery Market in Europe

The Sunday Telegraph reported today that UPS has made an informal offer of $15 billion (10 billion Euro) to purchase TNT suggests that we may be watching the beginning of a major consolidation of express and parcel carriers in Europe. The price discussed is around 25% more than TNT's share price in mid-July when the Financial Times reported that FedEx was interested in TNT. UPS's offer is not unexpected as some investment analysts suggested, at the time time of the report of both FedEx and UPS would be interested in TNT. At that time some analysts suggested that UPS would be in a stronger financial position to buy TNT and if a bidding war broke out. As UPS's reported bid amount is about equal to the value of TNT based on the stock's close on August 8, 2008, the reported bid does not represent a premium on TNT's current market valuation.

The Telegraph report provides significantly more detail than the earlier report on FedEx's interest in TNT. The report includes the names of the investment advisers for both TNT and UPS and indicates that A.T. Kearney has completed a study for UPS's adviser in the deal, Morgan Stanley. The report also indicates that TNT's mail operations would be sold, possibly to CVC, the European buyout firm that owns interests in both De Post-La Post and Post Danmark. (Post Danmark also has agreed to merge with Posten, the Swedish Post Office) It is unclear whether the price for the postal operations is included in the $15 billion cost of the deal. Given that some of the increase in TNT's price over its price in mid July when rumors of a possible takeover first surfaced reflect the decline in oil prices, it is possible that the value of a deal when consummated will be greater than $15 billion. Also, what is unclear is whether TNT's ground parcel business would convey to UPS or the purchaser of the postal business.


The purchase of TNT by UPS would have a significant impact on competition within Europe. Currently, the five largest express competitors are TNT (17%), DHL (16%), UPS (8%), La Poste (the French Post Office) 7%, and FedEx (6%). The remaining 46% of the market is divided the national post offices and regional operators. With the merger UPS would be the clear market leader with 25% of the intra-European market and would be in stronger position for traffic between Western Europe and the rest of the world than the remaining two other global competitors, DHL and FedEx. Most importantly, UPS would then be in a better position to fill up its growing capacity in China and the rest of Asia with express traffic going between China and Europe than carriers with a smaller market position in Europe. In addition, UPS's stronger position in Europe would give it the opportunity to take market share from DHL and FedEx in the trans-Atlantic market.

The sale of the postal operations makes sense given that mail is not part of UPS's core business.
The proposed sales of TNT's mail business raises questions about the long term financial viability of European national posts, and in particular the posts of smaller countries. A merger of the TNT mail operations with Posten (Sweden), La Post (Belgium), and Post Dankan (Denmark) creates an entity with greater heft when competing with the larger national posts in Germany, France, and Great Britain. If TNT's growing ground parcel business remains with the postal entitity then the merger would have created a significant European competitor in parcels with particular strengths in the Benelux and Nordic regions. Without TNT's European ground parcel business, it is not clear how much an outside investor would be willing to pay for just mail services.

The merger of TNT's mail services with that of the other posts could have some positive impact on service. It could result in improved coordination of cross-border mail service among the linked companies with the possibility of stronger service to Great Britain and other regions where TNT has established itself as a leader in the competitive mail business.

Finally, if this merger goes through, one would expect that other competitors in the European market to start looking at defensive moves to improve their business position. The easiest
linkage to imagine is one between FedEx and LaPoste, since they have had a business relationship since at least 2000, but less obvious mergers may occur with a focus of FedEx and/or La Poste working to strengthen their position on a country by country basis. On the mail and ground parcel side, one could see an interest in smaller posts in Eastern and central Europe exploring mergers and operating agreements. The logical leaders in this region are Deusche Post, Oesterreich Post, and Swiss Post.

Universal Service and Under-served Communities

In most cases, under-served communities are thought to be in geographic areas where delivery mail volume per delivery point is low and demand for retail services is also low. It is in these communities that the cost of delivery per piece is believed to be higher and a postal administration might offer inferior, slower service to minimize losses. These perceived under-served delivery communities are those with a large number of lower mail volume delivery points and are concentrated in lower income communities. On the retail side, these communities are thought to be the most rural communities where the distance that a customer would have to travel for service might be longer and post offices are open for a limited number of hours.

It is possible though that, at least in regards to retail access, the geographic areas that are most at risk for being under-served are those with the greatest population growth. Given the challenge that the USPS has had in closing, moving, or consolidating retail facilities in communities with little demand, it may be more cautious than it should be in opening new retail facilities in communities with rapid population growth. In the United States, there are 42 metropolitan areas which have had a population growth of greater than 100,000 since 2007, the size of small city. These cities and their growth in population are listed at the end of this post.

It is in these high growth markets that the Postal Service should be experimenting with both modifications of the exiting employee-staffed business model of providing retail services and begin to expand consumer access at less conventional locations and through contractual models that differ from what have been offered in the past. In doing so, the Postal Service could expand access to its network as fast as the population grows generating more parcel and other mail volume. Using a mix of employee and contractual models will also allow it to expand services to communities earlier in a growth cycle than just using a traditional post office model would allow.

Metropolitan Areas Growing by More Than 100,000 Since 2000

Metropolitan Statistical Area	Increase in Population Since 2000
Atlanta-Sandy Springs-Marietta, GA	1,030,892
Dallas-Fort Worth-Arlington, TX	983,517
Phoenix-Mesa-Scottsdale, AZ	927,551
Houston-Sugar Land-Baytown, TX	912,699
Riverside-San Bernardino-Ontario, CA	826,554
Washington-Arlington-Alexandria, DC-VA-MD-WV	510,502
Los Angeles-Long Beach-Santa Ana, CA	509,964
New York-Northern New Jersey-Long Island, NY-NJ-PA	492,606
Las Vegas-Paradise, NV	460,798
Chicago-Naperville-Joliet, IL-IN-WI	426,058
Miami-Fort Lauderdale-Pompano Beach, FL	405,224
Orlando-Kissimmee, FL	387,933
Austin-Round Rock, TX	348,413
Tampa-St. Petersburg-Clearwater, FL	327,936
Charlotte-Gastonia-Concord, NC-SC	321,129
Sacramento--Arden-Arcade--Roseville, CA	294,263
Denver-Aurora, CO /1	285,524
San Antonio, TX	278,954
Seattle-Tacoma-Bellevue, WA	265,462
Raleigh-Cary, NC	250,623
Portland-Vancouver-Beaverton, OR-WA	247,232
Minneapolis-St. Paul-Bloomington, MN-WI	239,395
Nashville-Davidson--Murfreesboro--Franklin, TN	209,648
Jacksonville, FL	178,073
Indianapolis-Carmel, IN	169,933
San Diego-Carlsbad-San Marcos, CA	161,026
Cape Coral-Fort Myers, FL	149,676
Kansas City, MO-KS	149,006
Columbus, OH	141,493
McAllen-Edinburg-Mission, TX	141,051
Philadelphia-Camden-Wilmington, PA-NJ-DE-MD	140,817
Salt Lake City, UT	131,090
Bakersfield, CA	129,055
Cincinnati-Middletown, OH-KY-IN	124,024
Tucson, AZ	123,343
Boise City-Nampa, ID	122,849
Provo-Orem, UT	116,528
Richmond, VA	116,022
Baltimore-Towson, MD	115,060
Stockton, CA	107,394
Albuquerque, NM	105,467

Encouraging and Discouraging Early Retirement

The Postal Service now has indicated that it will offer voluntary early retirement to all clerks mailhandlers and supervisors in processing facilities and retail units. In addition, they have now asked for the authority to offer Voluntary early retirement for postmasters but have not indicated if they will use that authority.

While employees are eligible nationwide, the Postal Service has the incentive to work hard to encourage retirement in some geographic regions and discourage retirement in others. These regions can be identified by looking at U.S. Census estimates of population changes. In those metropolitan areas that have seen population declines since 2007, the Postal Service in all likelihood has the greatest need to reduce its headcount. In metropolitan areas that have experienced substantial population growth, the Postal Service may not push early retirement as hard. The following two lists identify the metropolitan areas that fall into these two categories. It should be noted that the New Orleans-Metairie-Kenner, LA and Gulfport-Biloxi,MS metropolitan areas may represent special cases due to the impact of Hurricane Katrina and may not face the same level of labor overcapacity as the other metropolitan areas with declining population.


Metropolitan areas with population declines since 2000 a higher participation rate than average in voluntary early retirement may be preferred.

Metropolitan Statistical Area	Census 2007 Population Estimate	Population Decline Since 2000
New Orleans-Metairie-Kenner, LA	1,030,363	-286,149
Pittsburgh, PA	2,355,712	-75,375
Cleveland-Elyria-Mentor, OH	2,096,471	-51,539
Buffalo-Niagara Falls, NY	1,128,183	-41,926
Youngstown-Warren-Boardman, OH-PA	570,704	-32,260
Gulfport-Biloxi, MS	231,523	-14,667
Dayton, OH	835,537	-12,616
Scranton--Wilkes-Barre, PA	549,430	-11,197
Weirton-Steubenville, WV-OH	122,580	-9,428
Beaumont-Port Arthur, TX	376,241	-8,849
Toledo, OH	650,955	-8,229
Saginaw-Saginaw Township North, MI	202,268	-7,774
Wheeling, WV-OH	145,454	-7,724
Johnstown, PA	144,995	-7,603
Rochester, NY	1,030,495	-7,338
Decatur, IL	108,732	-5,974
Ocean City, NJ	96,422	-5,904
Binghamton, NY	246,426	-5,894
Pine Bluff, AR	101,484	-5,861
Charleston, WV	303,950	-5,682
Pittsfield, MA	129,798	-5,155
Utica-Rome, NY	294,862	-5,034
Syracuse, NY	645,293	-4,861
Huntington-Ashland, WV-KY-OH	284,026	-4,624
Danville, VA	105,773	-4,383
Springfield, OH	140,477	-4,261
Parkersburg-Marietta-Vienna, WV-OH	160,656	-3,968
Santa Cruz-Watsonville, CA	251,747	-3,853
Altoona, PA	125,527	-3,617
Wichita Falls, TX	148,148	-3,376
Muncie, IN	115,419	-3,350
Lima, OH	105,233	-3,240
Williamsport, PA	116,811	-3,237
Mansfield, OH	125,679	-3,173
Elmira, NY	88,015	-3,055
Niles-Benton Harbor, MI	159,589	-2,866
Danville, IL	81,191	-2,733
Cumberland, MD-WV	99,316	-2,692
Bay City, MI	107,517	-2,640
Sandusky, OH	77,323	-2,228
Anderson, IN	131,312	-2,046
Erie, PA	279,092	-1,751
Kokomo, IN	99,845	-1,696
Lake Charles, LA	191,926	-1,639
Terre Haute, IN	169,346	-1,608
Flint, MI	434,715	-1,433
Battle Creek, MI	136,615	-1,370
Lawton, OK	113,811	-1,185
Duluth, MN-WI	274,308	-1,178
Abilene, TX	159,343	-898
Sumter, SC	103,943	-693
St. Joseph, MO-KS	123,339	-481
Waterloo-Cedar Falls, IA	163,329	-378
Michigan City-La Porte, IN	109,787	-319
Sioux City, IA-NE-SD	142,794	-259
Gadsden, AL	103,217	-242
Hinesville-Fort Stewart, GA	71,803	-111

Metropolitan areas with population growing by more than 20% since 2000 where a lower participation rate of voluntary early retirement than average may be acceptable.

Growth Ranking	Metropolitan Statistical Area	Census 2007 Population Estimate
1	Palm Coast, FL	88,397
2	St. George, UT	133,791
3	Greeley, CO /1	243,750
4	Cape Coral-Fort Myers, FL	590,564
5	Bend, OR	154,028
6	Las Vegas-Paradise, NV	1,836,333
7	Raleigh-Cary, NC	1,047,629
8	Provo-Orem, UT	493,306
9	Gainesville, GA	180,175
10	Phoenix-Mesa-Scottsdale, AZ	4,179,427
11	Austin-Round Rock, TX	1,598,161
12	Myrtle Beach-Conway-North Myrtle Beach, SC	249,925
13	Prescott, AZ	212,635
14	Boise City-Nampa, ID	587,689
15	Lake Havasu City-Kingman, AZ	194,944
16	Naples-Marco Island, FL	315,839
17	Fayetteville-Springdale-Rogers, AR-MO	435,714
18	Ocala, FL	324,857
19	Riverside-San Bernardino-Ontario, CA	4,081,371
20	Port St. Lucie, FL	400,121
21	McAllen-Edinburg-Mission, TX	710,514
22	Atlanta-Sandy Springs-Marietta, GA	5,278,904
23	Charlotte-Gastonia-Concord, NC-SC	1,651,568
24	Coeur d'Alene, ID	134,442
25	Wilmington, NC	339,511
26	Orlando-Kissimmee, FL	2,032,496
27	Sioux Falls, SD	227,171
28	Laredo, TX	233,152
29	Dover, DE	152,255