PRC Conducting Study to Allow More Flexible Costing And Pricing

On August 2, the Postal Regulatory Commission issued a Request for Proposal to produce a “Report on Peak Load Costs.” Peak load costs are traditionally thought of as additional costs that are born to cover higher demand than normal. For electric utilities that have multiple options for producing or purchasing power, the most profitable operating model involves using the lowest cost electricity first and as demand rises going to more and more expense options for producing power. For that reason, many utilities have developed models that show that costs of handling peaks in power demand are higher than the cost of handling base demand and often set tariffs that encourage electricity customers to use power when there is likely to be excess capacity of the lowest cost option for producing Power.

Traditionally, it is thought that Postal volume peaked in the fall and is at a low point in the summer month. Similarly, certain days of the week, and days of the month have more mail volume than other that relate to publishing, billing, and sales cycles. To the extent that labor, capital, and purchased transportation assets are less flexible than the variation in mail volume would result in times when there is excess capacity and other times when all asset are more than fully utilized and overtime costs are born or additional transportation is added. Recent changes in the American Postal Workers Union contract that increases flexibility through the use of both non-traditional full time schedules as well as the introduction Postal Support Employees to the mix of labor resources available increase the flexibility of the Postal Service to deal with variations in volume.

Study Suggests Commission Believes Existing Costing Models May No Longer Be Sufficient

In the first paragraph of the scope listed in its request, the Commission indicates that measuring the differences in costs between peak and slack periods will likely become a more important part of its regulatory role in the future and existing costing approaches can no longer meet these needs. (The underlined sentence reflects the traditional view of Peak Load issues.) More importantly from a rate regulation standpoint, the first paragraph of the scope suggests that the Long Run Marginal Cost Models may have less value in the future and a new costing approach that can deal with costs associated with a large number of specific customers or groups of customers whose cost differ from the long run marginal costs due to when and where mail that they want the Postal Service to deliver enters and exits the network.

“Under prior law (the Postal Reorganization Act, or PRA), the Commission’s analysis of cost behavior focused primarily on how product costs respond to changes in volume over a multi‐year rate cycle. This focus on long‐run volume variable costs reflected the Commission’s primary duty under the PRA, which was to recommend relatively infrequent changes to the Postal Service’s rate schedule. The current law (the Postal Accountability and Enhancement Act, or PAEA) places less emphasis on the Commission’s duty to evaluate periodic changes in the Postal Service’s rate schedule. The PAEA places more emphasis on the Commission’s duty to evaluate the costs and benefits of various proposals to adapt postal services to the fundamental changes that are occurring in the economic environment in which they are provided. These proposed adaptations include changing the frequency of delivery, offering seasonal discounts, using a short‐run marginal cost standard to evaluate periodic changes in rates, and downsizing the Postal Service’s processing and delivery networks. Common to all of these proposals is a need to estimate the costs of coping with short‐run fluctuations in workload (generally, workload that fluctuates more rapidly than labor resources can be adjusted) while adhering to preferential mail service standards and the staffing and scheduling constraints imposed by collective bargaining agreements.”

Scope Appears to Go Beyond Peak Load Cost Analysis

The second paragraph of the scope suggests that the costing issues that the Commission believes that it may have to address questions in the future may go beyond what is required to respond to proposals for experimental and discounted rates by the Postal Service. The paragraph begins by focusing on traditional peak load issues as they relate to mail processing, delivery and transportation costs.

• Mail Processing: “The Commission needs to be able to estimate the effect on mail processing labor costs of workload fluctuations within eight‐hour labor tours, by day of the week, and by season (as well as annually, if it is determined that labor resources take longer than a year to fully adjust to workload).
• Delivery: “The Commission needs to estimate the effect on city delivery carrier labor costs of workload fluctuations by day of the week and by season, and by year.”
• Transportation: [A costing model] “needs to be able to estimate the effect on purchased transportation costs of workload fluctuations by time of day, by day of the week, by season, and by year.

These costs should be modeled in such a way that the effect on costs volume variation, of relaxing preferential service standards, and of relaxing staffing and scheduling constraints, can be separately identified and estimated.”

Specific Tasks Have Could Have Significant Impact on Postal Policy and the Details of Postal Reform Legislation

The policy focus of the Postal Regulatory Commission’s costing model problem is further indicated by the focus of Task 2:

Contractor shall prepare, a proposed methodology, or methodologies, for analyzing peak load costs under the constraints applicable to the Postal Service such as labor union rules and product specific service standards. The methodologies should be able to answer the following questions:

1. How might changes in delivery frequency impact peak load and what are the costs associated with those changes? This question is designed to improve the Commission’s approach in providing information to Congress and other policymakers regarding how changes in delivery frequency could affect costs.
2. What savings will be gained from new labor flexibilities and when will they be achieved? This question recognizes that existing cost models provide little information about Postal Service costs in 2012 and beyond as it implements new work-rule flexibility in the APWU and other contracts yet to be signed.
3. Can operational inefficiency be quantified? The issue of inefficiency goes to the heart 0f the policy problem and implies a second question “how much can costs be cut before service changes are required?” So answering this question is important for the Commission is important so that Congress has an independent assessment of the limits of efficiency gains in under current operating constraints and if service level (i.e. delivery frequency and time between acceptance and delivery) or labor related restraints are changed. Due to the unpredictability of mail volumes, even an efficient operation may have slack labor, overtime costs, idle sortation equipment, and empty space on trucks under all scenarios and understanding potential efficiency goals will be needed for sound policymaking. The introduction of inefficiency is particularly interesting given the focus on “labor union rules.” It raises the possibility that a study of the impact of variances in volume by hour, day, week, month and season could be used to estimate the “efficiency” impact of relaxing specific union rules that affect management’s ability to match labor resources employed during each hour of work day to the amount of work required to meet customer service commitments.
4. How do unit costs change with seasonal fluctuations in volume? The seasonal fluctuation focus raises four particularly interesting policy questions.
1. Do prices need to be uniform over a year or can prices vary with a year?
2. How can prices under a price cap deal with seasonally adjusted prices especially when prices were uniform over the course of a year before?
3. Which products can be allowed to fluctuate from season to season, or for that matter month to month or even day to day which ones cannot?
4. As the mix of customers that use a particular product may change from season to season, are rates based on seasonal differences in costs the first step toward customer specific rates and therefore customer specific costs?Good examples of customers that only use mail in specific seasons are political campaigns. Political campaigns use the mail heavily the month before both primary and general elections. In highly contested election years, political campaigns and independent groups can generate a sufficiently significant increase in mail volumes that the Postal Service in its long range volume forecasts has to account for election years in their forecast models.

Implications of Study for Cost Differences Unrelated to Time or Calendar

The last of these four questions is particularly important given the implication that mail sent by customers that only use the Postal Service during specific times of a year could pay different rates than customers that use the Postal Service year round or during other time periods. If customer costs can be differentiated based on the time of the year that they send their mailings, what other factors could be used to distinguish customers whose mail has different levels of cost than other customers. For example,

• Do customers that send mail on a regular schedule impact operating costs differently than customers that do not?
• Do customers that can provide the Postal Service advance information about a mailing including both total volume and the number of pieces to be delivered by 5, 9, and 11 digit bar-codes as well as carrier routes affect costs differently than those customers that do not provide advance information?
• Could First Class bulk mail customers that can accept an additional day to deliver the mail than those bulk mail customers that do not? (Having such a service could allow the Postal Service to develop a service that competes with pre-sorters using slack machine time in originating sortation operations that are idle today.) 
• Should customers that use the Postal Service for either last mile delivery of parcels or first mile handling of returns pay different rates depending on the destination or origin respectively if the costs of handling those parcels differ in different parts of the country?
• Should drop shipment discounts be uniform nationwide if the cost of delivery differs between one region and another?

Implications of the Study for Existing Long-run Marginal Cost Measurement and Activity Based Costing

All of these examples, as well as the time based example identified by the Postal Regulatory Commission illustrate that developing modern cost-based postal rates may require accepting that the existing long-run marginal cost models used in ratemaking may have outlived their usefulness and a new approach and new data systems are required. A recent article by Jessica Lowrance and Gene Del Polito, “Rationalizing Postal Costing in the 21^st Century,” suggests that it is time to seriously look at a bottom-up, activities-based-costing approach for Postal Costing.

While the Lowrance and Del Polito paper makes the case to moving to a new costing system, it does not detail the regulatory and legal challenges of making this transition. The Commission, in requesting proposal to study how costs vary by time of day, week, month and season illustrates that it is interested in starting the process of making a transition toward customer based costs and prices. The limited scope of this project illustrates that a transition under current law and regulatory precedent will likely be cautious. If Congress believes that greater customer focused service and price flexibility is required to improve the Postal Service’s ability to serve its customers and speed its return to profitability, then it will need to assist the Postal Service and the Postal Regulatory Commission to replace the current cost model with one more suited for measuring customer based costs and setting customer based prices.

Turnover at the Postal Regulatory Commission.

Today's announcement that Dan Blair has accepted the position of President and Chief Executive Officer of the National Academy of Public Administration assures that within the next six months the Postal Regulatory Commission will have two new members. Commission Blair will resign from the Postal Regulatory Commission on June 30, 2011.  This could leave the Commission with four members until President Obama appoints and the Senate confirms a replacement.

Those that have carefully read some recent Postal Regulatory Commission decisions will recognize that who President Obama appoints to replace Commissioner Blair could have a major impact on how the Postal Regulatory Commission opinions and the Postal Regulatory Commission's recommendations to Congress on changes to the Postal Accountability and Enhancement Act.

Right now the Postal Regulatory Commissioner's are as follows:

Current Commissioners	Term Expiration Date
Chairman Ruth Y. Goldway (D)	Nov, 22, 2014
Vice Chairman Mark Acton (R)	Oct, 14, 2010
Commissioner Dan G. Blair (R)	Oct, 14, 2012
Commissioner Nanci E. Langley (D)	Nov, 22, 2012
Commissioner Tony Hammond (R)	Oct, 14, 2010

Expected Changes:

Vice Chairman Mark Acton was reappointed by President Obama in May for a term that would end in 2016.  If the Senate does not act by October 13, 2011, that seat on the Commission becomes vacant until he is confirmed or until another nominee is confirmed.

Commissioner Tony Hammond has announce that he will leave his seat by the end of his term in October. Robert Taub was nominated by President Obama to fill that seat. His nomination is waiting both hearings in the Senate and Senate Confirmation.   If no action is taken by October 13, 2011, then that seat remains vacant until he is confirmed or another appointee is confirmed. 

Commission Dan Blair  will depart on June 30,2011.  Unless Robert Taub is confirmed quickly to fill Commissioner Blair's seat, so that both Tony Hammond and Robert Taub serve concurrently, the Postal Regulatory Commission will drop to four Commissioners on July 1.  Commissioner Blair's resignation opens up a Democratic seat on the Commission, so his replacement, (or the replacement of Tony Hammond if Robert Taub is confirmed soon, will be a Democrat.  

The opening of a seat on the Postal Regulatory Commission gives President Obama to pick a non-traditional nominee.   President Obama and his advisers should look at the choices that President Carter when he made three appointments to the Interstate Commerce Commission in the late 1970's that transformed the agency in order to modernize trucking and rail regulation as a model for the PRC.

These nominees were:

• Darius Gaskins, a Phd Economists with a specialty in transportation who prior to being named Chairman of the Interstate Commerce Commission  was the Director, Office of Economic Analysis, Civil Aeronautics Board, under Alfred Kahn and Director, and director of the Bureau of Economics, Federal Trade Commission;
• Marcus Alexis, Chairman of the Economics Department of Northwestern University, whose research areas included management strategy and urban economics; and
• Thomas Trantum, a Wall street transportation financial Analyst with H.C. Wainwright & Co who worked with Arthur Laffer to convince United Airlines to become the first airline to support Airline Deregulation.

These three individuals were the core of the ICC when I was there as a graduate school intern.  I saw first hand how the appointment of individuals who understand the need to take risks that included changing years of regulatory precedent in order to ensure the revival of the rail industry, and improve service quality and competition in trucking.  These individuals were not afraid to support legislative changes that more politically cautious and precedent bound commissioners would shy away from. 

Clearly, given the problems facing the Postal Service, the postal market would be well served in the next PRC appointee is a person who has a background similar to the three Carter appointees to the Interstate Commerce Commission.  Just as they brought a fresh, policy-focused, perspective to the question to transportation law and regulation, the next appointee to the Postal Regulatory Commission must to do the same to postal law and regulation.   The survival of the postal ecosystem in 2020 and beyond depends on it.

Who Represents the Administration on Postal Policy?

The Office of Management and Budget media office has provided the following response to my question regarding why OMB Director Jacob Lew is not testifying at the Postal Hearing this Wednesday.

"As a matter of policy, the OMB Director doesn't testify before subcommittees on issues not directly related to OMB’s appropriations." 


If this is standard policy for OMB then the Subcommittee may have posted the hearing schedule prior to knowing the protocol.  

The problem that the Committee faced in trying to pick a witness to present the Obama administration proposal for the Postal Service that is included in the 2012 budget is who represents the administration's position.  For most departments it is clear.   The Secretary or Administrator of the department of the department or agency gets the call to explain the proposed budgetary changes.   For the Postal Service, this is not so clear.  

It is not the place of either the Postmaster General or the Chairman of the Postal Regulatory Commission to present government policy for the postal market.  The adversarial relationship between the regulator and the regulated entity prevents either from doing more than present the perspective of their own organization on the proposal made in the Obama 2012 budget.   For example, it is clear that if the Postal Service could have submitted a budget proposal of its own choosing it would have removed the requirement that it maintain 6-day delivery.   What changes the Postal Regulatory Commission would have made is less certain.   There are also a fairly long list of postal policy issues that the Postal Regulatory Commission and the Postal Service would differ that affect postal finances and how they affect the budget which creates the appearance that there is no such thing as "government postal policy" in the United States.

Let's hope that the Committee can quickly find out who will represent the Obama administration on postal policy.   Until that happens, the 2012 budget proposal for the Postal Service risks becoming little more than a policy orphan.

Social Value of Mail

Last week the Postal Regulatory Commission announced on its website that it has funded six studies examining the social value of mail.     The Commission's studies provide a couple of snapshots as to the impact of the Postal Service on the markets and communities that it serves.   The summary of the studies are as follows:

• SJ Consulting will quantify the benefit of the Postal Service’s rural services by measuring the percent of population affected by Delivery Area Surcharges and determine if there is a cost basis for the Delivery Area Surcharges by the two major parcel carriers and the benefits from the Postal Service having a more frequent delivery network in rural areas.

• Urban Institute will measure the Economic Effects of Post Offices by researching available data and providing an impact analysis of the presence of post offices on real estate values, business activity, and employment through sampling the impact of about 125 closed post offices.

• Urban Institute will research the role and benefits of Price Leadership of the Postal Service from lower priced postal products such as parcels or expedited services, money orders and post office boxes to determine the competitive advantages the Postal Service offers with these products compared to its competitors.

• Urban Institute will quantify the benefits of the Postal Service to Community Security and Public Safety by researching Postal Service and NALC data, and Metropolitan Police Department crime data to measure the impact on crime in the District of Columbia by changing retail service hours and postal carrier routes, considering neighborhood characteristics, and Postal Service personnel training regarding community security and public safety reporting.

• Leong Consulting will quantify the benefits of the Postal Service’s Disaster Response, Emergency Preparedness, and Safety including its role in neighborhood safety, as a first responder and as a communications network in an area devastated by natural disaster by estimating the “savings” to government agencies from Postal Service performance of these duties and assess the Postal Service’s role in the Nation’s preparation for bioterrorism, including neighborhood safety, and the Cities Readiness Initiative (CRI), the Bio-Detection System, and the Custom-Trade Partnership Against Terrorism (C-TPAT).

• Leong Consulting will also quantify the Essential Services for the Unbanked Population provided by the Postal Service using publicly available data from banking industry organizations and consumer advocacy groups and assess the value of Postal Service products provided to the unbanked population and identify other areas where the Postal Service could offer useful financial-type services, particularly to those receiving hard-copy checks.

The studies that the Postal Regulatory Commission funded are examples of studies that are necessary in order to fully develop a postal market policy and the business model that the Postal Service should follow and the regulatory structure under which the Postal Service should operate.  Many of these studies could help clarify questions about whether the Postal Service could continue to provide the benefits that it provides the nation if it operated as a private sector corporation, a government corporation operating under standard business law, the current model, or as government department.    Similar questions need to be asked about the impact of regulatory policy on the social benefits and economic impact of the Postal Service and private sector participants in the postal market.  

Beyond the broad questions of business models and regulatory frameworks, these studies can help Congress understand more fully the impact of changes in the operating model, including changes in how retiree obligations are calculated, the network of sortation facilities and sortation plans for single piece and bulk-tendered mail, and the retail strategy including the types of products and services that a Postal Service retail outlet can offer, and the mix of contracted and corporate facilities used to provide service that will be necessary to ensure that the Postal Service finally becomes financially self sufficient and the risks to the economy and the nation's communities if it does not.   

Netflix: What is Driving It Out of the Mail?

Postalnews.com reported that Netflix stated in a filing with the Postal Regulatory Commission that a decision in GameFly’s favor could “result in reduced DVD shipment growth from Netflix as well as accelerate the ultimate decline of DVD shipments as Netflix would shift more resource to the digital delivery of content”.   In addition, Netflix is concerned about the Postal Regulatory Commission requiring the Postal Service to release confidential research conducted by Netflix that the Postal Service has that “certain changes in DVD design, manufacturing, packing and handling would enable GameFly to avoid DVD breakage from automated letter processing."

Netflix's assertion raises a couple of interesting question that are independent of whether GameFly's complaint has merit.  

• Does increased competition among entities providing a service using an old technology hasten the decline in the use of the old technology?  Currently only Blockbuster offers a competitive mail delivery movie service.   Netflix's other competitors are the remaining Blockbuster and other retail outlets, and kiosks operated by RedBox and Blockbuster.
  
  Competition from new technology is most likely to knock out the weakest competitors offering services using older technologies.   Blockbuster is likely to file for bankruptcy early this month which will allow it to jettison a significant number of its retail outlets.  The Los Angeles Times reports it plans to concentrate its business on its licensed arrangement for kiosks with NCR Corporation and developing an on-line operation. 
  
  
• Do lower costs for delivering and selling software for devices that can be used to stream movies affect the shift away from old technology?  All three of the major video game consoles (i.e. Nintendo Wii, Microsoft XBox 360, and Sony Playstation 3) have Wi-Fi capabilities that allow a viewer to stream Netflix's online content using the console.  Currently, there are over 60 million of these consoles in use.   If GameFly's service makes these consoles more attractive for potential buyers then it is possible that it creates a larger market for the consoles that are used for video streaming.   However given as a September 30, 2009, GameFly had 330,000 subscribers, it would appear unlikely that it has much impact on increasing the share of homes that have Wi-Fi capable game consoles.
  
  
• If the current Netflix Envelope permits Postal Service automation equipment to handle envelopes containing CD's and DVD's why did GameFly not reverse engineer or license the envelopes?  Unless Netflix holds a patent on the envelope  there would be nothing to prevent envelope manufacturers from reverse engineering the envelope Netflix uses and selling them to other firms that want to mail large quantities of CD's and DVD's by mail using the Postal Service's lowest cost processes. Similarly, GameFly could have paid for the reverse engineering themselves.   The proprietary study that GameFly wants would significantly cut the costs of this reverse engineering if it has not done this already.  
  
  Netflix holds a a patent on its envelope, patent #6,966,484.   The patent was issued in 2005 and and refrences versions of the envelope since 2001.  Netflix's patent has not prevented Blockbuster from having its own envelope as does GameFly.   However, it  is possible that the patented envelope design may allow the Postal Service to handle Netflix's discs more efficiently than the envelopes available to mailers who do not have access to the patent.  
  
  GameFly has two options in regards to the patent.  First, it could seek to license the patent.  However, Netflex may not want to relinquish any competitive advantages from its patent.  Second, it could reverse engineer the envelope with the goal of designing an envelope that that does not violate the Netflix patent  yet still can be handled on the Postal Service's automation equipment.   The proprietary study that GameFly wants would significantly cut the costs of this effort.  (Thanks to Brian Sheenan of postalnews.com for the patent information.)
  
  
• Why did the Postal Service not do the research on envelope design itself?  The Postal Service has always relied on private industry to design envelopes that meet its specifications.  Creative requirements of mailers often result in a cornucopia of designs designed to attract attention and increase the impact of mail.  In the case of Netflix, the Postal Service worked with Netflix's envelope designers to help design and test potential envelope designs that  Netflix developed that led to the envelope that was patented. movie by mail business.    
  
  An alternative approach may have developed if the Postal Service operated under a different business model and had more capital.  Under this model the Postal Service would have developed and patented the envelope itself and then licensed the design to all mailers that required an automation compatible self mailer with return envelope for CD's and DVD's.  This way the Postal Service could make money both on the patent and in the mail that uses the envelope. 
  
  
• Does the envelope issue raise questions about how the Postal Service manages its customer relationships and how the regulatory process influences these relationships?  The public fight between GameFly and the Postal Service appears to also be a fight between two of its customers.   The regulatory process forces the Postal Service to choose sides in a public battle between two of its customers rather than trying to find a way to privately maximize its return from both customers.  UPS does not have to figure out the impact on Walmart if it proposes a certain discount structure to Amazon. Why does it make sense for the the Postal Service to do this in public or for the Postal Regulatory Commission to have to make an evaluation of how rates charged to one corporate customer affect the business of a second corporate customer? 
  
  
• How is new competition from Apple, Amazon, Hulu and others affecting the pace that consumers are shifting from mailed to streamed video content?   Consumers now have the choice of a number of options for viewing video content streamed over the web including subscription, rental, and free services.    Both Apple and Amazon are offering streaming of offer streaming of individual TV shows and movies.  Both charge 99 cents for TV shows and 3.99 for movies.    Hulu also offers a large number of current television shows, a wide selection of older shows and many older movies free of charge with commercials  Hulu also offers the full season of shows on three broadcast networks for a $9.99 monthly fee.    CBS and Comedy Central currently have many of their current shows on line for free.  Many of the movies offered on-line by competitors for rent are not yet on Netflix's on demand service.
  
  Currently none of the services offering streaming content offer as easy an interface for selecting movies or as wide of  a selection of as the one Netflix has for viewing by mail.   Nor do they offer as wide a selection of movies for watching on line as Netflix.   In order for Netflix's on-line competitors to make a significant inroads into Netflix's business they will have to improve their interface, expand their selection, and reduce the risk that movies will be interrupted by network issues.  Given that these firms currently dominate sales of music mp3 files and sales of DVD's and CD's, they can be expected to make the neccessary changes to offer a competitive customer experience for selecting movies for streaming.
  

GameFly's complaint and the responses of Netflix and the Postal Service illustrate how the regulatory process perverts the process of negotiating rates between the Postal Service and its customers.  This complaint case and Netflix's response is similar to case filed before the Interstate Commerce Commission prior to trucking and rail deregulation where contracts had to be filed with the Commission and carriers were limited as to the number of contracts that they signed.   This prevented carriers from offering services that were price competitive and limited the growth of new and innovate ways to distribute goods in the United States.

I do not know whether GameFly's or Netflix's cases have merit.   I do know that both companies and the Postal Service would be better served if the companies were able to negotiate rates with the Postal Service without regulatory interference.  Shifting both companies to a negotiated contract model for rates would require the Postal Service to know nearly as much about GameFly's and Netflix's business and their distribution requirements as they know themselves.  The Postal Service would find it to be in its interest to try to find ways to use its assets to provide transportation and distribution services at a lower cost than these companies now do themselves.  

The potential benefits that exist for GameFly and Netflix are not unique.  All mailers would benefit from a Postal Service that had to know its customer's businesses as well as the customer in order to design its services and price its products.   However, the current regulatory process does not encourage this and instead creates the adversarial environment illustrated by the exigent rate case.   The future of the mailing industry, and the Postal Service itself requires this change.  The question is what would it take for Congress to recognize and act to make this change.

Why the Exigent Rate Case Should Not be Approved

I have tried to avoid commenting on the exigent rate case up till now.   I have long held that the Postal Service can no longer hold accounting break-even as the standard for financial self-sufficiency.  Over a year ago I wrote that financial self sufficiency requires an operating margin of 10 to 15 percent and until the Postal Service manages its business with that goal in mind it will be in a continuing state of crisis.

In addition, I have written that the decline in First Class mail, and in particular single-piece First Class mail will impose significant costs on the Postal Service for shrinking its workforce and network that should be borne by current users of this product today as otherwise the Postal Service will not have sufficient cash to cover those costs when they incur in the future.   Then these costs will be mostly born by advertising and parcel mailers in the future as there will not be enough single piece First Class mailers left to handle the brunt of these costs. However, the current costing approach does not recognize this need so the Postal Service is less likely to take steps that cost money to quickly reduce its workforce and network as demand declines.

So if I believe that the Postal Service needs to have a significant operating margin and higher prices on products to cover transition costs, why do I believe that the exigent rate increase should not be approved?

1. Approving the exigent rate case reduces the pressure on Congress to fix the retiree benefit over-payments for pensions and miscalculations of these obligations.   No solution to the Postal Service's problems exists without this fix.   This is true regardless of whether one believes that the Postal Service should be privatized or should continue operating using a business model similar to the one it now has.   The exigent rate case reduces the level of adjustments that Congress must make to prevent an annual liquidity crisis, let alone solve this problem.
   
   
2.  The timing of the exigent rate case weakens the Postal Service's political position as it attempts to streamline its network.   The Postal Service has always faced pressure from Congress that often derailed efforts to streamline its network and modernize its retail operations.    Without the exigent rate case the Congress is more clearly faced with the choice between allowing the Postal Service to streamline its operations and subsidizing postal operations.   Given budget politics, subsidizing postal operations is clearly off the table.
   
   
3. The exigent rate case weakens the Postal Service's argument before Congress that it needs greater commercial freedom and ability to offer "non-postal" products.   The long term health of the mailing industry requires the Postal Service to have significantly greater commercial freedom to expand the value of its products to customers and to identify additional means of earning a profit off of its physical, intellectual, and human capital assets.  A change in law to expand this ability puts the Postal Service in direct competition with a number of powerful interests that benefit from these restrictions.    These restrictions weaken the U.S. economy as they limit competition in both the delivery of parcels and more importantly in the production and the delivery of advertising used to identify new customers and expand private sector businesses.
   
   
4. The exigent rate case makes little sense for an enterprise whose customers require that what they pay for postage generates a positive return.  Increasingly postal revenue is driven by advertising and parcel delivery.    These are highly competitive markets where spending on services provided by the Postal Service require that its service provide a higher return than those offered by competitive delivery modes, as well as a higher return than not advertising at all.   Higher prices reduce the number of customers that find that mail generates the positive return on their advertising spending necessary to use the mail.
   
   
5. The exigent rate case comes at the wrong time relative to the Postal Service's labor negotiations.   The Postal Service is likely to demand some significant, necessary and unpopular changes in its labor contracts within the next two years.    These changes reflect the fact that the total demand for labor, the mix of full-time and part-time employees, and a number of other contract provisions no longer make sense when few postal customers use retail outlets and most mail does not require originating sortation.    It makes little sense for Postal management to raise rates prior to beginning the negotiations and more importantly arbitration where its ability to raise rates could be a significant factor in the arbitrator's decision.   Postal labor unions recognize this fact and have been among the strongest supporters of the exigent rate case.
   
   
6. The exigent rate case does not introduce realistic financial goals for the enterprise.   It makes little sense to raise rates without changing the primary financial goal of the organization from whether there is enough money at the end of the year to pay the bills.    Before the Postal Regulatory Commission even considers raising rates, it should develop a position as to what financial goals are needed to ensure self sufficiency.  This is also critical for Congress to understand why fixing the retiree expense issues cannot be avoided but also why it is the first step and not the last step necessary if the Postal Service is to have a long-term future.
   
   
7. The exigent rate case maintains the cost plus approach dating back to regulation under the Postal Reorganization Act.   Postal rates eventually have to reflect a better understanding of demand for its products and the costs of an efficient operator.   Costing approaches, rate relationships, and worksharing discounts all take the focus away from the value of the service to the customer in determining prices.   Worksharing increased volumes of mail, not just because the private sector could sort mail cheaper because many of the automation related discounts could be received by mailers that did not have to incur any costs to sort the mail they tendered to the Postal Service at all.   Instead, the discounts put the price of the delivery service below the value of the delivery for more customers allowing advertising agencies and printers to sell their services to customers that would not have considered the use of mail previously.  Worrying about the level of cost pass-through prevents the Postal Service from asking two even more important questions.  1) What is the value of mail to the sender and how do postal prices compare with the value that senders perceive that mail has?  2) How can the Postal Service provide its services at costs below the customer's understanding of the value of the service?
     
8. The exigent rate case illustrates that a piece-meal approach to fixing the Postal Service's business model and regulatory framework does not work.  The exigent rate case, just like all other proposals made by the Postal Service is being handled independently of all other changes that may be needed to restore financial self sufficiency to the Postal Service.   As such, it is never clear if rate increases do little more than reduce the pressure on taking other steps neccesary to make the Postal Service self sufficient.

In closing, rates for Postal Services eventually need to reflect market realities and the costs of an efficient operator both capable of and working toward managing operations to cost levels that market realities can support.  This requires a better understanding of the value of mail to customers, the elimination of unwarranted retiree expenses, the streamlining of management and contract resources, the speedy restructuring of the network to minimize delivery, processing and transportation costs while still meeting universal service requirements, and elimination of restrictions that prevent the most effective use of human capital, physical and intellectual property assets.  The exigent rate case conducted in a vacuum brings us no closer to producing rates based on market realities and may hinder fixing a number of the serious flaws in the business model and regulatory framework that must be changed.

Is This Blog the Postal Service's Source of Information on its Customers?

I am honored that this blog has sufficient credibility to allow the Postal Service to quote it to support the Postal Service's proposal to move Commercial Standard Mail Parcels to the Competitive Products list.  On page 10 of Appendix B of its filing, the Postal Service referenced the post, "Why the Postal Service Matters, FedEx needs it."

In that post, I noted that a significant share of Standard Mail Parcels were used to deliver parcel delivery services sold by FedEx and United Parcel Service.  My post was based on an analysis of public information gleaned from the Postal Service's and FedEx's website which showed that the total volume of Parcel Select was less than the volume FedEx shipped using its SmartPost service.  

My analysis was limited as I could only use public data.  I presume that the Postal Service has better information on the use of the Standard Mail Parcel product by FedEx and United Parcel Service and the proportion of the volume and revenue from this product that is generated by United Parcel Service and FedEx.   That information would be far more credible than anything that I could generate and post in this blog.   

More importantly, this information will be critical in trying to price the product once it is placed on the competitive products list.    The Postal Service needs to know not only the total volume tendered by FedEx and United Parcel Service for specific products but also the volume and revenue by facility where the parcels are dropped.  This will allow it to identify differences in the portions of the Postal Service's processing and delivery networks used by parcels tendered by FedEx and United Parcel Service as individual customers.  For example, United Parcel Service and FedEx may use the Postal Service for different mixes of parcels destined to urban, suburban, exurban, rural, and remote addresses which affect the cost of handling their parcels.  With this information the Postal Service could maximize its return for serving United Parcel Service and FedEx by matching prices (or discounts from published rates) based on the differences in how the two companies use the Postal Service's delivery services.  This is exactly how United Parcel Service and FedEx set rates within contracts with their largest customers and how the Postal Service should estimate its costs prior to negotiating contracts for competitive products.

Fixing the Retirement Liability Calculation

Congress has begun to move on the Postal Service's retiree obligation issues.   The House Committee on Oversight and Oversight and Government Reform will mark-up H.R. 5746, The United States Postal Service’s CSRS Obligation Modification Act of 2010 on Wednesday, July 21 at 1:30 p.m.

Given the limited number of legislative days involved, any action on retiree issues has to move at a pace far faster than what is common in Congress.  While passage in the house in an expedited fashion would appear possible, passage in the Senate in a timely fashion is less certain.   Senator Carper has indicated that he is preparing his own comprehensive reform bill which may go beyond the retiree benefit fix and would have to be reconciled with the House language.  In addition, objection by any one Senator can hold up passage.

To understand how fast this is moving, at least in terms of legislative speed  here are some relevant dates.

• January 20th, 2010 -- The USPS-IG report, The Postal Service’s Share of CSRS Pension Responsibility released.
• March 2, 2010 -- Request from the Postal Service made to Postal Regulatory Commission for actuarial report.
• June 30, 2010 -- Civil Service Retirement System Cost and Benefit Allocation Principles (Segal Report) is released by Postal Regulatory Commission
• July 16, 2010 -- Congressman Stephen Lynch on Friday introduced H.R. 5746, The United States Postal Service’s CSRS Obligation Modification Act of 2010.  The legislation follows the USPS-IG methodology.
• July 21, 2010 --  House Committee on Oversight and Oversight and Government Reform marks up H.R. 5746, The United States Postal Service’s CSRS Obligation Modification Act of 2010.  After mark-up, the agreed upon language is sent to the Committee on Rules to set the parameters of debate on the House floor.

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.

Postal Service to Announce Price Changes

The Postal Service will announce the price changes that will be included in its exigent rate case on Tuesday, July 6, 2010.    The Postal Service will then file the rate changes with the Postal Regulatory Commission shortly thereafter.    The Postal Regulatory Commission will have 90 days to review these rates.

The rules regarding written comments on the Postal Service's proposal in an exigent rate increases define the 3 issues that will like be the focus of the PRC's decision on the proposed rates.  They are:

1. The sufficiency of the justification for an exigent rate increase;
2. The adequacy of the justification for increases in the amounts requested by the Postal Service; and
3. Whether the specific rate adjustments requested are reasonable and equitable.

As this will be the first exigent rate case, it would not be surprising if any decision is taken to court regardless of whether the PRC approves the Postal Service's proposed rates as they are presented, modifies the proposed rates or rejects them.

Postal Policy: Now its Congress's Turn

Now that the Government Accountability Office report is out it is time for Congress to get down to the serious business of re-evaluating the current business model and regulatory framework.  Congress is starting this process with hearings in the House and Senate, this week and next. In preparing for these hearing, members on the relevant committees have a significant challenge preparing for the postal and other governmental witnesses.
Both hearings will focus on reports by the Postal Service, Government Accountability Office and the USPS Office of Inspector General.

• Federal Budget Treatment of the Postal Service by the USPS OIG
• The Postal Service’s Share of CSRS Pension Responsibility by the USPS OIG
• Final Management Advisory Report – Estimates of Postal Service Liability for Retiree Health Care Benefits by the USPS OIG
• Ensuring a Viable Postal Service for the Postal Service: An Action Plan for the Future by the U.S. Postal Service
• U.S. Postal Service: Strategies and Options to Facilitate Progress toward Financial Viability by the Government Accountability Office
• The U.S. Postal Service’s Financial Condition: Overview and Issues for Congress by the Congressional Research Service

In addition to representatives of the entities that produced these reports, members of Congress will hear from the Office of Personnel Management and the Postal Regulatory Commission who have an interest in many of the suggested changes in law that the reports discuss.

The three reports by the USPS Office of Inspector General cover technical actuarial and accounting issues over which there is a dispute between the Postal Service and the Office of Personnel Management as well as a critique of Congressional budgetary actions relating to the Postal Service. The CRS, GAO and the Postal Service have recognized the importance of the resolving the CSRS accounting and retiree health care funding issues in their reports. The critique of Congressional budgetary actions provides some context as to how Congress and the Office of Management and Budget has historically viewed their responsibility for the Postal Service and how the Postal Service’s cycles of strong and weak financial performance can be used as part of the solution of meeting budget goals.

The Postal Service’s report provides an action plan for operating its business within the current business enterprise business model. The modifications requested are changes from current financial, operating, employment, and marketing efforts that Postal Service management and the Board of Governors are sufficient to return the Postal Service to financial stability.The Postal Service’s report does not address the overarching mail industry policy, corporate governance and regulatory framework issues in any detail. Nor does the Postal Service report provide a vision for the Postal Service’s role in the US economy in 2020 that is much different than what now exists with the exception that its impact will be much smaller.

The GAO’s report, like the one produced by the Postal Service, provides strategies necessary to improve Postal Service operating, and to a lesser extent revenue management, and highlights Congressional action necessary to allow those improvements to occur. The GAO report goes beyond previous reports in its examination of the Postal Service’s cost structure and the legal impediments that prevent it from adjusting its costs to match current and projected revenue. The GAO report, like the Postal Service report does not address in detail the mail industry policy, corporate governance and regulatory framework issues that affect the Postal Service’s ability to implement operating, and marketing plans to best meet the needs of mailers and parcel shippers.Neither does the GAO report provide Congress with information that would help it understand the role that the mailing industry, and the Postal Service as the core of that industry could have in the US economy in 2020 and beyond.

The Congressional Research Service (CRS)report focuses on a “number of ideas for incremental reforms have been put forth that would improve the USPS’s financial condition in the short term so that it might continue as a self-funding government agency, all of which would require Congress to amend current postal law.” The ideas that the CRS reviews are those previously presented by the Postal Service and the USPS OIG and include many included in the GAO report as well. The CRS notes the objections of the Office of Personnel Management to the changes in retiree benefit obligation calculation or funding schedules. CRS’s description of the report’s focus nicely summarizes the overall tenor of all of the reports that Congress will review in upcoming hearings.

Before developing their approach to questioning the witnesses, members of Congress have to first understand what the reports that the witnesses are presenting to them are and what they are not. The reports that Congress has before it present:

• Incremental reforms that proponents suggest would improve the Postal Service’s financial condition in the short term; and
• Incremental reforms that retain the current model of the Postal Service as a self-funding government agency

What Congress does not have before it is a framework for understanding the broader policy context within which these incremental reforms fit. As CRS notes, the incremental reforms in the various reports do not answer the question: “Is the USPS, as currently constituted, incapable of responding to a shifting, and possibly declining, market for its products and services?” It is this question that raises the fundamental questions about postal industry policy, governance of the Postal Service, and the regulatory framework that makes sense for the postal industry. If the answer to this question is yes, then the incremental reforms make little sense unless they are steps in the direction required to create an entity capable of responding to a shifting and possibly declining market for its products and services.

The following set of questions represent examples of the types of questions that Congress needs to ask witnesses in order to develop the framework within which incremental reforms make sense.   While some of the government entities can answer these questions, many of them go beyond the scope of the studies that they have just completed or their role in developing postal industry policy.
It may be time for Congress to begin the process of framing these questions so that GAO, CRS, the USPS OIG, the USPS or entities in the executive branch responsible for economic development, communications and transportation policy answer them.  After they are answered, Congress will be able to move forward on the incremental steps that the various reports suggest with an understanding of the broader policy context within the individual steps fit.

General Postal Industry Policy

1. What should the overall objective of postal industry policy over the next decade and beyond and where does the Postal Service fit into that objective?
2. Is that objective different from the objective of either the Postal Reorganization Act or the Postal Accountability and Enhancement Act both written when digital competition was less pervasive?
3. Is a self funding government enterprise, the best way to employ the postal market to generate economic growth and jobs in the United States or do other models provide greater opportunities to grow the US economy?
4. What impact do restrictions on entry of private sector entry into mail delivery and the Postal Service into non-postal products have on economic growth and jobs in the United States?
5. What benefits are generated by these restrictions and how do the benefits compare to the impact on economic growth and jobs?
6. What impact do current postal pricing law and the Postal Regulatory Commission’s interpretation of that law have on U.S. economic growth and jobs?  How would different postal pricing law affect or regulatory policy affect economic growth and jobs?
7. How does Postal Rate Commission regulatory responsibility affect economic growth and jobs and how does that compare to the benefits of regulation?

Postal Governance

1. Is the USPS, as currently constituted, incapable of responding to a shifting, and possibly declining, market for its products and services?
2. Is the USPS as currently constituted handicapped in responding to a shifting and possibly declining, market for its product and services?
3. How does the current governance structure as a government sponsored enterprise affect the Postal Service’s ability to manage the types of changes that the GAO, the CRS and the Postal Service describe?
4. How does the governance structure affect the speed at which the Postal Service reacts to changes in the postal market?
5. Does the current Postal Service board have sufficient experience in managing similar enterprises?
6. What would be required to ensure that it does?
7. How does the choice of a governance model (i.e. private sector vs. government enterprise) affect the choice of regulatory policy for the industry?

Financial Objectives

1. What is the financial measure that determines whether the Postal Service’s action plan or for that matter any action plan succeeds?
2. Is that financial measure sufficient to ensure that the Postal Service is self sufficient?
3. What is the financial measure that determines that a government enterprise is self-funding and is that the same measure that would determine if it is self sustaining?
4. Does self sustaining require only accounting break even or does it require a positive operating margin and rate of return?

The Postal Market

1. What is the fundamental role in the US Postal Service in the US communications and goods distribution infrastructure today?
2. By 2020, what proportion of mail will contain advertising whether in the form of direct mail, inserts in bills and statements or periodicals? How much greater is that from today?
3. How will the increased importance in revenue from advertising change the fundamental role of the Postal Service?
4. What impact does digital delivery of transaction documents, advertising, and personal communications have on the value of the Postal Service monopoly?
5. How should that impact be measured?
6. How does the existence of digital alternatives affect the price competitiveness of mail?
7. In particular, which industries using mail to distribute periodicals, send documents and correspondence, handle business transactions or advertise of customers are most sensitive to competition from electronic alternatives?
8. How does the proposal to eliminate a day of delivery affect individual vertical mail markets (i.e. personal correspondence, weekly newspapers, real estate advertising, supermarket advertising, utility bills and payments, etc.)?

Employee Costs

1. How do Postal Service wages and benefits compare with those offered by private sector firms in the postal industry such as FedEx, United Parcel Service, and Pitney Bowes?
2. What was the difference in the retirement rate of early retirement offers using voluntary early retirement authority and the incentives granted last fall?
3. How many months prior to normally planned retirement date do those that retire with an incentive retire and how much does that save the Postal Service?
4. What is the difference in net present value cost of offering an early retirement incentive to an employee as compared to retaining an employee whose position is excessed and paying them a salary above what their new position normally calls for?
5. How does attrition rate affect the decision to reduce network capacity?

Network Optimization

1. (For the GAO) How long have you presented recommendations that the Postal Service take effort to reduce its operating network?
2. What are the impediments in the Postal Service’s governance structure, labor agreements, cash flow, or culture that has prevented it from acting on network realignment faster?
3. How do attrition rates affect the decision to restructure the network?
4. How would the restructuring differ if the proportion of part-time employees increased?
5. How would the speed of the processing network optimization change if retirement incentives were readily available to handle the reduction in the need for employees?
6. What would be the upfront cost of using retirement incentives as part of a network restructuring?
7. What should the overall objectives of a postal network / retail network realignment commission be set?
8. Should a postal network / retail network realignment commission have the authority to make recommendations in regards to policy, governance, or regulatory impediments to the development of an efficient and effective network of processing and retail facilities?

Retail Access

1. What should the metric be for determining retail access to the services the USPS offers?
2. What proportion of users of retail customers of households and what proportion of users are non-households?
3. How often do households on average use a retail postal outlet? Does it vary by age, geography, or rural area?
4. What is the difference in access to retail services today in urban, suburban and rural parts of the United States?
5. How does access to USPS retail services compare to access to retail services of UPS and FedEx in urban, suburban and rural parts of the United States?
6. How have UPS and FedEx managed with primarily a contract/self-service model and are there differences in their retail customers that could affect the use of that model by the Postal Service?
7. What is the experience in other countries with their satisfaction with postal retail services before and after a switch to self-service and contract models?

Pricing

1. Is the issue of money losing products more an issue of cost levels or price levels?
2. What impact would only solving the problem with raising price have on the volumes handled and the ability of the Postal Service to meet its policy objectives?
3. GAO in its list of highlights for revenue generates suggests that the Postal Service revise pricing for market-dominant products, such as First-class Mail and Standard mail?
4. What revisions does the GAO suggest the Postal Service make?
5. How does current regulatory precedent and pricing objectives affect the ability to make the changes that GAO would suggest?
6. How do pricing objectives in the law and PRC precedent affect the ability of the Postal Service to implement the pricing flexibility that GAO and others suggest?

What is the Context for 5-day Delivery?

One of the problems with the current regulatory and business model is that every action that is proposed to make the Postal Service financially viable is evaluated independently.   This allows those that object to one solution or another to oppose the solution under review and argue that something else should be done to restore the Postal Service's viability.

Right now the solution in the public eye is 5-day delivery.   The Postal Regulatory Commission has begun its review and Congress will soon follow with its own.  Each review appears to be completed independently of any other changes in the business model or regulatory framework that would be necessary to create a viable Postal Service.  

Furthermore, both the Postal Regulatory Commission and Congressional processes face the risk of becoming the equivalent of a city council budget hearing that has to determine how many hours fewer hours per week libraries or recreation centers will be open when budgets have to be cut.    When this occurs, patrons just have to learn to do with less service.  The proposal of Congressman Jason Chaffetz, R-Utah, to eliminate service on 12 days illustrates this "how much do we have to cut to balance the budget" mentality that legislative processes are designed to handle.

In his comments, Congressman Chaffetz provided a framework that makes sense.  "You have got to serve your customers, or somebody else will come in and do it for you."  This framework requires Congress to ask very different questions than they would as part of a budget process and it particular it forces them to look at the question of how many days the Postal Service delivers as part of a larger package of changes in the business model and regulatory framework.   


Right now Congressman Chaffetz and his colleagues in Congress should be starting hearings to ask these questions:

• Who are the Postal Service's customers today and who will they be in 2020 and beyond?
• What do customers need now and what will they need in 2020?
• How is the Postal Service's ability to meet customer needs affected by the current business model and regulatory framework?
• How do the Postal Service's business model and regulatory framework affect the competitiveness of its services with digital, mobile and other hard copy delivery alternatives?
• What is the macro-economic impact of the Postal Service's current business model and regulatory framework and how do they affect the economic recovery?

Once these questions are answered, Congress will be ready to discuss 5-day and all other possible actions with an understanding of the business implications of each proposed change and how they fit into a long-term Postal Service strategy of serving customers and U.S. postal policy centered on enhancing economic growth and employment.   Postal customers and employees cannot afford to have Congress do less.  

USPS: February Financial Results, Still Not Good Enough

In February, the Postal Service continued to show financial results that were significantly better than plan and slightly better than last year.   Its results reflect a more robust advertising environment that resulted in the first month of growth in Standard mail volume in revenue this year and a smaller decline in periodical revenue than volume that most likely indicated that periodicals in February had more advertising pages per issue than a year earlier.

The results for February continue to illustrate the risks going forward for the Postal Service.  The continuation of high single digit declines in First Class mail at a time that advertising is flat if not growing, suggests that the shift of transaction and correspondence mail to digital formats now occurs at a rate faster than what occurred before the recession. Excluding the holiday season, November and December, First Class mail volume has decline year-over-year at a 10.4% rate.   First Class revenue in the non-holiday months declined at a 7.8% rate   

While it is clear that the Postal Service's financial results are better than plan they are not sufficient to ensure its self sufficiency.  The following chart traces the monthly EBITDA ratio (earnings before interest, taxes, depreciation, and amortization divided by revenue) with and without the retiree health payment. The chart shows that removing the retiree health payment would result in the Postal Service earning a small operating profit every month this year.   The chart also shows that removing the retiree health payment is not sufficient to ensure postal self sufficiency as self sufficiency would require an annual EBITDA ratio of between 10% and 15%.  After five months the Postal Service's EBITDA ratio is 9.8% if you exclude the retiree health payments.  This ratio will decline between now and the end of the fiscal year as the Postal Service faces 6 to 8 more months of seasonally lower revenues and volumes that traditionally results in monthly financial returns that fall below the annual average. 

Financial self sufficiency requires the Postal Service to increase revenues by 5 to 6%, reduce costs by around 6% beyond what its current efforts produce, or some combination of the two in addition to the removal of the retiree health payments to become self sufficient.   More importantly, the Postal Service needs to find the fastest way to increase its EBITDA ratio in order to generate the cash necessary to cover the transition costs that creating a Postal Service that efficiency delivers universal service for mailers that mail only 150 billion pieces annually, most of which will be advertising.

Currently, the easiest option to make the changes necessary is for the Postal Service to raise rates.  The process to raise rates is known as is the time that would pass between the filing of the case and the implementation of higher rates. The Postal Service will file an exigent rate case asking for an increase of around 5% this summer, a rate increase that would be nearly sufficient to generate an EBITDA ratio excluding retiree health benefit payments to put the Postal Service close to a level of self sufficiency.  If the retiree payment issue is not resolved in the Postal Service's favor than double-digit rate increases would be required.   

If the retiree health care issue is not resolved by the time the Postal Regulatory Commission files its opinion on the exigent rate case, Postal Regulatory Commission precedent suggests that the PRC may have little choice but to recommend the double-digit rate increase necessary to cover the retiree health payments. The only caveat relates to the 5-day proposal, as the Postal Regulatory Commission could take into account savings from the 5-day delivery proposal in recommending rates.  However, I am not sure as to whether the 5-day delivery proceeding could be resolved before an exigent rate case is completed.

All other options require Congressional approval (e.g. 5-day delivery, and modifying the retiree health payments), freedom from Congressional interference (e.g. network optimization) and/or negotiations with unions (e.g. changes in work rules including increasing the proportion of part time employees, a process to manage employee dislocation during optimization including localized early retirement incentives and severance pay for layoffs when needed ).  In addition all of the significant cost savings options take more time from proposal to implementation than increasing rates and some will have transition costs to deal with employee dislocation.

The Postal Service will start the clock running on 5-day delivery within the next week.   It should see if it can start the clock on the other initiatives and negotiations sooner than now planned.  Otherwise, it will have no choice but raise rates repeatedly at a time that its customers increasingly find digital alternatives to be more convenient and cost effective.    

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

USPS: Known Knowns, Known Unknowns Unknown Unknowns

There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know. 

Donald Rumsfeld

After nearly a year of study, the Postal Service has presented its proposal for modifying its business model and regulatory framework.   The Postal Service's proposal reflects the gravity of the business challenges it faces now and will face in the remainder of the decade. The tone of the Postal Service's presentation also reflected the gravity of the challenge as it lacked both the sentimental imagery and boosterism that had the Postal Service and others previously used to justify minimizing changes from the status quo.

Anyone who has read the comments on the proposal written by editorial writers, or spoken by members of Congress, representatives of the labor unions and management associations and representatives of mailer trade associations will immediately see that there is no consensus yet on how to proceed on the Postal Service's proposal.

This creates a significant challenge if a solution is to be found for the Postal Service's current difficulties.   Donald Rumsfeld's silly sounding framework of known knowns, known unknowns and unknown unknowns may provide a way to develop a common knowledge base and language for parties to discuss possible solutions that will actually ensure the viability of the postal industry and create as secure a future as possible for current and future Postal Service employees.

Known Knowns

1. Total Postal Service mail volumes in 2020 will not be greater than volumes handled today.
2. The mix of mail handled in 2020 will include a higher proportion of advertising mail than is handled today.
3. The mix of mail handled in 2020 will include a lower proportion of single piece mail than is handled today. 
4. The revenue associated with projected volumes cannot support the Postal Service's payments on legislated long-term obligations and debt or the current operating model. 
5. Expanding revenue through diversification is not an option now for covering the revenue shortfall of  declining volumes.  
6. Privatization is off the table for now.  
7.  The Federal budget deficit and tight state and local budgets remove taxpayer subsidies as a solution.     
8. The Postal Service's proposal to change its business model and regulatory framework has diffuse benefits and specific costs.

Known Unknowns

1. The amount that actual volume and revenue will differ from the forecast.
2. The amount that economic activity and inflation will differ from statistics used in revenue and cost forecasts and how much they will differ from tend on a year-to-year and quarter-to-quarter basis from the long-run average.
3. The difference in the rate of penetration of high-speed digital and mobile technology from the current forecast.
4. When new communication technology just entering or not yet on the market will find wide acceptance as an alternative to existing print, digital, and mobile alternatives.
5. The time it will take for the Postal Regulatory Commission to review the 5-day delivery proposal.
6. How the Postal Regulatory Commission will rule on an exigent rate case that does not produce break-even results in a test year or changes precedent regarding rate relationships and relative mark-ups on classes and sub classes.
7. The outcome of negotiations between the Postal Service and its labor unions.
8. The time frame for any action required by Congress and whether there is time in this Congress to move legislation forward.

Unknown Unknowns

As these are unknown, none are listed.  


The lists of known knowns and known and unknowns are not exhaustive.   Comments are requested on others that should be added.    A latter post will detail some of the implications of these known knowns and known unknowns.