Rate Increase Coming in 2011

In a letter to the Postal Regulatory Commission, the Postal Service asked for clarification regarding the total increase in rates under the cap.   The Postal Service stated that it wanted the clarification so that it could better to do its financial planning for Fiscal Year 2011.  However, mailers should clearly understand that rates will be rising in calendar year 2011.

Rate increases will be relatively modest.   Rate increases will be rising on average around 2% and most likely slightly below that figure.  

The price of  a single piece stamp will likely increase by a penny to 45 cents. (2.3%)   Bulk First Class mail will rise slightly less to ensure that rates for the entire class rise less than the cap.

The largest rate increases will likely be felt by Standard Mail parcels and non-machinable flats.   The Postal Service will likely raise these rates by between double and quadruple the cap for Standard Mail as a whole. The large rate increase on this product will occur due to the confluence of two factors that generally influence pricing decisions at any firm offering a product in commercial markets.  First, it is in the Postal Service's interest to ensure that all parcel products earn a positive return, and eventually a return equal to the firm wide average.   As single piece First Class mail volume declines, the Postal Service can no longer to price products that do not have a legislatively mandated discounted rate at a loss. 

Second, both UPS and FedEx are making significant changes in their rate structure that would allow the Postal Service to raise rates in small parcels significantly without affecting its market position.   The two private sector carriers are raising the minimum shipment charges on express shipments and expected to raise the minimums on ground parcels that large shippers pay for low weight shipments going to destinations in zones 2 through 4 or 5.  For smaller shippers what matters is not only the rate increases that the private carriers set for the base rate but also changes in accessorial charges for remote and home delivery, as well as changes in the method of calculating package density that can push a light-weight parcel into a heavier weight cell.   All of these changes combined means that shippers spending less than $100,000 annually on parcel and express shipments may see rate increases from in light weight parcels in the high single digit range from the private sector carriers early in 2011.   

The previous two times that that the Postal Service raised rates under the cap, the increase went into affect late in 2nd calendar quarter.   Clearly the Postal Service would like to raise rates earlier.   Whether the Postal Service could propose a rate increase under the cap that would go into affect earlier in 2011, and closer to the timing of the rate increases of United Parcel Service and FedEx requires greater knowledge of the law than I have. 

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.    

USPS' December - Better But Still on the Precipice

USPS finances marked steady improvement on a month-by-month basis in its first fiscal quarter.  These improvements allowed it to earn a small operating profit in the December and a smaller than forecast loss for the quarter.   The improvements while promising do not suggest that within the foreseeable future the Postal Service can earn a sufficient operating profit to sustain the enterprise even if its retiree obligations are removed.


What does the data tell us?

Revenue and Volume

In general, the trends in revenue and volume suggest that the Postal Service's business is now recovering at about the same pace as other advertising and parcel delivery modes.  The economic recovery is tempered by increasing preference of consumers for documents in digital form. 

First Class Mail: The declines in volume in First Class mail in November and December represent a return to the trend in 2007 and 2008.    Single piece First Class most likely declined at high single digit rates (6-9% decline Y-to-Y).  Bulk first Class volumes likely saw volumes decline at a rate similar to what was seen for Standard mail (1-2% decline Y-to-Y).  First Class bulk volumes may have benefited from financial mailers ending advertising budget cuts and some tentative increases by some mailers.

Periodicals: Periodical mail is a troubled product.   There is not indication that recovery in the general economy or advertising markets are having an immediate impact on periodical volumes.   This market faces new competition beginning in 2010 from the iPad and other tablet computers that should shift even more content to digital delivery.    The Postal Service faces the real possibility that by 2020, periodical volumes will be much less than half of the volume now handled.

Standard Mail: Standard mail may have bottomed out in Postal Service's first quarter.   The declines reflect the cautious spending by retailers on advertising.  Going forward, the Postal Service should experience slightly better than normal seasonal patterns as economic tailwinds should loosen advertising budgets.   The Postal Service would benefit if it could develop programs targeted for geographic markets with the most limited real estate inventory. 

Package Services and Shipping Services: These two segments represent the regulated and unregulated parcel products that the Postal Service offers.   Combined, the 1st quarter trends are not promising as the declines in the regulated package services more than offset significant growth in unregulated shipping services.   However, because two-thirds of the regulated products volume in 2009 was from bulk printed matter the Postal Service's success in attracting parcel shippers will not be clear until the 1st quarter RPW figures come out.

Comparing the revenue and volume trends to those of UPS and FedEx is difficult because 1) a portion of the USPS volumes are counted as volume by the Postal Service and either FedEx or UPS; and 2) the Postal Service's revenue for single piece parcels is set under a price cap while competitive services offered in the private sector saw their prices rise.  The trends experienced by the Postal Service's shipping services alone at least equaled the experience of UPS and FedEx.   It will be worth keeping an eye on the monthly statistics in the next few quarters to see if the Postal Service's marketing and operating changes have resulted in market share growth.

Summary: Revenue and volume trends suggest that FY 2010 revenue and volume will be significantly better than the projection made in September and included in its budget.   This means that instead of having percentage declines in revenue in the mid to high single digits in 2010, the Postal Service could see a revenue decline of between zero and four percent, with the decline determined whether the recovery in advertising spending can sufficiently counter digital diversion of printed documents.

   

Year-To-Year Change in Volume
	October 2009	November 2009	December 2009
First Class	-11.5%	-3.3%	-3.9%
Periodicals	-14.5%	-6.3%	-11.5%
Standard Mail	-22.2%	-4.6%	-1.2%
Package Services	-9.9%	-16.2%	-23.8%
Shipping Services	-5.0%	3.1%	8.6%

Year-To-Year Change in Revenue
	October 2009	November 2009	December 2009
First Class	-9.1%	1.3%	-1.8%
Periodicals	-15.5%	-10.5%	-12.2%
Standard Mail	-19.0%	-14.0%	-1.4%
Package Services	-15.6%	-10.9%	-23.9%
Shipping Services	-1.7%	6.7%	12.0%

Costs and Operating Margins

Costs throughout the first quarter were generally on plan and 3.9% below last year.   Excluding the retiree health obligation expenses are 5.8% below comparable figures for FY 2009.  This is an admirable reduction in costs but not sufficient for the Postal Service to be financially self sufficient.

A self sufficient Postal Service would have an annual EBIDA margin of between 12.5% and 17.5%.   [The EBIDA margin equals (revenue minus operating expenses excluding interest, depreciation and amortization) divided by revenue.]  As the Postal Service cannot adjust its labor or other expenses much on a quarterly basis, it must earn EBIDA margin much greater than the annual figure in the first quarter in order to meet an annual target.

In the first quarter of FY 2010 the Postal Service had an EBIDA margin of 3.5%.  This improves to 13.6% if the retiree health benefit obligation is removed.  Comparable margins for the first quarter of 2009 were 3.0% and 12.2%.   While margins are better this year, the Postal Service does not even reach the low end of the target range in the first quarter until the retiree health obligations are removed.   For it to come close to the target range for the year it will have to break traditional financial patterns and find a way to adjust costs as volume and revenue changes on a seasonal basis.

 

Looking toward the future


The three months worth of data reviewed raise certain issues that those trying to envision postal policy for 2015 and beyond should think about:

• The current Postal Service's revenue and net income plan are clearly no longer relevant.   The economic recovery is stronger than the Postal Service forecast in September and volumes of economically sensitive First Class bulk, Standard, and Shipping Services products are above plan and will likely remain better than plan all year as the economy continues to recover.  This is consistent with what both customers of the Postal Service and its competitors are saying about their businesses.
• The Postal Service by the middle of this decade will handle significantly less single-piece First Class and Periodical mail than today.  Volumes and revenue from these products will continue to decline regardless of economic growth.
• The growth of all other products will depend upon the tug-of-war between economic growth and digital diversion.
• The Postal Service cannot become self sustaining without relief from the retiree health payments.
• The Postal Service needs to incorporate real financial goals other than break-even in order to ensure that it remains a viable enterprise, otherwise stakeholders will not understand the severity of the financial challenge ahead.  
• Announcements of new operating strategies should indicate how they will allow the Postal Service to meet relevant financial goals.
• Decline in single piece mail will require continuing contraction of the network of facilities sorting originating mail at a rate faster than normal employee attrition and existing work rules can accommodate.   The pace of this consolidation will likely depend upon the ability of the Postal Service to locate facilities in logistically optimal locations and fund the capital, employee redundancy and other transition costs associated with consolidations.
• The trends in flats volumes across all products may require a new processing strategy with fewer sortation facilities than the network processing letters. Given the time it takes to plan, allow public input, and implement new operating strategies, a new coherent strategy for flats should be introduced soon.
• Meeting required operating margins will require putting all revenue and cost cutting options on the table.   Obstacles in the law and regulatory policy to rational pricing and management decision making need to be clearly identified and their impact quantified.  Obstacles in the law and regulatory policy that delay rational pricing and management decision making need to also be clearly identified and their impact quantified.
• Postal Service labor contracts will need to reflect the new business reality of real financial targets, lower volumes and a smaller operating footprint.  In order to maximize the number of full time jobs in the new environment, new job classifications are needed that include characteristics of the work now performed by clerks or mailhandlers and letter or rural carriers.