Privatizing the Post

In the United States, the policy debate is over how the Postal Service will survive past the end of the fiscal year.   In Great Britain and Canada the debate is now respectfully when and if the Post should be privatized.

Royal Mail clearly is on a path toward privatization.

In July, Sky News reported the government hired advisers on a potential Royal Mail sale.

More recently, Royal Mail hired Moya Green, former CEO of Canada Post who the Times (London) steered the "organization to a trebling of its net profit to C$281 million (£183 million), despite a 5.1 per cent drop in revenue."  Ms. Greene also served as "Assistant Deputy Minister of Policy in the Department of Transportation, Canada from 1991 to 1996 and was responsible for broad reform of the over-burdened transportation system; the privatization of CN; the deregulation of the Canadian airline industry; and the commercialization of the Canadian port system." (Biography from Business Week) With this hire, Royal Mail has hired both an executive who has experience cutting costs in a postal enterprise in a period of declining revenue as well as one who understands the privatization process from the government's (owner's) side of the sale.

Hellmail has reported that Richard Hooper, who is engaged in his second evaluation of the future of Royal Mail, "argues that the recent hiring of former Canada Post CEO Moya Greene and the swap from Allan Leighton to Donald Brydon as Chairman will have increased the value of Royal Mail."


The departure of Moya Greene has raised the privatization issue in regards to Canada Post as it is clear that the key difference between her position at Canada Post and the one at Royal Mail is the challenge of taking a government enterprise through the privatization process.   The issue of privatization of Canada Post was first raised by the Organization for Economic Co-operation and Development (OECD) last spring and received a tepid response from the Harper government at the time.    The departure of Moya Green has generated a number of articles and letters to the editor on the subject which include those by Michael Warren, former CEO Canada Post, Denis Lemelin, National President, Canadian Union of Postal Workers (CUPW), and Kevin Gaudet, federal director of the Canadian Taxpayers Federation.

The expected privatization of Royal Mail and the discussion of privatization of Canada Post illustrate that the decision to privatize is a decision of the government and not the postal operator.   While the operator may have the data necessary required to determine whether privatization is possible, and its management may have opinions on the advisability of privatization for the long term viability of the enterprise, the decision is that of the owner of the enterprise, the government involved.

Any examination of privatization of the United States Postal Service would have to be approved by Congress and most likely have the support of the Administration with the lead most likely taken by the Department of Treasury with the support of Departments of Transportation and Commerce and the Federal Trade Commission and the Federal Communications Communication.  Even if privatization is not on the table, it may be time for Congress to begin demanding that administration recognize its position as owner of the Postal Service and designate a point person for examining potential business models and a regulatory framework that would ensure the Postal Service's survival as a self sufficient enterprise in 2020 and beyond.

Could a retail slowdown help mail advertising?

Today a number of stories illustrated the weakness in the consumer economy.

The Associated Press reported that consumer spending in July, the traditional beginning of the back to school season continued to decline in items other that food, gasoline, and automobiles.   is resulting in a below expectations back-to-school season "Sales were down 1 percent at department stores and also dropped at specialty clothing stores, furniture stores, hardware stores and appliance stores."

Bloomberg reported Both J.C Penney's and Kohl's, department stores that cater to a broad cross-section of American consumers both reduced guidance in the third quarter. (July-though September) "J.C. Penney is counting on consumers doing their back-to-school shopping later this year as they shop closer to the start of the school year."   The lowered earnings guidance and reliance on later season sales suggests that a higher share of back-to-school across all retailers will be sold at a discount and greater promotional activity (i.e. advertising across all modes including mail) will be required to induce consumer spending.

Another indication that retailers may have anticipated stronger retail sales than are now developing is the continuing growth in both domestic and international intermodal rail volumes.  A recent W.H Blair analysis reports the following:

Absolute [rail] intermodal volumes at 2008 levels, +20% yoy for week 31 (+0% vs. 2008). 2Q's seasonal momentum has continued into 3Q. Intermodal volumes to end [of] July / begin[ing of] August were 2% above mid-June volumes, modestly better than traditional seasonal 1% improvement; improvement was realized within both international and domestic lanes. We expect both domestic and international growth to continue given ongoing domestic truckload conversion, rebounding ocean freight import volumes and modest economic growth. 

So what does this mean for the Postal Service and firms trying to sell mail as an advertising media?

Now is the time to start contacting retailers before they realize how serious their need is likely to be. this is particularly true for smaller retailers that have the least sophisticated sales tracking systems that most major chains now have.  Now is the time to develop ideas for using the mail to boost sales earlier in the season to reduce the risk that items in the supply chain from overseas suppliers will need to be sold at a large end-of-season discount and begin presenting these ideas to potential customers.     Finally, now is the time to start talking to retailers about the need to plan print purchases in order to ensure that the print capacity they need is available when they will need it.  

Would fixing the retiree health issue "solve" the liquidity problem?

A number of comments on my piece highlighting the problem of Postal Service liquidity suggested that fixing the retiree health issue would solve the liquidity problem.   This is easily evaluated by asking the following question. 

If one assumes that the Postal Service no longer had retiree health care payments, would its liquidity improve sufficiently to move it away from a range commonly found among firms that face bankruptcy in the private sector?

The following table answers this question.   It updates the liquidity measure contained in the previous post by eliminating retiree health care expenses as a current liability.

Removing the retiree health care expense improves the current ratio from 0.13 to 0.17.   It still is far below the ratios of firms that either went through bankruptcy proceedings or had the equivalent of a bankruptcy proceeding.

The current ratio is not the only way to measure liquidity.    Another way is to look at cash the Postal Service has already received for services not yet rendered and its available cash.   Given that the Postal Service is operating at a loss with retiree health expenses and break even without this expense, one can assume that the cost of providing the service in the future will equal or exceed the revenue already collected.   Here are the figures:

• $4.909 billion -- Revenue collected for services to be rendered   
  
• $1.014 billion -- Cash on hand
  
• $3.894 billion -- Cash shortfall to be born by future Postal Service customers

The decline in mail volume, and in particular high-margin First Class mail, exacerbates the problem of not having sufficient cash to provide the services already paid for.   As time passes, the Postal Service will need either even greater cost cuts or rate increases to build up its cash reserves to the point that it has the cash to cover the costs of services that it has already promised to deliver.

The liquidity problem should be a concern to all stakeholders.    The future of viable self-sufficient means of delivering the 150 billion pieces of hard copy communications and parcels expected to be sent in 2020 depend on solving this problem.  

Is the Postal Service facing "bankruptcy?"

In a recent article D. Volt highlights Postal Service Chief Financial Officer's near term and long term liquidity problems.   Mr. Volt's analysis is correct that the Postal Service's inability to cover its near and long term cash obligations is a serious problem. He is incorrect in his analysis that the Postal Service's liquidity situation does not put it at risk of being "bankrupt."

In order to understand why " may be appropriate for describing the Postal Service's current financial situation, one need only compare the liquidity of two other firms that have gone through major restructuring processes recently These are General Motors and YRC Corporation, a large unionized less-than-truckload trucking firm.    The following table compares the Postal Service's liquidity problem to that of General Motors and YRC Corporation at points prior to restructuring efforts that wiped out all or nearly all of the value of the equity held by shareholders prior to the restructuring.

If the Postal Service was a private sector firm, its current liquidity position would force its financial and legal officers to investigate bankruptcy as a means of restructuring its obligations to ensure it could cover them with projected cash flows.   The bankruptcy proceeding would allow it to restructure its loans, leases, unpaid bills, and contracts with suppliers of real estate, materials, services, and labor subject to the approval of a bankruptcy judge.  Bankruptcy could result in an orderly restructuring of these items if all creditors agree to the modification prior to filing.   Otherwise, bankruptcy could result in litigation among secured creditors over whether liquidation, sale, or restructuring of the enterprise is the best way for them to recover what is owed to them.   The structured bankruptcy of General Motors, supported by finances from the U.S. and Canadian governments allowed the company to restructure its operations under fairly strict guidelines set by the government as the provider of financing while General Motors adjusts its assets, operations, labor contracts and internal processes to fit what would allow it to be a profitable enterprise going forward. As part of the restructuring GM shareholders were wiped out and the restructured enterprise was owned by the major creditors prior to the bankruptcy filing.  Following over a year of restructuring, GM has emerged as a viable enterprise which will attract significant interest in the public offering of stock in the next few months.  

Bankruptcy is not the only option.    The threat of bankruptcy alone may be sufficient reduce the financial burdens of a financially troubled firm, especially if bankruptcy might mean liquidation of the enterprise in cases where the liquidation value is minimal.   In such cases the threat of bankruptcy  causes the creditors and holders of material, service and labor contracts to renegotiate terms of their agreements rather than face the prospects of restructuring within a bankruptcy proceeding.  This is what happened in the case of YRC Worldwide.  YRC Worldwide has been in serious financial difficulties dating to at least the fall of 2008.  In order to survive YRC converted a significant portion of its debt to equity and restructured its union agreements.  Creditors agreed to swap their loans for common stock and the Teamsters employees agreed to contract changes that included a freeze in pensions due to the company's stopping its contributions to its pension plans and multiple cuts in wages.  All of these are actions could occur in bankruptcy but the parties involved concluded that restructuring the enterprise outside of bankruptcy gave them a better prospect than what would have occurred if YRC Worldwide had filed for bankruptcy. 

It should be noted that shareholders of YRCW fared not much differently than they would have under bankruptcy.   YRCW shares that were worth $40.16 at the end of March in 2007 are worth only $0.34 today.  That is not much different than the results in a bankruptcy where existing shareholders could have the total value of their investment wiped out to pay creditors. 

Mr. Volt correctly notes that the Postal Service cannot file for bankruptcy.   In addition, the Postal Service cannot not just stop service and liquidate its assets in order to pay its obligations.   Therefore, it has less leverage over creditors and holders of contracts to renegotiate their agreements in order to ensure payment of at least a portion of what they are due.  The Postal Service also less leverage over unionized employees who face neither the prospect of major job losses that would occur in liquidation, nor new less favorable contracts, if there were contracts at all which would happen if the Postal Service went into bankruptcy.

So what options does the Postal Service have?

1. Raise rates - This is what it has chosen to do with the exigent rate increase.   Raising rates provides some short-term increase in cash.  However, it is not clear whether increases, as proposed in the exigent rate increase, are justified under current market conditions especially in regards to those products that are most sensitive to the economic cycle.   For private firms in the Postal Service's position, raising rates is not an option for most products that they offer as prices are set in competitive markets and the firm facing financial difficulties is a price taker not a price setter.
   
   
2. Reduce service - The Postal Service has proposed two options for reducing service, closing post offices and eliminating Saturday delivery.   It appears that legal restrictions make it nearly impossible for it to close the tens of thousands of money losing retail facilities or eliminate a day of delivery.   
   
   However, it still can reduce service in ways that limit regulatory or legislative blow back.   It can reduce the hours that existing post offices are open.    For example, there is no requirement that retail facilities be open a particular number of hours per day.    So it could reduce the losses from money losing offices by restricting opening hours to the bare minimum.  If it were possible, it could try to reduce its opening hours to one or two days per week rotating clerks among multiple retail facilities, the way some optometrists rotate between multiple offices.  (Check the hours that a Sears or J.C. Penney's optical department has an optometrist available for illustration.)
   
   It could also reduce the reliability and speed of service for its customers.    Reducing reliability  could cause it to violate its "modern service standards" but it is unclear how the Postal Regulatory Commission could compel the Postal Service to improve service quality.    While this reduction in service quality would generate complaints, regulatory proceedings and possibly even Congressional hearings, it represents a cost cutting strategy that has been used by firms like Conrail, Greyhound, and Trailways during periods when they no longer had the financial resources to meet service obligations under required under their common carrier obligation to customers.   This is the equivalent of the Postal Service no longer having the financial resources to meet service related characteristics of its universal service obligation.  The deterioration in service was a prime mover behind deregulation and the eventual restructuring of the rail and bus industry in the United States.   
   
   
3. Renegotiate its obligations -   The Postal has begun the process of renegotiating its obligations that are coming due in the next few months through a request for a waiver of its $4 billion payment to cover disputed retiree health care obligations.  While this will allow it to put-off its liquidity crisis another year it would not eliminate the risk that mailers would have that the Postal Service would be forced to look at price increases and service changes degrading quality described above in a subsequent year.

In conclusion, Congress and the Obama administration need to begin looking at the challenge of fixing the business model of the Postal Service through the equivalent of a bankruptcy restructuring.    Only through this lens can the Postal Service make the necessary changes needed to ensure a revenue stream and cost structure that would allow it to thrive as a financially self-sufficient enterprise.   Without a restructuring equivalent to bankruptcy, Congress could find itself dealing with a "postal financial crisis" as frequently as it has to pass a Federal budget.  

Drudge Report picks up the Postal Service Story

Consolidating Delivery Units

The Postal Service has announced that it is considering consolidating delivery operations into fewer locations in the Syracuse area.  The consolidation of delivery operations has received little attention in discussion of streamlining the Postal Service network but may be as important to mailers that drop-ship and the competitiveness of the Postal Service's parcel services.  

Consolidating delivery operations increases the number of delivery points served by a single delivery office.   This reduces the cost of companies drop-shipping mail by reducing the number of stops that they would have to make to serve the delivery points prior to consolidation.   By reducing the number of stops, the consolidation increases the likelihood that dropping to a particular delivery unit would be economically viable for the mailer / parcel consolidator.  Consolidation could make products that are drop shipped to carrier stations even more attractive in periodical, advertising mail, and parcel markets as they reduce the mailer's transportation costs and increase the probability that their mail/parcels will qualify for the lowest drop-shipment rates.

The advantages to the Postal Service of consolidating carrier stations is less clear.   While the Postal Service will save some transportation costs in moving mail from processing centers to delivery units, it will occur additional transportation and labor costs associated with longer drives from carrier stations to carrier routes.   It is possible that there would be some savings associated with in-office labor, supervision, management costs, and facility costs especially if the Postal Service can move the retail operations to a smaller location dedicated to retail services.

Consolidating delivery operations may be under consideration in Syracuse because one or more of the facilities involved is large enough to accommodate more carriers.  Consolidating delivery in other locations might be possible depending on the availability of space. 

Investing in a new network of delivery units should be investigated in locations beyond Syracuse even if the cost savings are minimal because of the potential that consolidation offers for making Postal Service drop shipped products more attractive to mailers. 

Why are the finances worse than expected?

With its announcement of the third quarter results, the Postal Service a net loss of $3.5 billion, compared with a net loss of $2.4 billion for the same quarter last year.  The loss raises four questions.

1. Why are finances worse than last year?
2. Were the poor results unexpected?
3. Could the Postal Service have taken actions to mitigate the financial losses?
4. Will there be consequences for the Board of Governors and senior management?

Why are finances worse than last year? 

Finances are worse for three reasons.  

First, workers compensation liability adjustments required an accounting adjustment of $789.  This has an impact on both the income statement and balance sheet but should have no impact on the Postal Service's cash flow. 

Second, mail volume is declining and the mix is becoming unfavorable.  Mail volume in the quarter was down 1.7% even though Standard mail volume rose by 4.2%.   As such the average revenue per piece of mail (the yield) is more than likely declining more rapidly than volume is.  Evidence to date suggests that the shift toward advertising focused products, which includes periodicals, is occurring at an accelerating rate.   For example, single piece First Class mail is declining at a faster rate than prior to the recession and at a faster rate than the forecast contained in the exigent rate case.

Third, the need for labor and capital resources is declining faster than the decline in mail volume and faster than the decline in available resources through attrition.   The shift toward advertising mail, and other products that are usually entered sorted and near the delivery address, is the primary reason why the demand for labor and other resources are declining. 

Were the poor results unexpected?

The ability of the Postal Service to anticipate the problems in the third quarter depend on whether their planning included scenarios that anticipated the adverse trends that occurred and whether they had in place a system that generates warning flags months prior to end of the quarter that would indicate that financial results were falling below financial goals.   Given that the Postal Service only took actions recently to freeze hiring, it is not clear how early Postal Senior management knew that financial results would be falling behind.  

If the forecasts contained in the exigent rate case are the forecasts that the Postal Service used for planning, then information that indicated that financial results might deteriorate should have been available by the end of the second quarter.  At that time First Class volumes were declining more rapidly than forecast and both senior management and the Board of Governors should have been aware of that trend at that time.

Could the Postal Service have taken actions to mitigate the financial losses?

Clearly the Postal Service could have instituted the hiring freeze a quarter earlier.   It is not clear from information that is publicly available which additional actions should have been taken in the past few months that would have reduced the impact of the adverse trends and workers compensation adjustment.   To the extent that the Board of Governors and management expected that Congressional or regulatory action would mitigate problems in time to reduce losses, then that expectation was mistaken.

Will there be consequences for the Board of Governors and senior management?

Consequences for either the Board of Governors or senior management appear unlikely.  As the Postal Service does not have shareholders, the Board of Governors faces no risk from the poor financial results.  The Postal Service's board does not face the prospect of a disgruntled investor proposing a proxy fight to replace the board.  The Board of Governors all serve fixed terms and the worst that could happen is that they will not be reappointed.   Postal senior management serves at the pleasure of the Board.    However, given that the Board has fully supported the strategic and policy directions suggested by management, there is no indication that the Board has lost confidence in current postal management and would seek their replacement.