Funding retiree healthcare in the Private Sector

At the joint Senate-House hearing, the issue of funding the Postal Service's retiree health care obligation was raised by every witness.   There is near unanimity among all non-governmental stakeholders on this issue which can be summarized in four bullet points.

1. The Postal Service cannot be a viable enterprise, maintain current service levels, pay wages at or near current levels, and price products at levels that allow mail to be a competive mode for delivering advertising, other firms of business and personal communications and parcels as long as the retiree health obligations hang over its head.  
2. The Postal Service's obligation has been overstated by the Office of Personnel Management.
3. The Postal Service has overpayment of its obligation for civil service pensions exceeds its obligation for retiree health benefits.  Fixing this problem would eliminate most if not all of the Postal Service's annual obligation for retiree health benefits.
4. The only obstacle to fixing the problem is budget scoring and pay-go rules.

Delegate Norton asked the panel of postal customers, how they handle funding retiree health and pension benefits in the private sector and did not receive any clear answer to her question.   This is not because the panel did not want to answer the question but because most firms on the panel did not offer retiree health benefits or pensions.  

Today, Bloomberg reported that Ford would cover its quarterly obligation for its retiree health benefits by issuing $610 million  in shares of Ford stock and handing it over to the United Auto Workers Retiree Medical Benefits Trust.  Ford has not always used to stock as in December it made its $610 million payment in cash.  Ford has the obligation to make funds to the Trust until 2022 and prior to making payments it had an obligation of $13.2 billion most of which s funded with Ford debt that the trust holds.

The description of Ford's debt obligations to the United Auto Workers Retiree Medical Benefits Trust from its first quarter 2010 10Q is as follows:

At March 31, 2010 we had outstanding $7.1 billion in amortizing notes due to the UAW VEBA Trust made up of a non-interest bearing Amortizing Guaranteed Secured Note maturing June 30, 2022 with a par value of $6.7 billion ("Note A") and a non-interest bearing Amortizing Guaranteed Secured Note maturing June 30, 2022 with a par value of $6.5 billion ("Note B").  For Note A, we had outstanding $3.1 billion ($4.7 billion par value net of $1.6 billion unamortized discount) using an effective yield of 9.2%.  For Note B, we had outstanding $4 billion ($5.9 billion par value net of $1.9 billion unamortized discount) using an effective yield of 9.9%.  The Notes allow for prepayments on the annual scheduled principal payment dates.  The Notes are secured on a second lien basis, limited to the lesser of an aggregate $3 billion or the outstanding principal amount of obligations thereunder, with collateral securing our obligations under the Credit Agreement.

Under Note B, we have the option, subject to certain conditions, of making each payment in cash, Ford Common Stock, or a combination of cash and Ford Common Stock.  Any Ford Common Stock to be delivered in satisfaction of such payment obligation is to be valued based on its volume-weighted average price per share for the 30 trading-day period ending on the second business day prior to the relevant payment date.

Ford has the obligations that it has for retiree health benefits because it agreed to the funding in return for concessions by the United Auto Workers on contract provisions. Similar obligations were made by GM and Chrysler, although both GM and Chrysler have paid a higher share of their obligation than Ford in the form of company stock.

Why would Ford use stock?  "Paying in stock means Ford could deploy the cash it saves to reduce its debt and improve its balance sheet"  Ford needs to conserve cash so that it can pay down the $31.3 billion in debt that it holds.   Ford has so much debt because it borrowed heavily in early 2008 which allowed it to avoid the structured bankruptcy fate of GM and Chrysler.   

The Postal Service has only the option of paying cash.   Privatizing the Postal Service would give it the same options that companies like GM, Ford, and Chrysler have to pay these obligations without using cash.  As long as the Postal Service remains part of the federal government, its only option will be cash payments and pay-go rules will determine how much the Postal Service and therefore employees and postal customers must pay.

Why the First Mile Matters

Many postal commentators have suggested that the Postal Service take a last mile strategy, focusing on the advantages that the delivery network offers shippers and advertisers for a low cost solution.   What these commentators miss is that a last mile strategy results in an enterprise that has little control over what it handles and little understanding as to what the mailer or shipper really needs for service.

FedEx and UPS and for that matter Pitney Bowes, Valassis, and Val-Pak all have first-mile strategies, working closely with customers to ensure that their shipping or mailing needs are met from the point of production until delivery.  All of these customers invest heavily in the sales and customer support efforts required to offer service in the first mile.   By controlling the first mile, these companies control the entire process including in the case of FedEx, UPS and Valassis who actual delivers the item to the home or business. 

The importance of the first mile in a globalized manufacturing environment can be seen in the distribution of the new iPhones. as illustrated on the tracking screen shots posted on the apple insider website.     FedEx is handling the shipments direct from the manufacturer in China all the way through home or business delivery.  FedEx's focus on the first mile which included the full understanding of the critical shipping needs of customers like Apple drove its investment in infrastructure and information systems that produced a seamless delivery chain that included planeloads of iPhones from China connected to air and truck movements in the United States, and finally delivery routes that will deliver iPhones to hundreds of thousands of addresses in all 50 states on June 24.

Among the debates currently waging in Postal Policy are two that relate to the first mile.  The first relates to retail services which raises the question as to what kind of first mile strategy the Postal Service should have for its retail customers, those that buy services one at a time or in very small quantities.  There are multiple models for providing first mile retail services other than the corporate post office that the Postal Service now uses.  Whether the Postal Service will have the resources and legal authority to try those options is now on the table.

The second relates to its first mile strategy for commercial and small business customers and whether the Postal Service should be allowed to offer services integrating the process from concept to delivery.  The Postal Service has posted an request for information for developing an integrated product for small businesses and has some limited efforts in that regard using postcards.   However, these efforts are controversial and the policy debate will likely decide how far they proceed.

How Smart Post Makes FedEx More Profitable

In the conference call with analysts this week, Mike Glenn, President and CEO of FedEx Services, explained how Smart Post makes FedEx more profitable.


One of the key advantages that we have in our ability to not only deliver solid growth rates, but yield improvement at the same time is the ability to balance our ground and home services with SmartPost.

Customers that are benefiting from e-commerce and e-tailing in general tend to be growing at higher rates. At the same time, many of those companies produce packages that result in lower yields for us. While we’re prepared to handle that traffic, we’re going to ship that traffic where appropriate into the SmartPost network and allow us to balance our growth in the respective networks, and ensure that we get an appropriate yield per package for each one of those transactions. So we really have a good portfolio of services that is ideal to take advantage of the market trends and the growth out there yet at the same time deliver yield improvements.

FedEx SmartPost volume grew 23% in the quarter which is far faster than any Postal Service shipping or package service.   This growth confirms that FedEx is more than likely the largest supplier of parcels for delivery to the Postal Service and is taking market share from shippers that used to deal with the Postal Service directly as well as those that used parcel consolidation services offered by United Parcel Service and other providers. 

As noted earlier, SmartPost is used to handle light weight shipments for home delivery.   SmartPost as well as FedEx Ground and FedEx Home fit well as the last leg in the current supply chains that involve manufacturing overseas, sales via the internet, and delivery to a home and office.  

National Envelope Company Bankruptcy Details

A Bloomberg story has more details on the bankruptcy that provides some guidance as to how tough the decline in mail has been on the envelope business.

• NEC began defaulting on the bank loan agreement in 2007.  The problems facing produces of envelopes to be mailed began showing up well before the recession.
   
• In May, the lenders called a default on the latest forbearance agreement when a buyer wasn’t signed to a letter of intent before the May 12 deadline. NEC received four bids in early May after extensive marketing, according to court papers.
  
  
• Assets and debt are both less than $500 million, according to the bankruptcy petition.
  
  
• Liabilities include $74.3 million on a secured term loan, $70.6 million on a secured revolving credit and $89 million owing on unsecured debts to trade suppliers.  Given the pressure for the sale are the secured lenders, it would appear that they have a better prospect of being paid from proceeds from a sale than from profits from ongoing operations. 
  
  
• National Envelope has 14 plants in 11 states, plus three warehouses. Four fewer plants than two years ago.
  
• National Envelope Company has 3,389 people and many of the production workers are unionized. A year ago National Envelope had 4,037 employees.    This is a 16% decline in the number of employees in just one year.  (Source on number of employees is FinancierWorldwide.com )
  
  
• Sales declined to $676 million last year from $867 million in 2007.  This is a 22% decline in revenue in the past two years.
   
• Net losses were $44.2 million in 2009 and $6.1 million in the first four months of this year. Losses this year are less than in 2009 but are still National Envelope is not earning profits to pay back its secure creditors.
  
  
• The Chapter 11 case will be financed with a $135 million loan.   The loan provides National Envelope Company with the ability to continue operations and pay trade suppliers while it completes the process of selling the company.  

Given the continuing losses, National Envelope Company will likely find a buyer only if that buyer can reduce costs by around 10-15% in order to return the company to profitability.  Most likely the new buyer will reduce capacity quickly in order to match current and future demand.

The bankruptcy filing in the midst of an effort to sell the company suggests that National Envelope may have to make some changes that only can occur in bankruptcy prior to sale.   Postal observers may find following this bankruptcy instructive in trying to understand the value that private investors see in a streamlined company serving mailers.

National Envelope Company Bankruptcy

The Wall Street Journal reported that the National Envelope Company, the largest envelope manufacturer in the United States filed for bankruptcy today. The bankruptcy filing indicated that the company had between $100 and $500 million in both assets and liabilities.  The company is family owned.

National Envelope Company is unlikely to cease operations under bankruptcy.   The bankruptcy proceeding will allow it to renegotiate existing contracts with employees  and vendors, renegotiate terms of loans, and renegotiate or terminate real estate leases that could not be completed outside of bankruptcy. 

National Envelope Company's bankruptcy follows a nearly two year process during which it has been consolidating operations.   During this period it has closed facilities, ended production, or curtailed production in:

• Chino, CA,
• Union, NJ,
• Long Island City, NY, and
• Houston, TX

The Houston TX closure represented the last step in the consolidation of three facilities in Texas into a new facility near Dallas.

National Envelope bankruptcy most likely represents an orderly way for it to deal with the need to reduce capacity at a pace faster than just waiting for existing capital and real estate leases to expire would allow.   It also allows some more flexibility in adjusting its workforce, that currently numbers around 3,000 employees.  However, there is no information yet available that would indicate that renegotiating union agreements, which may be permissible under bankruptcy, is anticipated.

The financial challenges that caused National Envelope to close these four facilities and now file for bankruptcy reflect the decline in the demand for mail and therefore the envelopes that National Envelope Company produces.  National Envelope is not alone in requiring significant consolidation of capacity.  The recent merger of Quad Graphics with Quebecor World Color will likely result in consolidation of printing operations of these two companies that will likely include some plant closures.   If the supplier's of the envelopes see the speedy consolidation of existing production facilities as critical to their survival as financially viable enterprises, it would seem that the Postal Service cannot delay its consolidation efforts either.  

What National Envelope Corporation's bankruptcy says to postal stakeholders is that mail volume declines, particularly in single-piece first class mail and flat shaped mail across all classes, may not allow the Postal Service to use painless ways to reduce capacity.   The decline in mail volume, combined with improvements in mail automation, means that the number of employees that the Postal Service needs is declining at a rate faster than the rate of attrition.   Similarly, the number of plants that the Postal Service needs may be declining faster than the rate that real estate leases are expiring.

The Postal Service could even find itself in the position, like National Envelope Company found itself in Texas, that it needed a new facility in a different location to replace a group of existing facilities that are no longer optimally located to provide efficient and timely service.  In this case the capital investment in a new optimally located facility could reduce both operating and transportation costs and creates the possibility of improving service previously served by the facilities that are replaced.

Unfortunately, the Postal Service does not have the ability to go through a pre-packaged bankruptcy process like National Envelope Company is likely about to begin. Nor will it have the financing needed to handle the transition costs to a move quickly to a smaller and more efficient mail-processing network that National Envelope Company will have so that it can streamline its current production network during its bankruptcy proceeding. 

It may be worthwhile now for the Postal Service to lay out the capital and transition costs necessary to reduce operating costs and consolidate its processing and transportation network.   This information could be quite valuable in trying to develop a case for restructuring the retirement expenses that the USPS-OIG has indicated should be adjusted.

The problem of capital and transition costs is illustrated in recent statements from Postal Service officials to mailers regarding the automated flat sortation and how a key constraint to fully taking advantage of the technology is availability of funds.    While flat volumes are down significantly, a streamlined flats sortation network modeled after the NDC network could handle bulk flats efficiently with the ability to automate sortation to the finest level that the technology allows at a lower cost to periodicals, catalogs, and other bulk flat mailers.  Such a network would allow mailers to reduce transportation costs by drop-shipping flats to fewer facilities that specialize in sorting flats using automation and then the finely sorted flats would be transported directly to delivery units, or transported to downstream plants for cross-dock movements onto transportation to delivery units.   A full explanation of the capital and transaction spending needed to put such a network in place should be demanded by flat-shaped mailers.  

The current problem with flats is just the canary in the coal mine.  The next product that will face an equivalent challenge will be single-piece mail and.   Single piece mail is declining now at above 10% year-to-year, a rate faster than what was seen before the recession.  This is different from nearly all other postal products which have seen volumes stabilize at 2009 levels and it does not seem unreasonable to believe that demand could rise from that low level as advertising spending across all modes begins to increase in 2010 and 2011.   

The problem with single-piece mail is two-fold.  First, it is highly profitable and its loss reduces contribution to overhead that must be generated elsewhere.   Second, its decline is far faster than the rate of retirement of employees that process single piece mail.    Therefore, the Postal Service will face continuing excess capacity of employees, and especially employees working on shifts handling originating single-piece mail unless it plans to reduce its workforce to reflect the decline in demand in the mail that has the greatest processing requirements. Similarly excess capacity will exist in facilities and possibly equipment.   Now is the time to plan the network for single-piece volume in 2015 and beyond.  A network planned geared for this change would go far to convince stakeholders and Congress that the Postal Service is serious in its efforts to manage its business which will be needed to get the changes in retirement obligations and postal labor law that the Postal Service wants.

Optimizing the Postal Service Network and 6-day Delivery

One of the benefits of the 6-day to 5-day proceeding is that it provides an enormous amount of data relevant for trying to understand the Postal Service's strategy to control costs.  A recent response by the Postal Service to an interrogatory by Douglas Carlson provides the first nationwide picture of the Postal Service's effort to consolidate sortation on Saturday among fewer facilities.

The Postal Service can consolidate sortation of collection mail that is collected on Saturday because it has at least 12 hours of time to transport the mail for sortation at a distant facility and get that mail back for final sortation at the destination facility.  The list of facilities that Douglas Carlson elicited from the Postal Service identifies 139 facilities that do not sort on Saturday.  A cursory look at the distance between facilities that sort mail only Monday through Friday and facilities that sort mail within that facility's territory on Saturday suggests that the Postal Service could be significantly more aggressive in consolidating sortation on its slowest day of the week.


The question as to how many facilities are needed to sort Saturday collection mail is determined by the time it takes to sort this mail, the available capacity in the canceling and originating sortation operations and the time it takes to transport the mail from one facility to another.  The Postal Service has shown that it can handle its service commitments by consolidating Saturday sortation at facilities more than 100 miles away from the facility that sorts the mail the other 5 days.  Examples include:

• Rapid City SD to Sioux Falls, SD - 348 miles
• Truth or Consequence, NM to Albuquerque, NM - 149 miles
• Green Bay, WI to Milwaukee, WI - 116 miles

If it is physically possible to consolidate sortation into a network that transports mail collected on Saturday 100 miles or more in South Dakota, New Mexico, and Wisconsin, then it should be possible to do the same in all other regions of the United States.  

Now this raises a second question is, "does it reduce cost of operations?"  Is the reduction of processing costs greater than the increase in transportation costs?  Given that the Postal Service can cost-justify consolidating operations from Rapid City to Sioux Falls and between Green Bay to Milwaukee, that I would expect that similar analysis in Pennsylvania might support consolidating all Saturday sortation in no more than three facilities in Pittsburgh, Harrisburg, and Philadelphia and it may even be possible to consolidate Saturday collection mail sortation in Pennsylvania in two facilities. Similar examples can be constructed in other states. 

What this means for the 6-day to 5-day proposal is that the Postal Service could most likely provide 6-day service using fewer facilities and at a lower cost than it does today.   Choosing to become more efficient has a major drawback for postal management; it creates more excess career employees.    Excessing these employees would have up-front costs in terms of retirement incentives and severance pay.   The Postal Service does not have the cash to cover these costs.  In addition to increasing immediate cash needs, excessing career employees create additional political headaches that the Postal Service does its best to avoid.

The possibility that facility consolidation could reduce the need to cut one day of delivery also creates a conundrum for postal labor.  Postal unions are all opponents of the 6-day to 5-day proposal, however, it is unlikely that their filings before the Postal Regulatory Commission will identify how the Postal Service could change its operations to reduce costs and union jobs if that was needed to keep 6-day delivery service.  In many ways, unions may find that 5-day delivery is preferable to consolidating the processing network as it minimizes the number of career jobs that are lost.

Of all stakeholders with an interest in the 6-day to 5-day proposal, clearly the Postal Service's customers have the most to lose by the less than aggressive strategy consolidating the operating network.   If 6-days of delivery are preferred by the postal market, it appears that the Postal Service did not act aggressively enough to reduce capacity and costs to keep 6-day delivery financially viable.   If the market is indifferent to 6-day or 5-day delivery, or if financial losses are so great that 6-day is unlikely to ever be financially viable, then customers still lose as the less than aggressive effort to consolidate facilities has resulted in higher costs that the Postal Service needs to recover through an exigent rate case it will file this summer.  

Congressional hearings are not a particularly good forum for analyzing the consolidation of the postal processing network and the impact of any consolidation strategy on postal costs and the rates that its customers pay.  Yet testimony from Michael Coughlin, and the Government Accountability Office indicted that such an analysis needs to be conducted by an independent entity.   It may be worthwhile for Congress to ask a government entity other than those that have previously provided testimony to the relevant committees to conduct such an analysis.  For example, the Department of Transportation and in particular the Volpe National Transportation System Center has the capability of managing such a study.  Such a study could help Congress evaluate all of the legislative changes that the Postal Service requests as well as whether GAO's proposal of a BRAC type commission is needed.

Smart Post - What Does its Success Suggest for Letter and Flat Mailers

In my previous post, I noted that FedEx volumes for Smart Post exceeded the Postal Service's measured volumes for Parcel Select.   This implied that FedEx Ground, UPS and other parcel consolidators used other postal products, most likely Standard Mail Parcels, to handle the parcels that they want delivered less than 1 pound.  The attention that Smart Post received from analysts raised some additional questions that suggest that there may be Postal Service revival strategies that are not the focus of the current discussions about future business models for the Postal Service.

So lets start with what we know about Smart Post and how the Postal Service handles it.

What We Know

1. The volume of parcels that FedEx Ground and United Parcel Service employ the Postal Service to delivery are growing faster than the United States parcel market is growing.
2. The volume of parcels that the Postal Service is handling for all customers is not growing as fast as the overall market.  
3. The Postal Service's volumes for its products that that FedEx Ground and UPS use is declining while their volume using these products are increasing.  This trend means that the Postal Service is becoming increasingly reliant on FedEx Ground and United Parcel Service to market its delivery services to shippers.
4. The growth in the use of the Postal Service by FedEx Ground is attributed to the improvements in delivery service quality that came when the National Distribution Center network restructuring was implemented.
5. The growth in the use of the Postal Service also came at a time that the Postal Service held rates for parcels under 1 pound constant (due to the rate cap) making the Postal Service's delivery service more competitive with FedEx Ground or United Parcel Service using their own resources to deliver light weight parcels.  It is unlikely that costs that FedEx Ground or UPS would have incurred using their own resources remained constant during this period. 
6. The network distribution center realignment has reduced the cost of handling bulk parcels.  See USPS-OIG (Management Advisory Report – Network Distribution Center Phase 1Activation (Report Number EN-MA-10-001)
7. The cost savings from the network distribution realignment would have been larger if management had taken actions to reduce excess employees months earlier than they had.  (See (Management Advisory Report – Network Distribution Center Phase 1Activation (Report Number EN-MA-10-001. p 12) 

What Are The Implications?

• A serious network realignment effort both cuts costs and improves service.
• Improvements in service and competitive prices increase use of the Postal Service's delivery service.
• The Postal Service could improve its competitive position in the delivery of printed advertising if it implemented a network realignment for its letter and flat mail streams that at least as aggressive as it just did for parcels.
• It may be time to rethink the current classification of some parcel services as market dominant products as most users of these products are buying delivery services from the Postal Service in a highly competitive market for the provision of services to deliver small parcels.

What is holding back the Postal Service?

1. Cost savings from network realignments require that plans to excess employees need to begin before it is known how many employees may be released.  The USPS-OIG report indicates that it takes between 4 and 11 months to complete the Article 12 provisions in its labor contracts.   So unless it begins the excessing process before a consolidation is approved, it will have excess employees in standby rooms for months waiting for the negotiated process to be completed. 
2. Currently network realignment including excessing unneeded employees takes as long as 18 months from the time a proposal is announced until all excess employees are reassigned.
3. Current facilities may not be the right size or in the right location to optimally restructure the network.  For example, consolidating carrier route sequencing in processing plants would reduce operating costs and increase the proportion of mail that the Postal Service handles that is route sequenced, as this consolidation reduces mailer transportation costs to the location where the sequencing occurs.
4. Capital does not exist to cover the costs of relocating or expanding facilities to meet the needs of a more streamlined network.   
5. Capital does not exist to cover the severance or early retirement incentive costs required to handle excess employees.
6. Political considerations make it difficult to consolidate facilities and just as importantly increase the time required to complete public hearings prior to announcing that a consolidation proposal will proceed.   The effort required to prepare and hold public hearings add to the cost burden. 

Network realignment should have been the Postal Service's first priority in its effort to cut costs as it is the one cost cutting move that actually improves the quality of service the Postal Service offers by streamlining the delivery process.  The combination of numerous actions of Congress that drained the Postal Service of needed cash, declining revenue due to electronic diversion and the recession, a nearly 18 month time frame from the time a proposal is proposed to the time all excess employees leave the payroll, the political minefield of reducing postal employment at any time and in particular during a recession put it on the back burner.

Instead the Postal Service is moving forward with actions that affect its core customers (mail that contains advertising, including advertising in magazines and accompanying bills and statements) the most: eliminating service on Saturdays and raising prices.   The impact of this strategy is clear.

• Valassis is expanding its use of alternative delivery networks in nearly every market where such services exist.
• Firms that provide alternative delivery in portions of markets are expanding the geographic reach to cover more households.  For example, Donnelley Distribution has just added Delaware County Pennsylvania to its coverage area and Power Direct is expanding into the Las Vegas market.  Both of these companies provide services that effectively compete on a price and service basis with the rates the Postal Service charges for saturation flats.
• The Economist is experimenting with home delivery using delivery services that provide newspaper or periodical delivery for other customers.  If the Economist's subscribers like the new method of delivery, it is likely that the Economist will continue to use alternative delivery. 
• Major media companies, in addition to expanding their use of alternative delivery for periodicals and saturation advertising, are discussing nationwide distribution deals with hand delivery companies to move items currently handled as First Class mail to alternative delivery using a combination of drop-shipping and same day delivery, a service that the Postal Service does not offer, to avoid violating the private express statutes.