We’ve reached the end of our blog series.
We want to thank all of the guest bloggers who participated:
We also want to thank all of the commenters who took the time to add their views.Read More
This is the fifth topic in our “Five Elements of a Postal Solution” blog series. Link to last week’s topic.
Link to the blog by Elmar Toime.
Link to the blog by Jim Sauber.
Link to the blog by Roger Kodat.
There is nothing new in the U.S. Postal Service’s concern about retirement liabilities, but this is part of a larger issue of employee compensation. In developed economies around the world, postal employees enjoyed or still enjoy civil service labor conditions. This is not just about take-home pay. Civil servants typically have better leave and medical arrangements, better working hours, and importantly, more generous pension and medical schemes. This is my first point. Comparisons of postal compensation to compensation in other industries must be made on the value of total remuneration.
In itself, higher compensation need not be a problem. The crucial element is whether superior remuneration can be matched by superior productivity. If it can, then the labor cost is justified. And to be fair, in this context, productivity should include both efficiency (as measured for example by labor cost per postal item) and service (for example timely delivery of mail). Whatever the situation, postal services have to be paid for, either by users (when they buy postage) or by the government through subsidies and market protection for mail services. That’s a public policy choice that governments cannot duck. If you want users to pay, then either postage prices have to increase, or services reduced, or labor productivity improved, or assets worked harder. We see all approaches being implemented in other countries.
In some places, total labor remuneration growth has been slower than the market, rebalancing in that way. We have seen dual pay structures emerge – existing civil servants retain all benefits, new employees simply don’t get them. We have seen service quality change, through post office closures or a five day service. Everywhere there has been investment in new sorting technology and work practices that require less labor for the volume of mail processed. And we have seen governments allow prices to rise more than inflation, protecting the postal company from competition at the same time. New services have emerged, such as banking in post offices, in order to better use assets or fixed costs.
It’s an optimization problem that can’t avoid difficult decisions. Want my 5 cents worth? Transfer existing pensions and medical insurance liabilities to the federal government. That is soon going to happen in the United Kingdom. Separate these ‘old’ benefits from a new employment contract based on existing conditions but which can be allowed to evolve with the business. Implement five-day a week delivery (Monday to Friday), accept private sector provision of retail services, rationalize the sorting center network, and increase prices to provide a 5 percent return on capital invested for the first three years. Announce that market liberalization will occur in the third year. In other words, do what most other countries have done!
Back to top
Legacy costs: The Postal Service’s hidden strengths
I often joke that the Postal Service is the most financially sound ‘failing business’ in the country. It has two overfunded pension plans (FERS and CSRS), even with the application of grossly inequitable cost allocations methods in the postal portion of the CSRS fund and it has pre-funded nearly 50% of its future retiree health liability when the median level of funding for such benefits among Fortune 1000 companies is zero (0%), according to an annual survey by Towers Watson.
These strengths suggest that the financial crisis at the Postal Service is not hopeless. Smart policy on pensions and retiree health costs can help save one of America’s greatest economic assets, a last-mile delivery network that links 150 million households and businesses for an industry that employs 7.5 million Americans.
One solution already proposed would be to suspend the retiree health pre-funding during the near term emergency. Restructuring must take priority over pre-funding now. No other agency or private company faces such a mandate. The remaining unfunded liability for retiree health could be covered by implementing the recommendations of the PRC/Segal company audit of CSRS benefits as called for by H.R. 1351, a bill with bipartisan majority support in the House of Representatives.
Although the October 2011 GAO report on this issue backed the OPM’s interpretation of the law, and the methods it used for allocating pre-1971 pension costs between USPS and the Treasury, it also concluded that the methods endorsed by the OIG and PRC audits were “reasonable” and that the choice of methods is essentially a “policy decision.” I agree – Congress should make the policy decision, not OPM.
There is more that can be done to handle future legacy costs.
First, Congress should allow USPS and its employees to invest the assets in the Postal Service Retiree Health Benefits Fund (PSRHBF) in a more appropriate manner. A fund with $45 billion in it, operating on a 75-year time horizon that will pay out $3 billion per year for retiree insurance premiums, should not be invested exclusively in low-yielding Treasury securities. The group of diversified index funds in the Thrift Savings Plan (which also invest for employees’ retirement years) have earned 7.3% annually since their inception. Raising the returns in the PSRHB to this level would cut prefunding cost significantly.
Second, legislation to facilitate the intelligent integration of FEHBP and Medicare benefits as well as bargaining between the Postal Service and its unions on health benefits within a FEHBP context could dramatically reduce future retiree health benefit costs. NALC is aggressively exploring the options right now.
Of course, these policy changes alone won’t be enough to save the USPS. NALC knows that costs must be properly aligned with the economic realities of the 21st Century through pain-staking collective bargaining – a process that is still underway. More importantly, the Postal Service needs a new business model and a growth strategy that will preserve a robust national network to serve the nation. That will require Congress and all the stakeholders in our industry to come together to reach a consensus on a vision for the future.
Back to top
The legislative process often leaves us wondering if form trumps substance. Take the Postal Accountability and Enhancement Act of 2006, particularly Section 803. This section requires the Postal Service to make cumulative $58.8 billion of specified annual pre-payments from 2007-2016 into a Retiree Health Benefits Fund (CBO report on HR 6407); over $5 billion per year for 10 years in a row. In hindsight, we know now that the law’s payment schedule has since been modified – to date, the Postal Service has been permitted to pay $9.5 billion less than the amounts called for in the bill, but payments totaling $11.1 billion are now due by the end of this year. Even so, the question still remains: How could the Postal Service possibly survive such financially crippling, front-loaded, payments to cover unfunded retiree health liabilities?
As legislation was drafted, OPM estimated the Postal Service’s accrued unfunded retiree health liabilities to be about $64 billon; it is now calculated to be around $90 billion. Given the legal requirement for the Postal Service to meet all of its obligations through operating profits, it was deemed prudent that the Postal Service incrementally prefund such an enormous future cost to its employees. As a finance guy, I preferred a 30-year straight-line amortization schedule for Postal to incrementally prefund this future obligation, in keeping with how a private sector corporation might operate. Smooth and steady contributions help ensure a more secure future for the Postal Service and its employees – a key policy objective.
Due to budget rules, government does not always work this way. Enter CBO (and don’t forget fiscal constraints the nation faced at the time). In order to gain congressional and administration support to enact a Postal Service reform bill, it was imperative to structure the financial flows in order to minimize, or even zero-out, net cost to the unified budget over the 10-year period following enactment (CBO’s analytical scope in calculating budget cost impacts).
Once it was decided by congressional leaders to use this bill also to return the cost of military service retirement credits back to the Treasury (previously a Postal Service obligation), a balancing cash inflow had to be structured to gain support for the legislation. Credit those in Congress who worked creatively and tirelessly to weave a passable reform bill – we needed one. Also remember: the Postal Service had minimal debt at that time; and we could not know how extensive electronic diversion of mail would be; nor the depth of the economic downturn we would face.
The $5+ billion yearly obligation, passed with bipartisan support by Congress and the White House, kept the reform budget neutral and did not result in increased costs for the taxpayer.
What can be done? Remain vigilant to identify and implement cost savings; expand operating flexibility to drive greater efficiencies; evaluate whether excess CSRS and FERS account balances could be applied to satisfy a portion of this obligation (bear in mind that OPM, in future, could change its long term assumptions, which might result in the Postal Service having a negative fund balance); and ask Congress for a more smooth and steady prefunding schedule. As for the last prescription, I have come full circle.
As the Postal Service’s financial crisis deepens, we often hear about overfunding and overpayments by the Postal Service for retiree benefits. This issue is complex and controversial. While some argue that there are overpayments, others respond that the Postal Service has not overpaid but simply paid what is required to ensure that taxpayers are not burdened with future Postal Service liabilities.
Postal employees participate in federal pension and retiree health programs, and the Postal Service must set aside money to fund these obligations. On the pension side, the Postal Service has covered the obligations accrued to date. According to the most recent projection by the Office of Personnel Management, the Postal Service’s 2011 pension surplus was over $13 billion. (Most of this surplus was for the newer FERS pension plan.)
The Postal Service has only partially funded its retiree health obligations. The federal government does not prefund retiree health benefits, and the Postal Service only started funding these obligations in 2007. Since 2007, the Postal Service has amassed $44 billion, 49 percent of its $90 billion in current liabilities. However, because of its financial problems, the Postal Service is having difficulty making its annual payments to fund retiree health benefits. Last year, Congress delayed the $5.5 billion payment due at the end of September 2011 until August 2012. The Postal Service does not believe it will be able to make the $11.1 billion in retiree health payments it owes for both this year and last year. What should be done about these looming bills?
This issue is part of a broader issue of entanglements with the federal government. As part of the federal government, the Postal Service uses federal benefit programs but has little control over their structure; as a self-financed entity, the Postal Service is expected to set aside funds to pay for obligations incurred by these programs. In fact, to gain more control over the cost of health benefits, the Postal Service has proposed moving to a health benefit plan that it operates rather than using the federal plan.
Any effort to set the Postal Service on a course for financial sustainability will need to address the question of how to approach retiree benefit funding and federal entanglements. This week, we’ve asked the following guest commentators to discuss the topic over the next few days:
• Roger Kodat, former official at the Department of the Treasury.
• Jim Sauber, Chief of Staff, National Association of Letter Carriers.
• Elmar Toime, independent advisor to the postal sector.
We hope you can join the debate. Please check in throughout the week for their thoughts, and share your comments along the way. On Friday, April 6, we will summarize and conclude the discussion.
Our Guest Bloggers
|Roger Kodat||Jim Sauber||Elmar Toime|
Roger Kodat was Deputy Assistant Secretary of the Treasury from 2001 to 2007 and logged more than 130 different postal-related meetings while working on the reform bill enacted in 2006. In addition, he has over 20 years of investment and commercial banking experience with JPMorgan in Europe, NYC, and Washington, DC. He is currently Principal of The Kodat Group, a consulting firm specializing in helping businesses expand international markets, finance exports, and mitigate risk..
Jim Sauber is the Chief of Staff to President of National Association of Letter Carriers (NALC), where he served many years as its Research Director. He joined the staff of the NALC as an economist in 1985 and has participated in seven rounds of collective bargaining with the United States Postal Service. He is responsible for coordinating the research, collective bargaining, public policy and legislative activities of the union.
Elmar Toime is an independent advisor to the postal sector based in London. He is chairman of Postea, Inc, a postal technology group, and a member of the Supervisory Board of Deutsche Post DHL, the world’s leading logistics company. Elmar was the chief executive of New Zealand Post Limited from 1993 to 2003 and Executive Deputy Chairman of the Royal Mail Group from 2003 to 2004. In 2004 Elmar was awarded a life-time achievement award for leadership in the postal industry.
Back to top
This is the fourth topic in our “Five Elements of a Postal Solution” blog series. Link to last week’s topic.
Link to today’s recap.
Link to Thursday’s blog by John Waller.
Link to Wednesday’s blog by Jeff Colvin.
Link to Tuesday’s blog by Jessica Lowrance.
In the fourth week of our blog series, we asked three experts to give us their opinions on an appropriate pricing regime for the Postal Service.
Our bloggers offered diverse ideas about a future pricing regime. Jessica Lowrance believes “eliminating the current concept of classes of mail is a natural step in streamlining operations and simplifying mail usage… [and]…it makes sense to adapt the product offering to how the USPS currently processes mail.” Jeff Colvin envisions “tailoring the price structure of bulk mail to the vast differences in delivery cost around the country.” Lastly, John Waller sees “current competitive market conditions warranting the exploration of a more flexible [price] cap with a narrower scope of application.”
Although Waller identifies the need for a more flexible price cap, he thinks the current requirement has had positive results because “it has forced cost cuts and attention on developing new business models.” However, Colvin points out that “the price cap freezes prices at inflation, effectively removing an important tool companies ordinarily employ to achieve financial stability.” Both do agree that a future price cap should factor in a continued decrease in mail volumes. Lowrance’s blog differs by focusing on Postal Service operations and mail classes. She states, “The major differences within operations are when and where the [mail] piece is accepted and the service standards surrounding the class of mail. The Postal Service could rationalize its services by creating shaped-based products that followed many of the same regulations that exist today.”
Comments to date on this week’s blog include varying ideas. Most agree there should be a responsible approach to increasing prices based on current market conditions. Others added that any Postal Service products or services that cost more than the revenue they bring in should be minimally priced at the breakeven level.
We thank each of the bloggers for their comments and will continue to keep the blogs open for additional input from the public. In addition, we invite you to keep up with the Office of Audit’s latest work through the Audit Project Pages. This site provides a forum for you to share your ideas, comments, and concerns on our open audit projects.
Next week’s blog series will examine the question: What should be done about the overfunding, overpayment, and other unfunded federal mandates?
Back to top
The CPI cap requirement has forced cost cuts and attention on developing new business models. These achievements should not be lost in any new pricing requirements. But a CPI cap does not account for the impact of on-going volume and revenues erosion due to electronic diversion and economic downturns. Current competitive market conditions warrant the exploration of a more flexible cap with a narrower scope of application.
Without annual pricing flexibility in excess of the CPI, the Service becomes dependent on exigent, breakeven or legislatively authorized price increases, with periodic rate shock impacts as in the pre-PAEA days. With more flexibility in the cap and more limited application, these impacts can be avoided through manageable, predictable, annual increases sufficient to ensure a financially viable Postal Service.
Ideally, a new pricing policy would mimic PAEA requirements for competitive products as closely as possible. Market conditions will act as a restraint on unreasonable price increases given the competition that exists between postal products and the Internet, especially for commercial mailers. However, as a matter of public policy protection for the individual citizen mailer, a cap may still be warranted for single-piece letters and packages.
While the cap could initially be applicable only to single piece letters and packages, a safety valve could be established for other products by authorizing the Commission to extend the cap coverage, if unreasonable prices or undue discrimination is detected. The recognition that excessive price increases could trigger a death spiral will keep the Service focused on cutting costs and developing new sources of revenue. The Service has exercised appropriate restraint with reasonable, but above CPI, price increases for competitive products. This pricing flexibility has allowed those products to remain affordable and profitable yet keep management attention on cost cutting and innovation.
As with competitive products, it is reasonable to require market dominant prices to cover cost plus a reasonable contribution for institutional costs. If a product suddenly fails to cover costs, then a specific period of time could be required for returning the product to profitability before mandating price increases through the regulatory process. Pricing requirements should also foster workshare discounts to continue the privatization of upstream functions.
At some point it may be reasonable to transfer most bulk mail products to the competitive category. But in the meantime, once a lean system is established, removing the cap for commercial products is a means of testing the feasibility and value of such a move.
To the extent that a cap is retained, it should take into consideration the financial impact of the steady erosion in volume due to competing media. As volume declines, non-volume-variable costs in a lean postal system become a larger share of total costs and average unit costs increase even if input costs (labor, transportation, etc.) are under the CPI. The percentage of total costs that are fixed accelerates as volume becomes ever smaller due to the structure of street delivery.
The cap should also allow for price adjustments to offset the loss of contribution due to the change in mail mix. Since 2006, Standard mail has become the largest component of volume with about 1/3rd the unit contribution of the previously dominant First-Class.
Additionally, universal service requirements should be taken into consideration. The need for an above CPI cap can by mitigated by reducing legal constraints, such as a required 6-day delivery or mandated price preferences for certain products. If Postal Service requests for changes, especially in delivery innovations, are rejected, then the resultant impact on profit can either be subsidized or be incorporated in the cap to allow recovery of these costs through postage.
A future cap should be less than CPI if volume trends turn around. When volume is growing, price caps less than the CPI are reasonable. The Service could propose the mechanics of a new cap with adoption requiring regulatory approval based on public hearings. To allow a capability to respond to new price impacts, a legislated cap could be a simple CPI plus an x factor to be determined by an expert body informed by public hearings. The legislation could specify certain factors that must be considered in future caps, such as volume per delivery point.
Back to top
You hear it all the time.
Question: What company, facing a precipitous decline in demand for its product, would raise prices?
Answer: A state-owned monopoly, with a mandate to meet a multi-billion dollar service obligation.
Question: What company, losing billions a year, would not raise prices?
Answer: A business facing such powerful multi-modal competition that its captive market is slipping away like time into the future.
So the Postal Service, and the $900 billion industry it supports is in a huge mess – but what’s price got to do with it? And what can be done, via pricing, to make things better?
The problem is well-known. The Postal Service’s most profitable product First Class Mail was already battered by e-substitution, when the postal ship sailed into the greatest recession in recent memory. And it’s still taking on water, losing $1.3 billion in January 2012 alone, according to unaudited results filed with the PRC. January volume fell by 2.3% from last year.
While there is some improvement in shipping services, there isn’t enough to make up for the gigantic losses in the letter market. Like it or not, the action is all in letters, and increasingly, in bulk letters.
But raising the bulk letter price is not easy. The price cap freezes prices at inflation effectively removing an important tool companies ordinarily employ to achieve financial stability. Of course, Congress could soften its impact by loosening it to compensate for falling volumes, but it may not be enough. But Royal Mail and its regulator Ofcom recently concluded that even a cap watered down by such a volume-adjustment mechanism fails to provide for adequate pricing flexibility in labor intensive industries like postal.
More importantly, the pricing problem is not strictly a legislative issue. The Postal Service says that it wants to raise the stamp price to 50¢, but is much more cautious when it comes to raising bulk mail prices.
The worry is that demand might now be significantly more sensitive to price increases, because of e-substitution, than in the past. The jury is out on that one. The available research on what economists call ‘elasticity’ says First Class Mail, and even Standard Mail, are still pretty price insensitive, so much so that an increase in price would actually raise revenue and contribution. It may be that e-substitution to letters is more a trend, whose ebbs and flows depend more on technology and culture than on incumbent pricing.
Still, the question is an empirical one, and short of the basic research on whether demand characteristics have really changed, the obvious test – raise prices and see what happens – does carry risk. So, what can be done with prices to improve the Postal Service’s bottom line?
Let me offer a modest proposal. Why not tailor the price structure of bulk mail to the vast differences in delivery cost around the country. Delivery costs vary dramatically by ZIP code according to the density of the population. It would improve efficiency if prices tracked those differences.
In fact, simulations indicate that, even keeping total revenue constant, adjusting prices to delivery costs, could increase contribution by $800 million by shifting volume from high cost to low cost delivery areas.
It won’t solve the problem, but as they say, a billion here and billion there . . .
N.B: The views presented in this blog posting do not necessarily reflect the views of the OIG or any other organization. They are the views of the author alone.
Back to top
Today, the Postal Service offers an array of products that ultimately deliver a piece of mail from point A to point B. This original product has been sliced and diced to over 4,000 price points. From this price list, mailers pick the shape that best fits their mailing – a letter, flat, or package. Next, the mailers chooses a class of mail (First-Class, Standard, Periodicals, or Package Services/Parcels) based on rules and regulations established by the Postal Service. The Postal Service further distinguishes classes of mail by delivery or service standards. Additional services are available to mailers that occur pre- or post-delivery, especially if the piece is found to be undeliverable.
Eliminating the current concept of classes of mail is a natural step in streamlining operations and simplifying mail usage. From my perspective, it makes sense to adapt the product offering to how the USPS currently processes mail. Today, shape influences how a piece gets processed and which machines are used to move the mail through the system. This, then, affects how much it costs the USPS to process the piece and ultimately the price of the service.
In the eyes of a postal machine, a letter is a letter. The major differences within operations are when and where the piece is accepted and the service standards surrounding the class of mail. The Postal Service could rationalize its services by creating shaped-based products that followed many of the same regulations that exist today. Under such a revised product list, the Postal Service could offer a letter product that was differentiated further by where the piece was entered and the services purchased through the IMb.
For example, if the piece contained a bank statement and the mailer wanted 1-3 day service, it would be entered at a facility that met those service standards as well as any presort and destination entry requirements. The Intelligent Mail barcode on the piece could indicate that it was sealed against inspection and would be automatically forwarded if the recipient changed addresses. If the mailer wanted or needed additional return services, it could indicate which services were requested via the IMb. The Postal Service would no longer have to be concerned with processing preferred over deferred service letters, as all letter pieces when processed would be processed together.
This a la carte price offering would provide the mailing community with the opportunity to reach deeper presort levels and dropship further downstream in postal operations. Over time this should reduce upstream operations and postal costs.
In order to move forward with this suggested alternative, the Postal Service would need to go before the Postal Regulatory Commission to change its mail classification schedule (MCS). This process would allow for interested parties to comment to the Commission on the Postal Service’s new product categories and how it translates to existing service performance reporting, pricing, and costing.
Back to top
The pricing of postal products is critical to ensure value for Postal Service customers. Although, the Postal Accountability and Enhancement Act of 2006 streamlined the pricing and classification process, no significant changes have been made in almost 6 years. Additionally, law requires that all market-dominant product price increases to be tied to a Consumer Price Index (CPI) price cap. Is this an adequate pricing approach for a 21st century postal service?
Are there other objectives that should be achieved with modern pricing? The Postal Service’s president and chief marketing/sales officer said ―”…when we make it simple to mail, our customers will do business with us.” However, mailers, employees, and the public do not always understand all of the prices the Postal Service offers. Stakeholders have noted that complex rates aren’t necessarily a bad thing for mailers and that most large mailers calculate their postage with a computer rather than paper and pencil. Is the use of computerized pricing by mailers a 21st century solution or a symptom of a disease?
In fiscal year (FY) 2010 the Postal Service had more than 7,600 domestic prices with 2,361 prices (31 percent) not used in FY 2010 and another 1,237 (17 percent) used on less than 10 mailpieces. This means that nearly half of the Postal Service’s domestic prices were not used by customers at all or not used often. Today there are over 8,000 domestic prices for the Postal Service’s three primary product lines: letters, flats, and parcels, along with additional services such as insurance, delivery confirmation, and certified mail. Does it make sense to have so many prices or should pricing be simplified?
Continuing pricing discussions include how to establish prices — a top-down or bottom-up pricing model? What pricing tools could potentially promote better efficiency and incentivize good performance? Are work sharing pass-throughs an efficient measure of costs avoided by the Postal Service? Is the CPI an adequate safeguard to ensure efficiency and financial viability for the future?
We would like to hear from you about how the Postal Service should or should not redefine pricing in support of a lean and simple national infrastructure with a right-sized workforce in the 21st Century and beyond.
For this week’s topic, we’ve also asked the following guest commentators to discuss this topic over the next three days:
• Jessica Lowrance, Executive Vice President for the Association for Postal Commerce, on Tuesday, March 27.
• Jeff Colvin, Director, USPS Office of Inspector General, on Wednesday, March 28.
• John Waller, consultant on postal and regulatory issues, on Thursday, March 29.
We hope you can join the debate. Please check in throughout the week for their thoughts, and share your comments along the way. On Friday, March 30, we will summarize and conclude the discussion on this important topic.
Our Guest Bloggers
|Jessica Lowrance||Jeff Colvin||John Waller|
Jessica Dauer Lowrance is the Executive Vice President for the Association for Postal Commerce (PostCom). She has been with PostCom for almost four years working with and representing business mailers to all postal stakeholders. Prior to joining PostCom, she was a pricing economist for the Postal Service.
Dr. Jeffrey Colvin has published many articles on postal issues. After 23 years with the Postal Service, he is now with the USPS Office of Inspector General.
John Waller is a consultant on postal and regulatory issues. Previously he was the Director of the PRC’s Office of Accountability and Compliance.
Back to top