Imrecon

Of all the regulated sectors, as citizens, it seems we have a special relationship with post.  Postman Pat would not have been an electricity worker or a baggage handler[1].  We have daily contact with postal workers: they come to the door, we often talk to them as we sign something, we entrust them with precious things and they give us what we are looking forward to receiving.  But what is the future for this special relationship in an internet world?

Here in the United Kingdom, the Hooper Report acknowledged the public's affinity with the postal service and their affection for, and trust in, their local postmen and women.  It is not an unqualified affinity, as the media often focuses on poor service, inefficiency, financial losses and falling volumes.  But it is important background for policy making, at least at a political level, for a service that seems in decline.

Volumes are in decline

At present, overall postal volumes are falling rapidly.  In 07/08, Royal Mail's mail volumes fell from their 06/07 levels by 3.2%, fell a further 5.5% in 08/09 and it estimates will fall by up to another 10% in 09/10[2]. 

The following chart from the Hooper report highlights how the internet has hit growth in mail since early this decade[3], leading to falling volumes even before the recession.

From what some were saying in Bordeaux[4] last month, volumes could go down by a further 1/2 to 2/3. 

This would be a seismic shift that would change the nature of postal services. 

But, is volume the whole story? 

However, the headline volume figures obscure what is going on underneath.  Post is losing volumes in the relatively low-value applications: transactional mail (invoices, statements, payments etc., information that is more efficiently conveyed electronically) and advertising mail is under pressure during this recession. 

There is growth, however, in fulfilment mail (e.g. delivery of goods ordered on-line).  This is the highest value part of the market, and the most contested, but it barely registers in the volume statistics.

In the chart below, the left hand column is getting bigger and the rest is getting smaller.

Not in decline, in transition

Post is traditionally thought of as a communications medium, delivering ideas, sentiments and information. 

Though we will continue to depend on post for some communication, post as a communication medium is bound to diminish as it cannot compete in terms of speed or cost with the internet.  Looking forward, the bigger role of postal services is bound to be on the other side of the internet economy - where we buy things on-line and get them delivered. 

The question is how much of the fulfilment market can be, or should be, serviced by the universal service provider, i.e. Royal Mail in the UK.  

Efficiency matters

I will argue that, because Royal Mail is delivering to every property already, it has the potential to be substantially more cost effective than any other carrier.

Maintaining the universal service has been a central pillar of EU policy for postal services since the European Council Resolution of 7 February 1994 and the postal directives follow from this objective.  The universal service means daily deliveries to all for letters and packages up to 10 kilograms.  In most countries, including the UK, it also means a uniform price.

The EU policy objective of guaranteeing the universal service is enabled by the economics of the sector and the ‘flanking measures' put in place by the Third Directive[5].  With these flanking measures, which include pricing flexibility for downstream access and business mail, universal service providers should have substantial economies of scale and density in their delivery businesses to protect them from bypass competition.  Elasticities of demand are historically low so, politics permitting and absent substantial inefficiency, they should be able to price their services to recover their costs. 

In the letters market, those dynamics have largely protected Royal Mail from competition in downstream, delivery activities (they cannot protect it from upstream competition - other firms compete on upstream activities before handing the post to Royal Mail for the final mile).

In packets, however, lots of companies deliver to the door - I had three this morning, two driving vans and one Royal Mail postman on a bicycle.  This indicates that Royal Mail either does not have the same compelling economies of density in packets that it does in letters or that it is, for whatever reason, not harnessing those economies. 

But could it, and what would happen if it did?

The central insight behind universal service economics is that multiple carriers delivering to the same address is a duplication of effort and thus inefficient[6].  If one carrier is able to secure the available economies, it acquires some attributes of a natural monopoly.  It becomes substantially more cost effective at doing the most critical part of the supply chain and, with suitable measures to protect upstream competition, consumers and the economy benefit overall . . . And it makes economic sense of the universal service.

To this extent, the economics behind the universal service obligation depend on the provider having this natural monopoly privilege. 

Can Royal Mail secure this privilege in an increasingly packets-dominated world?   

Royal Mail would have to earn it.  It will not be given the privilege.  It would have to become so cost-effective at that final mile that it becomes attractive for other carriers to hand over their standard-service packets for the final delivery - just as they do for letters.

But Royal Mail has access to economies of density in final mile distribution through its letters business.  Royal Mail is delivering to every property already.  If it can find a way to deliver packets as an integral part of that delivery, at minimal marginal cost, it should be substantially more cost effective than any other carrier delivering to order.  This would require Royal Mail to integrate the delivery of letters and packets - as soon as it has to send vans to deliver the larger packets, it has lost its potential advantage.

There are obstacles.  There is a 16kg limit to the mail pouches delivery men and women can take on their rounds.  It would be a challenge to integrate packet tracking systems between carriers and Royal Mail's delivery service.  It may not always be possible to deliver service features that carriers develop to make their offerings distinctive.  The costly problem of what to do when householders are not in to receive large packets or sign for items may need to be solved.  And the relatively high price for packet deliveries, and the relatively high value of their contents, mean that Royal Mail's cost advantage would have to be substantial to change the dynamics of the market.

Could Royal Mail overcome these and, no doubt, other obstacles? 

I do not know the answer but, for me, the question captures something about the challenge facing universal service providers such as Royal Mail.  As the internet plays an increasing role in the economy, harnessing the letters-based economies in delivery of packets would have a positive impact on Royal Mail and on national productivity.  At stake are the universal service provider's competitive position and, by implication, the sustainability of the universal service.

The potential upside for the economy is considerable, but it would require a major shift in thinking - about what Royal Mail is for, what it does and how it should be regulated.

The challenge

This is not a ‘modernise or decline' agenda.  It is not about Royal Mail bringing itself up to modern, letter-based norms.  Instead, it is about looking forward to a different paradigm. 

It will need vision to re-optimise a major industrial process.  New ways of working will need to be adopted.  We can only guess what it will mean for the kind of vehicles, delivery staff, mail pouches, intelligent ‘letter' boxes[7], sorting systems, tracking systems and delivery frequencies we will have in the future. 

Most immediately, it will need political courage (more important than the corporate experience of a private investor?) to address legacy labour relations and other issues.   

And it will need a strategic-thinking regulator.  A service in profound transition sits uneasily in the current regulatory regime, which is designed to encourage incremental productivity improvements rather than structural change.  Post is becoming less of a communications medium and the transition will involve big shifts: in thinking, operations, cost accounting, price structure and the scope and role of price control.  An appropriate regulatory response will be strategic, flexible, risk-aware and focused on fundamentals recognising that, for a regulated business, the scale of change and the challenge is exceptionally large while the capital base of the business is exceptionally small.

Unfashionably positive

It seems to me that there is room for a rather more creative future for Royal Mail than the polarised choice set out in ‘Modernise or Decline'.  There are plenty of challenges ahead, but they are about more than just improving Royal Mail's efficiency.   They are about harnessing strategic opportunities, earning an even deeper public affinity with the service and making a real difference to the internet economy. 

[1] He might once have been a steam train driver, perhaps, but not now. 

[2] Addressed Inland volumes, Royal Mail Holdings plc Report and Accounts, year ended 29 March 2009, page 6

[3] ‘Modernise or Decline', 16 December 2008, pages 9 and 42

[4] At the CRRI's ‘17th Conference on Postal and Delivery Economics'

[5] The ‘flanking measures' permitted by the Directive are not yet fully in place - Royal Mail and its regulator have not yet agreed a basis for pricing flexibility in business mail and Royal Mail argues that pricing for its downstream access product does not properly reflect its costs.

[6] See page 6 of ‘Initial Comments of Time Warner Inc. in response to Commission Order No. 71', 25 June 2008 on www.prc.gov

[7] Using RFID or other technologies to allow for secure, recorded receipt of large packets.