Analysis: From pilloried to posting a profit: Royal Mail

Adam Crozier, the chief executive, says services used to be designed around what Royal Mail thought it could do Photograph: Graeme Robertson/Getty Images

The trade and industry minister, Alan Johnson, used to be general secretary of the Communications Workers Union. He may need all his experience gained from that job in his new one.

One of the tasks high on his to-do list is a review of Royal Mail in the run-up to the letters market being fully opened to competition. He is likely to face some tough talking from Royal Mail's chairman, Allan Leighton.

In a sense, Mr Johnson will be relieved that there is still something to talk about. Three years ago Royal Mail was in trouble: Mr Leighton dubbed it a "basket case" – a business the government could not even give away. It had the worst strike record in Britain, it was losing pounds 1m every working day, wages and morale were at rock bottom and the Equal Opportunities Commission was contemplating an investigation into harassment and bullying. Its very ability to trade as a going concern was in doubt.

Since then, Mr Leighton and the executive directors under the chief executive, Adam Crozier, have led a dramatic turnround, though as yesterday's remuneration packages revealed, they have been well rewarded under the company's long-term incentive plan.

The company is back in the black, reporting a profit from operations of pounds 537m in the last financial year. The number of letters lost has fallen from 28m to 16m. Morale and performance have improved, though there will be plenty who will say it still has a lot more to do.

Mr Leighton is among them. He knows Royal Mail still has problems. The Post Office is losing pounds 100m a year. It is faced with transforming itself from an organisation that doled out state benefits to one trying to compete across a broad spectrum of financial services provision – hardly the least competitive sector of the economy.

Yet tampering with the post office network, though possible as the closure of urban offices has shown, is politically fraught.

Overall margins are too thin, with a return on sales of just 4.1%. Royal Mail says that 90% of services by volume, which are price-controlled, are losing around pounds 200m. No doubt at its next price review, Royal Mail will be pressing regulator Postcomm to be generous. However, the signs are that Postcomm may not be unduly impressed. Even if it were, would Royal Mail really want to greet the onset of full-blown competition in the mail market from next year by jacking up its prices?

Competition means that Royal Mail needs to invest both in the products it offers and in automating its sorting operations to levels that match those of its rivals. Mr Crozier argues that in the past, Royal Mail services were designed around what it thought it could do, not what customers wanted.

It knows it is vulnerable. New entrants will be determined to cherry-pick the best bits of a market where just 100 customers account for half the business. The new products and new equipment Royal Mail needs to fight back cost money.

But Royal Mail is struggling with a balance sheet that is undermined by a pension fund deficit of pounds 2.5bn. To borrow the money to fund the fight-back, Royal Mail needs to sort out the deficit. Given its strong cash- flow, it should be able to deal with the deficit on liabilities going forward of, say, pounds 1bn.

But it may want rather more than a little help with historic liabilities,perhaps pounds 1.5bn. Mr Leighton is not likely to be shy about asking Mr Johnson whether he is prepared to be part of the solution to that problem.

Mr Leighton will also have another thorny question for the new trade and industry secretary: ownership. Though he is not looking for a Thatcher-style privatisation – he believes it simply wouldn't work at Royal Mail – Mr Leighton would like to see a "chunk" of the company owned by the employees.

That part of his plan is unlikely to be too well received at the DTI, where the topic of privatisation, of whatever hue, is regarded as "not being on the table". Mr Johnson may also argue that if Royal Mail has money to buy its own shares to give to its employees then it has plenty of other calls on its cash. He would not be wrong.