One-price-goes-anywhere UK mail service set to unravel as regulator gives competitors access

Postcomm’s access proposals will put Royal Mail’s recovery at risk by forcing the company to deliver millions of letters for competitors at a loss even after all the efficiency gains set out in the company’s turnaround plan, a submission to the regulator today makes clear.

The funding and pricing of the one-price-goes-anywhere mail service in the UK will unravel if the regulator’s proposals remain unchanged. In addition, those customers who aren’t targeted by new access competitors seeking profitable business mail will find themselves picking up the additional costs in the form of higher stamp prices, Royal Mail has warned.

“Our position is very, very simple,” said Chairman Allan Leighton. “If we have access services they must be profitable for both Royal Mail and new competitors.”

“We know that within three years this will wipe up to £650 million from our bottom line – despite the regulator’s repeated assurances that it would put in place prices which were neutral for Royal Mail and maintained the cash position created by the price control agreed earlier this year. We’ve repeatedly asked Postcomm to explain how it has ended up with the prices it wants to charge – but up until now it’s refused to share the theoretical models it claims to be using.”

The true average cost of delivering a letter is over 13p – and even Postcomm acknowledges that this is not far off the mark. But the access proposal will only allow Royal Mail to charge less than 11.5p for its delivery. The artificially low pricing will pull traffic from other, profitable, streams of mail, hitting Royal Mail’s profit by up to £280 million over the next three years.

In the long term, Postcomm’s proposals mark a major shift towards basing postal prices solely on the cost incurred, without the balances and cross subsidies which characterise the postal marketplace. As it pushes some prices down to and below real costs, other prices will have to rise. Postcomm’s price control limits Royal Mail’s ability to do this, even if the end result would be neutral. This restriction on rebalancing, combined with customer demands to see lower prices in line with access rates, will remove up to £370 million of revenue during the current price control period.

“This can’t be what the regulator intended,” said Mr Leighton. “In the end something will have to give and it will probably be the universal service. It’s
Catch-22 time for Royal Mail. To compensate for Postcomm’s overall shift on prices, we’d need to put stamp prices up four pence on First Class and seven pence on Second Class – rises of 14% and 35% respectively. If we don’t we take a huge hit on profit and the whole basis on which the universal service is financed starts to unravel.”

“There are now even bigger issues at stake than the simple access price. Postcomm are about to let the genie out of the bottle with no precedent, no control and no way back. The regulator’s primary duty is to maintain a universal service at a uniform price. Dismantling the existing pricing structure isn’t the way to do it.”

Ends

Issued by Royal Mail:
148 Old Street
LONDON
EC1V 9HQ
www.royalmail.com

Note to editors

The key points in Royal Mail’s submission are as follows:

1. While Royal Mail welcomes the introduction of downstream access, Postcomm’s methodology for deriving access prices contains several major flaws:

– It is inconsistent with Article 12 of the European Postal Services Directive, which requires that access prices be set equal to a benchmark retail price minus the costs that Royal Mail avoids as a result of access.
– Postcomm’s proposed 6% pre tax return on access sales is too low and does not offer an acceptable commercial return given the risks associated with the delivery network.
– The proposals result in access prices on basic weight step items (11.46 pence) that are below Royal Mail’s minimum cost of delivery for a letter currently estimated at over 13 pence and even Postcomm’s own estimate of the minimum cost of delivery (12.7 pence for a letter) .
– Postcomm’s proposal encourages inefficient entry into the postal sector and thereby penalises retail customers.

2. Because Postcomm’s approach will set a precedent for all users, the flaws in Postcomm’s methodology for setting the access price mean that the introduction of access will substantially reduce profits for Royal Mail, for the following reasons:

– Royal Mail’s financial analysis shows that the access prices being proposed will lead to a reduction in profits for Royal Mail of up to £280 million more than if there were only bypass competition over a three year period. This is because the proposed access price creates a large gap between the retail and access prices. This gap will encourage rapid take up of downstream access by both customers and portal operators, even if they have higher costs than Royal Mail . The fact that the price does not cover Royal Mail’s costs at the basic weight step exacerbates the problem. In addition the geographically uniform access prices will trigger inefficient bypass competition by enabling competitors to deliver in urban areas only, while handing back their unprofitable costly-to-deliver mail to Royal Mail for access at a price particularly in rural areas, that is substantially below Royal Mail’s actual cost of delivery.

– Postcomm’s own published legal opinion recognises that the precedent established by Postcomm’s cost based methodology could allow existing retail customers to demand that presort (and potentially non-presort) products with margins above 6% be repriced on a cost plus basis with a 6% margin. This would potentially driving further losses of up to £370 million over a three year period.

3. Royal Mail therefore estimates that the total reduction in profit for Royal Mail will be up to £650 million over a three year period, and does not therefore accept Postcomm’s assertion that the effect of its access proposals will be “broadly neutral” on Royal Mail’s finances. Royal Mail is very disappointed that as yet Postcomm has failed to explain fully how this conclusion has been reached and on what basis and assumptions.

4. Given Postcomm’s moves to liberalise the UK postal market ahead of the rest of Europe, Royal Mail is moving towards more cost reflective pricing – for example in August 2003 it submitted to Postcomm its proposals on size based pricing . Until Royal Mail’s retail prices are allowed to become more cost reflective, Royal Mail proposes that the way to resolve the flaws in Postcomm’s proposals would be to adopt an interim avoided costs determination. This would circumvent the need to reprice presort products while Royal Mail implements further pricing reforms to increase cost reflectivity. While there are other ways in which Postcomm’s methodology could be improved (and a critique is set out below) an avoided cost pricing methodology minimises the financial risks of access and repricing.

5. Whatever access pricing methodology is adopted, additional safeguards will be required to maintain the universal service. These safeguards could include a surcharge on access to rural deliveries that compensates Royal Mail for the high cost of handling rural items and discourages inefficient urban entry that is cross subsidised by the ability of an entrant to utilise an access price below Royal Mail’s actual delivery cost to secure the delivery of rural mail.

6. Postcomm’s operational proposals contain several requirements that would be unworkable even if, contrary to Postcomm’s legal opinion, the determination applied only to UK Mail. In particular these include Revenue Protection, volume limits, quality of service targets and DO access pricing. The operational proposals also include terms that, while feasible for a single access seeker, do not form the basis for the scaleable solution necessary – for example on DO access windows, printed postage impressions on letters and allocation of access time slots.

7. Postcomm’s 98.5% next day Quality of Service target for the proposed access products is far in excess of any service target that the Royal Mail network is designed to provide for standard next day delivery of mail. The 98.5% target is inequitable and unrealistic for a service sold for as little as 11.46 pence and will result in additional costs to ensure this target is met. Time certain postal products with a next day delivery quality of service of this order are currently sold at prices of several pounds per item. The target for mail introduced via Condition 9 downstream access should be no higher than the next day delivery local-to-local target already agreed with Postwatch and Postcomm (i.e. 92.5%).

8. Royal Mail proposes in this document a scalable operational access solution that, moving forward, will meet the needs of all access users. This solution includes access at Inward Mail Centres, fees per handover point to reflect the fixed costs that Royal Mail incurs for each consignment, quality of service targets at 92.5%, and payment and indicia arrangements that would operate industry wide.

www.royalmail.com