Talks to seal changes in UK postal market

Royal Mail's prospects will become clearer over the next few months as the postal market opens up to meaningful competition for the first time.

Talks between Royal Mail and its rival UK Mail will set a precedent on how much private sector operators will have to pay to use the postal network. The figure for this "access charging" will be crucial in determining how attractive the market is to new entrants.

Companies such as Deutsche Post and TPG, of the Netherlands, are keen to start delivering business mail in Britain. But Royal Mail will try to hold on to some of this lucrative trade to offset losses from its universal postal service.

Given Royal Mail's market share of more than 99 per cent in its letters business, the casual observer could be forgiven for thinking that liberalisation of the postal market had yet to start. Royal Mail also enjoys a range of special privileges, such as exemption from value added tax and immunity from parking fines, which could be barriers to competition.

However, the postal market has been slowly opening up since the passing of the 2000 Postal Services Act. Specialist parts of the market such as parcels, special delivery post and international mail are already open to competition. Royal Mail's experience of operating in these liberalised sectors has been mixed. It is, for instance, one of the biggest operators in the parcel market, with a 20 per cent share of the business, but its Parcelforce subsidiary has recorded heavy losses over the years.

At the start of last year Royal Mail's monopoly on regulated mail, weighing less than 350g, was ended by Postcomm, which aims to liberalise the postal market fully by 2007. Private companies such as UK Mail and Hays can already handle bulk business mailings of more than 4,000 letters. Rival operators have made slow progress so far, but the bulk mailing threshold is due to drop to 1,000 letters over the next few years, taking in more of the profitable business market and eating into Royal Mail's revenues.

Postcomm's efforts are part of a wider plan to create a level playing field in European postal services, spearheaded by Frits Bolkestein, the European Union's internal market commissioner. The EU has removed restrictions on all mail more than 100g, allowing private companies to move in, and this will drop to 50g in 2007.

Royal Mail has complained, however, that Postcomm is bringing in changes far faster than required by the EU, which plans to review progress in 2009 before moving to full competition. Apart from Sweden, most other EU states are behind the UK in opening up to private postal companies, Royal Mail says.

Meanwhile, Postcomm has been criticised by Royal Mail's rivals for being too slow to usher in genuine competition. Deutsche Post, for example, set up a substantial UK team last year but had to dismantle it when Royal Mail and the regulator became deadlocked over the next stage of liberalisation. But the German company, which is likely to be Royal Mail's main competitor in the medium-term, says it is ready to expand rapidly when the regulatory conditions are right.

Private postal companies are likely to choose between two models of operating in Britain. The first, the end-to-end model, is preferred by Express Dairies and TPG and covers the whole postal process, from collection to delivery. No company would try to replicate Royal Mail's network and deliver post to every address in Britian for the same price – after all, three-quarters of Royal Mail's letters business is loss-making. But these operators may choose to specialise in profitable areas, such as delivering business-to-business mail in London.

The other choice is the access model, favoured by Deutsche Post and UK Mail, where the private company collects and sorts the mail but uses Royal Mail to deliver it. This is more suitable for business-to- consumer post. Royal Mail is worried about competitors choosing this option, as it creates operational complications for the group but undercuts existing margins.

Royal Mail has been in talks with UK Mail since before Christmas about how much it will charge to deliver the private company's business mail. The terms of any eventual contract will apply also to other competitors and ultimately determine how much the access model will affect Royal Mail's finances.

Even when the market is fully liberalised, Royal Mail is still likely to be handling the bulk of post. But one official said that it was misleading to focus purely on market share. "Having a big market share of an unprofitable market is not very attractive. We need revenues to offset the costs of the universal postal service."