Entry and the USO in the Postal Sector ACCC 2004 Regulatory - PowerPoint PPT Presentation

Entry and the USO in the Postal Sector ACCC 2004 Regulatory Conference July 29-30, 2004 Sea World Nara Resort Gold Coast, Australia Paul R. Kleindorfer Kleindorfer@wharton.upenn.edu

Summary* • Changes and Challenges: Special Focus on U. S. Postal Service • Recent Research on Entry and the USO • *Based on joint research with Michael Crew. See our several edited books from Kluwer Academic Press on Postal and Delivery Economics. These books are, in turn, based on the contributions of postal economists from around the world.

State of the USPS • Cash flow and Value adding Prospects poor for USPS – Current situation fairly stable – Continuing electronic competition evident; letter mail growth has stopped; no competitive presence in parcels market – Continuing low productivity growth; Labor inflexibility, investment in automation, and new product development – Little or no control of Labor Cost (75% of Total Cost) – September 11, 2001 and Anthrax exacerbated situation

Trends in 4-Quarter Moving Average in Single Piece Letters and Card Volumes 1972-2005 15,400 15,100 14,800 M 14,500 Ii L 14,200 L I 13,900 O N S 13,600 O 13,300 F 13,000 P I 12,700 E C E 12,400 S 12,100 11,800 72-4 73-4 74-4 75-477-477-478-479-480-481-482-483-484-485-486-487-488-489-4 90-4 91-492-493-494-495-496-497-498-499-400-401-402-403-404-4 Fiscal Year - Quarter Single Piece Letters and Cards Polynomial Fit Source: Alan Robinson (2003)

4-Quarter Moving Average of All Mail Except Single-Piece First Class 1972-2005 42,500 40,000 37,500 M I 35,000 L 32,500 L I 30,000 O N 27,500 S 25,000 O 22,500 F 20,000 P I 17,500 E 15,000 C E 12,500 S 10,000 7,500 5,000 72-4 73-4 74-4 75-4 77-477-478-479-480-481-482-483-484-485-486-487-488-489-490-4 91-4 92-493-494-495-496-497-498-499-400-401-402-403-404-4 Fiscal Year - Quarter All Mail Except First Class Single Piece Poly.nomial (All Mail Except First Class Single Piece) Linear (All Mail Except First Class Single Piece) Source: Alan Robinson (2003)

Possible Scenarios & States USO No or “Weak” Imposed USO Imposed Public Regulated Public Regulated Ownership Private or Private or Structure GSE GSE Lingering Airline- Slowly Lean Letter Demand style shrinking Private PO Declines Death & Bailout? PO Emerges Subsidies Rapidly Robust Letter Sustain- Sustain- Bloated & Profitable able PO able PO Private PO Inefficient Demand Returns GSE

Entry & the USO: Two Camps • Camp 1: Stresses the dangers of competitive entry for financial viability – the graveyard spiral (GYS) • Camp 2: Stresses the efficiency benefits of entry as overwhelming and sees the PO’s surviving because of scale, scope, ubiquity and other advantages – Sweden and New Zealand

USO Drives Debate on Entry • Reserved area provides protection to allow cross subsidy involved in ubiquity and uniformity obligations • Both camps seem to agree on continued USO • Disagreement on need for reserved area and likelihood of GYS

Graveyard Spiral (GYS) • Dynamic Process • Entry allowed • Entrants take most profitable business • Uniform price raised • Previously unprofitable traffic now profitable, attracts more entry • Increase in the uniform price again fails to raise sufficient revenue to break even • More iterations, no break even, financial collapse of the PO.

Ways of Avoiding GYS • Reduce USO • Limit the extent of liberalization – Entry policy – Access policy • Increase price flexibility for Incumbent PO • Promote greater product variety/innovation • Related Issues: Contestability and Loyalty – Camp Cohen – Camp d’Alcantara

Need for Changed Thinking • “Competitive” not “Monopoly” thinking now required • Entrants and PO compete for customers and not routes • Traditional route profitability curves not meaningful under entry • Unlike airlines, customers and not routes are lost, partly because of USO

Initial Route Profitability Curve: ABC Post Entry Route Profitability Curve A’B’C’

Impact of Entry on Route Profitability • Unclear (depends on customer dynamics) • Formerly most profitable routes may become unprofitable • Routes with greatest losses likely to lose less • Post-Entry Profitability Curve likely to be flatter than Pre-Entry Curve

Competitive Scenarios • PO Charges Single-Piece Rate Only • PO Offers Presort and Possibly Quantity Discounts but no Downstream Access Rates • PO Offers Discounts plus Downstream Access Rates

Approach Taken in Many Papers • Model is Proposed and Calibrated to a Particular Country Setting • Simulations are used to explore base case and sensitivities to Demand and Cost Parameters • Effects on Welfare and GYS under various Entry and Access Pricing Policies are Explored

A Typical Model* • Contestability/Loyalty – Business contestable – Residential not contestable • Demand growth (decline) • Fixed costs drive USO & Entrant Pricing • Upstream and Downstream Costs for I and E • Route structure – 10 zones distinguished by delivery cost – Entrants have advantage in low-cost areas – PO has advantage in high-cost areas • Welfare/Feasibility Analysis of Policy Options *M. A. Crew and P. R. Kleindorfer, “Competition, Universal Service and the Graveyard Spiral”, to appear in M. A. Crew and P. R. Kleindorfer (eds), Regulatory and Economic Changes in the Postal and Delivery Sector , Kluwer Academic Publishers, Boston, 2005. Paper presented at the XII International Conference on Postal and Delivery Economics, Cork, Ireland.

Policy Issues • To Liberalize or Not – Base Case: Only Upstream/Worksharing with all deliveries accomplished by Incumbent – Liberalization: Entrants can either deliver end-to-end or utilize I’s network for delivery at given access costs • Access Pricing Regimes – Avoided Cost/ECPR – DAP-Limited Info (more efficient) – DAP-Full Info (utilizes information on Entrant’s Costs) • Considered Implicitly: Redefinition of USO, Incentives and Regulation affecting Productivity, Product and Pricing Flexibility, etc….

Results on I’s Fixed USO Costs Access Pricing Method = DAP 100 1 80 0.8 Marketshare PI 60 0.6 Price Wgt PE 40 0.4 Marketshare 20 0.2 0 0 28000 30000 32000 34000 36000 38000 40000 42000 44000 46000 Incumbent's Fixed Cost (F)

Effects of Business Segment Demand Access Pricing Method = DAP 100 1 80 0.8 Marketshare PI 60 0.6 Price Wgt PE 40 0.4 Marketshare 20 0.2 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 8 0 2 4 6 8 0 2 4 6 2 3 3 3 3 3 4 4 4 4 Level of Demand (XB)

Effects of Entrants’ Upstream Cost Access Pricing Method = DAP 100 1 80 0.8 Marketshare PI 60 0.6 Price Wgt PE 40 0.4 Marketshare 20 0.2 0 0 5 6 7 8 9 10 11 12 13 14 Entrants' Upstream Unit Cost (CEU)

Loyalty and Switching Costs Case: Loyal to Incumbent Zone k 1 3 5 7 9 1.11 1.16 1.22 1.28 1.35 L(k) 63.8 63.8 63.8 63.8 63.8 P I 24.6 40.3 49.3 65.0 92.1 P E (k) Case: Less Loyal to Incumbent Zone k 1 3 5 7 9 0.91 0.94 0.98 1.02 1.06 L(k) 72.8 72.8 72.8 72.8 72.8 P I 24.6 40.3 49.3 65.0 100.8 P E (k)

Interdependencies: Complexities Graveyard Spiral Value of F as a Function of Entrants' Markup 100000 80000 Fixed Cost Y1 (Full 60000 Liberalization) Y2 (Base Case) 40000 20000 0 0 0.1 0.2 0.3 0.4 0.5 0.6 Entrants' Markup

“Conclusions” on USO/GYS 1. GYS more likely under complete freedom of entry; different countries will face different scenarios 2. Access and access pricing will be important 3. The factors driving a GYS are both intuitive (cost and demand drivers) as well as complex, especially in the interdependencies across these factors and cost economies (e.g. scale economies in delivery) 4. GYS likely manifestation through emerging long- term losses, not a one-shot affair 5. Cautious policy implied. Look before you leap! Big Question: Are the likely gains worth the effort?