Media briefing Securing the universal postal service: The future framework for economic regulation Ed Richards, Chief Executive 20 October 2011
Overview • Why is the universal service under threat? • Ofcom’s focus and priorities • The universal service in the UK • The regulatory model needs radical reform • Ofcom’s proposed approach 1
A challenging market context • Delivered mail has fallen 25% since 2006 Royal Mail performance (Hooper Report 2010) (% ) per annum • Royal Mail delivered 84m 8.0 letters a day in 2006 but 62m 6.0 in 2010 Economic growth and demographic growth 4.0 • Access has grown rapidly but 2.0 RM still delivers 99% of all mail 0.0 -2.0 Letter volume growth • Mobile connections tripled between end 1998 (13m) and -4.0 end 2000 (40m) -6.0 82/83 85/86 88/89 91/92 94/95 97/98 00/01 03/04 06/07 09/10 • Broadband take-up doubled Note: Data refers to three year moving average annual growth rates between 2004 (6.1m Source: Economics Forecasting, Group Regulation connections) and 2006 (13.0m) 2
Royal Mail’s financial performance has suffered Royal Mail revenue and volume 2006/07 to 2010/11 • Royal Mail Letters’ revenues have declined to £6900m 23,000 £6.4bn from £6.8bn in 2006 £6800m 22,000 £6700m 21,000 • Royal Mail reported that £6600m 20,000 Revenue the Letters business profits Volume £6500m 19,000 are erratic £6400m 18,000 £6300m 17,000 £6200m • A loss of £120m last year £6100m 16,000 (allowing for exceptionals) 06-07 07-08 08-09 09-10 10-11 Revenue Volumes (m) 3
As volumes have declined, product mix has changed • People have switched from First to Second Class mail Royal Mail product mix changes 2005/06 to 2010/11 £9,000m • Businesses have switched from £8,000m Royal Mail’s retail products to £7,000m £6,000m competitors’ access mail Revenue £5,000m c.£3bn £4,000m c.£1.5bn £3,000m • Product mix change is responsible £2,000m for around a 10% revenue decline £1,000m £0m 05-06 06-07 07-08 08-09 09-10 10-11 • Packets and parcels growth has Other Downstream Access Presort not offset letters decline 2c Public Tariff 1c Public Tariff 4
Stamp prices have lagged behind inflation for nearly two decades 50p 45p 40p 35p Price (pence) 30p 25p 20p 15p 10p 5p 0p 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 1st class stamp price 2nd class stamp price RPI (indexed to 1983 1st class price) RPI (indexed to 1983 2nd class price) 5
Prices have been low and unsustainable • Prices for products have in many cases been below cost • Until recently prices have been among the lowest in Europe, despite one of the most demanding USOs Second class stamp prices First class stamp prices EU-15 average 2C stamp prices up to 100g using EU-15 average 1C stamp prices up to 100g using UK 69 UK volume weights, May 2011 volume weights, May 2011 67 70 60 54 60 50 56 48 60 55 55 54 54 50 52 44 43 47 46 46 50 45 37 42 36 40 37 40 Pence Pence 30 30 20 20 10 10 0 0 FRANCE SWEDEN DENMARK SPAIN IRELAND LUXEMBOU NETHERLA UK AUSTRIA FRANCE GERMANY FINLAND PORTUGAL BELGIUM SWEDEN GREECE DENMARK ITALY UK PORTUGAL FINLAND GREECE NDS RG 6
Overview • Why is the universal service under threat? • Ofcom’s focus and priorities • The universal service in the UK • The regulatory model needs radical reform • Ofcom’s proposed approach 7
Ofcom’s focus and priorities • Ofcom is the independent regulator and competition authority for the UK communication industries • Since 1 October 2011 this includes post • The Postal Services Act 2011 sets Ofcom’s clear priority as securing a financially sustainable universal service • We will aim to do this by ensuring: – Clear service obligations are set for Royal Mail – Royal Mail has commercial flexibility to deal with a very challenging market environment – The regulatory regime provides real incentives for Royal Mail to improve efficiency levels 8
What we can regulate, and what we don’t We can regulate We don’t regulate Universal service products – including The composition of the minimum the prices that are charged requirements of the universal service – this is for Parliament Access to Royal Mail’s network- Post Offices should it be mandated End-to-end competition should it arise Parcelforce and GLS (Royal Mail’s European parcels operator) Quality of service Royal Mail’s pension deficit and payments 9
The circumstances are extremely challenging – as recognised by Hooper RM has a Hooper’s findings remain valid: RM share of large the market pension • Universal service is loss-making is declining deficit • Public sector owned and operated company Provision RM RM faces a • Market is declining operating in of the challenge to a declining modernise USO Hooper made three main proposals: postal quickly threatened market 1. Privatisation – to bring in capital and experience to drive modernisation 2. Pensions – addressing the pension deficit by moving it to the Treasury Regulatory regime promoting competition 3. Regulation – moving regulatory responsibility to Ofcom 10
Overview • Why is the universal service under threat? • Ofcom’s focus and priorities • The universal service in the UK • The regulatory model needs radical reform • Ofcom’s proposed approach 11
The UK’s universal service is set at the high end Directive requirement UK Denmark Germany Spain Italy 5 day per week 6 day per week delivery and delivery and 6 days per week 6 days per week 5 days per week 6 days per week collection collection Minimum D+1 = 93% D+1 = 93% D+1 = 80% D+3 = 90% D+1 = 87% standards of service D+3 = 98.5% D+3 = 93% D+2 = 95% D+5 = 98% D+2 = 95% Priority service price comparison D+1 = 46p D+1 = 66.8p D+1 = 53.8p D+3 = 37p D+1 = 69p (pence) D= day of posting D+X = day of arrival 12
... but the universal service is in real difficulty • The universal service is currently not Royal Mail performance 2005/06 to 2010/11 financially sustainable £600m • Royal Mail is making a financial loss and struggling to strip out costs from its £400m Operating profit / net cashflow network £200m £0m • There is no appetite for continued tax 05-06 06-07 07-08 08-09 09-10 10-11 -£200m payer funded model – State aid -£400m application aims to restructure Royal -£600m Mail’s £1.7bn debt Operating profit (£m) Net Cash Flow (£m) -£800m • The evidence suggests the need for a Cash flow includes pension deficit payments and new approach modernisation costs 13
Royal Mail is spending more than it receives Royal Mail’s cash flow 2006/07 to 2010/11 • Forecasting Royal Mail £100m cash flow has proved to £0m be difficult -£100m -£200m • Since 2006, Royal -£300m Mail’s cash flows have -£400m been £3bn less than -£500m anticipated -£600m -£700m 06-07 07-08 08-09 09-10 10-11 Cashflow N.B. includes annual cost of servicing pension deficit 14
Royal Mail has struggled to strip out costs from a largely fixed cost network Royal Mail efficiency • Since 2006 capital investment 7000 including modernisation (but not redundancy) has been around 6800 £1.6bn 6600 6400 • Royal Mail must convert 6200 Costs £m expenditure and cost savings 6000 into real efficiency improvements 5800 • The total workforce has fallen by RM 1.5% 5600 Postcomm 3% 20,000 since 2007, but unit costs 5400 RM Actual <1% have increased 5200 5000 2005/06 2006/07 2007/08 2008/09 2009/10 15
Overview • Why is the universal service under threat? • Ofcom’s focus and priorities • The universal service in the UK • The regulatory model needs radical reform • Ofcom’s proposed approach 16
Features of current regulation • Price control of around 85% of Royal Mail’s revenues • Direct regulation of access prices • Royal Mail’s commercial freedom to change products and prices constrained by prior notification and publication requirements 17
The regulatory settlement needs to be re-drawn The regulatory challenge: – In the short-term the universal service must be returned to a sustainable basis – Royal Mail needs to make a commercial return and become more efficient – Competition should be efficient and not undermine the universal service 18
The conventional approach to regulation is not appropriate • Price controls are usually applied to stop private operators from earning excessive profits while driving efficiencies. • Price control regulation has failed in post: – Patterns of demand are insufficiently predictable – Incentive mechanisms have not worked: efficiency improvements proved very challenging – Royal Mail were highly constrained while facing a rapidly changing market 19
Overview • Why is the universal service under threat? • Ofcom’s focus and priorities • The universal service in the UK • The regulatory model needs radical reform • Ofcom’s proposed approach 20
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