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
• ur 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

11,800 12,100 12,400 12,700 13,000 13,300 13,600 13,900 14,200 14,500 14,800 15,100 15,400 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

M Ii L L I O N S O F P I E C E S

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

5,000 7,500 10,000 12,500 15,000 17,500 20,000 22,500 25,000 27,500 30,000 32,500 35,000 37,500 40,000 42,500 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 M I L L I O N S O F P I E C E S 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

Robust Letter Demand Returns Letter Demand Declines Rapidly

Profitable Private PO Bloated & Inefficient GSE Sustain- able PO Sustain- able PO Lean Private PO Emerges Slowly shrinking PO Airline- style Bailout? Lingering Death & Subsidies Regulated Private Public

• r

GSE Regulated Private Public

• r

GSE

Ownership Structure No or “Weak” USO Imposed USO Imposed

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
• f 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

• r 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

20 40 60 80 100 28000 30000 32000 34000 36000 38000 40000 42000 44000 46000 Incumbent's Fixed Cost (F) Price 0.2 0.4 0.6 0.8 1 Marketshare PI Wgt PE Marketshare

Effects of Business Segment Demand

Access Pricing Method = DAP

20 40 60 80 100 2 8 3 3 2 3 4 3 6 3 8 4 4 2 4 4 4 6 Level of Demand (XB) Price 0.2 0.4 0.6 0.8 1 Marketshare PI Wgt PE Marketshare

Effects of Entrants’ Upstream Cost

Access Pricing Method = DAP

20 40 60 80 100 5 6 7 8 9 10 11 12 13 14 Entrants' Upstream Unit Cost (CEU) Price 0.2 0.4 0.6 0.8 1 Marketshare PI Wgt PE Marketshare

Loyalty and Switching Costs

Case: Loyal to Incumbent Zone k 1 3 5 7 9 L(k) 1.11 1.16 1.22 1.28 1.35 PI 63.8 63.8 63.8 63.8 63.8 PE(k) 24.6 40.3 49.3 65.0 92.1 Case: Less Loyal to Incumbent Zone k 1 3 5 7 9 L(k) 0.91 0.94 0.98 1.02 1.06 PI 72.8 72.8 72.8 72.8 72.8 PE(k) 24.6 40.3 49.3 65.0 100.8

Interdependencies: Complexities

Graveyard Spiral Value of F as a Function

• f Entrants' Markup

20000 40000 60000 80000 100000 0.1 0.2 0.3 0.4 0.5 0.6 Entrants' Markup Fixed Cost Y1 (Full Liberalization) Y2 (Base Case)

“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?