Securing the universal postal service: The future framework for - - PowerPoint PPT Presentation

Securing the universal postal service: The future framework for economic regulation

Ed Richards, Chief Executive 20 October 2011

Media briefing

1

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

A challenging market context

• Delivered mail has fallen 25%

since 2006

• Royal Mail delivered 84m

letters a day in 2006 but 62m in 2010

• Access has grown rapidly but

RM still delivers 99% of all mail

• Mobile connections tripled

between end 1998 (13m) and end 2000 (40m)

• Broadband take-up doubled

between 2004 (6.1m connections) and 2006 (13.0m)

2

• 6.0
• 4.0
• 2.0

0.0 2.0 4.0 6.0 8.0 82/83 85/86 88/89 91/92 94/95 97/98 00/01 03/04 06/07 09/10 (% ) per annum Letter volume growth Economic growth and demographic growth

Note: Data refers to three year moving average annual growth rates Source: Economics Forecasting, Group Regulation

Royal Mail performance (Hooper Report 2010)

Royal Mail’s financial performance has suffered

• Royal Mail Letters’

revenues have declined to £6.4bn from £6.8bn in 2006

• Royal Mail reported that

the Letters business profits are erratic

• A loss of £120m last year

(allowing for exceptionals)

3

Royal Mail revenue and volume 2006/07 to 2010/11

16,000 17,000 18,000 19,000 20,000 21,000 22,000 23,000 £6100m £6200m £6300m £6400m £6500m £6600m £6700m £6800m £6900m 06-07 07-08 08-09 09-10 10-11 Revenue Volumes (m) Revenue

Volume

As volumes have declined, product mix has changed

• People have switched from First to

Second Class mail

• Businesses have switched from

Royal Mail’s retail products to competitors’ access mail

• Product mix change is responsible

for around a 10% revenue decline

• Packets and parcels growth has

not offset letters decline

4

Royal Mail product mix changes 2005/06 to 2010/11

£0m £1,000m £2,000m £3,000m £4,000m £5,000m £6,000m £7,000m £8,000m £9,000m 05-06 06-07 07-08 08-09 09-10 10-11 Other Downstream Access Presort 2c Public Tariff 1c Public Tariff

c.£3bn c.£1.5bn Revenue

Stamp prices have lagged behind inflation for nearly two decades

5 0p 5p 10p 15p 20p 25p 30p 35p 40p 45p 50p 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)

Price (pence)

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

6 37 42 45 46 46 47 52 54 54 55 55 56 60 67 69

10 20 30 40 50 60 70

SPAIN IRELAND LUXEMBOU RG NETHERLA NDS UK AUSTRIA FRANCE GERMANY FINLAND PORTUGAL BELGIUM SWEDEN GREECE DENMARK ITALY

EU-15 average 1C stamp prices up to 100g using UK volume weights, May 2011

First class stamp prices Second class stamp prices

36 37 43 44 48 50 54

10 20 30 40 50 60

UK PORTUGAL FINLAND FRANCE SWEDEN DENMARK GREECE

EU-15 average 2C stamp prices up to 100g using UK volume weights, May 2011

Pence Pence

7

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

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 prices that are charged The composition of the minimum requirements of the universal service – this is for Parliament Access to Royal Mail’s network- should it be mandated Post Offices 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

10

Regulatory regime promoting competition

Provision

• f the

USO threatened

RM

• perating in

a declining postal market RM share of the market is declining RM has a large pension deficit RM faces a challenge to modernise quickly Hooper’s findings remain valid:

• Universal service is loss-making
• Public sector owned and operated
• Market is declining

Hooper made three main proposals:

• 1. Privatisation – to bring in capital and

experience to drive modernisation

• 2. Pensions – addressing the pension

deficit by moving it to the Treasury

• 3. Regulation – moving regulatory

responsibility to Ofcom company

11

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

The UK’s universal service is set at the high end

12

Directive requirement UK Denmark Germany Spain Italy

5 day per week delivery and collection 6 day per week delivery and collection 6 days per week 6 days per week 5 days per week 6 days per week Minimum standards of service D+1 = 93% D+3 = 98.5% D+1 = 93% D+3 = 93% D+1 = 80% D+2 = 95% D+3 = 90% D+5 = 98% D+1 = 87% D+2 = 95% Priority service price comparison (pence) D+1 = 46p D+1 = 66.8p D+1 = 53.8p D+3 = 37p D+1 = 69p

D= day of posting D+X = day of arrival

... but the universal service is in real difficulty

• The universal service is currently not

financially sustainable

• Royal Mail is making a financial loss and

struggling to strip out costs from its network

• There is no appetite for continued tax

payer funded model – State aid application aims to restructure Royal Mail’s £1.7bn debt

• The evidence suggests the need for a

new approach

13

• £800m
• £600m
• £400m
• £200m

£0m £200m £400m £600m

05-06 06-07 07-08 08-09 09-10 10-11

Operating profit / net cashflow Operating profit (£m) Net Cash Flow (£m)

Royal Mail performance 2005/06 to 2010/11

Cash flow includes pension deficit payments and modernisation costs

Royal Mail is spending more than it receives

• Forecasting Royal Mail

cash flow has proved to be difficult

• Since 2006, Royal

Mail’s cash flows have been £3bn less than anticipated

14

N.B. includes annual cost of servicing pension deficit

Royal Mail’s cash flow 2006/07 to 2010/11

• £700m
• £600m
• £500m
• £400m
• £300m
• £200m
• £100m

£0m £100m 06-07 07-08 08-09 09-10 10-11 Cashflow

Royal Mail has struggled to strip out costs from a largely fixed cost network

• Since 2006 capital investment

including modernisation (but not redundancy) has been around £1.6bn

• Royal Mail must convert

expenditure and cost savings into real efficiency improvements

• The total workforce has fallen by

20,000 since 2007, but unit costs have increased

15

Royal Mail efficiency

5000 5200 5400 5600 5800 6000 6200 6400 6600 6800 7000 2005/06 2006/07 2007/08 2008/09 2009/10 Costs £m RM 1.5% Postcomm 3% RM Actual <1%

16

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

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

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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 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

• Price controls are usually applied to stop private operators from

earning excessive profits while driving efficiencies.

20

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

Our proposals are designed to ensure the universal service is sustainable

• The provision of the universal service is our fundamental concern:

– Every home will continue to benefit from the universal service at existing levels of service – The universal service and quality of service requirements in post are at least comparable to the most onerous that apply in other sectors that we regulate – UK universal service is more highly specified than in comparable EU countries - as determined by Parliament

• As designated universal service provider, Royal Mail will be obliged to meet

the universal service requirements

• We have concluded that to do so, Royal Mail needs much greater commercial

freedom, subject to key safeguards

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Our proposals are fundamentally deregulatory...

• Change from detailed licence obligations to general authorisation

model

• Removal of vast majority of retail and wholesale price controls
• Removal of direct regulation of access pricing
• Removal of the requirement for Royal Mail to maintain a guaranteed

margin for access operators; known as access headroom

• Consultation on product and service commercial freedom for Royal

Mail before the end of the year

22

Average household expenditure on postal services is very low compared to other services

23

Weekly expenditure (£) % of average weekly expenditure Telephone 10.80 2.4% Electricity 10.20 2.2% Gas 9.70 2.1% Water 6.50 1.4% TV & internet 5.90 1.3% Postal services 0.40 0.1%

Source: ONS family spending 2009 Data is from most recent ONS family spending report – electricity and gas prices are now significantly higher

But with key safeguards

• Ensuring that a basic universal service

product is affordable to all

• Effective monitoring of Royal Mail’s

performance

• Competition within the mail market

24

Safeguard 1 – Ensuring that a basic universal service product is available to all

• A safeguard price cap for Second Class stamp prices

– The product particularly relied on by vulnerable consumers – Consistent with substantial flexibility for Royal Mail

• Strikes a balance between safeguarding consumers, and ensuring the

USO is sustainable

• Consulting on a range of 45p – 55p (inflation linked)
• Possibility of reassessing in two years in light of any relevant changes

in the market and evidence on affordability

25

Safeguard 2 – Effective monitoring of Royal Mail’s performance

• We will monitor Royal Mail’s performance to

ensure that: – The universal service is restored to viability – The universal service’s quality of service

• bligations are met

– Royal Mail becomes more efficient over time and consumers share the benefits – Prices do not become unaffordable for vulnerable consumers

26

Safeguard 3 – Competition within the mail market

End-to-end

• Case-by-case consideration of any proposals for end-

to-end services

• Balancing benefits with risks to financeability of the

universal service

27

Competition can help make Royal Mail more efficient and provide choice and innovation for customers Access

• Mandating access to Royal Mail’s network to ensure established

benefits remain

• Removing headroom control for ‘margin squeeze’ test protection for

access competitors

• Digital technology increasingly offers attractive

alternatives to postal services Growth of: – Electronic invoicing and settlement – Downloading of music and films – Electronic banking

28

Market constraints - digital technology

Market constraints - stronger efficiency incentives for Royal Mail

• Government policy for Royal Mail’s privatisation
• Privatisation of Royal Mail would:

– Establish stronger efficiency incentives for Royal Mail – Inject more commercial, customer oriented business practices

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A clear opportunity to deliver a sustainable future

• The proposals would apply for a period of seven years:
• Certainty
• Stability
• Opportunity

30

Next steps – our timeline

31

October 2011 – Final proposals on a future framework for economic regulation Late 2011 – Consultation about product and service commercial freedom for Royal Mail Early 2012 – Decision about the economic framework Spring 2012 – Economic framework takes effect

A phased approach

32

Phase one: Return the universal service to viability and Royal Mail to profitability Phase two: Establish clearer incentives to improve efficiency Phase three: A sustainable universal service provided by a profitable and efficient Royal Mail in a market with choice and innovation

33

Questions?