House of Commons - Public Accounts

Select Committee on Public Accounts Thirty-First Report

POSTCOMM: OPENING THE POST

POSTCOMM'S PROPOSALS FOR THE INTRODUCTION OF COMPETITION

16 Postcomm's primary duty is to ensure the continued provision of the universal service at a uniform price. One of their further duties is to exercise their functions in a manner best calculated to further the interests of postal users, wherever appropriate by promoting effective competition. The Comptroller and Auditor General's Report set out the risks to Postcomm's ability to meet these duties. The main risks to the introduction of effective competition are that there may be insufficient competition to generate an improved service to most customers, and that the introduction of competition could result in a breakdown of a universal service at a reasonable uniform tariff.[27] In the light of these risks, we considered Postcomm's proposals for the introduction of competition published on 31 January 2002. These proposals involved a significant increase in the area of the postal market open to competition, including a full liberalisation from April 2002 for bulk mailings of more than 4,000 items. Their proposals envisage a phased introduction of competition:

— from 1 April 2004 to 31 March 2006: A further liberalisation of bulk mail, involving bulk mailings of over 1,500 items.

— after 31 March 2006, all restrictions on market entry would be abolished.[28]

17 These proposals differ from the European Commission's proposals for liberalisation of mail markets within the European Union. In October 2001, European Union Ministers agreed to start liberalisation across the European Union from 2003. Under these proposals, which have now been submitted to the European Parliament, Member States would have to open up to competition:

— from 2006, letters weighing more than 50 grams or costing more than two and a half times the price of a standard letter.[29]

18 Consignia told us that it was content with the timetable and type of liberalisation proposed by the European Union, which in its view had the benefit of being a fairly clear change, with a fairly clear effect on the company. By contrast Postcomm's proposals were, in Consignia's view, more difficult to model, had not been tried elsewhere in the world and would be difficult to reverse. Furthermore, the company said, they would lead to greater access to the United Kingdom market for some of Consignia's key competitors, who include subsidiaries of the privatised Dutch and German post offices, than Consignia would have to those competitors' home markets.[30]

19 In Postcomm's view, Consignia's current monopoly was not working well, a view which the evidence suggests and which we share. They considered that competition represented the best tool available for the improving the company's efficiency, and we agree in principle. In drawing up their proposals for competition, Postcomm had analysed the risk identified in the Comptroller and Auditor General's Report that the introduction of competition could result in a breakdown in the delivery of a universal service at a reasonable uniform price. They told us that their proposals successfully avoided this risk for three reasons.[31]

20 Firstly, Postcomm told us that in their view competition would come in quite slowly. Consignia delivered 80 million items each night and no competitor could take a significant share of that volume quickly. They considered that Consignia had significant advantages over potential competitors, especially its provision of a universal service, which represented a very significant asset and benefit. In Postcomm's view, any incoming operator would have to deliver everywhere in the country to take significant levels of business from Consignia. This was because, in their view, large mail users would prefer to avoid having to segregate mail between that to be delivered by Consignia (who can deliver everywhere) and that to be delivered by a competitor (who may only deliver in parts of the country).[32]

21 Postcomm's view that "cherry picking" - when competitors take only the most profitable business from an incumbent, leaving the incumbent with low margin and loss-making business - is unlikely rests on their analysis of the nature of mail flows in the United Kingdom. The net flow of mail is from large business users of mail services, who originate 86 per cent of all mail, to domestic consumers, who receive 67 per cent of mail (see Figure 3). Postcomm therefore considered that most large customers - for example banks and utilities - would wish to contract with a postal operator capable of delivering to all of their customers throughout the United Kingdom.[33]

Figure 3: Mail flows in the United Kingdom

National Audit Office, Opening the Post: Postcomm and postal service - the risks and opportunities (HC 521, Session 2001-02), Figure 4

22 We asked Postcomm whether competitors could simply put a stamp on mail for more remote addresses or costly types of mail (such as non-machine readable mail) for Consignia to deliver, while making lower cost deliveries themselves. They told us that they did not consider that this would represent an intolerable burden for Consignia, given the small net cost of providing universal service at present. On the other hand, Consignia said that it would be entirely possible for competitors to Consignia to utilise technology to segregate bulk mailings (from banks, financial institutions, utilities and so on) into two streams: one which they would deliver themselves, and the other which they would pass to Consignia to deliver. Consignia added that competitors would not seek to compete head on with Consignia, but rather to identify those routes (for example London to Birmingham) on which they could get the most traffic for the least cost.[34]

23 Secondly, Postcomm told us that they had concluded from their examination of international experience that the introduction of competition did not lead to significant loss of market share for the incumbent postal operator. Postcomm considered that the experience in Sweden, which had removed the incumbent's monopoly entirely, supported their arguments in favour of liberalisation. But Postcomm acknowledged that the Swedish postal operator had recently dipped into loss, its prices had risen and a quarter of its workforce had lost their jobs.[35] Consignia confirmed that in Sweden, while prices for computer addressed mail had fallen by 43 per cent, prices for mail posted by households ("consumer mail") had increased substantially. Consignia said that those countries where full competition had been introduced - New Zealand, Finland and Sweden - were small in postal terms, and were not good examples for a country like the United Kingdom.[36]

24 Thirdly, Postcomm rejected the view that the provision of universal service represented a costly burden for Consignia. Their own analysis showed that the net cost to Consignia of providing a universal service was £81 million a year,[37] and that the most significant element within this cost was not geography (such as deliveries to rural or deep rural areas) but whether mail was capable of being read by automatic sorting machines, with non-machine readable mail representing the most significant element of cost within the provision of universal service.[38] Consignia subsequently supplied us with figures for the differential unit costs of rural and urban mail deliveries which stated that the cost of delivery alone (that is, excluding collection, sorting and transport costs) is 29 pence in rural areas and 4 pence in urban areas.[39] Since 86 per cent of mail is sent by businesses, it is clear that they and not the public are the main beneficiaries of the cross subsidisation of the rural delivery.

25 Postcomm have supplemented their analysis by commissioning Andersen to assess the potential impact of competition on Consignia's financial position. Andersen constructed a Base Case for Consignia's financial performance for each of four scenarios for market opening, (no further liberalisation; the European Commission's proposals; full liberalisation from April 2002; and Postcomm's current proposals) and also conducted sensitivity analyses for each. Their main conclusions were that the nature of competitive entry has a material effect on liberalisation results, but that Consignia could face bigger challenges than liberalisation if it failed to improve efficiency.[40] Consignia told us that it had some concerns about the financial modelling conducted by Andersen. The company said it had adopted a different approach to the modelling of universal service which examined the extent to which it would lose the profitable parts of its business once competition is introduced. This modelling approach produced an estimated loss in profits of up to £750 million based on a comparison of the company's profits before and after liberalisation.[41]

26 The differing conclusions drawn by Postcomm and Consignia arise from very different approaches and assumptions. For example, Postcomm and Consignia do not agree on the percentage of Consignia's mail revenues that would be exposed to competition under the first stage of Postcomm's proposals: Postcomm say 30 per cent and Consignia say 40 per cent. Consignia told us that Postcomm had arrived at their figure from information supplied by Consignia for other purposes, but after Consignia published their proposals Consignia reviewed what the figures should have been and came up with the higher figure.[42] Postcomm also told us that they had been consistently sceptical about Consignia's assumption that the ratio of fixed to variable costs was 40 per cent, given that facing up to the burden of a fixed cost base was a crucial part of any competitive organisation.[43]

27 Part of the explanation for these conflicting estimates and conclusions may be the management information available to Consignia. For example, Consignia told us that it did not know the differential unit costs between rural and urban services. The company told us that its systems were suitable for a state-owned monopoly, but that Postcomm wanted information in a quite different way. It was, however, in the process of developing systems to enable it to estimate the costs of sending specific items of mail from one location to another. Postcomm agreed, saying that one of the problems they had faced was that in many areas, Consignia did not have costing information, in particular on attributing costs to income streams. We find it alarming that in so many areas not only is there disagreement on the right way forward between Consignia and Postcomm, but they do not even agree on the facts underlying their business assumptions. There is in our view potential for wrong decisions to be taken, with disastrous results.[44]

28 At the time of the Comptroller and Auditor General's Report, while Postcomm's staff had considerable experience of economic regulation, none had direct experience of the postal business. We asked Postcomm about the level of knowledge of the postal industry among their staff. They told us that as a result of visits to postal facilities, and meetings with management, staff and unions, they had built up a good knowledge of the business.[45]

27 C&AG's Report, para 14 Back

28 Postcomm, Proposals for Promoting Effective Competition in UK Postal Services, 31 January 2002 Back

29 Letter from Consignia to Members of Parliament, 6 February 2002 (not printed here) Back

30 Qs 183-184, 445, 196-197 Back

31 Ev 53, Appendix 3, para 3a); Q1 Back

32 Qs 4, 172, 65, 77, 81 Back

33 Qs 65, 77 Back

34 Qs 172-176, 326, 448 Back

35 Ev, Appendix 3, Annex A; Qs 97-100 Back

36 Qs 309, 344 Back

37 C&AG's Report, paras 2.22-2.25 Back

38 Qs 64, 81 Back