House of Commons - Trade and Industry

Select Committee on Trade and Industry Second Report

2 Full liberalisation of the UK postal services market

8. Under the requirements of the EU Postal Services Directive, the UK postal services market has been open to partial competition for the last three years.[10] The Directive requires that all mail over 50g in weight should be open to competition as of 1 January 2006. Following consultation in 2005, Postcomm decided to fully liberalise the UK postal services market, including all mail under 50g in weight, from this date,[11] three years earlier than laid down by the Directive.[12]

9. When we asked our witnesses about the current access arrangements, none thought the current arrangements were unfair believing them to be a commercial agreement between Royal Mail and one of its competitors. Mr Crozier, Chief Executive of Royal Mail, told us that "the market has opened up a great deal further than the regulator expected and has been very successful both for end customers, competitors entering and, indeed, the Royal Mail as it stands today, so I think 'so far so good'".[13] Mr Moriarty, Director of Competition and Regulation at Postcomm, told us that "it means that customers can get new services with new operators, they will collect the mail, they will transfer the mail and then they will hand it over to the postman for the last mile, at a profit to Royal Mail. If competition comes along in that form, I think we can have a vibrant competitive market but also a safe universal service".[14]

10. Royal Mail currently retains over 99 percent market share of the UK postal services market. This led Postwatch to suggest to us that "at present, effective competition is far from a reality".[15] It told us that Royal Mail had the market power of an incumbent monopolist and that there were currently barriers to entry which were high enough to prevent new operators from establishing effective competition. Without the proposed full liberalisation of the market, Postwatch suggested that it was unlikely that the competitors' share of the upstream postal services market would exceed three to five percent over the next five years; downstream, through access agreements, it would continue to remain around one percent.[16]

11. Postcomm told us that opening up the remainder of the UK postal services market at this time would increase competition by giving new operators who wished to offer a full end-to-end service to all mailers, not just the largest, the opportunity to do so: "full liberalisation should extend the benefits of competition to more customers and further maintain the incentives on Royal Mail to improve its quality of service performance and customer focus".[17]

12. Most of our witnesses (most notably Royal Mail) agreed with Postcomm that the full liberalisation of the UK postal service market was desirable.[18] However, one area of contention which was highlighted by our witnesses was the pace at which Postcomm had decided to open the market, relative to the rest of the EU.

Timing of liberalisationTable 1: Experience of market opening in Europe (selected countries)

Experience Full Market Opening

UK From 2003 licensed operators able to offer "end-to-end" services to customers mailing over 4,000 items. In 2004 Royal Mail agreed the price for licensed operators offering consolidation services. 1 January 2006

Sweden Competition has emerged in relation to pre-sorted mail (Citymail - 3 day service) and small niche operators (many ex-Sweden post). Already fully open—1993

Finland Licensing regime is main stumbling block to development of competition. E-substitution is main competition to mail services. Already fully open—1994

Netherlands Direct mail market has been open since 1990s. Sandd (5% of market) and Selekt Mail (3%) are main competitors in addressed bulk mail. 2007

Germany Competition in relation to "high quality" services (eg timed delivery) and now consolidation. 2007

Norway (EEA country) Competition in unaddressed mail (Norpost) I day a week 2007

Slovakia Competition in unaddressed mail. 2007

Denmark Moved to 50 grams in January 2005—a year ahead of EU requirement

Spain Competition has existed in local intra-city mail since late 1960s.

Estonia Competition in direct mail. Already fully open

Source: Appendix 15, Annex C. From 2004 WiK and Ecorys studies for European Commission on European postal market

13. Table 1 above shows the current position of postal services market liberalisation in some European states. According to the information provided to us by Postcomm, the Swedish and Finnish postal markets have been fully open to competition since the early 1990s,[19] while Estonia has no reserved areas.[20] A number of other EU Member States have moved to open all or part of their markets to competition, or have announced plans to do so. Postcomm told us that the Netherlands, which had what was widely regarded as one of the most efficient postal services operators (TPG Post), had faced competition in direct mail for some years.[21] Further, Germany, the Netherlands, Slovakia and Norway had all committed to market opening ahead of the 2009 target.[22]

14. Both Intellect and Postwatch[23] told us that they fully agreed with Postcomm's decision on the timing of full liberalisation: "Intellect support Postcomm's move to open the market in January 2006, ahead of the rest of Europe"[24] and "Postwatch has consistently supported opening up the postal service market to competition and fully supports Postcomm's decision to proceed with full market opening on the 1st January 2006".[25] Royal Mail also told us that they 'welcomed' Postcomm's decision to 'go early'.[26]

15. The Mail Competition Forum (MCF) told us that it believed throughout the liberalisation process, Postcomm had moved from "stage to stage only after the most careful and thorough study, consultation and evaluation, and with self evident concern to ensure that both key elements of its remit were fully respected".[27] Although, perhaps understandably as the main beneficiaries of the move towards full liberalisation in the UK, it also suggested "from our members' perspective, this process, however necessary, has been excruciatingly slow at times".[28]

16. The Direct Marketing Association (DMA) told us that it believed there was a "very strong likelihood that this date [for EU-wide liberalisation] would be a great deal later [than 2009], probably 2012".[29] They told us that both the Netherlands and Germany had set their market opening dates, conditional on the UK's opening of its market.[30] With neither country having set a specific date for full liberalisation, the CWU told us that they believed this suggested that there was no guarantee that these countries would open their markets in the near future[31] and criticised Postcomm's "rush to liberalisation [which] will place significant additional pressures on Royal Mail at a time when it is only now beginning to recover from a period of severe financial difficulty".[32] The CWU thought early liberalisation would place Royal Mail at a considerable disadvantage in comparison to the majority of other large postal services operators in the EU.[33]

17. The MCF agreed with the DMA but suggested to us that it believed the accusations that Postcomm was opening the UK market in advance of the rest of Europe might be designed to produce an emotive impact, but that they fell "some way short of reflecting reality".[34] However, it accepted that an EU Directive requiring all Member States to move to liberalise their markets by a certain date might be some way off and full liberalisation would be resisted until Member States were obliged by the EU to do so.[35]

18. Although the DMA believed that liberalisation was unlikely to happen in other EU Member States in the near future they were still in favour of the liberalisation of the UK postal services market on 1 January 2006. They told us that if Postcomm waited for liberalisation elsewhere in the EU, UK customers would suffer. The DMA also suggested that the continued absence of choice, price pressure and innovation in other markets would lead many users to switch to other media.[36] Competition could "only thrive in an open market with all the market and its associated volumes open. Therefore opening up the market early ensures the postal services market thrives, competition can thrive, and users can be given real choice, quality and downward pressure on prices and Royal Mail benefit from a strong market and competitive pressures".[37]

19. We asked the DTI what efforts the Government was making to secure full liberalisation across all 25 EU Member States. The Minister told us:

20. Mr Allan Leighton, Chairman of Royal Mail, told us that "either way there is no point complaining about it [Postcomm's decision on the timing of full liberalisation], it is a fact of life, and the fact of life is that the way it has been set up is that we have to give access to our network"; early full liberalisation "gives the competition a start, it is the easy place to start".[39]

21. The evidence that liberalisation delivers an improved service for customers is compelling. However, we regard Postcomm's choice of dates for the move to full liberalisation in the UK postal services market to be an untimely one—not because we believe that Royal Mail will be unfairly disadvantaged against other operators, as we have faith in the competitive strength of the Royal Mail, but because Royal Mail has also been asked to prepare for competition at a time of great commercial uncertainty. Postcomm is reviewing the price Royal Mail can charge for its regulated services and the company also faces huge challenges in addressing its pensions deficit and investment needs, both of which we turn to later. Although the review process is now nearing conclusion, we believe that the difficulties for Royal Mail have already been caused.

22. An increasing number of EU Member States are committing to full liberalisation before 2009. The DTI told us that the "Government continues to press for full liberalisation across Europe to happen as soon as possible".[40] We strongly support the Government in this approach and we recommend that they continue to push this point to provide Royal Mail with the level playing field it requires.

The advantages of a liberalised postal services market

23. To understand why Postcomm had pushed for full liberalisation in the UK ahead of the rest of the EU, we asked our witnesses what they believed would be the main benefits for the UK of a fully liberalised postal services market. The main benefits suggested by our witnesses were improved innovation and customer choice, better quality of customer service and a more efficient Royal Mail.[41]

INNOVATION AND CHOICE

24. Postcomm told us that the introduction of limited competition had already begun to benefit users in large parts of the UK postal services market. By offering different products and 'add-ons' such as 'track and trace', new operators had brought about a greater range of choices for customers.[42] New operators had also begun innovating, introducing new services such as UK Mail's "two-day, time-certain product"[43] with Royal Mail providing the final mile delivery; overnight services with early morning delivery to business addresses throughout mainland UK; and secure deliveries to both business and residential addresses of sensitive documents such as passports and credit cards.[44]

25. Royal Mail had responded to new competitors and products by developing a new product range of its own which would be "better aligned with customers' needs"[45] and which it would introduce on a phased basis, from 2006.[46] Changes in their customers' demands and technological advances over the last fifteen years had left Royal Mail behind its competitors as it struggled with an operationally inefficient business and a poorly performing product set.[47] It now faced a major challenge in redesigning its entire product portfolio in order to address the rapidly evolving needs of its customers.[48] Royal Mail told us that its new product range would cover every major product category as well as the innovation process itself:

The earliest type of products Royal Mail had introduced included 'Easy to do Business With' and 'Order to Cash'.[50] Postcomm maintained contact with many of the major mail users, the vast majority of whom, they told us, had acknowledged the benefits of more choice and felt Royal Mail had become more responsive to their needs.[51]

26. Intellect told us that the introduction of limited innovation in the postal services market was fundamental to support change and the postal technology sector needed to be engaged with Royal Mail.[52] Intellect also said that they believed full liberalisation would drive up the choice of services for customers and stimulate innovation in serving customer needs. A fully liberalised postal services market would provide customers with "a business environment that would lead them to seek new products and services from providers".[53] This was in contrast with the current market where they believed Royal Mail's customers were conditioned to a 'take it or leave it' approach to the business.[54]

IMPROVED QUALITY OF SERVICE AND ROYAL MAIL EFFICIENCY

27. Postcomm told us that the Royal Mail had responded to increased competition by becoming more efficient and flexible and was set to continue this process following full liberalisation.[55] Royal Mail currently had at least 15 quality of service targets, which were originally agreed between Postcomm and the Royal Mail in 2001, and were conditions in Royal Mail's licence. The targets covered Royal Mail's key postal service products such as first and second class stamped mail.[56] Appendix 16 shows Royal Mail's historic quality of service performance targets and results for the financial years 2001/02 to 2004/05.[57]

28. The CWU told us that recent months had seen a marked improvement in the overall quality of service provided by Royal Mail. While in 2004/05 there was only a relatively modest improvement in the number of products which achieved their cumulative annual performance targets compared to the previous year (in 2004/05 four products out of 15 reached or exceeded their full year targets) recent figures had provided stronger evidence of improvements. First quarter figures for 2005/06 showed that nine of the 15 service target levels had been exceeded—including those for first and second class letters and for a number of 'key' business mail products.[58] Postcomm expected this improvement to continue as liberalisation increased the incentives for Royal Mail to make service quality a priority which, they considered, for many people was more important than price. [59]

29. The CWU did not, however, believe that the quality of service improvements provided evidence of the positive effects of competition is contrary to "the simplistic argument which some interested parties have attempted to promote" and they added: "instead we believe that Royal Mail has had a degree of success in addressing some of the short term issues relating to quality of service, in spite of (rather than as a result of) the additional pressures which are being brought to bear by Postcomm's liberalisation agenda".[60]

30. The DMA told us that opening up the UK market further would have a profound effect on quality of service.[61] New competitors already focussed on quality of service as one of the key features which needed to be delivered to customers. Because of this, it believed that Royal Mail had raised its standards in order to compete: "as the majority of existing competitive mail goes through downstream access, this has had a beneficial effect on Royal Mail, as they try to improve their quality of service. The overall competitive pressure on Royal Mail has led to a refocus on improving their quality of service".[62] The DMA suggested that fully liberalising the UK postal services market would lead to further improvement of quality of service as Royal Mail, and its competitors, reacted to new customer demand.[63]

31. The Mail Users' Association (MUA) told us that the benefits competition would bring to the marketplace would act as a catalyst for increased quality of service. Its members stood by this position, believing its basic principle was now beginning to come to fruition. As a direct result of Postcomm's liberalisation timetable, mounting competitive pressure had driven Royal Mail to 'gear up' to become more efficient and customer-focussed, and as a consequence "quality of service has been pushed to the top of Royal Mail's agenda".[64]

32. The Federation of Small Businesses (FSB) told us that they considered the liberalisation of the postal services market would improve the quality of postal services which Small and Medium-sized Enterprises (SMEs) experienced in the UK: "historically, SMEs have not been able to benefit from Royal Mail's best value business services because they are only available to larger businesses. The majority of SMEs do not send enough mail to benefit from a lot of the bulk mail schemes (e.g.: Mailsort, Walksort, Presstream). SMEs have to pay to be able to collect their post before 8am. There is no evidence of mitigation benefits for SMEs under the new pricing in proportion scheme".[65] The FSB used the example of New Zealand to suggest how the UK's postal market should be allowed to develop to the benefit of SMEs. Although only seven percent of the New Zealand market had been opened up to competition, this had led to specialist small business suppliers and the creation of niche markets in certain areas, meaning postal supplies to the rural areas had not been compromised and the SME community was now getting 'better' deals from its postal service.[66]

33. Postcomm provided us with evidence which agreed with this. They told us that while new competitors had so far targeted only large business customers, who pre-sorted the majority of their mail, new competitors were beginning to target SMEs. Investment in sorting technology by some new operators had meant that they were beginning to offer new services to SME business mailers.[67]

34. Given that Royal Mail was required by Postcomm, as part of its licence, to publish its performance against targets decided by Postcomm, we were interested in finding out if our witnesses believed it would be beneficial for consumers to have access to similar performance information for Royal Mail's competitors, and who should collate such information.

35. Postwatch believes it is vital that "Royal Mail's quality of service measurement engenders consumer confidence. Unfortunately this is not currently the case".[68] Users had told Postwatch that they were not satisfied that the current 'end-to-end' target measurement surveys were sufficiently independent of Royal Mail. Leaving performance measurement in the hands of Royal Mail also threatened to undermine new entrants' confidence in the market and was detrimental to the development of competition. Postwatch told us that it had already recommended to Postcomm that responsibility for commissioning the performance measurement be removed from Royal Mail and passed to an independent body.[69] Postwatch did not think it was appropriate to impose such targets on Royal Mail's competitors when they did not have 'significant market power'.[70] However, robust and reliable information on the performance of licensed competitors was necessary to allow customers to make informed decisions.[71]

36. We asked our other witnesses what they thought about all postal service licensees having to publish performance targets. Dr Doherty, Policy Manager at Postwatch, told us that:

37. Ms Chambers, Chief Executive of Postcomm, told us that:

38. The views of Postwatch and Postcomm were echoed by Mr Sibbick, Director of Regulatory Affairs at the MCF, "we are discussing this still with Postcomm and Postwatch, but it is likely to be based around the services that we say we provide and how well we actually perform against what we have said we will do."[74]

39. Postcomm already informally collects evidence of quality of service targets, and performance against those targets, for each EU national postal operator.[75] We believe that this information should form the basis of a formal set of EU-wide statistics which should be produced in an independent, consistent and robust manner.

40. Few of our witnesses disputed that the arrival of liberalisation had served as a catalyst to drive through positive changes in Royal Mail. These changes have benefited users, the Royal Mail and shareholder, the Government, alike. We are aware that data on Royal Mail's quality of service are already published and that Postwatch and Postcomm have started discussions with other licensees to ensure that similar data for them is published. We recommend that comparable quality of service and complaints data should be published to inform users of the comparative merits of all postal service operators in the UK.

41. We believe that Postcomm has to remain vigilant that the quality of such statistics is not compromised by the licensee that provides them. One way this could be achieved would be to require new operators to have their quality statistics independently audited by an appropriate body, such as Postcomm or the Office of Fair Trading, to be decided by the Secretary of State.

The advantages Royal Mail will retain

42. Postcomm told us that their experience from other utilities and postal markets abroad showed that the established national operator, in this case Royal Mail, would remain in a dominant position following full market liberalisation because Royal Mail would retain advantages that acted as barriers to entry.[76] We wanted to know a little more about these barriers and asked our witnesses what advantages they believed Royal Mail would retain following full liberalisation.

ROYAL MAIL'S VAT EXEMPTION

43. The main advantage our witnesses suggested Royal Mail would retain following full liberalisation was its exemption from paying VAT.[77] Under this, Royal Mail does not add 17.5 percent VAT to the prices it charges its customers, whereas Royal Mail's competitors are obliged to do so.[78] In the past, this has enabled Royal Mail to price competitors out of some types of business and in some cases this has forced some customers into using Royal Mail even when competitors were willing to provide a similar service.[79]

44. The Association of International Courier and Express Services (AICES) told us that a universal service provider, which could provide services that were VAT exempt, had a competitive advantage over service providers that were not VAT exempt.[80] Royal Mail's competitors, would "need to offer prices which are at least 17.5% cheaper than those charged by Royal Mail if they are to be able to start to compete on price, when targeting VAT exempt customers".[81] Competitors had "an almost insurmountable hurdle to overcome if they are to access these sectors".[82] Royal Mail told us that: "The VAT thing is very interesting because it is not quite all that it seems because if you are a business and you charge VAT you can claim VAT back. It is not exactly as it seems. There are one or two customers who you know do not pay any VAT so there is an issue on the back of that".[83]

45. To find out more about the impact of removing Royal Mail's VAT exemption, we asked Postcomm, the MCF and the DTI for an explanation of the impact on the UK postal services market if VAT were introduced at 17.5 percent and a reduced rate of five percent.

46. Postcomm told us that it did not think that VAT exemption was required for the provision of the universal service, and it would continue to distort competition significantly:

A number of the VAT exempt institutions, including banks, financial institutions and some charities, had told Postcomm that they were discouraged from switching provider due to the fact that alternative providers had to charge the full 17.5 percent VAT rate, which they would not be able to reclaim.[85]

47. Postcomm also told us that :

Postcomm would support a reduced rate of five percent being applied to all postal services: "we would also support the VAT exemption being extended to all operators." Postcomm does not, however, support the full rate of VAT at 17.5% being applied to all postal services as the resultant price increases would not be in customers' interests.[87]

48. The MCF told us that it was difficult for it to make a precise analysis of the impact of the removal of Royal Mail's VAT exempt status as MCF members were not privy to most of the relevant information. However, as a VAT exempt operator, Royal Mail was unable to recover its input VAT, so that when Royal Mail was dealing with a VAT exempt customer its prices were around 13 percent cheaper than those of its competitors, all other things being equal.[88] As users demanded discounts in return for using a competitor of Royal Mail, this had had the effect of making MCF's members' services uncompetitive for VAT exempt customers.[89] The concern of MCF members was that they were unable to compete on a level playing field: "we have been advised by Queen's Counsel that all competing postal services ought to be subject to VAT at 17.5% on the basis that the current legislation breaches the principle of fiscal neutrality by treating the providers of competing services in dissimilar ways so as to distort fair competition".[90] Any 'solution' on VAT which resulted in lower prices for all customers was good for the mail market as a whole. For that reason, it believed there was "much to commend the application of a lower rate of VAT to all postal services. This would lead to an effective 12.5% price reduction of our members' services (assuming that the reduction in VAT rate would not affect the current ability to fully recover input VAT) when providing services to customers who are unable to recover VAT". [91]

49. The MCF also told us that Postcomm had conducted modelling on the impact of VAT on Royal Mail's prices and concluded that these (excluding VAT) would drop by 2.6 percent following retraction of the VAT exempt status, since Royal Mail would be able to recover its input VAT:

This was confirmed to us by the Minister: "if VAT were to be introduced it would have to be at 17.5 percent, so I think you were absolutely correct in what you said, and the only way that one could derogate from that is with the agreement of all 25 EU Member States to bring it down to the five percent level".[93]

50. The Minister said that the Government was opposed to VAT on stamps but that the "DTI and Treasury officials meet regularly, including discussions on VAT and postal services [...] the imposition of VAT on postal services, even at a lower rate would increase postal costs for many postal users. This would impact on social users and most heavily on large volume mailers—including many charities".[94]

51. We are disappointed that the DTI failed to provide supplementary information, which the Minister had agreed to send us in his oral evidence, in good time. This has made the task of completing our Report unnecessarily difficult and we hope that this will not set a precedent for future inquiries.

52. We do not want to see stamp prices increase owing to the imposition of VAT on postal services because of the impact on those users who are not registered for VAT, especially, but not exclusively, private individuals. We understand Royal Mail's competitors' arguments of unfairness, because of Royal Mail's VAT exemption, but also note that it has the unique reqirement, and costs, of a universal service obligation. Moreover, we are sceptical that the UK Government would be able to secure derogation in the EU for a lower than normal rate.

The disadvantages of liberalisation for Royal Mail

53. Postcomm told us that the postal market was often perceived to be a mature market that was, or was about to be, in decline. However, both it and Postwatch[95] told us that the market was currently growing by around one to two percent per annum and that this was forecast (by both Postcomm and Royal Mail) to continue for the next few years.[96] Most growth in mail was currently coming from direct marketing. Alternative media, for example electronic substitution, were a threat to mail volumes, but there was equally a growth opportunity through the fulfilment of electronic transactions: items ordered over the internet have to be delivered. These were more profitable per unit for Royal Mail as they were typically larger or heavier weight items and, therefore, of higher value.[97]

54. Royal Mail told us that the letters market had experienced some growth over this price control period but that volumes this year had been flat. This was not a trend confined to the UK market and, moreover, "most markets around the world are in decline and it is likely that within this price control period the UK will experience both volume losses from the electronic substitution that is pervasive elsewhere and much slower growth in volumes of direct mail than in the past. In short, the outlook for UK postal market volumes is uncertain and represents a major risk to the business".[98]

55. Royal Mail told us that over the last four years "the total UK market for addressed mail volumes had been growing by an average of around two percent per annum. However, the rate of growth has been declining, from about 3% in 2000/1 to 1% in 2004/5 (with about ½% additional growth in downstream access). During the year to date from March 2005, volumes have been flat, inclusive of downstream access".[99] The evidence which Royal Mail provided to us was based upon a series of assumptions: "if we strip out the impact of GDP, household growth and price changes we find that the underlying trend in volumes was negative at about -1% per annum over the last four years. This underlying decline in UK volumes may be partially explained by e-substitution, a trend that has been seen in other major postal markets"[100] and later "if we examine the market growth in other major postal markets where data is available—the US, the Netherlands and Germany—we see that they have been experiencing flat or declining volumes. In the US, volumes of First Class and Standard Mail have remained unchanged over the period 2000 to 2004, where a significant decline in First Class mail has been offset by growth in Standard Mail. In the Netherlands, volumes of Total Addressed Mail have fallen by an average of about 1% per annum from 2001 to 2004. In Germany, volumes of private and business mail have declined slightly by an average of 0.3% per annum from 2002 to 2004".[101]

56. We were concerned that the evidence given to us by Postcomm and the Royal Mail appeared to be contradictory. To get a clearer picture of what was happening to mail volumes in the UK postal services market, we asked Royal Mail and Postcomm for the evidence on which their suggestions were based. Postcomm provided us with figures which showed that volumes in the UK were growing by around one to two percent per annum. However, in 2004/05 there had been a relatively small fall in total mail volumes,[102] confirming what Royal Mail had told us. Mr Wells, Managing Director of TNT Mail UK Limited, representing the MCF, told us that some mail sectors were growing but some were shrinking:

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FALLING MARKET SHARE

57. The CWU told us that Royal Mail's own information provided clear evidence that competitive pressures were already beginning to bite: "The company confirmed in the summer that 'major contracts worth almost £50 million have already been lost' as the likes of TNT and UK Mail secure access contracts and also take trunking work with major customers away from Royal Mail".[104] The CWU believed that it was particularly worrying that this represented only the initial stages of the development of competition in the UK market and was occurring at a time when Royal Mail was only just beginning to recover from what they called its "recent difficulties".[105]

58. Mr Crozier, Chief Executive of Royal Mail, said that Royal Mail was already losing customers as businesses switched to using competitors to fulfil part of their business requirements: "we have lost around one billion items annually"[106] 'and later' "the current projections are of a market that is growing by 2 percent per annum. Since January we have seen almost a 1 percent decline in the market, which is what has happened in every other country in Europe".[107] Royal Mail also argued that the competition which had occurred so far, and all future entry, was 'cherry picking'. For example, downstream access competitors, such as UK Mail, were targeting Royal Mail's top business account customers who held a disproportionately large share of postal services.[108] Royal Mail told us that it believed that by the end of 2006, it could lose up to 20 percent of market share through cherry picking of second-class bulk mail by downstream competitors, with volumes at a level similar to that which Postcomm had assumed for 2009/10.[109] The CWU said, "we strongly hold the view that the general public will not benefit from this competition".[110]

59. The CWU also told us that it believed the potential profitability of the UK market would make it particularly attractive to competition from overseas postal operators, explaining, "this is clearly evidenced by the fact that both TNT (which owns the Dutch state operator [TBG Post]) and Deutsche Post World Net (which owns the German state operator [Deutsche Post]) have already obtained licences and are actively providing bulk mail postal services in the UK".[111] However, Mr Crozier, Chief Executive of Royal Mail, suggested that:

112

60. The DMA told us it believed that, even with the opening up of the market, the majority of competitive volumes would remain downstream through Royal Mail. Royal Mail would lose some volume but the likelihood of huge volume loss was remote:

113

The MCF agreed with this view,[114] but Intellect challenged it and told us that: "1st Class mail volumes will not be affected by competition over the period of the price control is seriously questioned by Intellect as we know that many organisations are looking at the cost/delivery equation of remaining with First Class versus moving to an Access model".[115]

61. The main concern of our witnesses for the future of Royal Mail centred on the fact that competitors would be free to 'cherry pick' the services which they chose to provide. It was feared that, under such circumstances, new entrants would get involved only in the most profitable parts of Royal Mail's business and that this would impact negatively on the service provided by Royal Mail, especially the universal service, as revenues fell.[116]

Universal Service Obligation

62. Postcomm's statutory duty to "seek to ensure a universal postal service at an affordable tariff"[117] under the Postal Services Act 2000 is derived from an obligation on Member States in the EU Postal Services Directive. The Directive requires the universal service provider to offer at least one collection and delivery each working day, and a service for registered and insured items.[118] After liberalisation, for Postcomm this will mean ensuring that Royal Mail continues to be able to fund its mail activities, including an affordable universal service.[119] For reference purposes we asked our witnesses how the definition of the universal service differed in each EU country. The MCF provided us with this information in the form of a table.[120]

63. In April 2003, Postcomm began a two year consultation with a wide range of users in the UK to find out what they wanted from a universal service. The consultation concluded that what users expected was a range of postal services, which met the needs of domestic, business and other customers. On this basis it was agreed "that the universal service should include 1st and 2nd class letter mail up to 2kg, a standard parcel service up to 20kg, a registered service, support services such as redirection, and international mail".[121] Users also wanted a generic bulk mail product to remain. Mailsort 1400, which required 'pre-sortation' by the customer, was considered the most popular, in terms of volumes, and the Royal Mail's bulk product which appeared to exhibit the characteristics of universality most. A number of users also made it clear that there was a risk that some smaller users would not be able to meet the preconditions of Mailsort 1400, so Postcomm also included Cleanmail.[122] A full breakdown of the products which were included in the universal service can be found in Appendix 16.[123]

64. In their evidence to us Postcomm told us that Royal Mail had not yet agreed the licence modification that was necessary for these changes to be made and was currently considering whether to refer the matter to the Competition Commission or to retain the present broader definition of the universal service as set out in Royal Mail's licence.[124]

65. When we asked Royal Mail whether agreement had been reached since our inquiry began, Mr Leighton, Chairman of Royal Mail, told us: "No, I think we have a disagreement".[125]

66. We were worried about the future of the universal service given the evidence we had received about falling volumes, cherry picking by new entrants to the market, and Royal Mail's ability to finance the universal service following full liberalisation. We asked our witnesses whether they perceived full liberalisation to be a threat to the provision of a universal service by Royal Mail. Our witnesses' views were split on this matter. The CWU and Royal Mail told us that full liberalisation was likely to undermine the Royal Mail's ability to deliver the universal service if Royal Mail lost 'significant' market share in terms of volume and/or value. Postwatch, Postcomm, the DTI, the DMA, MUA, Intellect and the MCF all suggested that full liberalisation would not be detrimental to the Royal Mail's ability to provide the universal service. In fact our witnesses—including the Government— believed the universal service should be viewed as a benefit to Royal Mail, "I believe that the Universal Service Obligation is of great benefit to the company, it is not a drawback".[126]

67. The CWU emphasised that it believed that the regulator's proposals constituted a substantive material threat to Royal Mail's core business activities and its ability to finance the provision of a universal service: "the proposals would have the potential to starve the company of funds at a time when it faces the introduction of full market liberalisation for the first time in its history".[127] Nevertheless, the CWU believed that competition had the potential to increase rapidly under the less than level playing field which Postcomm was currently imposing. Royal Mail had already lost significant large customers to upstream competition as a result of third party access. While the impact of competition was still at a relatively low level, the CWU suggested that all the available evidence showed that competition was likely to continue to grow rapidly and could undermine the ability of Royal Mail to meet its universal service obligation duties as a result.[128]

68. Mr Crozier, Chief Executive of Royal Mail, told us that "business customers have overpaid and by and large social customers have underpaid, and everyone accepts that that is part of the market that existed. The problem with that when competition comes in is that competition only targets the business mail, and that gives them a lot of headroom to steal that business and, unless we have the ability to rebalance those prices, clearly we have got a problem". This would "really puts pressure on the USO: "Either the USO would have to go, which I do not think anyone would agree with, or stamp prices would really have to go up at that point to compensate for the loss in business mail".[129]

69. Postcomm argued that:

130

Postcomm told us, that although it was sure that there would be no negative impact on the universal service, it would remain vigilant "at any stage, if it looked as if there were any problems, we have the powers and the duty to intervene to make sure, in particular, that the universal service is safe, and that is what we will be doing".[131]

70. The MCF saw no reason why Royal Mail's universal service obligation should extend beyond the expressed statutory requirement: "if Royal Mail is thus obliged to maintain an infrastructure to meet this obligation, it will have the most powerful commercial incentive to offer a wide range of services to maximise usage of the network and thereby lower unit costs and hence its commercial competitiveness".[132] Postwatch argued that as the incumbent operator with the unique ability to deliver mail daily to each and every one of some 27 million addresses throughout the land, Royal Mail gained, through its universal service obligation, a "powerful and valuable advantage over its competitors in the market".[133]

71. Postcomm told us that competition may also bring some threats to the universal service. Royal Mail had high fixed costs which meant that a significant loss of mail volumes could jeopardise its ability to provide a universal service at an affordable price.[134]

72. Postwatch held the view that competition and the universal service were compatible.[135] The main threat to the universal service came not from falling volumes but from an "inefficient and failing monopoly".[136] Their research had shown that the universal service was a net benefit to Royal Mail and not a burden as "Royal Mail has no national competitor with ubiquitous coverage"; and Postwatch had estimated that the commercial benefit of the universal service to Royal Mail's business was in excess of £500 million per annum.[137] Royal Mail later confirmed that in 2004/05 profits from the universal service area were in the region of £400 million.[138]

73. The MUA agreed with Postcomm and maintained that Royal Mail's universal service obligation was a net benefit to them, and as such would not put them at a disadvantage against emerging competition. However, once sustainable competition had been established, the MUA's members had suggested that Postcomm would then be in a position to review Royal Mail's universal service obligation, and perhaps release parts of Royal Mail's "licensed obligations to other service providers, and/or the postal network infrastructure that accompanies it".[139]

74. The DMA told us that Royal Mail had a competitive advantage in offering the universal service rather than a cost burden and that "in order for Royal Mail to finance the universal service, it is essential that the universal service reduce as competition develops, so reducing any burden to Royal Mail. Also as competition develops and offers similar services, the universal service obligation could be shared across operators. The universal service is at the fulcrum of UK postal services but it must evolve. It cannot be fixed in time, it must reflect the developing market and change accordingly".[140]

75. Intellect also believed that the USO was a benefit to Royal Mail and was not in conflict with market opening "as the market changed and with the continued growth in electronic alternatives to paper mail and physical products (pictures, videos and films), Intellect proposed that a thorough study and consultation should be undertaken to consider the re-definition of the USO and the drivers behind it".[141]

76. The definition of the products which should be included in a universal service is particularly vague in the EU Postal Services Directive and Postal Services Act 2000. What is encompassed in the UK's universal service is a matter for negotiation between Postcomm and Royal Mail but we believe that the products included in the universal service should not be unchanging, especially as postal services will evolve over time.

77. We recommend that Postcomm should continue to monitor and review the products included in the universal service, taking account of users' changing needs and the new types of postal service products offered to the market. The universal service is rightly valued as a public service, especially in remote rural areas. Therefore, Postcomm should also have regard to the views of the Secretary of State, and, through him, of the Government, on what the definition of a universal service in the UK should be. In particular, we emphasise that a 'universal service' is not worthy of the name if it allows for any geographical exemptions.

78. The majority of our witnesses told us that opening up the UK postal services market to competition would pose no immediate threat to the universal service and we agree with this. However, the regulator must remain vigilant to ensure that greater competition in the postal services market does not come at the cost of the universal service. This is, after all, the regulator's statutory duty.

79. It is too soon to tell if falling mail volumes are a temporary blip or a change in trend. Unfortunately, due to its choice of timing, the regulator cannot wait to find out before setting the price controls. However, we note with confidence that in its amended price control proposals, Postcomm has allowed for the possibility of an automatic price adjustment should mail volumes fall short of its forecasts.

80. We are also happy that there is a further 'safety net' possibility of a universal service compensation fund which would require other operators to contribute to the costs of providing a universal service, if it were in jeopardy. However, in our opinion the fund would almost inevitably come too late. Therefore, we recommend that a mechanism for an early price control review be put in place by Postcomm as soon as is reasonably practicable to maximise the chance of preventing the universal service being jeopardised in the first place.

10 Appendix 7, para 3.2 Back

11 Appendix 15, para 15 Back

12 Opening up the market was also supported by the results of Postcomm's recent business customer survey which sought feedback from business customers. Source: Appendix 15, para 34 and Annex B. Back

13 Q 3 Back

14 Q 206 Back

15 Appendix 17, para 3.3 Back

16 Ibid. Back

17 Appendix 17, para 3.3 Back

18 For example see Appendix 17, para 3.1; Appendix 9, para 4, Appendix 7, para 3.1, and Q 15 (Mr Crozier) Back

19 Appendix 15, Annex C Back

20 Appendix 6, para 15 Back

21 Q 124 (Mr Carr) Back