House of Commons - The Postal Services Bill - Business and Enterprise Committee

The Postal Services Bill - Business and Enterprise Committee Contents

3 Regulatory Framework

36. Postcomm, the industry regulator, was established by the Postal Services Act 2000. Postcomm's statutory duties are set out in sections 3 and 5 of the Act:

3(1) The Commission shall exercise its functions in the manner which it considers is best calculated to ensure the provision of a universal postal service.

And

5 Other duties of the Commission in the consumer interest

(1) Subject to section 3, the Commission shall exercise its functions in the manner which it considers is best calculated to further the interests of users of postal services, wherever appropriate by promoting effective competition between postal operators.

(2) In performing its duty under subsection (1), the Commission shall have regard to the interests of—

(a) individuals who are disabled or chronically sick,

(b) individuals of pensionable age,

(d) individuals residing in rural areas,

but that is not to be taken as implying that regard may not be had to the interests of other descriptions of users.

(3) Subject to section 3 and subsection (1), the Commission shall exercise its functions in the manner which it considers is best calculated to promote efficiency and economy on the part of postal operators.

(4) In exercising any of its functions in relation to licence holders under Part II, the Commission shall have regard to the need to ensure that such licence holders are able to finance activities authorised or required by their licences.

37. In other words, Postcomm's primary duty is to protect the universal service; subject to that overriding duty, it is to introduce competition where possible.

38. To allow it to do this, Postcomm has the power to licence postal service operators. It has the power to determine what should be regulated, and what particular services should fall within the universal service obligation. It can set quality and service standards. It also has powers to regulate prices of Royal Mail products.

Competition in postal services

39. There are good reasons for introducing competition into the postal market. If it is done appropriately, competition can increase the standard of service, and reduce costs. As the Trade and Industry Committee noted "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."[37]

40. However, although we support the principles underlying Postcomm's work, it is clear from the Independent Review that relations between the regulator and Royal Mail Group are unsatisfactory, and that Postcomm's recent decisions have increased Royal Mail Group's difficulties without necessarily increasing the health of the overall market.

Market Opening

41. The 1997 EU Postal Directive was aimed at opening Member States' postal services to competition, while requiring a universal service to be maintained. This first postal services directive established minimum standards for the universal service obligation, defined the services which could be reserved to the universal service operator and set a timetable for gradual and controlled liberalisation. It also required the establishment of national regulatory bodies. In June 2002 the second postal services directive was agreed, which opened up more areas of competition. This directive set 1 January 2009 as a possible date for opening markets completely. The third directive was agreed in February 2008. It set 31 December 2010 as the date for full market opening for most member states.[38]

42. Postcomm decided to open the UK market to full competition from 1st January 2006, three years ahead of the then expected deadline, and five years ahead of the deadline eventually decided upon. This was widely criticised at the time. The Trade and Industry Committee noted:

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. Although the review process is now nearing conclusion, we believe that the difficulties for Royal Mail have already been caused.[39]

43. Most recent studies suggest market opening elsewhere in Europe is slowing. The most recent study of the European Postal Services Sector, commissioned by the European Commission from the Dutch consultancy, Ecorys, notes

There is a slow down in the liberalisation process. Apart from DE (Germany) which has fully liberalised its postal market as from 1 January 2008, several countries have postponed their plans to liberalise ahead of the European time table (Netherlands, Norway) and most likely no [further] country will fully open up its postal market before December 2010...[40]

Price transparency

44. It is inherently difficult to assign costs in a network system, and one of the issues which has made relations between Postcomm and Royal Mail Group difficult has been lack of cost transparency. As Mr Hooper told us:

We talk a lot in the report about costing and one of our main recommendations, when we recommend that regulation should pass from Postcomm to Ofcom, is that Ofcom have to get a grip of what we call the cost transparency model. We do not have sufficient costing information, which means that discussing, as we probably will later on, access prices, the cost to the user is actually quite complicated. We do not have the real figures. That is something which is needed and it is particularly needed as you change the regulatory regime in 2010, the beginning of the next price control regime.[41]

45. Postcomm and Royal Mail Group have long disagreed over the adequacy of Royal Mail group's costings. In part, this is because of the inherent difficulty of assigning costs precisely in network business, particularly when, as the Independent Review explains, accurate measurement of inputs has not previously been required.[42] It should be noted that this difficulty in establishing costings adequately is far from unusual. Indeed, even if Royal Mail Group's figures are unsatisfactory, they appear to be fuller than those of most of their European counterparts, as the Ecorys study shows:

Currently, it is understood that only the UK, Danish and Icelandic NPOs (National Postal Operator) publish regulatory accounts in sufficient detail for the accounting costs and profits of the USO services to be ascertained publicly and therefore studies such as this cannot provide a detailed comparison across countries unless the NPOs who do not publish their accounts provide the information to the consultants. This has not been the case with this study as the NRAs (Natioanl Regulatory Authority) and NPOs have deemed the information confidential.[43]

Scope and cost of the universal service obligation

46. Even where costs can be established, Royal Mail Group and Postcomm differ in their interpretation of those costs. Postcomm's evidence to the Independent Review did not put a figure on the cost of the universal service obligation. In evidence to us, Mr Brown, the Chief Executive, clarified the position:

Mr Brown: Royal Mail has quoted that those products that come within the universal service we talked about earlier in answer to Mr Clapham made a loss of £100 million in 2007/08, but those products that are classified as being outside the USO but still use the network, for example things like special delivery on account, make a profit. It is our view that we look at the whole entity of Royal Mail Letters and at profitability. At the moment on Royal Mail's numbers it approximately breaks even on that basis.

Q218 Mr Wright: There is a huge disparity between what you are telling us and what Royal Mail Group suggest. RMG says quite clearly that the cost is £3.4 billion. Quite a number of zeroes are added to that figure.

Mr Brown: I think it takes us back to some of the discussions we had about costing and such like. The cost without the associated revenue is £3.4 billion. The net cost if you add back the revenue Royal Mail earns for the universal service products is the number we have given, so it is the difference between pure cost and the earned revenue for those products.

47. Further discussion with Mr Stapleton, Postcomm's Chairman, established that he did not dispute Royal Mail's assertion that the USO itself had made a loss in the previous year, but "the numbers show that the USO made a loss last year of £100 million. There was an equal profit from the rest of the mail business, so overall the letters business was profitable."[44] Mr Brown reasoned "The Royal Mail Letters business and therefore all the products use the infrastructure and we take the view that we should look at the profits of all of them."[45]

48. There is a profound difference between Royal Mail and Postcomm on this. Royal Mail considers that the universal service obligation should be self financing and should be limited to those products which would not otherwise be available. Postcomm set out the current scope of the USO for us:

Universal Services

First Class Stamped

First Class Metered

Second Class Stamped

Second Class Metered

Standard parcel

Airmail Europe

Airmail World Zone 1

Airmail World Zone 2

Surface Mail

Special Delivery (Next Day) other than when sold to users having an account with the Licensee buying the service using their account

Cleanmail OCR 1^st Class

Cleanmail CBC 1^st Class

Cleanmail OCR 2^nd Class

Cleanmail CBC 2^nd Class

Mailsort 1400 1^st Class

Mailsort 1400 Residues 1^st Class

Mailsort 1400 2^nd Class

Mailsort 1400 Residues 2^nd Class

Recorded Delivery

Redirections (12 Months)

HM Forces Mail

Poste Restante

Petitions to Parliament

Petitions to Her Majesty the Queen

Certificate of Posting

Business Collections

Electoral Letter

Articles for the Blind

Keepsafe

International Signed For

49. There are difficulties in allocating costs to the USO; in the first place, as we describe above, there are limits to the amount of price transparency possible. Indeed, over-enthusiastic pursuit of such transparency could increase costs by preventing efficient worksharing between activities and products. Second, the choice of which products fall within the USO can affect its profitability. As Mr Stapleton indicated, the Royal Mail Letters business last year made a profit of £3 million; special delivery for business had been within the USO and was transferred out of it, which transferred a profit of £40 million from one side to the other.[46] We asked Postcomm to explain the rationale behind the status of various services. We were told that this to some extent depended on the relevant circumstances of the service in question, but that decisions were made in compliance with Postcomm's duty to ensure the provision of a universal postal service, and to exercise its functions in a manner which it considered best calculated to further the interests of users of postal services, wherever appropriate by promoting effective competition between postal operators. So, for example Postcomm removed most bulk mail products from the universal service from April 2006 to give Royal Mail more flexibility to compete. However, to protect consumers two bulk mail products were left within the service.[47]

50. The postal services directives recognise the vital role that postal services play. It would be possible to reduce the universal service obligation simply to those matters which would not be provided by the market. Such an approach would guarantee that universal service obligation could never be both affordable and self financing. Moreover, it would also run the risk that market failure might threaten services which were socially and economically vital, but which the regulator had wrongly thought would be provided by the market alone. We note that the Directive itself envisages that the USO may potentially be profitable by requiring that "the duration of this designation provides a sufficient period for return on investments."[48]

51. There is a choice between ensuring the Universal Service Obligation (USO) covers all those services which are socially and economically necessary, without reference to the market or limiting the USO to only those products which the market will not provide. In the first case, it is likely the USO will be self financing; in the second it is possible that extra costs will need to be met, either by a levy on industry or directly from the taxpayer. Parliament may wish to reflect on whether it or the regulator should make that important choice.

Price Controls

52. Broadly speaking, there are two forms of regulation; ex ante, in which the regulator sets out the terms on which a regulated body can trade in advance, and ex post regulation, in which the regulator can take action if it considers companies are behaving in an anti-competitive manner. Ex ante regulation, by definition, removes some of a regulated body's freedom to make its own commercial choices; ex post competition can allow market abuse to take place before action is taken.

53. As Royal Mail complains, Postcomm imposes a high degree of ex ante regulation. A far higher proportion of Royal Mail Group's products are subject to price controls than in other European markets. Price controls are not restricted to USO products. Postcomm's rationale for this is twofold. Firstly, price controls drive efficiency in the organisation; they are, in effect, a substitute for competition.[49] Secondly, Royal Mail Group's market dominance is so great that such controls are necessary to enable competition to take place. The regulator has said in the past that the growth of competition could reduce the amount of regulation in future.[50]

54. The main competition in the United Kingdom mail market is for bulk mail. It is not surprising that the most contentious piece of ex ante regulation that Postcomm has imposed is its system for regulating the terms on which companies can gain access to the bulk mail market. Companies are able to compete for "upstream" competition, and require access to Royal Mail's network to deliver the final mile. Postcomm has described the system as follows:

Typically, through these commercially negotiated 'access' agreements, new entrants collect and sort mail from their customers and then give it to Royal Mail for delivery over the 'final mile'. Royal Mail receives from the 'access' operator around 13p versus the typical retail price that they charge for an 'end to end' bulk mail letter which is around 18p.

This means that the new entrants work within a headroom of around 5p out of which they must cover their costs and offer a sufficient discount to encourage customers to switch from Royal Mail. The Royal Mail price control, covering the four year period from April 2006 regulates the minimum headroom between the 'access' price and the Royal Mail retail price for the equivalent product.[51]

It is clear the system reduces Royal Mail's commercial freedom. Witnesses, including Postcomm, agree it costs Royal Mail 2p per item — £100m p.a.[52] The question is whether the intervention is proportionate, given the need to sustain Royal Mail's position as provider of the USO and the need to prevent market abuse.

55. There are two issues in play. The first is the cost at which access is granted. Postcomm maintains that this was freely negotiated between Royal Mail Group and its competitors. Nonetheless, in evidence to us, Mr Stapleton conceded that this negotiation was settled in the knowledge that if an agreement was not reached, Postcomm might determine an access price, which could be still lower than the negotiated settlement.[53]

56. The second is whether the access head room arrangement, which requires Royal Mail Group to retain a fixed margin between its own retail prices and the prices it charges to competitors for access, is working properly. The system is unique to the United Kingdom. As the Ecorys study of postal services in the EU noted:

Most countries with mandatory access adopted the principle that (downstream) access prices should be based on the retail prices minus the avoided cost of the NPO. Apparently, only Postcomm in the UK is in favour of linking the access prices to the cost of downstream delivery (the difference between the two methods is that in the latter no compensation for the fixed costs upstream of the point of injecting the access mail is included). Moreover, the UK is the only country that has regulated the minimum price difference between the bulk retail prices and the access prices with the aim to prevent margin squeeze of access competitors rather than to reflect the avoided costs of Royal Mail.[54]

57. The argument about access is not about the principle that competitors should have access to Royal Mail's network; as Postcomm says, that is not unusual. We understand that many European mail companies may accept pre-sorted mail from competitors. The factor that is unique, and which has led to criticism, is the headroom regime. This interacts with the regulator's role (albeit indirect) in setting prices. The issue is whether access is being provided on fair terms. We agree that the regulator has an important role in ensuring Royal Mail is fair to its competitors; it is also important to ensure the regime is fair to the universal service provider.

58. Royal Mail Group claims that access head room regulation gives the company no incentive to pass on upstream efficiency savings to customers, since if it did so, it would also have to reduce the prices it charges competitors. Similarly, if Royal Mail Group is to raise access prices, it must also raise the retail prices of its own products. It cannot use efficiency to lower prices and increase its market share. But although Royal Mail Group complains about the access system, as Postcomm says, increases in its own efficiency would benefit its profitability, even if they did not feed through to customers. Moreover, Royal Mail Group did not object to the system from the outset; if had not agreed to this price control regime it would have been referred to the Competition Commission. We assume that at the time the regime was agreed, Royal Mail believed it would be possible to make it work.

59. For its part, Postcomm defended the access regime. It made two points: the first was that on Royal Mail's proposed service costing methodology, the regime would make a slight profit.[55] The second was that the fact that the company lost the same amount per item both on its retail mail and on access products proved that there was no cherry picking by competitors, and the problem was not with the access regime.[56] We note that the regime allows Royal Mail to charge extra if it has to deal with contracts which disproportionately cover expensive-to-deliver areas of low population density.

60. We cannot judge the first point, save to note that it contradicts both Royal Mail's own evidence to us, and Postcomm's apparent acceptance, elsewhere in its supplementary memorandum, that a loss was made on each item of bulk mail, access or retail. We agree with Postcomm that much improved cost transparency is desirable.

61. We are puzzled by the second set of claims. Postcomm complains that Royal Mail's costs are not transparent, yet the regulator itself has put forward claims which cannot be judged without far more cost information than it provides. It is possible that Postcomm's claims are true and the fact that both retail bulk mail and access are losing money simply demonstrates that all Royal Mail bulk mail is underpriced at the company's current level of efficiency. However, the United Kingdom regime allows Royal Mail to charge for downstream costs, and takes no account of upstream costs for sorting etc. We note that other European operators charge access at retail less "avoided" upstream costs which may be a recognition that not all upstream costs are in fact avoidable.[57] (The Hooper report shows that the same offices are used for both upstream and downstream operations.)[58] If these upstream costs are mostly fixed and Royal Mail does not have the scope to ensure that its access price to competitors takes into account such costs, competitors taking away business and thereby reducing volumes upstream could potentially increase Royal Mail's losses per item. We note that although Mr Stapleton asserted that the regime "is covering costs",[59] he later conceded that (like bulk mail) access lost money on a fully allocated cost basis.[60]

62. Similarly, it is at least possible that access providers are cherry picking larger contracts, which are cheaper to handle upstream, and that the fact that the same loss is shown both on access and retail is the result of Royal Mail handling a relatively costly market segment more cost effectively than it can handle access. We stress that we make no judgement here on either point; we simply point out that, like Royal Mail Group, the regulator has not made its case.

63. Modernise or decline recommended a full evaluation of the access price control regime. We agree; we have great doubts about its continued operation. We are sure its problems have been increased by the poor relationship between Royal Mail Group and the regulator, and the lack of clarity on both sides.

2007 REVIEW OF ROYAL MAIL'S PRICE CONTROL

64. In 2007, Postcomm was asked to reconsider the access headroom arrangement by both Royal Mail and its competitors. Royal Mail Group wanted a lower degree of access headroom; its competitors wanted various other matters reviewed. Postcomm declined to make changes. It is clear from the determination that the regulator had no confidence in the figures Royal Mail Group provided.

65. However, it is also notable that the regulator declined to change its policy even though it was clear that competitors were taking a far higher share of the market than Postcomm had anticipated. Access mail in 2008 was over 4 billion items rather than the 2.5 billion forecast. In contrast, end to end competition had declined, rather than grown as forecast. The Ecorys study of the development of postal services in the European Union suggests that the method of regulation directly affects the type of market opening, and the access regime adopted by Postcomm would have contributed to the reduction of end to end competition.[61]

66. The Postcomm memorandum states that the £100 million per year lost through access is small compared to the amount lost through e-substitution and the potential savings from efficiency gains[62], although we note that if it had not been lost Royal Mail would have halved its losses on price controlled products.[63] We have some sympathy for the regulator's point about efficiency. However, workers cannot simply be laid off without compensation or redundancy: it is hard to make rapid efficiency savings in business where nearly 70% of the cost is labour costs.[64] However the fact that there are greater losses from e-substitution, a market trend which mail operators can only affect if they lower prices, is, if anything, a reason for the regulator to reconsider its regime.

67. It is clear from the Ecorys study that while Royal Mail's costings may be imperfect, they are more open than those of many of its European counterparts. It is also clear from the Independent Review that there will always be an inherent difficulty in establishing precise costings in a network business like Royal Mail's. We understand Postcomm's frustration with Royal Mail Group. Its analysis that changes in market share did not necessarily mean that barriers to entry had been set too low may have been correct. Nonetheless, the USO depends on the continuing financial health of Royal Mail Group. Given that full cost transparency may be unachievable, we are surprised that when faced with evidence that the USO provider was losing access market share at twice the rate predicted, and that end to end competition had actually declined, Postcomm did not reassess its regime, particularly since e-substitution was also affecting Royal Mail's business.

68. We particularly note the regulator's suggestion that:

We do not think that it is reasonable for Royal Mail to raise concerns that it is making losses on its access services when these could be partially addressed by raising its retail prices or by reducing its costs overall. We also think that Royal Mail should consider changing access prices, where currently it is not charging the maximum access price available under the current price control provisions.[65]

69. As Mr Crozier told us, there is as much or more competition between post and new media as there is between different postal providers:

Big companies and even individuals start by saying they want to talk to their customers, or their advertising agency says that they want to reach their customers. What they look at is relative cost and strength and whether to do it through television, the press, magazines, direct marketing or a piece of door-to-door communication. As you stand at that point you look at your relative cost competitiveness. Only once they have decided amongst all those choices to use post do they then get to the choice between different postal operators. Therefore, if you have lost the battle at that point the business has already gone somewhere else. What we need the regulator to understand is that those are the people against whom we are competing in any media.[66]

70. In suggesting that Royal Mail Group could improve its position by increasing prices, Postcomm appears to have overlooked the fact that competition in the mail market is not just between rival mail carriers, but also between post and other methods of communication. The purpose of regulation is to benefit the customer; indeed, this is the rationale for introducing competition into the market. Something is seriously wrong when a regulator proposes measures which would increase the cost to the customer, and might even risk reducing the size of the market overall.

Effect of competition

71. The Independent Review suggests that competition has cost Royal Mail £100 million per year,[67] and notes that this is small compared with the effect of changes in mail volumes overall. Assuming that the review group had access to the figures we were given, the estimate contained in the review covers only the direct cost to Royal Mail of the access regime; not any consequent loss of market share. It is reasonable to assume that without the access regime other companies would not be able to offer such attractive terms, and Royal Mail might also benefit from greater market share.

72. We share Postcomm's concern that it is important Royal Mail should not abuse its market position. We also agree that competition can act as a spur to improve performance, and has done so for Royal Mail Group. We have no doubt that further efficiencies are possible and desirable. However, the reason why the EU postal service directives advocated gradual market opening was to allow time for incumbent universal service providers to adapt. In its submission to the regulator's consultation on price control, the Government noted that "the regulatory risks to Royal Mail should be kept at a minimum otherwise Royal Mail may be at a disadvantage to other operators." The Trade and Industry Committee warned that market opening was ill timed. Royal Mail Group asked for price control to be reviewed because of its rapid loss of market share. In retrospect, Postcomm has paid too much attention to market opening, and to using price controls to increase Royal Mail Group's efficiency, and too little to the need to preserve the universal service obligation.

Government role

73. We note that the Government has limited its role in postal matters to that of responsible shareholder. Mr Crozier noted:

in other countries governments are allowed to wear two different and entirely separate hats: one as a policymaker and the other, as in our case, as a shareholder. They are not the same thing. In other countries and markets governments give regulators a clearer brief and it is then for them to regulate entirely independently within the parameters of that brief. I believe the kind of dual objectives that Postcomm has had — in fairness, it was not what it chose but what it was given — to protect the USO and bring in competition, to paraphrase it, clearly gives rise to a lot of potential conflict between the two. I think the lack of clarity about which is the more important was deeply unhelpful.[68]

In fact, the Department of Trade and Industry, when it was responsible, was clear that the regulator "needs to give priority to its principal duty, which is to ensure the continuing availability of the universal service at a uniform tariff."[69] The difficulty appears to be that it had limited powers to ensure this was the case.

74. Some of the questions which face the Government as shareholder are also public policy issues. In 2005 the Department told the Trade and Industry Committee:

The Government, in its role as shareholder, has responded to Postcomm's price control document setting out the key principles that we consider ought to be respected and reflected in the final regulatory settlement. These cover the following points:

— the taxpayer, through Government on behalf of taxpayers, is entitled to a reasonable rate of return on existing capital assets;

— the balance between the interests of customers and taxpayers needs to be struck through attributing a "fair" regulatory value for existing assets;

— efficiency targets must reflect what it is practical for a publicly owned Royal Mail to achieve, by way of speed of change, in a single price control period—with full regard given to legacy problems that the company is starting to address;

— the unavoidable costs of servicing the pension fund deficit are inherited costs of the business and as such should be borne over a suitable period by postal service customers, not by taxpayers;

— the regulatory risks to Royal Mail should be kept at a minimum otherwise Royal Mail may be at a disadvantage to other operators; and

— the Government should not be expected to provide support to Royal Mail's regulated business on a non-commercial basis.[70]

75. Postcomm's initial pricing proposals suggested a regulatory asset base (RAB)[71] of £2.2 billion, as opposed to the £5 billion put forward by Royal Mail Group. It proposed to allow the pension deficit to be funded over 20-year period, saying that if the trustee decided that the deficit should be dealt with more quickly, the shareholder should be responsible. The final determination of the pricing review showed some movement in that Postcomm made greater allowance for the pension deficit and slightly raised the value of the RAB (to £2.33 billion). The system also allowed flexibility if market conditions changed, either in terms of the size of the pension deficit, or in Royal Mail's share of the market. However, its final determination also required Royal Mail Group and the shareholder to bear a significant proportion (10%) of the risk of volatility in the pension deficit:

S24 Postcomm recognises that these Final Proposals represent a potential extra burden on customers compared with the Initial Proposals. For this reason it believes strongly that it is reasonable to expect that Royal Mail and its shareholder will also do all they can to address the situation. For example, Postcomm has, therefore, assessed a scenario for financeability where the shareholder does not take dividends out of the company for the duration of the price control. Postcomm also believes that Royal Mail should act like any other commercial company in this situation. This means that it should look for every opportunity it can to become more efficient, to cut other operating costs to help pay off the deficit as soon as possible and to take what measures it can to stop the deficit from further increasing.[72]

The Trade and Industry Committee welcomed the revised price controls, which had been agreed with Royal Mail Group.

76. The relationship between the Government and regulator when a regulated company is publicly owned is complex. The history of the pricing review demonstrates that there is a thin line between the Government's role as shareholder and its role in setting policy. Some of the principles the Government set out in its submission to the pricing review have been respected, but Postcomm's regulatory regime has left the taxpayer with no return on assets, and Royal Mail has been exposed to significant regulatory risks. Economic matters for which the regulator should be responsible can overlap, or even conflict, with wider policy matters, where Government has a legitimate right to expect its views to be taken into account.

77. It also seems to us that the regulator may have treated the shareholder more harshly than it would have done if the shareholder had not been the government. Even though the final outcome of the price review was not as severe as the first proposals, a regulator faced with a private sector pensions deficit of the scale of that of Royal Mail, and a company which had not paid a dividend for some time, might have found it harder to put forward a pricing regime which expected that much of the cost of the pension deficit would be borne by the company, and not passed on to customers.

The proposals of the Postal Services Bill [Lords]

78. Part 3 of the Postal Services Bill [Lords] sets out the new regulatory regime. It is notable that not one of our witnesses has opposed the proposal to pass responsibility from Postcomm to Ofcom which will be able to consider the regulation of postal services in a wider context. Given the changing structure of the communications market and, more particularly, the regulator's inability to work effectively with Royal Mail, we support the abolition of Postcomm and the transfer of responsibility to Ofcom.

79. The Bill also makes radical changes to the regulatory regime. The Postal Services Act 2000 requires all postal service providers to have a licence before they begin. Under the new regime there is no requirement for a licence, but the Secretary of State can require postal operators to give notification before they begin business, and Ofcom can impose regulatory conditions on postal operators. Ofcom has greater powers to require accounting and other information than does Postcomm. The Bill also contains powers for the universal service obligation to be funded by a levy on all postal services operators. The House will need to examine the details of the regulatory structure set out in the Postal Services Bill [Lords] carefully, but, on our reading, it is more likely to result in targeted regulatory conditions. The Bill allows regulation to be loosened if this is appropriate. In principle, we welcome the increased flexibility that the Bill will provide. In the rest of the section we will identify some points where it may be useful to look in detail at the Bill.

Ofcom's role in relation to the USO

80. The statutory definition of the universal service has been re-drafted between the Postal Services Act 2000 and the current Bill but in essence, it remains the same. The need for a six day a week a service is set out clearly. Most other provisions are carried over from the Act to the Bill. The one exception is that currently the Secretary of State can amend the definition of the universal service obligation by affirmative order; the Bill contains no such provision.

81. Ofcom is required to prepare the "universal postal services order", which will supplement the definition of the universal postal service by including a description of the services which must be provided and the standards that apply to those services. Before making or revising an order, Ofcom is required to carry out an assessment of whether the existing universal postal service meets the reasonable needs of the users of the services. We welcome the requirement to assess the universal postal service by whether the reasonable needs of the service users are being met. As we have explained above, there is a danger that if the universal service is narrowly restricted to products which the market will not offer, its economic value will be diminished and there will be a risk that the regulator would be unable to act to protect service users if there were rapid changes in what a market provided. Moreover, the more narrowly the universal service is defined, the greater the risk that it will have to be subsidised either by the taxpayer directly or by all postal service operators. However, we consider the House should consider carefully whether it is appropriate to remove the current power to change the definition of the universal service by affirmative order. If the Bill is left as it stands, then any change will require primary legislation. On a more detailed point, we would like an explanation of how the requirement to set the universal service by reference to users' reasonable needs fits with the provisions relating to the designation of the universal service providers, where continuing designation is linked to the imposition of conditions on the provider. It is possible some universal service requirements might be provided without the need for such conditions.

82. It will be for Ofcom to designate the universal service provider and inform the European Commission of its decision. Ofcom will have powers to vary the designation. It will also have the power to impose conditions on postal services operators but, whereas under the Postal Services Act 2000 Postcomm can include "such provisions as it considers appropriate." (s13), there are limits on Ofcom discretion. For instance, the Bill defines the range of conditions that can be imposed by Ofcom and limits their use to circumstances in which they are proportionate, transparent, objectively justifiable and not unduly discriminatory. There are restrictions on the circumstances in which each of the main conditions can be imposed, including the provision of access by the universal service provider under clause 34.[73] Overall, the regulatory framework is more clearly defined.

83. While the provisions of the Postal Services Act 2000 should have meant that the requirement to secure a universal postal service was paramount, as we have seen, the regulator was able to exercise discretion in a way which undermined this. The current Bill attempts to make the requirement to protect the universal service still stronger. Clause 28[74] sets this out:

(1) OFCOM must carry out their functions in relation to postal services in a way that they consider will secure the provision of a universal postal service.

(2) Accordingly, the power of OFCOM to impose access and other regulatory conditions on postal operators is subject to the duty imposed on them by subsection (1).

84. As we have seen, regulators have a difficult task in balancing the need to ensure that organisations have strong incentives to become efficient with the need to ensure that the universal service provider has the resources it requires to carry out its work. Clause 32 of the Bill provides that in using its price setting powers:

4) ...OFCOM must seek to ensure that—

(a) the prices are affordable,

(b) the prices take account of the costs of providing the service or part of a service, and

A designated universal service condition may impose performance targets.[75]

Clause 34[76] of the Bill also allows Ofcom to impose access requirements on the universal service provider, but sets out conditions for the use of those powers. (Conditions and access conditions imposed on the universal service providers are termed USP conditions or USP access conditions in the Bill.) There is one odd difference between USP conditions and USP access conditions: when considering whether to set tariffs as part of a "USP condition" under clause 32, Ofcom is required to take account of the universal service provider's costs of providing the service. There is no equivalent requirement when Ofcom is considering whether to impose price controls on the universal service provider as part of a "USP access condition" under clause 34, under which Ofcom need only consider "prices at which services are available in comparable competitive markets" and "efficiency by using cost accounting methods".

85. We recommend that the Government clarifies exactly what restrictions will be placed on the regulator in practice. For example, why are the conditions the regulator can place on access different from those it can use in its general price setting powers? Is it the Government's intention to prevent Royal Mail Group from being forced to provide services to other postal operators at less than cost? If it is, does the Bill satisfactorily reflect that?

VULNERABLE USERS

86. As part of its duty to act in the best interest of users of postal services, Postcomm must have regard to the interests of individuals who are:

Disabled or chronically sick,

Individuals of pensionable age,

Individuals with low incomes, and

Individuals residing in rural areas

But that is not to be taken as implying that regard may not be had to the interests of other descriptions of users.[77]

87. There is no such explicit reference in the Bill. This might be welcomed by some; Consumer Focus has recently argued that "it labels everyone falling within these groups as vulnerable; which ignores the diversity of capability within these groups, and feels patronising to the individuals targeted."[78] Consumer Focus goes on to suggest that such a statutory framework of may lack the flexibility to allow regulators to respond to changing ideas about the nature of consumer disadvantage.[79]

88. The Communications Act 2003 requires Ofcom to have a Consumer Panel, advisory committees for different parts of the United Kingdom and on elderly and disabled persons. We are concerned about the extent to which Ofcom will be required to take into account the interests of vulnerable or marginal members of society in provision of postal services. Under the Bill their interests would have to be taken into account as part of Ofcom's duty to review whether the universal service provider is meeting the reasonable needs of users, but members of particular groups may feel better protected if the requirement to address their needs is listed expressly on the face of the Bill, or if the Government can give an assurance that the advisory committees of the Communications Act 2003 will be expected to advise on postal services in addition to their existing tasks.

THE COMPETITION COMMISSION

89. Section 15 of the Postal Services Act 2000 provides that

15. -(1) The Commission may make to the Competition Commission a reference requiring the Competition Commission to investigate and report on—

(a) whether any matters, which are specified in the reference and which relate to the provision of postal services whose provision is authorised or required by a licence, operate against the public interest or may be expected to do so,

(b) if so, whether the effects adverse to the public interest which the matters have or may be expected to have could be remedied or prevented by modifying the conditions of the licence.

In contrast, under the Bill it will only be open to Ofcom to refer price control disputes to the Competition Commission as part of a decision over prices included in a USP condition or an access condition (clause 48[80]). And even then, Ofcom can only do so where there is an appeal against a price control decision (clause 48(1)). The thrust is to limit the Competition Commission's role to price disputes and for it to act as an appellate body,

90. The Government should explain why the power for the regulator to make references to the Competition Commission has been removed. We welcome the fact that the Bill includes the right for the universal service provider to appeal to the Competition Commission against price conditions imposed by Ofcom, but would like to know the reason why this right of appeal is not extended more generally to other conditions that are imposed by Ofcom.

FUNDING THE USO

91. In many cases, the universal service obligation can give its provider a competitive advantage, but the Postal Directive recognizes that there are circumstances in which the USO may impose a financial burden on the provider which is not matched by the benefits it brings. It permits these costs to be met directly through taxation or through a levy on all postal service operators.

92. Although Modernise or decline considered that a levy on all postal service operators would be inappropriate because it would in effect reward Royal Mail for inefficiency, the Bill contains powers for Ofcom to establish a mechanism for operators to share costs. We welcome this, although we agree that, given Royal's Mail current inefficiency, such a levy is not yet appropriate. We would like the Government to provide more detail about the circumstances in which it considers such a levy should be imposed. We draw the House's attention to the fact that, as the Bill currently stands. the decision to impose a levy will rest with Ofcom alone.

Relationship between the regulator and Royal Mail Group

93. There are provisions in the Bill which we hope will make relations between the regulator and those regulated less troubled than in the past. We have already described the restrictions on the regulator's power to set conditions and the right of appeal, which may remove some friction. Conversely, the Bill gives the regulator greater powers to require financial information, and to specify the information that should be provided. This has been a weakness in the current regulatory system, and we welcome its rectification. However, the Postal Directive sets out the method by which costs are to be allocated to different services. We think it is vital that Ofcom's regime is compatible with European requirements, and that the universal service provider will not be required to produce two sets of figures.

Funding the regulator

94. Currently, Postcomm is funded by Royal Mail.[81] As competition becomes established other operators will also contribute through their licence fees.[82] The Bill requires that all those providing services within the scope of the universal postal service should contribute. We welcome this broadening of the cost of regulation. Regulation is necessary to ensure that Royal Mail Group does not abuse its market position, and to ensure that it is under pressure to make the improvements in efficiency it so desperately needs. However, regulation benefits Royal Mail's competitors as well, and it is appropriate that they help pay for the regulator.

Accountability of the regulator

95. Modernise or decline recognised that although regulators need some economic independence, they also need to be accountable. The accountability model it suggested was that:

the regulator should provide parliament with an annual report on its responsibilities in ensuring the provision of the universal service, with a hearing before the BERR select committee. In turn, the regulator should ensure that, when monitoring Royal mails obligations, there is a clear and specific focus on the universal service.[83]

96. We think this accountability model is fundamentally misconceived. If the Bill is passed we shall of course monitor the work of Ofcom in relation to postal services just as we monitor its work in relation to broadcasting. But select committees have no power to direct; we can only make recommendations in reports to the House. It is for the Government to take action.

97. We can say with some pride that in the last five years the Trade and Industry Committee raised all the problems explored in the Modernise or decline. It identified the risks from the timing of market opening and the new price control regime; it drew attention to the pensions deficit; it expressed concern about the access regime; it took evidence on the industrial dispute in 2007. It had no power to make the Government or the regulator think again. The House of Commons at least has some influence and even some sanctions against Government, even if they are rarely used. Only the Government has the resources and powers to monitor a regulator.

98. This problem is not unique to postal services. When we took evidence from Lord Carter of Barnes on the Digital Britain report, he too explored the difficult division of responsibility between regulator and government.

It certainly was not clear to me - … - in 2002 quite how significant this sector was going to become, both in its industrial scale, …, in its reach in our lives, in the level of complexity, and in its importance in our competitiveness versus the rest of Europe and beyond. To that end, I think we are at a point whereby, however strong and capable and competent the regulator is, there is a need for government and Parliament to have a strategic view of what we should do in this sector.[84]

99. Even though the regulatory structure to be brought in by the Postal Services Bill [Lords] has the potential to be far more satisfactory than current arrangements, we do not believe that legislation will end the need for Government to monitor and indeed make policy on such an important area. The events of the past few years should demonstrate that. There is a need to find a mechanism which will preserve the regulator's economic independence, while allowing the Government to intervene on matters of legitimate policy concern without requiring primary legislation. We note that this is being examined as part of the Digital Britain report. We recommend that if as a result of that work Government and Parliament agree it is legitimate for Government and Parliament to have powers to ensure policy is implemented by Ofcom, those powers should extend to mail services as well as digital communication.

37 HC (2005-06) 570-I, para 20 Back

38 The exceptions are Czech Republic, Greece, Cyprus, Latvia, Lithuania, Luxembourg, Hungary, Malta, Poland, Romania, Slovakia, which have until 2012. Back

39 HC (2005-06) 570-I, para 21 Back

40 Ecorys, Main developments in the postal sector (2006-08), Final report, Netherlands, 16 September 2008, p 16 Back

41 Q 4 Back

42 Cm 7529,p 94 Back

43 Ecorys, Main developments in the postal sector (2006-08), Final report, Netherlands, 16 September 2008, p 91 Back

44 Q 163 Back

45 Q 221 Back

46 Q 223 Back

47 Ev 53 Back

48 Article 4 Back