Examination of Witnesses (Questions 263-279)
ROYAL MAIL
GROUP
24 FEBRUARY 2009
Q263 Chairman: Gentlemen, we welcome
both of you. I had not realised that Mr Smith had been before
us some three years ago. I apologise for not remembering. As always,
I ask you to introduce yourselves so we know who you are.
Mr Crozier: I am Adam Crozier,
group chief executive of the Royal Mail.
Mr Smith: I am Alex Smith, commercial
director of the letters business.
Q264 Chairman: To put this session
into context, sometimes this Committee has been critical of the
lack of transparency about Royal Mail Group's figures. Before
we begin, can you give an update of where you think you stand
commercially?
Mr Crozier: To try to keep it
reasonably brief, clearly over the past six years we have made
some real progress. Most people know that we turned a £1
million loss per day into a £1 million profit per day. We
have gone from failing quality of service targets to meeting them.
We have taken out of the business about £1.5 billion of gross
cost. We are 50,000 people fewer than we were. We have pretty
much the lowest stamp prices in Europe and are amongst the highest
quality in Europe and all of that has taken place in a declining
market which has been opened up to full competition. That has
resulted from a genuine effort by all our people right across
the country every day and that is a great testament of what they
have done. But the simple truth is that it is hard to think of
where we would have been if we had not achieved all that change.
Even today the simple fact is that the business does not generate
enough cash to fund the investments required to modernise the
business and ensure the future of the USO. If you take the period
2008 to 2011, we shall have negative cash flows in the letters
business of about £1.3 billion. Clearly, that is because
we are trying to modernise the business at the same time, but
that is quite an outflow of cash.
Q265 Chairman: That is a negative
cash flow assuming the pension deficit is funded out of that?
Mr Crozier: Yes. We have huge
challenges. The first is that we have rapidly declining letters
volumes. Last year it was 2.5%; this year it will be 4.5%, and
we predict it will be 8% next year. As a ready-reckoner, each
per cent of volume decline costs us about £70 million in
revenue. As you think of volume declines that is the rough order
of magnitude.
Q266 Chairman: An 8% decline in revenue
equates to approximately £560 million which is about twice
the contribution to the pension fund deficit?
Mr Crozier: That is correct. This
is a worldwide issue. In Holland it is predicted to be 6% to 7%
this year; in the States the prediction is 9%. This is not a UK
phenomenon; pretty much every single country in the world is experiencing
it. It is all about the change in the way people communicate with
each other. In many ways it is also not just about postal competition.
The USA is a monopoly marketplace and it still predicts a decline
of 9% and that it will make a $6 billion loss this year. Therefore,
it is about the wider communications market. The second huge issue
is a growing pension deficit which a number of Members mentioned
earlier. You will know that we tackled our future pension provision
last year, but our view is that when it is revalued this year—that
is done by the trustees, not the company—it will show a
deficit of the order of £8 billion to £9 billion. If
you bear in mind that the deficit already costs about £280
million per annum over 17 years the simple truth is that alongside
those volume declines we cannot afford to pay what might be up
to double that cost. Equally, we cannot afford to pass on that
cost to the customer because all that will do is exacerbate volume
declines. The more uncompetitive we make ourselves versus other
media the more we shall drive down volumes. Therefore, the two
really big problems are connected at that point. I understand
and respect everyone's right to have a view on some of the things
that are proposed. For us these are not ideological or philosophical
issues but real problems that the company must face up to. You
would rightly ask us the very simple question: what are we doing
to find a way round these problems? First, we shall accelerate
the modernisation and further improve the efficiency. At no point
are we saying that we are the most efficient organisation, but
clearly with 50,000 fewer people than we had we have made a lot
of strides on that. We are also investing £2 billion in modernising
the organisation. Second, we are building new revenue streams.
The simple truth is that by 2012-13 parcels will account for 50%
of our revenue and 75% of our profit because mail volumes are
declining and parcels volumes are increasing on the back of internet
fulfilment and all sorts of other things. But in future given
our strategic direction of travel we shall be a European parcels
business that uses the resources it creates to help protect and
nurture the USO. Frankly, the most important thing for everyone
in this room is that the quality of the USO is protected. Third,
we are trying to find a pensions solution. I have said that we
cannot afford the cost, nor can we pass it on. The truth is that
our competitors on price do not have this problem. La Poste had
this taken care of two or three years ago; TNT, Deutsche Post
and others had it taken care of as part of wider changes in structural
and privatisation processes in the nineties. Therefore, we are
competing on an apples and pears basis where we carry a cost that
our competitors do not. Clearly, in the end if we modernise we
want the benefits of it to go to the customer, not this huge and
continuing drain on cash. That is why our submission to Hooper
in summary was basically three things. First, we needed access
to equity capital. It is important to say equity capital as opposed
to more loans or debt; they are not the same things. Second, we
need a pension solution. Third, we need to move to the communications
regulator because the simple fact is that that reflects the reality
of our marketplace. Those are the people against whom we are competing
as we go forward in future.
Q267 Chairman: Thank you for that
introduction. We shall ask you questions about regulation, your
efficiency as an organisation, the issue of minority shareholder
and finally the Post Office. I was amazed that the BBC made so
much of the leaked letter from Royal Mail Pensions Trustees. Lord
Mandelson sat in front of this Committee a few weeks ago and said
that the deficit would be between £8 and £9 billion.
Do you want to speculate with me and Roger Berry about the reasons
why the BBC was suddenly encouraged to reveal this as news? It
was a rather tired old story to say the least, but why today?
Mr Crozier: The honest answer
is that I do not know. I was aware that Jane Newell was intending
to write, quite properly so, to give the trustees' view. I do
not think there is anything particularly new in that letter. Even
with last year's results and our happier results this year we
made very clear—we sent notes to all MPs—that we expected
the pension problem to double or more than double. Obviously,
it is a legacy problem and not one from which the company has
ever hidden.
Q268 Chairman: The BBC is unusually
slow off the mark on this occasion. I begin by asking about regulation.
I pick it up where Mark Oaten left off in the previous session.
How did you feel about Postcomm's definition of the USO and its
power to widen the postal service definition to include other
products? Is that a public policy decision that should have been
taken by government or an economic regulatory decision to be taken
by the regulator? That is important looking forward to the new
system.
Mr Crozier: I think it is very
important that regulators are entirely independent in any marketplace.
But 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.
Q269 Chairman: That is a public policy
matter. Government should say what is the more important; it is
not for an economic regulator to double-guess such an important
matter?
Mr Crozier: I am not sure that
it is for me to say that, but arguably, yes, one would set up
the policy and then someone would implement it.
Q270 Chairman: What about the nature
of the regulation under which you have and might labour? Can light
touch regulation ever really work in a market where you are so
dominant for reasons of history—that is not a criticism
but an observation—and are likely to remain so? If you brought
into the frame the Competition Commission, of which I am a great
admirer, inevitably very detailed work is required and it takes
for ever to reach a conclusion, by which time any abuse that is
alleged by a competitor will have subsisted during the period
and done huge damage to that competitor. Do you think the Competition
Commission is really part of the answer to the regulatory approach
to the mails market?
Mr Crozier: As far as I am aware
since competition has come in and certainly during the six years
when I have been chief executive I do not think we have ever been
found by Postcomm or anyone else to have abused that position.
I ought to say that for the record. We take great care to ensure
that we do not abuse our market position and if we ever did that
it would be a real problem. As to the Competition Commission,
I think the two extremes are difficult. Clearly, for many companies
one of the reasons for the threat of being taken to the Competition
Commission is to ensure they do not misbehave. Equally, at the
moment if we disagree with something Postcomm is doing our only
recourse is judicial review which, frankly, is just as long and
painful a process, if not more so. I think the current setup does
not help anyone. Obviously, we are not allowed to see whatever
legislation is coming forward for all sorts of reasons, but I
would have thought that in the context of new legislation one
of the things people ought to be looking at is what powers any
regulator would have to resolve disputes and issue as they arise.
Q271 Chairman: Obviously, it is not
for you as the major regulatee, which I think is the word, of
the new regulator to specify what those powers should be, but
it will be interesting to know what powers you think the new regulatory
arrangements should have to regulate your behaviour.
Mr Crozier: I think the most important
thing for me and Members of the Committee is absolute clarification
on what is the most important thing that people are trying to
do, ie to protect and nurture the USO. That is the thing that
holds together the social and economic fabric of the country.
In truth, if you do not have a healthy USO you also cannot have
competition because one relies on the other. You have to start
with the basic building block which says that protection of the
USO is the number one priority. That is not to say we are anti-competitive
because we are absolutely not, and I think we have shown that.
We operate in many markets across Europe in a very competitive
way, but there is need for clarity of brief which says that the
USO is extremely important.
Q272 Chairman: What about the resources
of Postcomm? That is an odd question to ask a person who is subject
to its regulation, but do you think that in its current incarnation
it has enough resources? What resource do you expect Ofcom to
devote to it? How should that resource be funded in the new world?
Mr Crozier: At the moment we fund
Postcomm and before it we funded Postwatch. I think that each
cost about £10 million per year. I would rather answer by
saying that what I think Ofcom will bring is an understanding
of the wider communications market. 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. We need to be competitive against them, not the little
bubble at the bottom. That is just a reflection of the fact that
our market and some others are undergoing a fundamental structural
shift. Everyone in this room is communicating differently; we
text, phone, email and do all sorts of different things. That
will not change; it will carry on into the future. Therefore,
it is absolutely vital that we have to generate, like parcels,
new revenue streams utilising our great skills, our network and
the fact that we are everywhere every day and building new products
on that. We believe that in five years' time 75% of our profit
will come from parcels. That tells you in a nutshell what is happening
to the letters business and in e-commerce.
Q273 Chairman: Who should pay for
the regulator? At the present you pay all of it. Should your competitors
make a contribution in future?
Mr Crozier: I am fairly agnostic
on it. I am not sure that it is the most important thing. The
most important thing is that we have the right kind of regulation.
Q274 Mr Hoyle: Is it fair to say
that you have had a strained relationship with Postcomm over the
period? Do you believe that you will have a better relationship
with Ofcom? BT has also had a very strained relationship with
Ofcom over the years. Do you see any benefits after Postcomm?
Will it be better or worse or much the same?
Mr Crozier: It is always difficult
to have a history where the relationship is between one company
and one regulator because there is nothing else for anyone to
think about. My understanding is that BT has found that to be
a very different experience because it is one of a number of companies
and industries being regulated. For us it is not so much about
the relationship as the issues. It is always better to depersonalise
it; it is not about people but issues and business. In our view
part of the problem is that perhaps a gamble was taken. If you
take the two priorities of the USO and the desire to bring in
competition, a gamble was taken that because market volumes would
continue to grow the USO would take care of itself and therefore
people could concentrate on bringing in competition. That was
not what happened because the marketplace declined at an increasing
rate. Therefore, it is more about the issues. Alongside that,
we and I believe Hooper felt that access headroom—we have
said this to the Committee many times, so I guess it is nothing
new—needed to change, and was an unfair piece of regulation.
Effectively, keeping a continual gap between what we charged and
what the competition was able to do meant that however efficient
we became, even if we improved efficiency by 50%, we never became
more competitive. That is an incredibly blunt tool that sometimes
is used to pull in competition and in our view at times it is
very unfair.
Mr Hoyle: There was a double-headed coin
and you always had to have tails. You were a bit like a masochist:
you were being beaten up but paying for the pleasure of Postcomm
doing you up?
Q275 Anne Moffat: It is a bit like
going to the dentist.
Mr Crozier: It has been a very
difficult matter to explain to our people. Our people have been
through a hell of a lot in the past six years. We have 50,000
fewer people. Those who remain are all working much harder. Their
future pensions are reduced. Their pay has been substantially
increased and they now work five days and not six, so there have
been good things for them too. One hopes that the jobs are more
satisfying, but it is very discouraging from their point or view
that no matter how hard they work they cannot close that gap because
that gap is guaranteed. That is a hard thing to get across to
180,000 people.
Q276 Mr Hoyle: Mr Stapleton seemed
to make different answers to different questions when it suited
him. He started by saying that with the access agreement you made
money and then he said that you might lose some money. What is
the case?
Mr Crozier: On our regulatory
accounts we are required to report on a fully allocated cost basis
and as such we lose 2p on every item of access mail—full
stop.
Mr Hoyle: That is one in the eye for
Mr Stapleton.
Q277 Roger Berry: To clarify that,
do you cover marginal costs?
Mr Crozier: Yes.
Q278 Roger Berry: How significant
is that?
Mr Crozier: Substantially, the
last mile is effectively a fixed cost network, so the marginal
costs of the last mile are variable.
Mr Hoyle: There is a difference between
delivering mail to John O'Groats and the centre of Manchester.
Q279 Chairman: You said that you
lost 2p per item. For the record, how many items are we talking
about?
Mr Smith: In terms of access mail
it is about five billion.
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