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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 172-ii House of COMMONS MINUTES OF EVIDENCE TAKEN BEFORE BUSINESS & ENTERPRISE COMMITTEE
INDEPENDENT
REVIEW OF THE
MR NIGEL STAPLETON and MR TIM BROWN MR ADAM CROZIER and MR ALEX SMITH Evidence heard in Public Questions 161 - 362
USE OF THE TRANSCRIPT
Oral Evidence Taken before the Business & Enterprise Committee on Members present Peter Luff, in the Chair Mr Adrian Bailey Roger Berry Mr Michael Clapham Mr Lindsay Hoyle Anne Moffat Mr Mark Oaten Mr Anthony Wright ________________ Witnesses: Mr Nigel Stapleton, Chairman, and Mr Tim Brown, Chief Executive, Postcomm, gave evidence. Q161 Chairman: Gentlemen, welcome to this session which is to examine the Hooper review and the recommendations that flow from it. It is a review which in theory brings to an end your own organisation, if what we hear about legislation is true. The House of Lords is to have such legislation before it later this week. Perhaps I may begin as I always do by asking you to introduce yourselves for the record. Mr Stapleton: I am Nigel Stapleton and I have been chairman of Postcomm since January 2004. Mr Brown: I am Tim Brown and have been chief executive since September of last year. Q162 Chairman: Do you believe it is fair to make the general observation that your organisation has given primacy to competition in its statutory remit rather than protect the universal service obligation? Mr Stapleton: I think that statement is entirely unfair in the sense we are very conscious of the fact that our primary statutory duty is to maintain the USO. We can put forward some pretty convincing evidence that competition has strengthened the USO rather than weakened it. Q163 Chairman: Would you like to share some of that evidence with us? This Committee was concerned about what it saw as a premature rush to competition well ahead of any European requirement. That concerned us in the report we prepared three years ago. Mr Stapleton: Clearly, 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. Royal Mail's own figures indicate that it lost £100 million of profit to mail competition and five times that amount to digital competition. Our figures suggest that the amount of profit left on the table from the delay in the modernisation of the Royal Mail is also five times that £100 million. I think it shows clearly that competition is a pretty small factor in terms of what has led the USO into loss. Q164 Chairman: But the European Commission's own directive, had you followed it, recognised the need to allow the USO operator to adapt to change. There have been decades of under-investment in post offices. It used to be an all-mail group which was ill-placed to cope with the competitive environment into which you thrust it prematurely. Mr Stapleton: Royal Mail's own chairman said in 2006 when we fully opened the market to competition that it was ready to face competition. Q165 Chairman: To put a more factual question, do you think from your experience as chairman and chief executive of the organisation that the regulatory framework gives you the powers you need? When legislation comes through the House very soon should we be looking for new and different powers for Ofcom when it takes on your responsibilities? Mr Stapleton: I think the Hooper report indicates that Postcomm lacks what he calls an essential part of a regulator's toolkit, namely concurrency under the Competition Act. We also lack specific powers to deal with access. We hope that both those weaknesses in the legislation under which we are working will be addressed in the new Bill. Q166 Chairman: You still have regulatory responsibility and you see them as weaknesses now in the toolkit available to you? Mr Stapleton: We have made that point over the past four or five years; it is not a new issue. Q167 Chairman: Do you accept the case for your abolition? Would you have done a better job had you had those powers? Mr Stapleton: I do not think you would expect me to say anything different, but we believe that Postcomm has done a pretty good job in the circumstances. I will ask my colleague to pick up that point. He has been with us for a relatively short period of time and may be more objective in his answer than I might be. Mr Brown: Over the past seven or eight years there have been quite a few improvements in terms of Royal Mail's quality of service. When we started out with regulation Royal Mail's quality was below 90%. In the four years before the strike action it was at 94%. We see a reduction by one third in the number of exceptions; that is, individual addresses that do not receive the same specification as everybody else have been reduced by a third. The number of losses has reduced. Royal Mail has delivered quite a lot of improvements in terms of quality of service over the period. We have also seen pressure on price. Independent research quoted in the Hooper report shows that the price is probably about 5% lower for larger customers than it would otherwise be. It is important that large customers see the relevance of that because it is they who underpin the universal service. There has also been an extension of choice for smaller businesses. For example, from 1 April of next year we will see metered mail, of which big use is made by smaller businesses and is at a discount to standard tariff mail. Q168 Chairman: We are all customers of Royal Mail Group. For me, the service has collapsed. My post came regularly at around breakfast time whereas now it comes at any time in the middle of the day. Small business people working from home just cannot rely on the post any more. To the average constituent the idea that the quality of service has improved is laughable. Mr Stapleton: One needs to be clear as to what is in the universal service and therefore what we are duty bound to protect. Q169 Chairman: Let me bank that question and allow others to ask about the universal service obligation. My colleagues who want to ask about USO may feel that I am treading on their territory. I want to ask about resourcing the regulator. You are resourced by the taxpayer; Ofcom is resourced by a levy on the people it regulates. How do you think the new regulator should be resourced in respect of mail services? Mr Stapleton: The regulator comprises a little over 60 people and the budget is less than £10 million. Had we continued that would have reduced by 15% next year. Therefore, it is a relatively small levy on Royal Mail as the dominant operator and that sort of approach has worked pretty well. Q170 Chairman: What do you think about Ofcom taking on your responsibilities? There are competing logics. You could be seen as a utility operator who should be regulating alongside the water companies and electricity networks - the Royal Mail is a network business - or you could say that you are a communications business and it is right to put you alongside telecommunications and broadcasting. Do you see the logic in the communications link? Mr Stapleton: The important thing for us is market certainty. If there is to be a change of regulatory responsibility that should be done in a way that minimises market uncertainty. Our own submission to Hooper was that it was better if the framework was put in place when the price controls in April 2010 were in place and then there was a change. That is the reason why to the extent we can we are working with Ofcom to achieve a smooth transition, but there are limits to it. Clearly, it can act only within its vires. It is important that sector-specific experience is maintained within the Ofcom organisation, because practically everybody who responded to Hooper, including the CWU, has said that post is different from a capital-intensive telecommunications business. Therefore, the regulatory principles need to reflect the different characteristics of the mail market. Q171 Chairman: It is always difficult to say goodbye to an organisation that you have cared for and cherished for a number of years, but you have no objection in principle to Ofcom becoming the regulator? Mr Stapleton: I do not think it is for us to object one way or the other. We were created. Q172 Chairman: But your experience is very important. The Committee wants to see regulation of the mail market and it needs to know whether you think it will be effective under Ofcom. Mr Stapleton: Clearly, Ofcom has a very good track record. The read-across to the communications sector is an important issue. That is an issue of which from my perspective I believe I already have experience, because I came into this role having been co-chairman of Reed Elsevier and having spent a lot of my career in the communications world. As long as the sector-specific experience is maintained and the transition is done in a way that minimises market uncertainty we are supportive of the move. Q173 Mr Oaten: Putting it bluntly, are you saying that Ofcom does so many things that postal issues will get lost within it as regulator? Mr Stapleton: I was not saying that but Ofcom must be careful to ensure that is something that does not happen. Q174 Mr Hoyle: Mr Brown, you talked about the successes. You referred to big customers by which I presume you mean bulk deliveries. Mr Brown: Large customers, yes. Q175 Mr Hoyle: How can you judge it to be a huge success when the bulk customers get it cheaper than everybody else? I thought the idea was that we would all be treated equally, but somehow you give a preference to bulk customers who are subsidised by the taxpayer. Mr Brown: That raises a number of points. It is important to understand the nature of the customer mix within the mail market. Eighty-seven per cent of all mail is sent by businesses; only 10% is sent by residential customers and that is mainly at Christmas. Within that make-up the top 50 customers represent 40% of mail; the top 500 represent 50%, so it is important in terms of how those large customers perceive mail as a useful medium for what they do so they continue to use it and therefore fund the universal service. Without those bigger customers there would be no universal service and no six-days-a-week delivery. Therefore, what we have seen is increasing choice and lower prices such that those larger customers continue to use mail. Q176 Mr Hoyle: That does not add up, does it? What you are saying is that under the access agreement you must have a USO that delivers for your competitors at a loss. Does that make sense? Mr Stapleton: Access does not involve Royal Mail making a loss on delivering the mail over the final mile. If you look at the detailed figures Royal Mail is making a loss on bulk mail products that it delivers end to end. If it makes a loss on that as well then it is not surprising it will make a loss in carrying it over the last mile for its customers. Q177 Mr Hoyle: You are saying to the Committee that it is a fact Royal Mail does not lose money under the access agreement. That is the first time the Committee has ever been told that. Everybody has stated to us that the problem is that the access agreement is so low that you cannot make money on it, and yet you are telling me that Royal Mail has been making money. Do you want seriously to consider your position on that? Mr Stapleton: I said that access carried bulk mail. Because the bulk mail market is a very competitive one it is the bulk mailers who have most of the choice in terms of using digital communications. Royal Mail loses money on end-to-end bulk mail and also on access, so you cannot carve out access and say that it is unprofitable when the rest of the product range is unprofitable. Q178 Mr Hoyle: I will make it simple for both of us and say it slowly. Is Royal Mail making or losing money on delivering access mail at 13p? Mr Stapleton: It is fully covering its variable costs. Q179 Mr Hoyle: So, you are saying it is making money? Mr Stapleton: On that measure. I am an accountant by training and therefore I can give you four measures of cost, but I am saying to you very clearly that access is not Royal Mail subsidising the competition. Q180 Mr Hoyle: You can go round it all day. Can we try yes or no? Is Royal Mail making money out of access delivery? Mr Stapleton: Yes, it is covering its costs. Q181 Mr Hoyle: So, everything that we have been told is wrong? You tell us what a good job you have done and how excellent you have been. Why is the government getting rid of you? They think that you have done a poor job. I do not know of anybody apart from yourselves who say that you have done a good job. Mr Stapleton: In that case I do not think you have read the Hooper report very clearly. Q182 Mr Hoyle: The government say that you have to go and Ofcom should take over because you have been a disaster. What is your answer to that? Mr Stapleton: I have not heard the government say that. Q183 Mr Hoyle: Do you think it is not keeping you because you have done such a good job? Mr Stapleton: It is not keeping us for the very tangible reason that the Hooper report has made perfectly clear that mail is competing within a wider communications market. That is the key reason why there is logic in changing the regulatory responsibility. Mr Hoyle: Everybody knows that you have been a disaster; you have been a problem to Royal Mail, and that is why the government is getting rid of you and moving to Ofcom. Let us hope that it is more successful than you. Q184 Mr Clapham: To clarify that point, is it not a fact that when the access price is combined with the headroom obligation it creates a situation where your competitors in effect are guaranteed gross margin? Mr Stapleton: No, it is not in the sense there is a margin within which the competition can compete with each other. Nobody will move their business away from Royal Mail unless they get a price and service advantage in so doing. There is a margin within which the competitors can compete. Because access competition has probably kept bulk mail prices down by 5% it has caused Royal Mail to carry more volume over the final mile. It carries 99.5% of all mail volumes over the final mile, so it has added to the health of the mail market, but it most definitely has not left the access operators with a guaranteed margin; it has left them with a margin on which they can compete against each other. It offers a lower price and better service to bulk mailers and increasingly to small and medium size businesses because it is now dealing with mail comprising as little as 250 items a week. Q185 Mr
Clapham: That is rather different from some
of the information we have. None of your competitors in Europe or Mr Stapleton: I will ask my colleague to explain that to you, but I must make the
point that access to the last mile is not something unique to the Mr Brown: The reason why we have introduced headroom is because Royal Mail remains dominant in the marketplace. It still has 99.5% of all deliveries. In terms of the contracts it has with customers it still handles about 75% of all bulk and access mail. Q186 Mr Hoyle: Can you repeat that figure? Mr Brown: Ninety-nine per cent of all addressed mail is delivered by Royal Mail. Q187 Mr Hoyle: That includes access? Mr Brown: Yes. Therefore, it is still a dominant player in those marketplaces. The introduction of the headroom was to prevent the potential of Royal Mail market-squeezing its competitors, playing with both the access price and the price it charged its customers to squeeze out legitimate competition. Q188 Mr Clapham: But has it gone too far and given your competitors an advantage? Mr Brown: The competitors can compete only if their costs are lower than those in the headroom. As my colleague said earlier, generally they compete at a price much lower than that headroom. Q189 Mr
Clapham: One matter that causes me some
concern when I look at the issue of competition is that the Mr Stapleton: I have just said that the access regime is considerably more
extensively applied in the Q190 Chairman: I am conscious that we are already behind time. This is an interesting and important point. Can you provide a note on the comparative regimes because I was certainly not aware of this? Mr Stapleton: The other point that needs to be made is that we acknowledged back in August 2007 when we did a strategy review as a precursor to the post-2010 price control that access headroom was a blunt instrument. Had the Hooper report not delayed the follow-through of our strategy review we would at this point in time have already been six months into consultation about an alternative to the access regime. We acknowledged its limitations and started as long ago as August 2007 to put a new system in place, and in the past two years we have also undertaken a very thorough review of Royal Mail's numbers to make sure that the access headroom is fair in terms of its amount. We have not just been sitting on our hands and saying we have got it right; we have been preparing the ground for a new system based on cost transparency and equivalence. Q191 Mr Clapham: Referring to the USO, Postcomm set the definition which is very wide. What is the rationale for the wide definition of the USO? Mr Brown: The six-day-a-week USO is defined in the Postal Services Act, not by us. The uniform price and the six-day-a-week service is defined there and that is the universal service we seek to operate and sustain. It is Parliament that can change the six-day-a-week service rather than us. Q192 Chairman: As a matter of fact that is not true. The Postal Services Act says "every working day" and the legal obligation is five days. I happen to think it is right that there should be a six-day obligation. Mr Stapleton: The directive says five days; the Postal Services Act refers to six days. Q193 Chairman: Section 4(1)(i) of the Postal Services Act says "at least one delivery of relevant postal packets is made every working day". Mr Brown: If you look at the definition of "working day", it says six days for letters and five days for all parcels, so the two together give us the six days. The work that we do looks at what products are classified as being within the universal service and which product fall outside it. That is done in conjunction with discussions with Royal Mail. Royal Mail makes applications from time to time to take certain products out. We review those as part of our price control, so that is where we influence what products are inside and what are outside. The products inside the universal service must be provided at a uniform price nationally. As to those products outside the USO, whilst they can still be subject to price control Royal Mail can seek to do zonal pricing or deal with it in other ways. Q194 Mr Clapham: If went from Postcomm to Ofcom is this something that you would seek to draw to its attention with a view to reviewing the situation? Mr Brown: I think it is Ofcom and the new legislation that will decide upon and define more clearly what the USO may look like going forward. We have been fairly clear in terms of our submissions to Hooper that we do not see any need at this point to change the definition of universal service. Q195 Mr Clapham: So, you are quite satisfied with the USO as it stands? Mr Brown: In terms of the six days, yes. Q196 Mr Clapham: When you are looking at prices what is the rationale for requiring you to consult on any changes? For example, do you find that that gives an advantage to your competitors? Mr Brown: Before we take any decision we always consult. As a regulator we have to take on board evidence and we normally consult for up to three months, so we go through a consultation process. We did that before the price controls were put in place, so there was extensive consultation on it. That sets overall price controls on Royal Mail. Within that Royal Mail has the ability to set individual prices. It has a requirement to publicise those prices three months in advance of implementation. There are some practical issues around that. People like Pitney Bowes and Neopost need a period of time to change meters and software, so it cannot happen overnight. Q197 Mr Clapham: It is these factors that make the process take such a long time? Mr Brown: Royal Mail announced its new prices for April in December. They come into operation at the beginning of April. Mr Stapleton: The reason why people need quite a lot of notice is that obviously a large part of the market is accounted for by postal franking machines or software-type mailing. Therefore, changing the chips on the franking machines and so on requires notice. It is not done to help the competition but first and foremost to help the customer. Q198 Mr Hoyle: You said that 99% of all addressed mail was delivered by Royal Mail, but it is bound to be, is it not? The universal service obligation is only on Royal Mail, not its competitors. The reason its competitors do not deliver mail is that you make Royal Mail deliver it so cheaply that they cannot compete, so why do you throw out a fact that is obvious? Mr Brown: Royal Mail is paid for those deliveries. Q199 Mr Hoyle: It is paid 13p? Mr Brown: On average it is 13p. Q200 Mr Hoyle: How much do you pay? Mr Brown: I pay 27p for second-class mail. Q201 Mr Hoyle: Therefore, we are subsidising bulk mail? Mr Brown: For example, a large direct customer like Royal Bank of Q202 Mr Hoyle: I understand all that, but is it not fair to say that the competitors do not have the universal service obligation imposed on them because of the cost of doing so? Mr Brown: Royal Mail is at the heart of the USO and they pay for that delivery. Q203 Mr Hoyle: If you want competition what you should say is that anybody who wants to compete with Royal Mail should also deliver everyone's mail. The reason you have not done it is because it would be too costly to do and, therefore, you have imposed on Royal Mail the obligation to delivery everybody else's mail and that is why it delivers 99% of mail, surely. Mr Brown: And it delivers that at a price that Royal Mail negotiates and charges its customers. Q204 Mr Hoyle: But it does not pick its own price; you do it? Mr Brown: No, we do not. Q205 Mr Hoyle: Who picked the 13p? Mr Brown: The access price was the price negotiated between Royal Mail and its access customers. Q206 Mr Hoyle: Can Royal Mail increase it? Mr Brown: It can increase its price of access, yes. Mr Hoyle: How? The minister said that it could not and he would have to look at the access agreement. Q207 Chairman: You said it was negotiated, but am I right in saying that if those negotiations did not result in an agreement you would impose the price of 11p? Was that not the position of Postcomm? Mr Stapleton: No. Back in April 2003 Postcomm opened up the bulk mail market -
over 4,000 items - to competition. Based on that a couple of operators, UK Mail
and BNSE, wanted to get into the access market. Royal Mail at that stage talked
about very high prices and, therefore, UK Mail came to us and asked us to do a
determination of the price. We worked on that and at five minutes to Q208 Mr Hoyle: You asked Royal Mail to play Russian roulette with a bullet in every chamber? Mr Stapleton: Not at all. Q209 Mr Hoyle: Of course you did. What you said was that if it did not negotiate you would tell it what the price would be, so it would have been less? Mr Stapleton: In terms of a competitive marketplace that is not unreasonable. Q210 Mr Hoyle: Do you agree that in a competitive market everything should be equal? Mr Stapleton: I think the point you have missed is that it is the massive volumes of bulk mail that provide Royal Mail with the economies of scale and mean we can have a universal service with a 27p second-class stamp. If it were not for those economies of scale that bulk mail brought to the market we would not see the universal service being as close to self-financing as it is. The real challenge is that as those bulk mailers move to the internet Royal Mail is losing those economies of scale. Mr Hoyle: I think you have answered the question. You said "close to self-financing", whereas before you told us that it was self-financed. CWU and the RMG claim that effectively they have been required to subsidise their competitors. Chairman: I think you asked that question earlier. Q211 Mr Hoyle: But CWU and RMG have also stated it. You still say that both of them are wrong? Mr Stapleton: I made the point that Royal Mail is losing money on bulk mail that it delivers end to end. It would be hardly surprising, therefore, that on a fully allocated cost basis it would also be losing money on access because that is a piece of the end-to-end business. Mr Hoyle: I rest my case. Q212 Chairman: I really do not understand your evidence. Perhaps I am being very stupid. It may be there are different accounting definitions for what constitute profit and what does not, but my understanding of what you have told the Committee is that Royal Mail makes money and does not make money on it. Mr Stapleton: It is very clear. The evidence is in Royal Mail's regulatory accounts. There are two definitions of cost. There is a definition based on fully allocated costs with all the overheads thrown in and there is a definition based on marginal or variable costs. All the mail that Royal Mail handles obviously covers the variable costs. Both bulk mail and access on Royal Mail's figures lose money on a fully allocated cost basis. That is the clear position. Q213 Chairman: If it is truly profitable for a company it should make money on both measures, should it not? Mr Stapleton: Yes, but at this point the choice that bulk mailers have to use electronic communication puts some constraint on that ability. Q214 Chairman: What you are saying is that it makes no contribution to the bigger overheads of the company? Mr Stapleton: I did not say that it made no contribution; I said that it did not totally cover those costs. Q215 Chairman: It does not meet the full costs to the company of providing the service? Mr Stapleton: No, and that is hardly surprising given the situation. Q216 Chairman: You referred to what powers you did not have that you would like to have. You mentioned powers to do with access. What powers do you think you should have had to deal with access? Mr Stapleton: The powers we would be talking about are not just what I said in terms of concurrency under the Competition Act but also powers in terms of cost transparency and accounting separation. Q217 Mr Wright: Continuing the line of questioning about costs, what is your current assessment of the costs of the universal service obligation? 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. Q219 Mr Wright: But this figure must be consolidated. The Hooper review came to the view that there was a distinct lack of agreement between Royal Mail and Postcomm on even the most basic statistics. Surely, it is something that should have been sorted out a long time ago? Mr Brown: Over the years we have worked with Royal Mail on its costings. Royal Mail's costing systems have improved. When we do the price control every three or four years we look at the financial strength of Royal Mail as a licensed entity in terms of letters, not at the individual product level. The result of the lack of cost transparency and information means that when we have conducted specific investigations and reviews we have done quite extensive and time-consuming analyses of that data. Therefore, the need for cost transparency is about speeding up the decision-making process. Q220 Mr Wright: You suggest quite clearly that it is self-financed. Royal Mail Group wanted to be self-financed but you suggest that it is already there as far as concerns the USO. Mr Brown: 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. Q221 Mr Wright: So, you do not consider there is a case to answer that there should be financial support for the universal service obligation? Mr Brown: We do not believe that that is necessary at this moment. We believe that the modernisation programme Royal Mail is undertaking and the improvement in its efficiency should fund the profitability of Royal Mail Letters. Mr Stapleton: My colleague has already indicated - Mr Hoyle picked up the point -
that Royal Mail carried 99.5% of mail over the final mile. There are three
postal operators in Q222 Mr Wright: I think the modernisation programme and pension deficit are huge problems, but as a lay person in terms of the universal service obligation I cannot accept that there is not a loss in providing that facility at the price of 27p for a second-class stamp to send a letter across the country. There must be an element of loss. I cannot figure out how you can come to the conclusion that it is self-financing. Mr Stapleton: The reason why there is not a loss is that the volumes handled by Royal Mail are enormous and the economies of scale more than make up for the inefficiencies. If you do a rural round, as I try to do pretty frequently, there is probably one stamped item in a postal delivery of five or six items to each house. It is the fact that the universal service is carried by the economies of scale and the 89% of Royal Mail's revenue comes from business mail. Our major concern is about the mail that is moving over to digital alternatives, for example banks sending electronic statements and asking you to use the internet. If that goes and Royal Mail does not modernise the only alternative will be either a reduced specification of the universal service or government subsidies like those being given to the Post Office network. I do not think that either of those is an option acceptable to government. Q223 Mr Wright: If one takes the view that it is making a loss then it is far better to accept that and for some negotiations between yourselves and Royal Mail Group, for instance, to come to that conclusion. You cannot have a situation where you say post-Postcomm that it is self-financing and then Royal Mail Groups says that it is £3.4 billion. There is a huge disparity there. I just think that in terms of the universal service obligation there is a form of subsidy in existence. Mr Stapleton: There is total agreement that the Royal Mail Letters business last
year made a profit of £3 million. As my colleague said, that was net of
the loss on the universal service and the profit on the non-universal service,
but there were some big items that we as regulator took out of the USO such as
special delivery for businesses which transferred a profit of £40 million
from one side to the other. You should look at the total picture. But our
concern is that mail volumes are falling at an accelerated rate. Usually mail
volumes lag Q224 Mr Oaten: How quickly do you think the loss will arise? Mr Stapleton: If Royal Mail is talking about a 7% volume decline for next year, which is obviously a reflection of the general state of the economy and the move to digital, clearly it faces an enormous challenge in terms of changing the direction in which its costs are moving if it is to avoid moving into loss next year, even before one takes into account the distinct possibility that if the pension deficit is not removed the £280 million that is now being contributed towards funding it may be two to three times as big next year. Q225 Roger Berry: Obviously, we did not need Hooper to tell us there was an issue about modernisation and the pensions deficit. This Committee has talked about it for years and years as have management and the trade unions. The distinct point about Hooper is the proposal for a strategic partner, minority shareholder or partial privatisation, call it what you will. The reasons that have been given in support of that proposition boil down to two or three basic ones. The first is about the need for external expertise and new management and leadership. Why is it that external leadership, management and expertise is necessary? Why has not the existing management been able to do the job properly? Mr Stapleton: The only point I make is that that is one of three reasons Hooper came up with and I do not see it as necessarily the strongest. Roger Berry: I was planning to take them one at a time. Q226 Chairman: You would not necessarily see it as the strongest reason? Mr Stapleton: Of the three. Q227 Roger Berry: How strong is it? You have been the regulator. Is this a criticism of existing management? Are they not up to the job? Do we need to get people from outside? Mr Brown: Management operate within the constraints they have been given. I think that the other reasons in terms of introducing access to third parties and such like enable it to get out of those constraints. If operates under a big constraint in terms of the pension deficit. When you look at many of the incumbents in other countries those pension problems have been removed and therefore they are not subject to it. There has also been greater separation between the company and government. Q228 Roger Berry: Management operates within constraints as we all do. I suspect that removal of the pension deficit will command almost universal support. For reasons we can go into - we do not have time - the government should pick up the pensions deficit, but in my view what is proposed by Hooper is the need for external expertise, management and leadership. Presumably, it means that Hooper and his colleagues believe that the present leadership is not up to the job. Why is it one of the three? Mr Brown: What Hooper has asked for is expertise among those who have made a transformation and have done this sort of thing before. It is getting access to that knowledge and expertise to work with Royal Mail to make those changes. Q229 Roger Berry: But you believed that people should be brought in to run Royal Mail. They were not people who had had expertise in the past in transforming and improving businesses. I seem to recall that that was the reason for changes at the top which I warmly welcomed. Mr Brown: I do not speak for Richard Hooper but he makes fairly clear recommendations in terms of getting access to the expertise and knowledge of those who have done this in a network business. It is that specific expertise and access to knowledge and understanding for which Hooper calls. Q230 Chairman: But you are allowed to disagree with Hooper; you do not have to endorse everything he says. It may be a package but you can disagree with bits and pieces of it. The question in my mind is: do we need someone with transformational expertise, a network company or a postal operator to be that strategic partner? Those are three different concepts. Mr Brown: Our submission to Hooper was that we thought the primary point was access to network expertise and skills and experience of it. Q231 Roger Berry: You do not believe that that can be brought in without a shareholding? Mr Stapleton: Strategic shareholding brings a package of things. Q232 Roger Berry: I want to turn to capital later, but on management you are saying basically that it is impossible to get new blood into the organisation, about which you apparently feel quite strongly, without private shareholding. You cannot buy in the expertise and employ consultants. I would have thought it was quite common practice in the private/public sector these days to buy in expertise that does not exist in the organisation. Are you saying that that cannot be done in this case? Mr Stapleton: I do not think that you will draw us on the point about separating out management expertise from the division of political versus commercial considerations and access to funding. Those three come together. Roger Berry: I have not mentioned politics yet, but let us turn to capital. Q233 Mr Oaten: If I may intervene quickly, are you saying that a cultural change is needed which cannot be achieved by consultants coming in? You need a total change in the culture of the management? Mr Stapleton: Correct. It is still a business which in terms of its culture goes back to the days of the 1990s; it is a very difficult culture to change. We are not critical of what the management team has achieved given the constraints under which it has been working. Q234 Roger Berry: I think the culture today is different from when I first became a member of the Committee. I recognise that the leadership of the organisation 10 years ago was radically different and not as good as it is now, but the question is whether or not the existing management is up to the job. Clearly, you do not want to be tempted too much on that. As to the question of bringing in a private shareholder for additional finance, all the major private companies that I know these days are running in the opposite direction; they are going to government to ask for money to keep them afloat. Do you believe that getting money from a private sector organisation is cheaper now and a better deal than for government to fund it if it believes that investment is necessary? Mr Stapleton: Mr Q235 Roger Berry: Are you saying that private companies would invest in Royal Mail without any strings attached? They have no agenda and will just give it some money and provide new management to do the job? Mr Stapleton: Clearly, they will want to see the rewards of a successful modernisation and share with the government in the receipt of those rewards. Ofcom as regulator will make sure that with or without a strategic shareholder Royal Mail lives up to its obligations in terms of providing the universal service. I read an awful lot which says that Royal Mail needs to be 100% public owned in order to secure the universal service. It is regulation that will make sure that the universal service and competition are secured. Q236 Roger Berry: With no disrespect, I did not ask that question. How much do you think the Royal Mail Group needs to modernise? If the responsibility for the pension deficit transfers to the government - there is a powerful argument for that - that releases £284 million a year. There is already £600 million in the pipeline. How much more is necessary? Mr Stapleton: Royal Mail's own figures indicate that it is 40% less efficient than best in class. Hooper has a table which shows margins and comparators. In a business that is 70% labour costs you can work out, with costs of £6 billion, quite how big that number is. Q237 Roger
Berry: These comparators of efficiency are
quite difficult, are they not? The cost of different businesses providing these
services in Mr Brown: Earlier my colleague talked about Royal Mail's forecast of volume reductions of about 6% or 7% going forward. A 7% reduction in volume could without action take £300 million straight off the bottom line of Royal Mail, so while a solution to the pension deficit will give a short-term boost to Royal Mail's profitability and cash flow in the long term with a decline at that level due to e-substitution and the recession Royal Mail's finances in the medium to long term are challenged. That does not save it in the longer term. As to how much money it needs to invest, the £1.2 billion loaned two or three years ago is part of a modernisation programme and plan that Royal Mail already has underway and is implementing, but going forward the changes in investment it will need to make - I know you will hear from Royal Mail after us - are larger than that and they have to continue. It is not a question of doing it and it is finished with; there must be continual investment. Roger Berry: Mr Stapleton, you mentioned quite rightly the issue of European legislation, state aids, competition et cetera. Would not a strategic partner taking a shareholding in Royal Mail be anti-competitive? Q238 Chairman: Particularly if that partner were to be TNT which is its major competitor? Mr Stapleton: Clearly, that would be an issue for the regulator. If what I read
in the papers is correct there are other parties with no presence in the Q239 Roger Berry: Despite all the qualifications you have made about management, the cost of finance and the issue about competition you have no doubt that it is absolutely necessary for a private shareholding in Royal Mail? Mr Stapleton: It is absolutely necessary to make significant changes to the direction in which the business has been moving over the past two to three years. Q240 Anne Moffat: Have the British public as stakeholders been getting value for money from Royal Mail, you and everybody who has been involved in the process up to now? Mr Brown: Every year we conduct independent research as to what consumers and residential customers think. Eighty-five per cent of all respondents say that they receive good or very good value for money and have overall satisfaction with Royal Mail services. The great British public still rates very highly the service that it gets from the Royal Mail. Q241 Roger Berry: There are different answers from a whole variety of sources. According to the media today, the letter that went from Royal Mail Pensions Trustees Ltd to the secretary of state asserted it was absolutely essential to have a strategic partner, but if you read the letter, which in total covers one side of a sheet of A4 paper, it does not say that at all; it says that the pensions deficit needs to be addressed and recommends support for the Hooper report. Are you surprised that the letter from the pension trustees in making the case for something to be done to address the pension deficit does not explicitly support what you have been saying which is a minority shareholding in Royal Mail? It is for the media to explain how that story became slightly distorted in the coverage. Mr Stapleton: That does not surprise me. I have not seen the letter as you clearly have. Jane Newell as chairman of the pension trustees has a very clear perspective in terms of protecting the interests of pensioners. She is making the point that the deficit is likely to move to the sort of number that Royal Mail cannot afford to pay. Q242 Roger Berry: But the trustees of the pension fund are not in a position to comment professionally on whether or not Royal Mail should have a private sector partner, are they? Mr Stapleton: That is precisely the reason why I am not surprised it is not in the letter. Roger Berry: It is interesting to note the difference between the media coverage and what we agree on. Q243 Anne Moffat: I am still very confused by everything I am hearing. If management cannot do its job and asks for consultants to be brought in to do it is the management any good in the first place? It seems to me that it keeps throwing good money after bad. If the money had been spent more wisely it might not be in the position it is in today. To say that the whole problem is to give the most profitable of the mail service to a private concern and leave the rest of it in the wilderness is ridiculous even to contemplate. How do you feel about that? Mr Stapleton: It is not my understanding that the government plan is to give the strategic investor a share of, in your words, the most profitable parts of Royal Mail. Q244 Anne Moffat: Did you not say earlier when talking about the internet and new technology that that is the way forward and that is where the profit will be? Do you agree that that is the case? Mr Stapleton: What we have said very clearly is that the profitability of Royal Mail is under threat because both recession and structural changes in the market cause mail volumes to decline. That was not foreseen back in 2006. A comment was made that we got the market estimates wrong. Our market estimates like those of any regulator were based on Royal Mail's market estimates. Our estimates and those of Royal Mail for the actual volumes in 2010 are 100,000 items apart on 21 billion items. Everybody has failed to see the structural change in the market, but the strategic investor will have to cope with competition and the effects of transition to digital media. That investor is not being allowed to cherry-pick the attractive parts of Royal Mail; it will try to get a profitable business in supporting the USO in this changing world. Q245 Chairman: Your recollection of the evidence about market volumes does not coincide with mine. I will have to check the record, but I believe the evidence we have received is quite to the contrary; it disagrees with you profoundly on the judgment you reach. Mr Stapleton: There is a difference in estimates in terms of the encroachment of access competition, but on total market volumes we are 100,000 apart. Chairman: I believe we have received evidence that total market volumes will go down contrary to your estimate, but I must check the record. Q246 Mr Bailey: Before I deal with my specific area of interest, I just want to follow up some of the points made about a minority shareholder. You have a situation where the most politically contentious recommendation of Hooper is that there should be a minority shareholder. In analysing the Royal Mail's lack of efficiency - it says it is 40% less efficient - it mentions the network of mail centres and delivery offices, automation, working practices and pay. At the end of the day all of those are management issues. What I cannot get my head round is why a minority shareholder and partner can transform the management culture to deal with those issues when in effect you could bring in somebody else and just change management. I do not think that central point has been adequately answered by you in the responses so far. Can you explain what it will bring? Mr Stapleton: First and foremost, it is an answer that needs to come from the shareholder rather than the regulator. The regulator does not manage the business; it looks after the interests of customers. Q247 Mr Bailey: But what reasons do you give for being in favour of it? Mr Stapleton: If you go back to our strategy review published in August 2007, then you saw practically the same headline on the BBC as it gave 15 months later to the Hooper report. The headline on our strategy review was "Royal Mail needs radical change"; the BBC headline on Hooper was "Royal Mail faces call to change". Our strategy review did not talk about ownership being part of that change but about the pension deficit and modernisation. Clearly, that modernisation has not happened. I think that with the passage of time we need to look at bolder initiatives to make it happen. Having as a partner someone who has made those changes before and has a track record must be bolder than just more of the same which was what we were looking at in August 2007. Q248 Mr Bailey: But you could just change management? Mr Brown: We are fairly clear that because of the third element, greater
separation between Royal Mail and politics and government and allowing
management to take decisions with as little political interference as possible
- we see much greater separation in places like the Q249 Roger Berry: At this point the government with a minority shareholding in the majority of banks is having the devil's own job changing the leadership and management culture of those organisations. In this environment I find it extraordinary that you are saying to us it is self-evidently true that a minority private sector shareholding in Royal Mail will bring about the leadership transformation that is necessary. If it is so easy to do that in the Royal Mail with 30% please tell the government how to do it in the banking industry because it is finding it very difficult to do it. I am astonished. Mr Stapleton: With respect, the government has had only two months to do it and we do not suggest that a strategic investor will make much difference in its first two months. Roger Berry: I doubt that it is only the timescale. Q250 Mr Bailey: The other issue is the political relationship. Again, that could be changed without a minority shareholding. Mr Stapleton: Essentially, that was tried when the Postal Service Act was created in terms of setting up Royal Mail as a plc with a commercial remit. It has not happened in terms of complete transparency with management being allowed to do what it thinks is the right thing for the business. One needs to look only at what happened over the protracted period when management felt that in order to transform the business it needed 20% employee ownership. It did not happen. Q251 Mr Bailey: Is a 30% stakeholding going to make a difference? There are unanswered questions. Basically, I still do not believe that you have made the case. Perhaps I may turn to the demerger between Post Office Ltd and Royal Mail. Normally, when companies merge the reasons given are "natural synergies, potential outlets" and so on. You have acknowledged in your comments that there is a natural synergy between Post Office Ltd and Royal Mail, but at the same time you support the demerger of the two. Why? Mr Brown: We are in favour of Post Office Ltd staying in public hands. Post Office Ltd has been a separate limited company for over 20 years. It has had its own board and managing director for that period of time. Currently, one third of its business is postal; the remaining amount is concerned with financial services, telephony and other things. To a decreasing extent, unfortunately, it is concerned with government and public sector business. There are important relationships between Royal Mail and Post Office Ltd. The latter is an access point for postal services, but we believe there are benefits in Post Office Ltd and Royal Mail concentrating on their own businesses which are different. Post Office Ltd is a retail business delivered through about 11,500 private businesses; it delivers information and financial services, whereas Royal Mail is a distribution company. We see the differences. We also make very clear in our recommendations two other things: first, it is important to have a long-term transparent contract between Royal Mail and Post Office Ltd; secondly, there is a need for greater cost transparency in the charges made between the two. The third aspect is the need for a commitment by both central and local government to continue to use postal services going forward. We believe that in the context of all those things demerger is the right thing for Post Office Ltd. Q252 Mr Bailey: Could you not envisage a situation where it was to the commercial advantage of Post Office Ltd to allow access to companies that might be in competition with Royal Mail such that it undermined the viability of Royal Mail? Mr Brown: I think there are two parts to that question. We already see other networks being created for access to packet and parcel services. DHL already has deals with people like Staples and WH Smith; recently HGM, another packet and parcel carrier, has been doing a return service through PayPoint which, as you know, has 19,000 outlets. We already see other competitors beginning to extend themselves into the retail business and having retail outlets. At the moment Post Office Ltd is excluded from that debate and discussion and does not have that access. We know there are one or two other operators who would welcome the opportunity to use Post Office Ltd. As to the second part of the question - whether that would lead to undermining the Royal Mail and the USO - we do not believe that is the case. Royal Mail is looking at other access points for its services. The innovation of SmartStamp and the accessing of stamps online has been a huge success and is a great way forward. Royal Mail already uses other outlets such as Tesco, Sainsbury and such like for access to stamps. At Costco you can get a discount on stamps. Therefore, we already see greater use of other access channels and we wholeheartedly support it because anything that improves and eases access to postal services is good news. It really illustrates the point that there are two different strategies, one for Royal Mail in ensuring access to its services including postal services and the other for the future of Post Office Ltd. Q253 Mr Bailey: Effectively, both acting independently could engage in wider competition that undermined each other? Mr Brown: I do not think it is a question of them undermining each other. They need to develop to support and sustain what they are doing. Mr Stapleton: In any situation where you demerge a business that is a major customer of another - at this point about one third of Post Office Ltd's revenue comes from mail - obviously you put in place a long-term agreement that ensures continuity of that business and a structured relationship. The key point is that the sustainability of the Post Office network requires two things: first, more revenue coming into the Post Office network; second, a closer identity with local communities. It is our feeling that that demerger direction, particularly in the context of a strategic partner in the Royal Mail Letters business, would be a good thing for the Post Office, but it requires a proper long-term agreement to make sure that what you are concerned about does not happen. Q254 Chairman: If you are promoting all of these alternative postal service access
points to Royal Mail in the interests of the consumer, which is probably good
thing, and also protecting the Post Office network what is the regulatory or
ownership issue as far as Post Office Ltd is concerned? How many flowers
bloomed in Mao Tse-Tung's Mr Brown: First, 70% of Royal Mail's business is not mail. Q255 Chairman: So, it is not a mail issue and is nothing to do with the regulator? Mr Brown: Our duties under the Postal Services Act are about access to postal services, so we are interested in how the consumer accesses postal services. Q256 Chairman: Notwithstanding the different ways to access postal services you expect Post Office Counters to remain the major way in which consumers access those services? Mr Brown: Absolutely; I did not mean to give any impression otherwise. Q257 Mr Oaten: In terms of accountability for the whole system and the role of government, is this something in which government should be heavily involved to ensure there is a universal service, or should it be a light touch? What kinds of controls under the new regime do you believe government should have over placing controls and demands on the future regulator? Mr Stapleton: One of the recommendations of Hooper with which we wholly agree - obviously, Postcomm produces an annual report but it is not discussed with this Select Committee - is that there should be more accountability to Parliament by the regulator. Q258 Mr Oaten: More of this? Mr Stapleton: Yes. Q259 Mr Oaten: I bet you are glad that it will not be you in the future. Mr Stapleton: Not entirely, no. Q260 Mr Oaten: How much government involvement has there been? What kind of pressure or relationship has there been with various ministers in your role as regulator? Mr Stapleton: There has been a substantial amount of change. In my five years there have been four different secretaries of state, starting with Ms Patricia Hewitt. I think there has been a very significant attitude change by government in terms of respecting the independence of regulation. There has not been as much as we might have expected in terms of government looking at the interests not just of Royal Mail but also other operators and the impact on customer values. Q261 Mr Oaten: Would you like to see greater involvement by government in ensuring the universal service in future? Mr Stapleton: I think the balance we have talked about is quite right, but clearly the situation we are in today arises because government has not applied more pressure for Royal Mail to modernise. The interaction between the shareholder and the company is clearly an issue, but I do not believe that the interaction between the government and regulator is as big. Q262 Mr Oaten: If Hooper were to be implemented and the changes we have talked about occurred you would want government to keep a very close watch and have a greater involvement to ensure that those changes were delivered? Mr Stapleton: Government will be a significant majority shareholder and it is probably even more important if there is a strategic partner that it does the job you would expect of a majority shareholder. Chairman: This has been a slightly longer session than we hoped. Mr Stapleton, this is probably the last time we will have you before us; in your case, Mr Brown, it is the first and last occasion. Although final farewells are always difficult to predict, I hope it is not a "Frank Sinatra" occasion. Gentlemen, thank you very much. Witnesses: Mr Adam Crozier, Chief Executive, and Mr Alex Smith, Commercial Director, Letters Business, Royal Mail Group, gave evidence. 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 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 do that. 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 and you rely to
some extent on the others. 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 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 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 because effectively in 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 200,000 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 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. Q280 Mr Hoyle: Mr Stapleton is not very good at his sums. He also said that everybody else was wonderful. You were pretty bad; you were the rotten core and were 40% more inefficient. I could not believe that figure was correct. Mr Crozier: If you look across Q281 Mr Hoyle: Does the 40% ring true? Mr Crozier: I am not sure that it is exactly 40%. Q282 Mr Hoyle: Do you think it could be less? Mr Crozier: I think it is slightly less. Q283 Chairman: The order of magnitude is right? Mr Crozier: It is substantial, and we have never shied away from that. So far we have improved efficiency and reached that first stage without investing. Q284 Mr Hoyle: You suggested to the Chairman that you paid £10 million for the pleasure of Postcomm. How much will you pay for the pleasure of Ofcom? Mr Crozier: I do not know yet. Q285 Mr Hoyle: Is there a reduction because it is merged? Mr Crozier: I have no idea. I guess that it will start with the legislation and its brief is and it will flow down. We genuinely do not know that. Q286 Mr Hoyle: It could cost you even more? Mr Crozier: I do not know. Q287 Chairman: My concern is that we shall become so obsessed with the pension deficit and the question of part-ownership that we may overlook the regulatory issues which are of fundamental long-term importance. Mr Crozier: Indeed; they are a big part of this, but I genuinely do not know the answer to this. Q288 Mr Hoyle: Can you send us a note telling us what you believe you will be charged? Mr Crozier: I really do not know. Q289 Mr Hoyle: You paid £10 million to Postcomm but you have not had any indication of cost from Ofcom even though it is about to take over? Mr Crozier: No. As we stand today our regulator is Postcomm. No new legislation about our regulator has appeared, so perhaps that answers your question. Q290 Mr Hoyle: I did not know whether you would get a discount and so save a bit of money. Mr Smith: That would be nice. Q291 Mr Wright: I believe that the review identified a number of areas in which it considered there were inefficiencies. What do you consider to be the most urgent area to modernise to improve efficiency? Mr Crozier: I think it goes across a whole number of areas. We shall be spending
about £2 billion on modernising it. That is all about efficiency. A lot of
is about bringing in automation. People have talked about walk-sorting
machines; they sort letters to the walks of each individual postman, but once
you have done that phase you bring in what we call walk-sequencing machines
which mean that the letters arrive with the postman in the order he does his
individual round. For us that automation is absolutely critical in taking out
work and improving efficiency levels. There is a danger of comparing apples and
pears, in that other operators like Deutsche Post and Q292 Mr Wright: It might be useful if we had a plan of what the progress is likely to be over the next five years. I move on to your submission to Hooper in which you say you will reduce costs in Royal Mail Letters by £1.5 billion over the next five years. What discussions have you had with the union over that? Have you got their agreement to that plan? Mr Crozier: Effectively, the national strike in 2007 was about pay and modernisation. Clearly, at the end of that dispute we reached an agreement with the union on modernisation. Those documents are signed by ourselves and the union leaders. I believe that at the time we sent them to MPs and Members of the House of Lords. To be fair to Billy Hayes and others at the union, they recognise the need for change; they have said it themselves a number of times. I believe that their own structure does not always make it easy for them to carry that down through the union itself. Q293 Mr Wright: What reduction in the number of jobs is represented by the £1.5 billion? Mr Crozier: We have never given a specific number of job losses. On the other hand, we have never hidden from the fact - we have made it clear to all our people and the union - that modernisation will involve job losses, but there are a number or different options as to how some of those scenarios might be dealt with. As and when we get to them obviously we shall consult extremely widely with the union on any of those changes, and we always do. Q294 Mr Wright: I can understand the need to negotiate and discuss with the unions, but there must be a global figure. The media put out all sorts of things in terms of proposed job losses. When you made your submissions to Hooper you said quite clearly that you would achieve a sustained cultural change by rationalising the network of mail centres, which is job losses, transforming delivery offices, which is job losses, standardising and simplifying working practices, which always means job losses, increasing levels of automation, job losses, and investing in and building the capabilities of colleagues. When you come to the figure of £1.5 billion clearly you must have in mind a global figure for the reduction in jobs. Mr Crozier: We have never hidden from that fact. All aspects of modernisation and improving efficiency eventually result in fewer people and that is true not just of our company but of any. As we get to each stage of the modernisation we shall re-evaluate what we are doing. We go through that stage with the union. There are always a number of different ways to skin any cat. We explain the different ways and then agree the best way forward. That is the reason we never give an overall number for jobs because it depends on how we choose to do each aspect of the modernisation. Under our agreement with the union not only would we want to discuss it with them but we are obliged to do so. As each element comes up we always do that. We have shared the overall strategy with the union many times. We have had a lot of sessions with them, sometimes extending over two days. We have taken them abroad to look at machinery and equipment and the kinds of things we do. We have trials running at various mail centres. None of this is hidden from people. These are things that we have to do and they are commonplace in modernised postal companies that have already been through it. We are not re-inventing the wheel here. Q295 Mr Oaten: It strikes me that the process of consultation with the unions you have described must take an awful lot of your time and energy. Is it not a barrier to modernisation? Is not the fact that you have to go through such a lot of consultation with the unions one of the reasons why there is such inefficiency in your structure and service? Bluntly, it holds you up from cracking on with the modernisation. You could probably have achieved a lot of these things two or three years ago if it had not been for the unions? Mr Crozier: I am not sure that is entirely fair. To be sure, to go through all the consultation affects the pace at which you can make change, but on the other hand there are examples where with the union's involvement we have managed to do some good and impressive things. I think the union's structure itself sometimes works against what we and in many ways the union leadership think needs to be done. For example, even if you come to a national agreement the union's structure is such that every branch is at liberty to decide whether or not it wants to take part in it. One matter we have suggested - I wrote to Billy Hayes about it recently - is that if, as Hooper suggested, what is needed is for the union itself to modernise its structure we shall be very happy to work with the TUC and whatever best practice might look like for the structure of the union irrespective of its cost we will help them to implement it and pay for it. If we get that best practice structure so that the union leaders feel we are on the same side it will be helpful not just to us but to them. The company needs to modernise but I do not think it is unfair to say, as would some within the union, that they have some modernising to do, too. Q296 Mr Oaten: That sounds like a very polite and diplomatic way of saying that the unions have been part of the inefficiency. Mr Crozier: I am not sure I agree. Mr Oaten: You just said the structure was such that if you made a national agreement you had a different pattern throughout the country. You said that it needed to modernise, so clearly it must be part of the problem. Anne Moffat: They are also part of the solution. Q297 Mr Oaten: Indeed. The reality is that there is inefficiency and the unions are part of it. Mr Crozier: Let me answer the question in a different way. Do I believe that Billy Hayes and others want to change and help the Royal Mail be successful? Yes, I do. Do I think there are issues with the union's own structure that sometimes prevents it, never mind me, from doing that? Yes, I do. Q298 Mr Wright: You need to take the workforce along with you; there must be discussions and negotiations and you must be upfront and transparent about what has happened within the postal service. I think everybody from the postman right up to the chief executive accepts that change needs to happen to sustain the postal service that we have come to expect. One matter that concerns me is that in the papers we read about postmen being timed from the moment they deliver their post office to the delivery of the letters. They have to do it in a certain time. That does not do anything for industrial relations. It is certainly a two-way process. It appears to me to be a one-way process. What I am getting at is: how is the relationship with the union at the moment? What are you doing to try to rebuild the relationship which I think has been broken over time? Are you prepared to sit down with the union exclusively over the next few weeks and months to talk realistically about what change will be needed and be upfront about what is to happen with the workforce? Mr Crozier: As we have seen over the past couple of days Royal Mail, like it or not, is an organisation that lives in a goldfish bowl where it is open to political interpretation from all sorts of different angles. Sometimes people use us as a bit of a football. Is it true that we ask our postmen to go at four miles an hour? That is absolute nonsense; it is complete tripe. Is it true, as we read recently, that there is something called Project Tiger where we plan to lose 16,000 people next week? I have here the union all-branch report which tells people that Project Tiger is not about people. Do we sometimes get used? Do things appear that are not entirely true? Yes. We are part of that political football. That said, the most important thing is that we need to take the union and our people with us, but do we also have to accept that in the situation that this company faces at the moment some of the things we need to do are not very popular? Yes. Is it popular to reduce people's future pension? Clearly, it is not. Will people like that? No. But that does not mean as a company even as it is currently funded by the taxpayer we can shy away from it. We cannot say on the one hand we insist that they improve efficiency and do much better and on the other hand not do the things that will allow us to get there. We have to take people with us but we must accept that we shall have to do some pretty difficult things; otherwise, the company will not survive. The twin issues of declining volumes and the huge pension deficit will not go away on their own; we have to find solutions to them; otherwise, the fact is that the company, the USO and the country has a bloody big problem. Q299 Chairman: We shall move to the issue of part-privatisation but I do not want to address that issue in putting this question. Following his appearance Richard Hooper has written to the Committee. After referring to capital issues and concluding that a strategic partnership is necessary, he says that the third issue of equal importance - it does not matter for the moment about the first two - is commercial confidence. He says that means modernising labour relations so that unions can engage in debates about the long-term future of the postal business and in turn management can press on with agreed plans free from confrontation and obstruction. I do not endorse what Mr Hooper says; I just comment that that was written to the Committee. He seems to place a good deal of the onus for the problem on the union. Anne Moffat may want to come in and ask a question to counter Mark Oaten's question, but Richard Hooper made a surprisingly strong statement to this Committee. Mr Crozier: If I gave the impression that it is all a union issue clearly it is not. We have to improve what we do. I have already written to Billy Hayes. We have talked about the need to improve the relationship between the company and the unions. We have met with the leadership of Unite. We have a two-day session set up between the leaders of the letters business and the union, so we have lots of work to do on our side, but in my view it requires a shift. Therefore, it is a personal one. I am up for change and I am actively going to promote it in the business every day. That is what we have to shift everybody into. We have to get on with this. I said to my wife at New Year that I intended to go jogging every night to try to get fit this year. I have not been out for a single jog yet, but that does not mean I was not sincere when I said it; it is just that I have not done it. Q300 Chairman: If we talk about change, perhaps I may be a little cheap for a minute or two. I think that the executive summary in your submission to the Hooper review talked about the need to accelerate the pace of the cultural and operational transformation. Are you happy that you have succeeded in changing the culture of Royal Mail? The people who work there say to me that you are still "mired in the worst of the public sector". They say that the top floor is fine but communications with middle and lower management still are not working. They say that you have all got chauffeured cars and senior directors wait outside for you all day; you still tend to employ expensive contractors and consultants rather than think of the payroll. There is a lot of criticism of the culture of senior management. Is that an unfair anecdote or do you recognise some of those criticisms? Mr Crozier: I do not. I will start where I should start. My personal belief is that the vast majority of our people are absolutely fantastic and do an amazing job, sometimes in terrible weather. I am full of admiration for what they do. As an organisation we are on a learning curve in moving to a world where we have to compete and be commercial. I think that shift has been a difficult one for our people. If you look at culture changes in any big organisation they will not happen in five years; they tend to take 10, 15 or 20 years. I speak to people at BA and BT who say that even today there are large elements of the cultures that existed in those organisations back in the 1970s and 1980s. Cultures in any organisations do not change in a short period of time. Do I think our people are willing to go on that journey? Yes. Are they genuinely concerned about what it means for them? Absolutely. I think there is a lot of fear but also recognition that we have to do it. A lot of the senior and middle management have changed. We used to have a group centre of over 11,000 managers. That group centre now consists of just over 200. The situation has changed beyond all recognition in some areas, but cultures take a long time to follow on. Q301 Chairman: You will know this Committee has been critical in public of some of the letters that the chairman has written to staff which have a very aggressive machismo style to them. Do you believe that the flow of information within the organisation now works well? Mr Crozier: It works a lot better than it did. When my colleague and I arrived one of the first things we did was write to our people and, naivety being a great friend sometimes, discovered that that was the first time management had ever written to them in 350 years. That seemed very strange to me as someone who had run other companies. Has it got a lot better? Yes. Is it perfect? Absolutely not. Do we need to find ways to improve it and bring people with us? Absolutely. When we look at it, what kind of expertise do we need going forward? Like all big companies, we need more and better project directors and in any situation like this people who are experienced at bringing in the kind of technology that we are about to use. This is not a kind of NHS IT issue. The machinery and technology we need to bring in exists and works so the risk is not to do with the machinery and the kit itself; it is the management capability in installing it. Do we need increased numbers and better skills in HR? Yes, we do. We know that we need to improve and we have been doing it steadily over the past few years. Like any company, we need to bring in skills at all levels of the business. Q302 Chairman: One of your major previous roles was as a consultant to an advertising agency. I was a public relations consultant. I value consultants, but do you think that Royal Mail Group makes too much use or not enough use of consultants and contract staff at present, or do you think you have it about right? Mr Crozier: We do not use many now. When I arrived I think one word to describe it would be "horrific". There was a ton of consultants in use; they were coming out of every door. We pared all of that back because we did not find it useful. We wanted to concentrate on the few things that would make a difference to the organisation. I am not saying that we do not use them; clearly we do in specialist areas where they can bring in skills that we really do not need to have all the time. We do not need to pay to have those skills sitting in the business day in and day out. I think that is the correct way to use consultants when they add value. Q303 Anne Moffat: I am not particularly in favour of consultants and the need for them in the way you describe, that is, to have consultants for consultants' sake. The amount of money they charge is extraordinary. Is not one of the successes of a slight improvement, if not quite a good one, of the industrial relations between you and the workforce and unions that now you have a single goal? You all want to see the success of the company? It is all about the survival of the Royal Mail and everybody has to work to that end. If you and the unions have that agenda it must improve the industrial relations even when there are very hard decisions to make. I welcome your words and the way you are now approaching the relationship with the workforce because, as I am sure you will agree, they are the absolute backbone of the Royal Mail and they work to protect the company. I think all of us, including government, should work hand in hand to do that. Do you agree that is the philosophy of the way forward? Mr Crozier: It almost has to be. Whatever our philosophical or ideological differences, I do not doubt that everyone in this room wants the Royal Mail to be successful and I think the support among the public for our people to do well is huge and is reciprocated by the vast majority of our people. We have to do more. The only caveat I give you is that we have done, are doing and will be doing some things that are very difficult not just for this union but any union to work with. They are hard and tough and are not things that ideally people would like to do, but they reflect the reality and scale of the challenges we face. That does not mean I disagree with what has been proposed. Anne Moffat: I do not want to steal other people's thunder, but maybe there is no support for a minority shareholding. Q304 Roger Berry: Believe it or not, I do not approach that question from an ideological point of view. I am quite interested in the evidence put on both sides of the argument. Why does the Royal Mail Group so passionately believe that a minority private sector shareholding is necessary for the future modernisation of the company? Mr Crozier: As part of Hooper we said that in our view it boiled down to three requirements: equity capital, a pension solution and a change in the way we were regulated and the fairness of it in the wider market. Richard Hooper came out with a package of various solutions. For us it is undeniable that that package of solutions would in the round leave the company in a better place tomorrow than it is today. As this debate has taken place over the past few months one interesting point that has been made - I have met various MPs - is that we have been ploughing money into the Royal Mail for years. That is not true. This is quite an important point. Undoubtedly money has gone into the Post Office. Under the system of external financing limits, which was normally an opportunity for public bodies to get funding - it was before my time - for the Royal Mail it worked in reverse. Between 1976 and 1998 the Royal Mail paid out under that system £2.4 billion. On top of that it paid about £1.4 billion in corporation tax. In the same period and since we have not had any injections of equity capital. The money put in recently by the government, as it has been at pains to explain, is very much a commercial loan that we have to pay back at a rate of interest. What this business desperately needs to make all these investments, give it a better balance sheet and provide a buffer against the huge risks it faces is equity capital. We do not need another loan or more debt, because we have more than enough debt thank you very much; we need equity. That is of great importance to us. Alongside that, we have never said anything other than that we need to continue the drive to bring better expertise into the business. As we make that journey we need that expertise to ensure that as we spend the money we run the modernisation process and get it right. We never say that we are carefree because we are far from it. Q305 Roger Berry: There are three elements in the package. Do you agree that if the element of equity is capital injection on sensible terms it is perfectly sensible to separate the three elements of the package? You have to solve the pension deficit problem - period? Mr Crozier: Correct. Q306 Roger Berry: As I recall, your submission to Hooper was less gung ho on private equity investment than some of you now are and made the point that capital injection was a third pillar but it had to be on sensible terms, so is it right that the question is: what is the best source of that capital injection? Mr Crozier: It is not for us to tell a 100% shareholder from where that capital should come. Our job is to say that we require equity capital, and it is undeniable that the company needs equity capital not just to cover all the risks it faces but for the extra investment and everything else. Q307 Chairman: It might be helpful if I remind you of what you said in your submission. Your third point was, "Access to equity capital would reinforce commercial disciplines and enhance access to talent that would help drive Royal Mail to transform itself into a truly customer-focused business." Therefore, access to capital would enable you to do the things that the package is supposed to achieve. Mr Crozier: Yes. Q308 Roger Berry: To cut to the chase, you have referred to equity capital, not private sector equity capital? Mr Crozier: We did not in our submission. Q309 Roger Berry: Exactly. Increased government equity would be a possibility, would it not? Mr Crozier: It is not for us to say from where it comes. Q310 Roger Berry: Intellectually, it would be a possibility, would it not? You have kindly pointed out that in your submission you did not talk about private equity capital but about equity capital. That is the phrase you have used repeatedly this morning. It is a matter for government to decide what to do. I do not ask you to tell government what to do, but as leader of the organisation there are three elements in the strategy with which I think we all agree, but when it comes to capital injection you are simply saying that there needs to be capital injection that does not burden you with debt that you might not be able to repay in a sensible period of time? Mr Crozier: We along with many others made submissions to Richard Hooper and he looked at the totality of those inputs and came out with a package of recommendations. We accept that undeniably in the round that package of recommendations is the best way forward. For us a crucial part of it is whether a partnership brings capital and experience and can short-circuit the introduction of experience, and, importantly, whether it can bring new commercial opportunities. That is what a good partnership brings. Obviously, in this process government has accepted the Hooper report and, assuming it goes through, in the process of finding a partner what we shall be looking for from that partner are three things: capital, expertise and a commercial opportunity. Q311 Roger Berry: Let us stick to the specific question. Your professional position as the leader of the company is that the third part of the package is the need for capital. You have repeatedly pointed out that you are talking of equity capital. You did not refer to private equity capital in your submission to Hooper. If the government came to you today and said that it wanted to give you x as additional equity capital would you turn it away? Mr Crozier: How would they do that? Roger Berry: At the moment in certain parts of the economy the question is: who is at the front of the queue? I know that you do not want to get into trouble with your major shareholder, nor do I, but you have said you want a capital injection on terms that do not burden you with loan repayments that are not sustainable. Equity capital from anywhere including government would do it. I am not asking you to say that you would prefer to do it one way or the other, but in terms of the capital part it amounts to the same thing. Now we come to the other points that you raise. You say that you want private sector involvement, even though you did not talk about that in the submission, but there are other things. Perhaps we can deal first with expertise. You have a lot of expertise. You can get some of these consultants back; you know far better than we do how that works. You do not need a private shareholding to get expertise, do you? Chairman: I think that what you said in your second submission to the Hooper review was that access to equity capital would enable you to access talent, so that was your view originally. Q312 Roger Berry: You must know as I do that there are ways to get that talent other than equity capital. It happens all the time. Mr Crozier: Please do not forget that we need timely and flexible capital and here we are four years into the process. If we look at when we started to talk to the government about needing more capital and where we are in the EU process four years later it still is not in place. Q313 Roger Berry: We on this Committee have been talking about this issue and know what the problems have been. I share your frustration. I think you have answered the question about capital injection. If we look at the other aspect of private equity other than capital injection, expertise, I assume you acknowledge that you know how to buy in expertise without the necessity of bringing in private equity capital. Am I being too obscure? We will come to the third point in a minute. Mr Crozier: If you ask what in our view is the most supportive way to bring in capital, expertise and commercial opportunity all at the same time in a structured way and on a reasonably full basis then a partnership is one of the best ways to do that. That goes alongside part of the wider package of pension reform and regulatory change. Q314 Roger Berry: This really is not good enough. We all agree on pension and regulatory reform; if we do not it does not matter for the purposes of this debate. It is intellectual nonsense to say that a package consists of three things and you cannot have any of it without having all of it. I am pursuing the particular bit about the minority shareholder and strategic partner. We have dealt with the question of capital. You can go out and buy the expertise. I think the third point is particularly interesting. I absolutely understand why you might want a strategic partnership of some kind with another company that has experience in expanding the kind of operation in which you are now engaged, but presumably you would also acknowledge that you can have partnerships with companies without them having private equity share ownership? Mr Crozier: You can of course. Q315 Roger Berry: Given that it was not in your submission to Hooper, why do you now say that somehow this strategic partner who is a minority shareholder is so important? Mr Crozier: The Hooper report very clearly said that here was a recommended package of solutions to fix the problems in its entirety. I may be using the wrong words, but the government has accepted those proposals in the round and said that is the package of measures it wants to take forward. It is undeniable from the company's point of view that that package of proposals leaves the company in a better place tomorrow than it is today. Q316 Roger
Berry: I am not sure that it would leave you
in a better position than it is today - I think it could be in an even
better position - not least because of the grief that will be caused in certain
quarters if the minority shareholding proposal goes ahead. I think that I have
got all I want on the record, with respect. To put one other question, are you
looking for a partner who would therefore cease to be a competitor in the Mr Crozier: In any aspect of any partnership in any business one of the things you have to take into account is any competitive issue that it throws up. That would just be a matter for the company, the regulator, the Competition Commission and no doubt various other bodies. There is no doubt that a fairly reasonable range of organisations would be interested in partnering with the Royal Mail. Some of them will give rise to competition issues and some will not. Obviously, that is something of which you must take account in the round. Q317 Roger Berry: I absolutely understand Royal Mail's position and I have a great deal of respect for the way you have presented it. My final question about the bit that was not in your submission to Hooper is whether you think there is a lot of private equity investment out there at the moment gagging to invest in Royal Mail after all we have heard this morning and in recent years? Mr Crozier: I give two answers to that. First, do I have tremendous faith in the Royal Mail? Yes, I do. Q318 Roger Berry: I do; we all do. Let us move on. Mr Crozier: Do I think people would like to invest in Royal Mail? Yes. Second, is the economic climate an extremely difficult one? Clearly, yes; you would be mad not to think that, but as always for the right investment there is a market there. Obviously, if there is a process that will tell us the answer to that question. You do not know until you have conducted it, but no one can deny that it is not an easy market. But if the thought behind the question is whether it can be done, yes, I think it can. Q319 Mr Bailey: So far you have emphasised the need for capital. You have got access to £600 million from the government. You believe that you will strip out of the business £1.5 billion in costs. You will be relieved of the annual sum £280 million for pension contributions. On the surface that would seem to be a substantial potential sources of capital in future. You say that you are on course to deliver profits that nearly double the performance in 2007/08. What is your assessment of the extra capital that you need, and what do you need it for? Mr Crozier: I will try to answer each of the questions you put. First, to be clear we got £1.2 billion from the government, not £600 million. Q320 Mr Bailey: The £600 million is allocated or at least not used? Mr Crozier: It is all allocated. Those funds were there to cover a five-year
period and clearly we would need to be shot if we spent all of it in the first
year because we would then have no money left. Therefore, that money is
allocated and we know what we are doing with it. But the £1.2 billion is part
of a wider £2 billion spend on modernisation itself. Without getting
overly technical, I should point out that even if the pension deficit is taken
away from us in some form there is no guarantee that we will get all of the
benefit of that through a system known as regulatory clawback. Any regulator
may not let us keep the full benefit of that. Q321 Mr Bailey: Your answer is somewhat vague as you acknowledge. Commercial confidentiality is always a convenient reason for keeping answers vague. On the basis of what I have heard so far it seems to me that what is being proposed is a capital solution to what is essentially a management and cultural problem. It has been acknowledged that industrial relations have been bad and that your costs are higher. I am not altogether clear whether or not the £1.5 billion cost reduction will change the fact that labour costs are so much higher. You have also acknowledged the access to skills that will come through a minority shareholder. Basically, if there is a minority shareholder do you not believe that your days will be numbered because to make those changes you need a change in management and that can come only via the minority shareholder? Mr Crozier: The only way to answer that question is to look at the track record. To correct one point, the £1.5 billion has already come out of the business and we need to take out another £1.5 billion. Q322 Mr Bailey: That reinforces the point I make. Mr Crozier: Did we move from losing £1 million a day to making £1 million a day
by accident? No. I think that in general the management of the company has
brought it a very long way and the track record shows that very clearly. Are we
one of the few organisations around at the moment in any business sector
reporting an improvement in profits? I cannot think of many. Are many of our
competitors announcing vastly reduced profits? Yes, they are. I think that the
management team - obviously, I would say this - has done a pretty exceptional
job under very difficult circumstances, but we must accept that pensions is a
legacy issue and a giant millstone round the company's neck. The management of
our competitors had this taken away from them; they did not have to solve it.
Clearly, we need a similar kind of solution and continue the drive to modernise
the business. Companies like Deutsche Post did it over 15 years; Q323 Mr Bailey: But your costs are still 40% higher after all these changes and improvements? Mr Crozier: Yes. Q324 Mr Bailey: Would any private sector partner be likely to enter into a partnership without a substantial change in the management and culture of the organisation? Mr Crozier: As a minority partner they would want to work very much hand in glove with the management of Royal Mail. It would look at the track record of that management delivery. Q325 Mr Bailey: The track record is that after all these improvements costs are still 40% higher. Taking up Roger Berry's point, it would be very difficult to get a private sector partner to enter into an agreement on that basis without substantial changes. Mr Crozier: I think the private sector partner would look at the opportunity to continue that modernisation and see a lot of benefit from it, and it would also look at the position of the company had it not taken out £1.5 billion of costs and it was still losing £1 million a day. Frankly, it would not be in great shape at all; I doubt that it would even be here. Q326 Mr Bailey: Therefore, a private sector partner would not be looking at how much money it would get on its investment in future and what changes would be needed to make that money? Mr Crozier: Frankly, the government wants a return on the investment it has put in and any private sector organisation would want exactly the same thing. Nobody invests in anything without wanting to get back the money and hopefully good return on it. Q327 Mr Oaten: Referring to the three reasons why we need a private sector partner to come in, Roger Berry appeared to be trying to get from you that you could achieve it with consultants and your own skills and knowledge. My understanding of what you are saying is that the issue are so big and the change in the market so enormous that you just cannot tag on some consultants and you do not possess the necessary skills and the only way to get that expertise is to bring in a major substantial partner. Mr Crozier: I think it is the quickest and best way to do it. We employ 185,000 people. It is not a case of bringing in the odd individual. Such an individual does not make a difference to 185,000 people; it is a bigger, wider cultural change. We have a lot of management throughout the company as you must have in an organisation of this size. The senior management is extremely well supported by the shareholder; it has made it clear to us in no uncertain terms on a number of occasions. All interested parties have also made that clear. But we accept that what we need within the organisation is a lot of project directors and people with the technology skills to deal with the stuff that we are about to put in. To refer to Anne Moffat's point, we also need HR skills within the organisation. We need lots of things. We need to find a way quickly to satisfy the combined criteria of capital, expertise and commercial opportunities. Please do not forget commercial opportunities. If you operate in a market where your business is declining by 8% per annum and you do not find new revenue streams eventually you have a horrible problem. Q328 Mr Oaten: You do not think that the three problems can be solved with independent solutions and the only way it can be done is to bring the three together in this package? Mr Crozier: I do not think anyone could say genuinely that it is the only way it can be solved. What I am saying is that we think it is the best way to solve it. Q329 Anne Moffat: I ask you a really easy question that you can answer yes or no. You said that absolutely everyone agreed you needed capital, cash, dough, money or whatever you want to call it. Given the position you are in, if money is offered to you do you mind from where it comes as long as it is legitimate? Mr Crozier: It is a matter for the shareholder. Q330 Anne Moffat: What is the shareholder offering you? Mr Crozier: I think the fairly simple answer to give is: it is a matter for the shareholder. Q331 Mr Hoyle: I think the management of Royal Mail is good; I think you have got it right and you deserve a pat on the back. Do you agree with that? Mr Crozier: It is definitely not for me to say, but thank you very much. Mr Hoyle: In that case you have turned the corner with £255 million profit in nine months compared with a loss of £1 million a day which is a major achievement. What expertise do you believe should come in and can do better than you have done? Why is it that the competitors you want to bring in are losing money when you are increasing them? I fail to understand what benefits will come from a company whose profits are dropping when at the same time your profits are rising. Mr Oaten: They are going down next year. Q332 Mr Hoyle: In fairness, so may theirs, but this is where we are at the moment. Mr Crozier: It is a good question. Let us stick to the letters business for now because that is the bulk area we are talking about. That business makes just under a 1% profit margin. There are different regulatory regimes, but TNT probably makes a 15% profit margin; Deutsche Post, I believe, makes about the same. Although the amount of profit we make sounds like a lot of money when it is put in the context of the sheer scale of the pension problem and the volume declines frankly it is nowhere near where it should be. I know this is a very difficult subject because people say that that is a lot of money. In context it is a tiny amount. Q333 Mr Hoyle: I accept all of that. To move on, with this deal the pension fund liability remains with the taxpayer. Mr Crozier: In some shape or form. Q334 Mr Hoyle: The liability is left with the taxpayer, so why does a private company want to come in? It wants to come in because it believes it can make money. It cannot come in for any other reason. Therefore, if profit is to be made I want that profit to come to the taxpayer because it is about having the best deal for the taxpayer. What we are saying is that this is the worst deal because the profits will go to a private company and a foreign government and the liability will remain with the taxpayer. I perceive this as a very poor deal. The big question is: how much money do you think you need as an investment? Mr Crozier: If I am being honest, I am not sure I agree with your statement. Q335 Mr Hoyle: I am a taxpayer and the liability is being left with me. Mr Crozier: All of us seem to be agreed that the pension problem needs to be fixed. Q336 Mr Hoyle: We fix the pension problem, but let us get down to the nitty-gritty: how much money do you believe you need to put the company right? Mr Crozier: Perhaps I may finish my answer. If the government sells a stake in Royal Mail - let us say it is 30% - clearly it will get 70% of any upside of putting these two things together. Therefore, the taxpayer is not losing out; it is the opposite. The taxpayer does not have to invest any money in equity capital in the business and it is getting a 70% share of a bigger and more successful organisation that is better than a 100% share of a lesser organisation. It is not an unusual route for us. If you look at the Post Office, there is a joint venture with the Bank of Ireland which has allowed us to get into financial services. Q337 Chairman: But it is not ownership in the Bank of Ireland? Mr Crozier: No; we have a joint venture company; we own 50%. Partnership is a tried and tested way for the Royal Mail Group to move into markets where it has not had experience or to bring in expertise that it does not currently have. We have done it on a number of occasions. Q338 Mr Hoyle: How much money do you need to put the company right? Mr Crozier: I have already answered that question. Q339 Mr Hoyle: Can you remind me? Mr Crozier: I said that we needed of the order of hundreds of millions of pounds, but I was not at liberty to give an exact number. Q340 Mr Hoyle: I do not mean that you should put a value on the sale. Mr Crozier: That is the question I am answering. At the beginning of a commercial process, if it happens, it would be wholly wrong to give away to any potential buyer what sort of money the company is looking to raise. That would be a big mistake from that point of view. I know that that does not answer your question, for which I apologise. Q341 Mr Hoyle: In part it does answer it; I think we are getting somewhere. Lord Mandelson said that hundreds of millions were needed. You have just made a couple of hundreds of millions in profit. Therefore, we are beginning to move in the right direction. The key is, surely, the loss-making access agreement. You have already said that for every letter you deliver at the moment you lose 2p, so why is it we do not renegotiate the access agreement and charge an amount that gives you the profit you require for investment including investment in the pension fund? Surely, that is a better way forward, because, first, you keep hold of the company; second, you are making money from what is at the moment a loss-making regime; and, third, the taxpayer retains its full interest? Mr Crozier: To take the second question first, in fairness in Richard Hooper's report it is very clear that there needs to be a number of regulatory solutions as part of the package. He absolutely identifies access headroom as being one of the problems. In our view and that of Hooper that needs to be fixed, but it is one part of an overall package of support. We are making £200-odd million profit, which is fine, but we cannot keep spending the same £200 million on everything. If we have an 8% volume decline that means £560 million is disappearing. If we have the pension problem and it doubles potentially that is another £280 million. These things need to be solved in the round. We have to find a package of solutions, whatever the right one is, that solves all of those problems. Mr Hoyle: I think we are more or less at the answer. You accept that you lose 2p, so what does that cost you? Q342 Chairman: It is about £100 million, is it not? Mr Smith: It is 2p on five billion items. Q343 Mr Hoyle: You are losing £100 million a year. Therefore, if we turn that loss into a profit by increasing it to, say, 6p that gives you an extra £300 million a year profit. Is that not sensible? Mr Smith: It depends on what you think will happen to competition. Q344 Mr Hoyle: Even Lord Mandelson referred to it being renegotiated. Mr Smith: There are people who want to enter the delivery market in the Q345 Mr Hoyle: Are you saying that Lord Mandelson was wrong to say that we should look again at the access agreement? Mr Smith: No; the headroom agreement does need to be looked at. Q346 Mr Hoyle: Therefore, we can make profits in that way as well and so it will be a benefit? Mr Crozier: It is already part of the package of solutions that Richard Hooper proposes. He has said very clearly - I completely agree with him - that a large number of changes need to be made on the regulatory side as part of this package alongside sorting out the pension problem. It is not for us to say how the government should solve it. We have always said that it should be done in some form. The third element is bringing in capital, expertise and a commercial opportunity. I think that the solution lies in that package in the round. Q347 Mr Hoyle: Did Lord Mandelson put you in an arm lock or head lock to agree it? Mr Crozier: No. Q348 Chairman: You talked about capital being timely and flexible. Referring to your defence of the case for strategic partner, to what extent is there real concern about the Treasury's reluctance to sign up to a long-term commitment to investment? The history of the period from 1976 and 1998 shows that the Treasury was not a very co-operative partner. To what extent - I do not like saying this because it is ammunition to UKIP - do the EU state aid rules have an impact? Richard Hooper placed great importance on putting the Treasury in an arm lock and compelling it to sign up to a long-term agreement. Mr Crozier: The state aid rules have a huge impact on the way investments can and cannot be made. We see that already in that the current investment plans has not yet had approval. It will also have a big impact on any solution on pensions. Any solution on pensions is likely to take north of a year, possibly 18 months, to go through or otherwise. These are not quick processes once the EU starts them. It is not an easy process. We still have some funding from 2001 and earlier that is being considered. To be fair to the Treasury, it makes it a lot more difficult for it to do it. Clearly, as in the case of the recent investment it must prove that it is a commercial loan with a commercial rate of return; it is not an investment as such. Q349 Chairman: You say that if you are to get timely and flexible access to capital EU state aid rules and the Treasury pose a problem? Mr Crozier: Admittedly, the markets are very difficult at the moment, but by and large in normal circumstances our competitors are able to get investment at a moment's notice. They can change prices at a moment's notice and therefore they are much more agile than we can ever be. Q350 Chairman: What structure do you expect to see for Royal Mail Holdings in the new world, if it happens? The Royal Mail part of the business will be x per cent if it happens; if there is a strategic partner it will be, say, 30%. Post Office Ltd will remain 100% state owned and Royal Mail Holdings will be above that and will hold a 70% and 100% interest in different bits of the business. Is that right? Mr Crozier: I was slightly confused by the previous debate on this part, so I ought to make our position very clear. Post Office remains part of the Royal Mail Group. Q351 Chairman: Holdings? Mr Crozier: I heard the debate about separation, but the way it would work in principle is that Royal Mail Holdings will be at the top. Obviously, that is 100% owned by government. On the other side is Royal Mail letters, parcels and what have you and that will be owned x per cent, though clearly much more than 50%; and over here is POL which is 100% owned. The Post Office gets about 30% of its income from the Royal Mail, but it is probably not as well known, though arguably it is more important, that the mails business generates approximately 75% of Post Office's footfall. Q352 Chairman: I just want to ask about the issue of ownership. There is no dispute - it is common ground between you and the government - that Post Office Ltd will remain 100% owned by Royal Mail Holdings which in turn will be owned 100% by the government? Mr Crozier: As far as I am aware, that is correct. Q353 Mr
Clapham: Before I turn to the Post Office, I
should like to make one comment having heard the exchange between you and Mr
Hoyle about the way we move forward. What you said about industrial relations
tended to suggest a very understandable approach. You have a situation where a 30%
partner is coming in. A company like TNT has a particular approach to
industrial relations and that might upset the apple cart and make things much
worse. You have to bear in mind those kinds of things. As to how things work at
present, the group wants to ensure that Royal Mail remains an integral part of
the business. Earlier you talked about the way you saw the business changing.
You said that in 2012 50% of the business would be dealing with parcels. What
is the relationship between parcels and the Post Office network? Where do the
parcels come in? Is it part of the European approach to your business, is it
the connection with the Irish venture or is it purely in the Mr Crozier: Fifty per cent of our revenue will come from parcels. Obviously, the parcel flows are from various sources. Some come in through GLS, our European parcels business; some come in from other international postal operators; some come through Parcelforce; and a huge number come through the Post Office itself. Bank of Ireland has no impact on the postal side; that is purely a joint venture in financial services. We see an increasing role for the Post Office in future from the point of view of customer convenience, for instance as a pick-up and drop-off point. One of the great reasons why people shop over the internet is for the convenience of getting everything delivered at home, but the reality is that something like 60% of people are not at home during the day. People who order goods from, say, Amazon or whoever may not want it delivered to their home but to a post office near their work or homes because it would be a more convenient place to pick them up. This was one of the things we trialled in the run-up to Christmas. Increasingly, for drop-offs and pick-ups the Post Office will have a very valuable role in what I suppose could be called the e-commerce economy as it opens up. Q354 Mr Clapham: That vision makes it plain that the link between postal services and the Post Office will be extremely important for that kind of development. Mr Crozier: Indeed. Q355 Mr Clapham: If we look at Post Office Ltd, you have a good network advantage at the present time such that you will be able to use it in future to grow the business. Presumably, when we begin to talk about postal services you will seek to retain that but with modernisation of the actual framework? Mr Crozier: Yes. Q356 Mr Clapham: Are we likely to see postal services retained or will there be a reduction in the number of such premises? Mr Crozier: I think you ask two different questions. If I get it wrong please correct me. The government closure programme is virtually complete and there are no plans to go through further closures. That does not mean that from time to time other post offices will not close for a specific local or individual reason, for example someone retires, but generally there is no closure programme. Will Royal Mail continue to use the Post Office? Absolutely, yes. Although we are very much part of the same group we also have what we call an inter-business agreement that runs between the two. You need to have that for all sorts of reasons to ensure that the mail is flowing from one to the other and back again. That is a very important arrangement. Obviously, at group level I must ensure that that is one of the things that works for the group in the round. I do not see any reason why anyone would not want that to continue. The Post Office is a very important part of providing the USO and giving people access points. The best way to think of it is that it is our shop window or retail arm. I see no reason why that would change. Q357 Mr Clapham: The delivery offices that are connected to the sub-post offices are likely to remain? Mr Crozier: Yes. There are about 1,100 special delivery offices, which we call SPDOs. They are very small sorting offices in small post offices usually in rural areas or villages. The truth is that that is the most cost-effective way to provide that service. Maybe in the long term - who knows - there will be another way, but it has been looked at many times and it seems to work. Mr Clapham: As to the moneys you receive, does they include an amount for the commercial advantage of the exclusive access to the Post Office network? Q358 Chairman: Do you pay for the uniqueness of the arrangement? Mr Crozier: No, because there is no exclusivity. I believe that Postcomm touched on something called condition 9 of its regulation. People can apply for access to post offices, so that already exists under the regulatory setup. Q359 Chairman: To be clear, anyone can apply to use the network for rival mail services but no one has chosen to do so? Mr Smith: Exactly. Q360 Mr Clapham: We have talked about an organisation that depends upon sub-postmasters et cetera. Do you believe that the operational effects of depending on people who underpin the network and run their own commercial ventures are likely to remain? Is that an advantage or is there likely to be some change? Mr Crozier: What that gives us is an incredibly flexible resource. In fairness to the vast majority of sub-postmasters, they have a very entrepreneurial approach and it works well. There are other countries where post offices are entirely sub-postmasters and franchises; there are others where there is a bigger proportion of what we call Crown branches. It is not the same solution in every country, but the solution we have at the moment seems to work pretty well. Certainly, the Post Office results with the help of financial services are improving. This year will be the first in many when the Post Office will make a small profit, so there is some real improvement. One thing that is very important to it is the work that this Committee will be doing in looking at what other opportunities there are within government services. You have started that process and it is a very important part of the Post Office's future. Q361 Mr Clapham: Within the network Crown post offices are of particular importance. Presumably, there will be emphasis on retaining the present number? Mr Crozier: Yes. The number of Crown offices has changed recently, as I am sure you know. Our view is that the balance is now about right. The ones that we have shifted over are now performing well. We also need to invest in those branches because the truth is that if you go into some of them they need modernising and upgrading better to reflect what we now do in terms of the totality of our services rather than just mail. A lot of investment in the Post Office outlets themselves is needed, and there are clear plans to do that. Q362 Mr Clapham: The government is making available £1.7 billion up to 2011 and it is then a matter of being able to negotiate beyond that time to ensure there is underpinning for the future? Mr Crozier: That is very important and that process really starts in the autumn of this year. Obviously, you have to do it well in advance. There are always issues on state aid and they take time. The reality is that that process will begin either in the autumn or very early next year at the latest. Chairman: This has been a very long session. I am not very provocative from the chair. It just amuses me that Post Office Ltd is said to be 100% publicly owned, but in order for it to deliver it relies on 11,000 strategic partnerships with small businesses, except for the WH Smiths, Tescos and Co-ops. I do not think we have asked anything from you by way of supplementary evidence, but if there is anything you want to clarify in writing subsequently please feel free to do so. I am sorry we have kept you for so long. This is a big and important subject. Thank you very much. |