Business, Innovation and Skills Committee - Stamp PricesWritten evidence submitted by Consumer Focus

About Consumer Focus

Consumer Focus is the statutory consumer watchdog for the postal and energy markets for England, Wales, Scotland and (for postal consumers) Northern Ireland. We work to secure a fair deal for consumers across the economy.

We consider that securing the universal postal service for all UK and Northern Ireland consumers is the most important priority of regulatory policy for the postal sector.

Executive Summary

Ofcom’s consultation document “Securing the Universal Service: The future framework of economic regulation” (Oct 2011) proposes a series of measures to deregulate the UK postal market, including measures to relax price controls for First Class or heavier letters and other postal items but only to retain a cap on standard Second Class letters of between 45p and 55p.

Our response and supplementary evidence submitted to the Ofcom consultation1 outlines our views and concerns:

despite Ofcom’s assurance that these steps will give Royal Mail the commercial freedom necessary to make the financial returns required to secure the Universal Service, the proposed measures may have the opposite effect;

Royal Mail needs to make significant efficiencies in order to secure the Universal Service—however, the pricing freedom proposed will enable it to raise prices but provides no incentive to make vital efficiencies;

increased prices could lead to many users switching away from post, decreasing mail volumes and threatening the viability of the Universal Service;

domestic consumers, and especially vulnerable ones, who lack alternatives to Royal Mail (for example, online options) will be captive to any price rises;

a safeguard cap is required across all Second Class products to ensure that vulnerable and low web users are not left to bear the brunt of price increases;

the proposals could impact upon micro-businesses and small and medium enterprises, which all rely upon an affordable and value-for-money postal service; and

the risks of widespread de-regulation upon the Universal Service Obligation (USO) warrant greater research and understanding of the impacts of the proposals upon consumers before proceeding.

1. The Ofcom proposals for economic regulation of the postal market

1.1 In its document “Securing the Universal Service: The future framework of economic regulation” (Oct 2011), Ofcom outlines a series of measures to deregulate the UK postal market. These include:

that proposed regulatory arrangements will last for a period of seven years;

measures to relax price controls for first class and for heavier letters and other postal items;

setting a cap on standard Second Class letters only of between 45p and 55p;

introducing regulatory safeguards in relation to the monitoring of Royal Mail’s performance;

a threat to re-impose ex ante regulatory techniques if Royal Mail does not undertake necessary cost controls and efficiencies;

setting a mandatory access condition on Royal Mail;

moving to contract headroom pricing; and

assessing impacts of potential end to end entrants before considering whether to impose Universal Service Provision conditions upon them.

1.2 Ofcom asserts that these measures are necessary to provide Royal Mail with the pricing freedom to continue to fund the Universal Service in the face of uncertain market conditions.

2. Regulating in the consumer interest

2.1 We recognise that Ofcom is facing difficult and complex judgements with risks associated with uncertain economic conditions combined with financial problems at Royal Mail and moves to sell the business. It is imperative that the right balance is struck between the contra policy aims of giving Royal Mail the ability to compete equally in those areas of the postal market where real competition exists; safeguarding the USO; and ensuring that users of mail pay a fair price for the service they receive.

2.2 In particular, Consumer Focus considers that a relaxation of ex ante price controls on Royal Mail at this stage of postal market development, and before a sale of Royal Mail has been achieved, is a very high risk approach that could damage the UK postal services market and act against Ofcom’s primary duty to safeguard the universal postal service.

2.3 Royal Mail has yet to tangibly demonstrate that customers and consumers lie at the heart of its business strategy. Consumer Focus is concerned that Royal Mail’s ethos, as seen through the decisions it has taken recently, is one of protecting its business model and not looking at what its customers need or want. Given that Royal Mail has not delivered on efficiencies under the previous price control, we are sceptical that Royal Mail, with the shackles off on prices, would get the balance right between raising its profits through efficiencies and doing so through price rises.

2.4 This could lead to steep prices rises for customers and could further persuade bulk mailers to make a permanent switch away from mail, critically reducing the revenues which underpin the universal service. Such a scenario would present reputational risks for Ofcom as it sought to establish itself as a postal regulator. In the worst case it could result in a financially troubled Royal Mail, which remained in public hands, imposing higher and higher prices on a dwindling customer base.

2.5 Consumer Focus commissioned experts to undertake financial modelling (see Figures 1 and 2 below) which indicates that Royal Mail could achieve reasonable returns without price rises, under current arrangements or following a sale of Royal Mail. However, this would be dependent upon achieving significant progress in implementing operating efficiencies and cost discipline strategies in, what are likely to be, tough market conditions. Internal incentives for such progress are critically important. In an environment where Royal Mail retains significant market power it is not clear how a regulator could provide such incentives without using ex ante price controls.

Figure 1

THE IMPACT OF COST EFFICIENCY ON MARGINS UNDER CURRENT CONDITIONS

Source: ESL UK for Consumer Focus

This suggests that even modest efficiency gains would transform Royal Mail’s financial performance.

Figure 2

THE IMPACT OF COST EFFICIENCY ON MARGINS FOLLOWING A SALE OF ROYAL MAIL

Source: ESL UK for Consumer Focus

The data above shows that Royal Mail’s decisions in relation to cost control and efficiency can have significant impact on its financial performance; and that privatisation may also significantly improve margins at the company.

However, Figure 1 also indicates that without privatisation and without efficiency savings of 5% p.a., Royal Mail’s operating margin will be negative by 2014.

We consider that while there are downside risks from Royal Mail’s financial performance, these are strongly related to decisions which the company may take in relation to cost control and efficiency and also to the timetable of the sale of the company.

2.6 Ofcom’s own analysis suggests that Royal Mail has found it difficult to manage down its costs even with the current ex ante price controls. But this is not an argument for removing price controls. The starting point should be that the current balance of regulation has set insufficient incentives for the company to be cost efficient. We consider that, by itself, further weakening of positive incentives by removing existing controls appears counter-intuitive.

2.7 Consumer Focus is also concerned about the suggested duration of the proposed package of measures which raises the possibility of higher prices exacerbating mail volume declines over a seven year period without the prospect of any remedial measures. If Ofcom decides to proceed with its proposals we would strongly urge that it conducts a formal review to assess their market outcomes at around a mid-point of the price control period.

3. The impact on consumers of stamp prices increases resultant from the proposals

3.1 Consumer Focus is concerned that significant price increases could lead to consumers and businesses switching away from mail entirely to other communication services (like e-mail), which would then cause mail volumes to decline further. As volumes decline, those consumers who are reliant on post (such as those without online options) would be left to pay even more to sustain the service.

3.2 A study by the Office for National Statistics revealed that in 2010 19.2 million households in the UK had Internet access (73% of households).2 This study also revealed that in 2008, households in the highest 10% of the income distribution in the UK were over three-and-a-half times as likely as those in the lowest 10% to have an Internet connection (96% of households compared with 26%).3

3.3 Research commissioned by Consumer Focus, and published in January 2012, indicated that vulnerable, low-internet-users are relatively unlikely to switch away from mail products when compared with consumers who have access to online alternatives and, as a consequence, are more likely to be captive to price increases.4 This is shown particularly with packets services, on which Ofcom does not propose to set a price cap.

3.4 Figure 3 below shows that vulnerable & low web users are predicted to reduce their usage of First Class packets mail at a slower rate as price increases. This may reflect the fact that vulnerable & low web users value speed over price. However this may also indicate that they are less able or willing to switch to alternative providers of packet delivery services, as those who choose Second Class show a similar lack of price sensitivity, demonstrated by Figure 4 (below).

Figure 3

PREDICTED PROBABILITY OF CHOOSING FIRST CLASS MAIL, BY SUB-SAMPLE (PACKET SCENARIO)

Source: London Economics for Consumer Focus

Figure 4

PREDICTED PROBABILITY OF CHOOSING SECOND CLASS MAIL, BY SUB-SAMPLE (PACKET SCENARIO)

Source: London Economics for Consumer Focus

3.5 Consumer Focus is very aware that for domestic consumers and SMEs, Royal Mail is the only show in town and there is no alternative operator (see next section for further information). There is no competition in the lower weight end of the market and Royal Mail is the monopoly provider. Ultimately, the consumer will pay, either directly and transparently or indirectly and opaquely, for the mailing costs associated with the delivery of goods purchased online or via mail-order.

3.6 Our research also indicated that First Class mail is still considered a vital service by many consumers with 19.5% of online respondents stating they use First Class all the time versus 8.7% who use Second Class all the time, and 28% of vulnerable low internet users stating they use First Class all the time versus 10% who use Second Class all the time.5 Consumers’ significant use of First Class could be because they value the speed of a First Class service, whilst vulnerable low internet users of both First and Second Class products could be as a result of a lack of alternate means of both priority items and mail more generally, and so we have urged Ofcom to reconsider the removal of the price caps.

3.7 Our research showed that as the price difference between First and Second Class options for mail products increased, more people would, not unexpectedly, switch away from First Class to Second Class. This is shown in Figure 5 below.

Figure 5

PERCENTAGE OF CHOICES WHERE FIRST CLASS MAIL WAS CHOSEN (STANDARD LETTER SCENARIO)

Source: London Economics for Consumer Focus

3.8 Royal Mail would want to set the price for standard Second Class letters as high as possible so that they could charge more for First Class without causing a switch away to Second Class.

3.9 Royal Mail has responded to the Ofcom consultation stating that they disagree with proposals to put caps on any of their products, but if a safeguard cap must be imposed on standard Second Class letters it should be set at the upper end of the proposed range at 55p. Part of the reason for this is the price differential, with Royal Mail stating publicly that: “If [RM] increase the class differential ie increase 1st class out of line with 2nd class, volume will switch to the 2nd class service and RM will only be marginally better off in revenue terms... this is due to many consumers being able to down trade due to the type of mail they send and, therefore, RM needs to be careful not to stretch the price differential too far, as this could actually result in a reduction in revenue overall... It is therefore essential that Ofcom sets the safeguard cap at the upper end of its proposed range.”6

3.10 Whilst we have not attempted to anticipate the scale of the price rises which may result from Ofcom’s proposals, our research has indicated that a safeguard cap is required across all Second Class products to ensure that vulnerable and low web users are not left to bear the brunt of price increases, particularly as our research also showed that consumers with online alternatives are much more likely to switch away from mail entirely as prices increase.

4. The impact on Small & Medium Enterprises (SMEs) of stamp prices increases resultant from the proposals

4.1 Small and medium enterprises SMEs are a vital part of the UK economy7 with some 4.5 million small businesses operating in the UK and accounting for circa 99% of all enterprise; 58.8% (est. 13.8 million people) of private sector employment; and 48.8% of private sector turnover.

4.2 Royal Mail states in its response to the Ofcom consultation that affordability is not an issue for SMEs partly because they have access to alternative operators for low weight 2nd class products. Royal Mail names the TNT products “Allsort” and “Premiersort” as examples of alternative products for SMEs; however, we note that the required volumes to qualify for collection under these products are large. For example, for TNT Allsort the minimum volume requirement is 250 items per collection, whereas for TNT Premiersort the minimum volume per collection are 10,000 letter items; 1,000 for Light Large Letter items; 1,000 for Heavy Large Letter items; and 250 for Packet items. There is a distinct possibility that many micro-businesses and SMEs will not send enough mail to qualify for the Allsort or Premiersort services but will still send enough mail to be adversely impacted by stamp price increases.

4.3 In its discussion paper on affordability (Feb 2011), Postcomm stated that an affordability test for businesses based on an assessment of the affordability of a universal postal service product price would be unworkable as “given the range of businesses and business models, it is likely that at any (non-zero) price some marginal business would face financial difficulty from that price.” Given the variation in business types and posting profiles of SMEs and the statement from Postcomm, Royal Mail should provide transparent evidence to support its assertions that affordability is not an issue for SMEs.

4.4 Furthermore, we are particularly concerned that any price increases could be passed on from SMEs to their customers. This is also suggested by Postcomm’s discussion paper on affordability in which it is stated that a business could mitigate the impact of higher prices by increasing prices for its products.8

4.5 Royal Mail has stated on page 8 of the document “Scope of Safeguard Cap” that it would be “disproportionate to provide a greater degree of regulatory protection to SMEs than is required for vulnerable social groups.” Royal Mail is basing this on its view that the safeguard cap should not be extended beyond Second Class standard letters as vulnerable consumers do not have any affordability concerns and their use of mail is low. From this position they have then attempted to argue against there being any affordability concerns for SMEs which would also justify an extension of the cap.

4.6 Consumer Focus report on potential impacts of stamp price increases on consumers has provided strong evidence for the need for a safeguard cap to be extended in particular to protect vulnerable consumers. As a consequence, and given that many micro-businesses and SMEs are captive in using standard Royal Mail products, we would expect any extension of the safeguard cap to benefit both vulnerable consumers and SMEs, negating any disproportionate bias.

5. The evidence base for decision making

5.1 Royal Mail has issued its own response to Ofcom’s document “Securing the Universal Postal Service: Proposals for the future framework of economic regulation.” We have raised a number of concerns with Ofcom regarding information Royal Mail has provided as part of this response, particularly information contained in the document “Scope of the Safeguard Cap.”9 The accuracy and robustness of information and analysis provided to Ofcom is of critical importance in ensuring their ability to undertake evidence-based decision-making. It must be able to stand up to scrutiny if it is to be of benefit in informing major policy decisions.

Understanding the impact on vulnerable consumers

5.2 We are particularly concerned about Royal Mail’s statements regarding vulnerable consumers’ use of mail services. We are unable, and would question whether Ofcom is able, to robustly assess whether information provided from a seemingly small and unspecified “DE” segment of the Royal Mail Consumer Panel10 fully, accurately and sufficiently captures the behaviours and attitudes of vulnerable consumers.

5.3 We are of the view that the “DE” category used by Royal Mail is very broad; only considers social grade and would not necessarily capture online and offline users. It is not as robust a method for capturing vulnerable consumers as we have used in the modelling for our report on potential impacts of stamp price increases on consumers, where, most significantly, we distinguished between online users and those who used the internet at most once a month. As a consequence we are concerned that Royal Mail’s analysis of this segment regarding vulnerable consumers’ use of mail is flawed as it does not distinguish between those that do and do not have access to the internet.

5.4 This is of particularly concern as Consumer Focus research11 showed that the habits of low internet users often significantly differed from users with online alternatives, and they appear to rely more upon the mail. Unfortunately we also recognise that without Royal Mail explicitly stating the amount of low internet users it surveyed we cannot make an assessment as to the validity of its claims.

Residential consumers use of mail delivery services

5.5 Royal Mail has stated that a price cap on Standard Parcels is unnecessary partly due to consumer choice increasing. As evidence of this statement, Royal Mail referenced the “Parcel2Go” website. Having assessed this service, we are far from assured that this provides an adequate alternative for residential consumers—the number of couriers offering a delivery service varies significantly by parcel size and many do not offer a 3–5 day service only a next-day or 2+ day service, both of which are more expensive than Royal Mail’s Standard Parcel service.

5.6 Parcel2Go also revealed that delivery charges for “Highlands and Islands” and “Northern Ireland” are up to four times as much as Royal Mail’s Standard Parcels service when using alternative couriers. For example, it costs £4.41 to send a 2kg parcel with Royal Mail’s Standard Parcels service, whereas Yodel Northern Ireland and Yodel Highlands and Islands charge £18.43 to send a (3–5 days) parcel. A random test using three different parcel sizes on the Parcel2Go website also revealed that Yodel Northern Ireland and Yodel Highlands and Islands are the only courier services listed on the website that offer delivery to those areas.

5.7 Further to this, the findings of a report commissioned by Citizens Advice Scotland (CAS) and published in December 2011 identified the importance of affordable parcel services for those in rural communities. Consumers in remote and rural areas in Scotland rely heavily on online shopping. The CAS report found that rural consumers were particularly vulnerable as end receivers as some alternative operators charged excessive prices to deliver packets and parcels to certain locations or sometimes refused to deliver them altogether—“84% of consumers said that they had been refused delivery because of their ‘remote’ location”.12

5.8 Royal Mail also cites Collect+ as an alternative for delivering parcels. While it offers a direct-to-door service from anywhere in the UK, for a price up to £4.99, unfortunately the service still does not have a significant coverage of parcel drop-off points, unlike Post Offices.

6. A strategy for postal consumers

6.1 De-regulation of stamp prices should not occur until Ofcom has undertaken substantial research as to the impact of their proposals.

6.2 Ofcom should carefully monitor the potential impact of their proposals not only on poorer consumers in respect of second class letter products but also on rural consumers and on SMEs in relation to packet and parcels services where competition may be limited or absent.

6.3 Consumer Focus have proposed a different regulatory approach to Ofcom that would involve the retention of the current ex ante controls, but would also allow Royal Mail sufficient rises in the prices subject to such controls (maybe set at RPI) to put its finances in order without threatening market stability. To ensure regulatory certainty these controls could be set for a five year period, with a review after two or three years. During this period, Ofcom would continue to review the scope of the control in light of the development of competition in the market with a view to reassuring market players that price control regulation will remain proportionate as the market develops. Ofcom should also continue to monitor Royal Mail’s performance, and that of the postal market as a whole in the UK, the EU and internationally, to provide it with sufficient benchmarks to assess the company’s performance in order to ensure that its efficiency is in line with its peers.

6.4 Such an approach would also avoid the potentially severe impacts on customers, SMEs and vulnerable consumers of unchecked price rises and consequent risks of market decline.

14 February 2012