Business, Skills and Innovation CommitteeWritten evidence submitted by Consumer Futures

About Consumer Futures

Consumer Futures (previously Consumer Focus) is the statutory consumer watchdog for postal services across the United Kingdom, of energy across Great Britain and of water in Scotland. It has a wider role in applying learning and insight across other regulated markets. We use evidence, analysis and argument to put consumers at the heart of policy-making and market behaviour.

Introduction

Consumer Futures works to protect and promote the interests of consumers in regulated markets. Our role is not only to consider current issues facing consumers, but to look ahead to the potential for problems or opportunities and identify action to be taken.

As the designated universal service provider, Royal Mail provides an essential service to consumers and businesses across the UK. The arguments for private or public ownership must be judged in terms of what is the best way to maintain and improve that service.

Whether in private or public ownership, consumers and businesses needs for value and quality services from Royal Mail are the same.

1. Executive Summary

1.1 Postal services across the UK face significant challenges from the increasing use of digital technology; the consequential reduction in letter volumes and increase in parcel mail; and the changing needs of users. Growth in market competition presents risks and opportunities for Royal Mail. Whether in the public or private sector, understanding and responding to consumer needs and changing behaviour will be crucial to effectively competing in the market and sustaining a universal postal service.

1.2 OFCOM’s primary duty, to secure the universal postal service, should not be conflated with protecting the financial position of Royal Mail. It will be necessary to ensure that Royal Mail provides an efficient service. OFCOM must apply rigorous monitoring and assessment processes to ensure consumers are not left liable for the price of corporate failure. Exercising its duties in securing the universal service; promoting competition; assessing affordability; and ensuring vulnerable consumers, especially in remote and rural locations, have access to this essential service is incumbent upon OFCOM regardless of the nature of the ownership of Royal Mail.

1.3 Royal Mail’s contractual relationship with Post Office Ltd (POL) is only one facet of an environment in which POL will increasingly need to be able to offer commercially competitive products and services which meet the needs of consumers, at a time and place of their convenience. The contract between Royal Mail and POL is not altered by any change in Royal Mail ownership.

2. Trends, Developments and Consumer needs in the UK Postal Market

2.1 Until relatively recently, Royal Mail had enjoyed a dominant position in the postal services market which provided a relatively secure revenue base for its operations. However, full liberalisation of the mail market in 2006, electronic substitution of letters and changes in the composition of mail volumes have altered the landscape.

2.2 Upstream competition, where mail is collected and sorted by an access operator and then delivered via Royal Mail, has grown at a far greater rate than end-to-end competition (collection, sorting and delivery by another postal operator). In 2011, postal regulator, OFCOM noted that around 40% of mail volumes, excluding parcels, were currently collected and sorted by access operators but delivered by Royal Mail. This was in sharp contrast with end-to-end competitors who delivered less than 1% of letters and large letters1.

2.3 Despite TNT UK commencing, in April 2012, the expansion of its access operation to offer its customers end-to-end services in West London, with reported delivery volumes as of December 2012 at an average of 345,000 items per week2, information provided by PostNL to OFCOM, to facilitate its analysis of end-to-end competition, highlights that, due to cash constraints, it would need €50 to €80 million of external investment in order to be able to complete a full rollout of end-to-end services in the UK3.

2.4 There is no information available publicly identifying if and when Post NL might realise its desired investment and ambition for a full rollout of end-to-end services in the UK. There is, however, no expectation from the regulator that those plans will be achieved in the short to medium term with OFCOM stating that ‘under current projections TNT Post’s market share is expected to be low in the early years of its [business] plan’4 and that, as the business model has yet to be tested, it is therefore ‘necessary to recognise there is a degree of uncertainty around TNT Post’s business plan’.

2.5 While end-to-end competition has a significantly greater impact on Royal Mail revenues than access competition—with Royal Mail still retaining some 85 to 90% of revenues from access mail5—competition across the postal market can provide distinct benefits to consumers. The initial competitive entry by TNT UK has already demonstrated one of the benefits of competition—Royal Mail recently announced significant investment in barcode technology which will allow business customers to electronically track delivery of their letters6, a value-added service originally offered by TNT UK in its West London operations. Value-added, competitive and innovative products which appeal to business customers, and therefore helps retain or win their custom, assists in securing the financial viability of a universal service for residential and business consumers alike.

2.6 Decline in mail volumes is well documented. In 2010, the updated review7 of the postal services sector carried out by Richard Hooper for the Department for Business, Innovation and Skills noted that in 2005 the average Royal Mail daily mail bag contained 84 million addressed letters, packets and parcels but that by 2010 this was down to 71 million items. The following year, OFCOM identified that the UK postal sector had seen the steepest decline in volumes of any European country, falling by 25% since 2006, with Royal Mail volumes now approximately 62 million items per day8. The updated review by Richard Hooper also notes that ‘Royal Mail predicts a further decline in Royal Mail addressed inland letter traffic volumes of over 20% between 2010/11 and 2015/16’9. Royal Mail’s recent preliminary results for 2012–2103 report an 8% drop in addressed letter volumes from 2011–2012 with some 14,079 million addressed letters handled by Royal Mail in year10.

2.7 Royal Mail has nevertheless recorded an increase in parcel volumes and revenues. Figures from the 2012–13 preliminary results11 show an increase from 1,016m parcels in 2011–12 to 1,081m parcels in 2012–13, an increase of 65m. Parcel revenue figures depict a 13% year-on-year increase between 2011–12 and 2012–13, rising to some £2,979m of the total £7,766m UK Parcels, International & Letters (UKPIL) business. While not sufficient to offset decline in other mail volumes, internet retail distribution has provided positive growth for parcel carriers.

2.8 Rapid change and innovation is however taking place in both the mode of delivery for some retail products which had contributed to growth in parcel volumes—such as books, audio & video content which are being digitally downloaded or streamed in ever greater numbers—and in providing greater convenience of delivery for other, non-digitisable, products—such as clothing and electronic equipment—with the expansion of click & collect services and pick-up point services.

2.9 While parcel volumes and revenue have increased for Royal Mail in this more competitive sector of the postal market, innovations and changing consumer behaviour in relation to the delivery of retail products purchased online presents further risks to Royal Mail’s delivery volumes, which could in turn weaken growth or reduce income or profits in delivery revenues.

2.10 The capability, capacity and drive to innovate are critical components for any market player looking to offer a consumer-focussed postal service. Retaining postal communication and delivery as a credible choice in an increasingly digital world also requires the availability of value-for-money, affordable products and services which meet the needs and demands of consumers and business customers.

2.11 Our research report, Sense and Sustainability12, interrogated residential and SME consumers’ needs from the postal service over the medium-term. We found that residential consumers expect greater innovation in terms of the delivery options for packets and parcels, including extending the number of pick up points, longer opening hours and more convenient locations—including pre-specified locations such as pubs or corner shops. SME consumers would like to see a range of delivery options offered, as is currently the case with all major courier companies, such as timed deliveries.

2.12 It will be incumbent upon Royal Mail to be able to respond to these challenges in order to continue to fulfil its role as the designated universal service provider. It will need to offer innovative, cost-effective products and delivery solutions and maintain a dynamic approach to a changing market and evolving consumer needs. Failure to adapt and respond to these challenges could have an adverse impact on the sustainability of the universal postal service and the ability of Royal Mail to deliver that service.

3. Safeguarding the Universal Postal Service

3.1 Royal Mail is subject to a declining market share of a declining letters market. Against this backdrop, Government identified securing a sustainable universal postal service as the central tenet of its postal policy and primary duty of the postal services regulator. Adopting the recommendations of the Hooper review, Government enacted the strategy it would employ and actions it would take in pursuit of this objective via the Postal Services Act 2011, including specifically allowing for private investment in Royal Mail; the transfer of the historic Royal Mail pension deficit to Government; and reform of the regulatory framework.

3.2 The Postal Services Act, 2011, also explicitly sets out the minimum services that must be included in a universal postal service. The requirements set out in Section 31 of the Act are for provision of:

a mail delivery and collection service six days a week for letters, and five days a week for parcels, at a uniform affordable tariff across the UK;

a registered items service, at a uniform affordable tariff across the UK;

an insured items service, at a uniform affordable tariff across the UK;

specified universal postal services to be provided free of charge to eligible blind and partially sighted persons;

free conveying of eligible legislative petitions and ‘addresses’.

3.3 Royal Mail, as the sole designated universal service provider, is obliged to provide these services as a minimum. Its continuing ability to do so is a significant consideration for OFCOM and was an important feature of the debate surrounding recent legislative and regulatory changes. The new regulatory framework specifically permits OFCOM to take proportionate steps to protect the sustainability of the universal service or address any “unfair” financial burden on a universal service provider in its provision of the universal service. It should however be noted that there is no definitive analysis from OFCOM, as yet, as to whether provision of the universal postal service is a net cost or net profit for Royal Mail or any assessment of the indirect impact of providing the universal postal service on the profitability of Royal Mail13.

3.4 Measures available to OFCOM to protect the universal service, should that be deemed necessary, include: imposition of General Universal Service Conditions (GUSC) on other end-to-end competitors—conditions such as an obligation to deliver a minimum number of days per week to each address in the area of operation or imposition of a minimum geographic coverage requirement on a given operator; the creation of a Universal Service compensation fund—where contributions could be required from other postal operators or from additional charges paid by consumers; alteration of the obligations requiring Royal Mail to provide other operators with access to its delivery network or imposing ‘access’ conditions on other postal operators obliging them to allow Royal Mail, and others, access to their delivery network; and the tendering out of elements of the universal service which were found to be a financial burden on the current designated universal service provider14.

3.5 OFCOM also has a general duty to encourage competition in postal services, providing that does not interfere with its primary duty to safeguard the universal service, with a view to delivering better outcomes for consumers. Of note, in respect of consideration of its primary and additional duties following notification from TNT UK about its trial end-to-end delivery service, OFCOM stated that ‘On the basis of the evidence provided to us and the analysis we have conducted, we do not consider it necessary to exercise our regulatory powers now to impose any new conditions (including the imposition of General Universal Service Conditions) for, or in connection with, securing the universal postal service’15.

3.6 Competition in the provision of postal services has opened the door to innovation and choice for consumers and business customers. While there has been some concern expressed publicly that competition in the postal services market could lead to adverse impacts on Royal Mail, and its ability to deliver the universal postal service, the suite of measures available to OFCOM to safeguard the universal service are capable of mitigating any potential adverse impacts.

3.7 Consumer Futures would, in fact, caution that ill-considered use of these measures could lead to less favourable outcomes for consumers through, for instance, the stifling or restriction of competition in the postal services market or the creation of a perverse incentive on Royal Mail to not address inefficiencies as competitors providing lower cost services could find themself liable for providing subsidy to Royal Mail, thereby forcing them to either keep prices artificially high to avoid the subsidy situation or increase prices to afford payment of a subsidy16.

3.8 Specific concerns have also been expressed that competitive pressure may see Royal Mail seek to withdraw from elements of the universal service which it has been suggested are loss making—such as daily deliveries to remote or rural areas—or to rebalance tariffs in a way which raises prices for rural consumers. However, as mentioned above in section 3.2, the existence of a uniform tariff and six-day-a-week collection and delivery service as part of the minimum requirements of the universal postal service is enshrined in primary legislation. Were Royal Mail to find itself financially burdened by these specific requirements of the universal service then OFCOM is able, as mentioned in section 3.4 above, to take steps to ensure these requirements are met.

3.9 OFCOM’s primary duty, and the tools and mechanisms available to it, to secure the universal postal service and ensure the minimum requirements of the service are met, are not altered by, and have no impact upon, the nature of the ownership of Royal Mail.

4. Regulating in the Consumer Interest

4.1 While OFCOM’s primary duty to secure a sustainable universal postal service is welcome, protection of the universal postal service should not be conflated with protecting Royal Mail’s revenues. OFCOM is required to have regard not only to the financial sustainability of the universal service but also its efficient provision. It also has a duty to ensure that the uniform tariff for universal postal service products is affordable.

4.2 While Royal Mail is the sole designated universal service provider, its economic viability remains a significant factor in sustaining the universal postal service. The Royal Mail modernisation programme, which began in 2006–07, has seen action taken to decrease costs and increase efficiency but as OFCOM notes, ‘Since volumes have started to decline in 2006, Royal Mail has in most years been unable to reduce costs at a sufficient pace to offset the rate of decline in its revenues’17.

4.3 Royal Mail’s most recent financial statements show that in the UK Parcels, International and Letters (UKPIL) business, significant investment continues to be made in pursuit of modernisation with eg the deployment of automation equipment. However, these statements also show that the modernisation programme is not delivering the anticipated cost savings in other expenditure areas. For example, people costs increased by 4.6% between 2011–12 and 2012–13 over a period when there was also a 46% increase in “property and project” costs18.

4.4 Unless able to deliver efficiency gains that exceed the effect of volume decline, Royal Mail is likely to find itself in a vicious cycle of having to increase prices for consumers which in turn is likely to further suppress demand, leading to additional volume decline. Unit costs would increase which subsequently puts even greater upward pressure on prices. The continued viability of an affordable universal service would be at stake.

4.5 Rigorous monitoring and analysis of the progress of the modernisation programme in driving efficiencies must be undertaken by OFCOM together with the application of robust pressure on Royal Mail to make efficiency gains. Consumers should not have to face increased prices or reduced standards as a result of corporate failure.

4.6 OFCOM will also need to carefully scrutinise and continuously monitor the effects of price rises on the affordability of mail services, particularly for those consumers who rely on the postal service. The impact of any substantial increase in price could accelerate the switch away from using mail in turn putting greater strain on the financing of the universal postal service, or cause those who can least afford any increase and cannot use alternate means—such as low-income, low-internet users—to bear a disproportionate amount of the cost19.

4.7 In April 2012, OFCOM reformed the price control framework for Royal Mail with most price controls removed. As a result of evidence and representations from Consumer Focus and others at the time, OFCOM extended the safeguard cap on Second Class Standard Letters to include Large Letters, packets and parcels up to 2kg sent Second Class, in an attempt to ensure there would always be at least one affordable option for consumers. There remains, however, significant scope for further price rises for these additional products now covered by the safeguard cap.

4.8 In establishing the safeguard cap, OFCOM assessed that the price parameters did not raise affordability concerns for small business or residential customers20. However, with some vulnerable consumer segments more liable to rely on postal services—and therefore more captive to price rises and more negatively impacted by them—than others, OFCOM will require to be proactive in assessing whether price rises in stamps and basic mail products are causing financial difficulty across the diversity of consumer and SME segments.

4.9 Whether Royal Mail is in public or private ownership, OFCOM must remain vigilant in its monitoring of prices and efficiencies to ensure that Royal Mail is not permitted to raise prices without making the cost efficiencies necessary to ensure the sustainability of the universal postal service. Consumer needs and a thorough understanding of consumer behaviour must be at the centre of regulatory policy development with any proposed changes considered in the context of their direct and indirect impacts on consumers and on the sustainability of a universal postal service.

5. Royal Mail and Post Office Ltd

5.1 Following formal separation of Royal Mail and Post Office Ltd (POL) in April 2012, with each forming a separate legal entity, their relationship is now governed by commercial contracts. A financially significant21 contractual arrangement remains between the two organisations in respect of retail postal services and in respect of mail access and distribution points.

5.2 OFCOM specify certain mail access and distribution requirements, within the conditions imposed on Royal Mail as the designated universal service provider, in order to meet the legislative requirements relating to the collection and delivery of mail. Royal Mail fulfils aspects of those conditions via the Mails Distribution Agreement with POL. Additionally, Royal Mail is the only postal operator to use POL, and therefore local Post Office branches, as either a retailer of postal services or as an acceptance or collection point for postal items.

5.3 While not a party to the contract, Government has stated that the Mails Distribution Agreement ‘will continue in force for a period of at least ten years from its commencement date—26 March 2012’22. It has also confirmed that there is provision for a review of the terms of the agreement, five years into its duration, and that either party ‘may seek a review of the agreement’s terms ... where there has been a material adverse effect on POL or Royal Mail’23. Furthermore, Government has also confirmed that there are limited circumstances, reflecting contractual law and practice, under which the agreement could be terminated by either party—such as persistent or material breach of the agreement by the other party24.

5.4 Pressures already exist on POL to modernise their offering in the postal service market with increased competition in both the retail postal services sector and the parcel acceptance and collection sector25. Additional challenges also exist for POL—for example, the current contract with the Department for Work & Pensions for the payment of welfare benefits and pensions through post office branches is scheduled to end in 2015, with a possible extension to 2017. Any new contract for the provision of these payment services would be subject to procurement regulations and open competition.

5.5 Regardless of the nature of, or any change in, the ownership of Royal Mail, POL will need to be able to respond to these pressures and challenges and offer commercially competitive products and services which meet the needs of consumers and their desired quality and convenience.

5.6 Consumer Futures would expect Royal Mail, whether in public or private hands, to ensure that selling practices and standards, associated with its products and services, in post office branches meet with consumer needs and expectations and the required contractual expectations.

18 September 2013