Competition in the postal services sector and the Universal Service Obligation - Business, Innovation and Skills Contents


2  The Universal Service Obligation

The ability to receive the same standard of service at the same cost in rural areas is of fundamental importance to residents and, in particular, businesses in rural communities. The USO is a good example of how 'rural proofing' of policies can work. It protects rural areas and effectively spreads costs across all areas so that all areas experience the same service. [The Welsh Local Government Association, Rural Forum][13]

Definition of the Universal Postal Service

8. Royal Mail has always provided a 'Universal Postal Service' (also known as the Universal Service). The legislation that empowered the Government to privatise Royal Mail—the Postal Services Act 2011—also named Royal Mail as the Universal Service Provider. Section 31 of the Act included the following:

·  To abolish the criminal offence of conveying certain letters without a licence, which had been contained in the Postal Services Act 2000;

·  Ofcom to take over regulatory responsibility for postal services, from Postcomm;

·  Royal Mail's and the Post Office's historic pensions liabilities to be transferred to the Government;

·  Royal Mail Group and the Post Office to became separate entities;

·  The Government put in place plans to offer shares in the Royal Mail Group before April 2014, and to move the Post Office into a mutual structure before 2015.[14]

9. Section 31 of the 2011 Act describes the "minimum requirements" of the Universal Services, which include:

·  at least one delivery of letters every Monday to Saturday, and at least one delivery of other postal packets every Monday to Friday;

·  a service of conveying postal packets from one place to another by post at affordable, geographically uniform prices throughout the UK;

·  a registered item service at affordable, geographically uniform prices throughout the UK.[15]

10. Royal Mail's own website provides more details on the Universal Service requirements, set out in the 2011 Act:

·  At least one delivery of letters every Monday to Saturday to every address in the UK;

·  At least one collection of letters every Monday to Saturday from every access point in the UK that is used to receive letters and postal packets for onward transmission;

·  Postal services at an affordable, uniform tariff across the UK;

·  A registered items service at an affordable public tariff;

·  An insured items service at an affordable public tariff;

·  A free-of-charge postal service to blind or partially sighted people;

·  Free carriage of legislative petitions and addresses;

·  Postal Packets up to 20kg.[16]

WHO USES THE UNIVERSAL POSTAL SERVICE (UPS)?

11. The PostalGroup—an organisation of three companies: Mail Matters Direct Ltd; Regional Mail Services Ltd; and PostalSort Ltd—highlighted the importance of customers when considering the Universal Postal Service:

    We feel it's important that the focus of the inquiry should be on the customers of the postal services and specifically on how the industry should look in the future if it is to provide products and services that will complement the needs of the country. A free flowing delivery network will allow the UK to take advantage of the country's competence in e-commerce. An industry that is dogged by infighting will only stifle its potential.[17]

Customers are not only residential users, sending personal letters, presents, birthday cards and Christmas cards. Customers of the UPS are also businesses that send communications to their customers, including direct mailing, banking and financial mailing. The Federation of Small Businesses described its members' use of postal services:

    The last survey conducted by the FSB on how members use postal services showed that they are used for: ordering goods, mail shots and publicity, delivering goods and services, information for employees, delivering supplies, sending invoices, sending parcels and paying suppliers, among others.[18]

12. TechUK—representing over 850 companies and technologies, the majority of which are small and medium-sized businesses—stressed the need for such businesses to be taken into account:

    It is small and medium businesses which commercially underpin the USO and make it viable, as opposed to residential users. The Select Committee's focus should be ensuring the requirements of such businesses are met and the Royal Mail service to them is secure.[19]

The Mail Users' Association, whose members "generate more than 10% of annual postal traffic in the UK",[20] wrote of business Super Users:

    Super Users of mail regularly spend in excess of £1 million a week on mailing activities, and as such form the backbone of the UK's postal system in terms of contribution. One MUA member has quoted a spend in 2013 with Royal Mail of £83 million, and another as delivering annualised postal volumes in excess of 640 million items into the network. Members would therefore argue that the future of the universal service is inextricably linked to the needs and wants of these mailers, and they have a vital contribution to make in informing debate on the wider issue of how best to sustain the universal service in the long term.[21]

THE UNIVERSAL SERVICE AND CONSTITUENT PARTS OF THE UNITED KINGDOM

13. We received several submissions from interested parties in Scotland, Northern Ireland, and Wales about the importance of the Universal Service to them, due to the high percentage of rural addresses in those areas. The Scottish Chambers of Commerce (SCC), representing a network of 11,000 businesses throughout Scotland, wrote:

    It is imperative that all businesses in Scotland have access to a universal service with regards to mail. While SCC supports competition, it is essential that this is not conducted in a way which could threaten the continuation of the universal service and therefore add unfair cost burdens to businesses in rural areas throughout Scotland.[22]

The Northern Ireland Chamber of Commerce and Industry wrote that: "the one-price-goes-anywhere universal service has particular significance for Northern Ireland given the high percentage of rural addresses and the fact that it is the only region to be entirely served by air and sea".[23]

14. The Welsh Local Government Association made the point about how the USO is subsidised geographically:

    The ability to receive the same standard of service at the same cost in rural areas is of fundamental importance to residents and, in particular, businesses in rural communities. The USO is a good example of how 'rural proofing' of policies can work. It protects rural areas and effectively spreads costs across all areas so that all areas experience the same service.[24]

Regional differences, in respect of rural and urban populations, highlight the cross-subsiding nature of the Universal Service, to ensure the provision of the same service for all in the whole of the United Kingdom.

Cost of the Universal Service Obligation to Royal Mail

15. The USO comes at a cost. The Social Market Foundation argued that the USO was sustainable as it was cross-subsidised, both geographically and by product:

    The USO is currently funded by Royal Mail. Whilst the costs of delivering across the UK vary substantially, from the cheaper, more densely populated urban areas to the more expensive, sparsely populated areas, retail prices must be the same, regardless of where mail is being sent within the UK. The USO is effectively funded through some customers paying more to subsidise others. This cross-subsidy occurs both by geography and product type. But the financing of the USO is likely to come under substantial pressure in the future.[25]

16. However, the Social Market Foundation noted the cost of the USO to Royal Mail was difficult to quantify :

    There is little transparency over the actual cost of the USO, and therefore how much cost is being imposed on different groups of consumers or businesses. This makes the sustainability of the current model hard to assess; and without fully understanding where the costs fall also makes it difficult for policy-makers to make well-informed choices about potential measures to ensure sustainability, both now and in the future.[26]

17. Richard Hooper—the author of three reports on the future of the postal services sector in 2008 and 2010[27] and currently an adviser to the CEO of Royal Mail—based his assessment of the costs of the USO on the following definition:

    The USO is also defined by Ofcom as that set of products which are inside the USO, for example parcels up to 20kg. It is better in my view to look at the USO as a total network embracing 'first mile' and 'last mile' with a strong element of fixed costs irrespective of volume. Your postman or postwoman has to deliver to your house or flat or business six days a week whether he or she has one letter for you or twenty.[28]

This definition was used by Moya Greene, the CEO of Royal Mail, when she estimated the cost to be £7.2 billion.[29] However, Ed Richards, the then CEO of Ofcom, offered a different method of calculating the cost of the USO:

    We have taken a different approach to it. That is the cost of the whole network, but of what goes over that network of that £7.2 billion, only 20% is USO defined—80% of what is carried over the network is not. When one then asks what costs should be associated with which area, the numbers are quite different. For example, in the Royal Mail's own regulatory financial statements, which it has to submit to us, the allocation from the USO, or the cost of the USO, is not £7.2 billion but £2.7 billion. They are very different numbers.[30]

18. Ed Richards went on to describe the profits that Royal Mail makes from the Universal Service Obligation:

    The audited 2013-14 regulatory financial statement from Royal Mail to us—so audited externally—reports an operating profit of £484 million on universal service mail after transformation costs, which are one-off costs. If you omit transformation costs, the operating profit on the universal service was £556 million, so half a billion pounds of profit on the universal service in the audited regulatory accounts for 2013-14.[31]

Ofcom's written evidence also highlights VAT benefits and economies of scale and scope for any Universal Service Provider:

    It has economies of scale and scope in relation to its historical position as the Universal Service Provider and potentially benefits in relation to brand recognition and trust. Royal Mail also does not have to charge VAT for any of its universal service or access products and this gives it an advantage over its competitors for VAT exempt business customers (such as banks and other financial institutions and charities) and for consumers and small businesses.[32]

19. We invited Royal Mail to explain the discrepancy between its figure of £7.2 billion and Ofcom's figure of £2.7 billion. Royal Mail's supplementary evidence stated that:

    Both figures are taken from Royal Mail's 2013-14 Audited Regulatory Accounts.[33] Both numbers, £2.7bn and £7.2bn, are calculated in line with the Regulatory Accounting Guidelines specified by Ofcom, which Royal Mail must abide by. An explanation of what each figure represents is as follows:

    £7.2bn:

    This figure represents the cost of maintaining a network that is capable of delivering the Universal Service, is the appropriate cost measure to focus on when considering 'the cost of the Universal Service'. This view is also held by Ofcom, as it uses the margin earned on this £7.2bn cost when assessing the financial sustainability of the Universal Service.

    Ofcom defines the costs associated with the Universal Service network as the 'Reported Business'. The 'Reported Business', as defined by Ofcom, includes:

    "The costs and revenues of both regulated and unregulated products that depend on the core universal service activities for their efficient provision. This includes all universal service products, [and non USO] retail bulk mail products and access products".

    £2.7bn:

    The £2.7bn figure is the proportion of the £7.2bn 'Reported Business' cost, which is allocated to Universal Service products that are delivered through Royal Mail's network.

    Importantly this figure does not represent the full cost of running a network capable of delivering the Universal Service.[34]

COST OF THE UNIVERSAL SERVICE TO ROYAL MAIL, REGION BY REGION

20. We also asked Royal Mail for a more detailed analysis of the cost of the Universal Service, broken down into geographical areas across the United Kingdom, region by region. Royal Mail replied with the following evidence:

    Royal Mail's Universal Service network is designed and run to serve the whole of the UK with a uniform service specification as efficiently as possible and maximising economies of scale. Much of its cost is comprised of national overheads which cannot be meaningfully broken down into regional costs. For example, the overnight road and air transport costs that allow Royal Mail to deliver the First Class service cover the whole of the UK.

    Royal Mail is required, by Ofcom, to maintain a zonal costing model. This model assesses the variation in cost of delivering mail in 4 zones (London, Urban, Suburban, and Rural). It does not calculate cost by geographic region.

    This model only considers downstream cost which may vary by zone. It therefore does not include key elements of the £7.2bn 'Reported Business' cost base that enable the end-to-end universal service. For example, central overheads, collection, sortation and distribution of mail around the country are not covered by the model. The results from this model are therefore not well suited to assessing an accurate regional cost of the universal service.

    However, taking this model as an indication of delivery costs only, it shows that rural deliveries have a significantly higher cost than suburban or urban deliveries, as may be expected. Sustaining the Universal Service network relies on revenues from some areas of the country contributing to its overall costs.

    Also, as Ofcom disclosed, London is the most costly area for Royal Mail to deliver according to the zonal costing model. This is due to factors including the higher costs attributed in the model to property in London, as well as higher wages paid to staff in the capital.

21. This supplementary evidence did not help us to understand the regional variations in the cost of the Universal Service, but did corroborate the evidence we heard in a different Inquiry. In our Inquiry into the Implications of Scottish Independence on Business, Higher Education and Research, and Postal Services, in June 2013, the then Company Secretary, Royal Mail, Jonathan Millidge, answered a question about the cost of delivering mail in Scotland:

    There are networks that go between Scotland and England and Wales and Northern Ireland and so on and we do not disaggregate those. We have an obligation to deliver mail at a uniform price everywhere across the UK. We do not separate out the cost for Scotland in doing that. […] We have 10,000 post boxes in Scotland that we collect from, for example, and 6,174 delivery routes. It is true that it is more expensive to deliver in rural areas than it is to deliver in urban areas. There are massive rural areas in Wales, for example, and also in England and Northern Ireland. So I could not give you a breakdown of what it is in Scotland. We do deliver about three times as much mail in Scotland as is posted in Scotland. So Scotland is a net importer of mail and that mail obviously then is delivered throughout the 16 postcodes that make up Scotland. But I am afraid I cannot say what the profitability of Scotland is.[35]

22. Given the fundamental importance of the USO, we were concerned to note that Royal Mail were unable to provide a regional breakdown of the cost of the Universal Service Obligation (USO). In addition, given the responsibility of Ofcom to protect the USO, we were surprised to learn that there is no consensus between Royal Mail and Ofcom over what constitutes the cost, revenues and profits of the USO. We recommend that both Royal Mail and Ofcom should, as a matter of urgency, agree a set of financial metrics against which the costs should be measured. If necessary, this should be carried out by the National Audit Office (NAO) or a mutually-agreed body of experts.

23. We recommend that Royal Mail—the Designated Universal Service Provider—using these figures, provides a geographical analysis of where the Universal Service is profitable and where it is not. Such detailed analysis and financial monitoring of the Universal Service would provide the evidence to assess the long-term sustainability of the Universal Service. This breakdown of costs should be included in Royal Mail's Audited Regulatory Accounts. If Royal Mail declines to provide these figures, we recommend that the Government should consider extending the remit of Ofcom, to enable Ofcom to enforce this requirement.


13   Welsh LGA - Rural Forum (USO 24) para 3 Back

14   Postal Services Act 2011, Section 31 Back

15   Postal Services Act 2011, Section 31 Back

16   Royal Mail Universal Service Obligation, accessed 5 March 2015 Back

17   ThePostalGroup (USO 38) page 4 Back

18   Federation of Small Businesses (USO 12) para 5 Back

19   techUK (USO 30) page 3 Back

20   Mail Users' Association (USO 23) para 1.1 Back

21   Mail Users' Association (USO 23) para 3.1 Back

22   Scottish Chambers of Commerce (USO 32) para 2 Back

23   Northern Ireland Chamber of Commerce and Industry (USO 36) page 1 Back

24   Welsh Local Government Association - Rural Forum (USO 24) para 3 Back

25   The Social Market Foundation (USO 19) para 3 Back

26   The Social Market Foundation (USO 19) para 8 Back

27   The challenges and opportunities facing UK postal services, May 2008; Modernise or Decline, Cm 7529, 16 December 2008; and Saving the Royal Mail's universal postal service in the digital age, Cm 7939, September 2010 Back

28   Richard Hooper (USO 06) para 2 Back

29   Q22 Back

30   Q155 Back

31   Q156 Back

32   Ofcom (USO 29) page 2 Back

33   Royal Mail Group Limited Regulatory Financial Statements 2013-14, June 2014  Back

34   Royal Mail (USO 56) para 1 Back

35   BIS Committee, The Implications of Scottish Independence on Business; Higher Education and Research; and Postal Services, HC 378-1, June 2013, Q72 Back


 
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Prepared 12 March 2015