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


3  Access mail and Direct Delivery mail

End-to-end competition can present either a risk to the viability of the USO if managed poorly or, conversely, an opportunity if competition is managed by Ofcom in a fair and reasonable fashion. [techUK][36]

Introduction

24. There are two types of competition in the postal services sector, Access mail and Direct Delivery mail. Access Mail, also known as Downstream Access or Access Competition, is when mail is collected and distributed from customers by a postal company other than Royal Mail, but is then handed over to Royal Mail, for the final processing (known as Final Mile delivery). Direct Delivery, or end-to-end delivery, is when postal operators other than Royal Mail collect mail from customers and also deliver them through their own network.

25. The following diagram sets out clearly the different routes that letters and parcels can take, from sender to receiver, by using either part or all or none of Royal Mail's infrastructure:

Ofcom: news release, 2 December 2014

Ofcom's Royal Mail Access Price Review illustrates the same routes, but in more detail:

Ofcom: Royal Mail Access Price Review, 2 December 2014[37]

Direct Delivery—a threat to the USO as a result of cherry picking?

26. 'Cherry picking' is a phrase frequently used to describe the effects of Direct Delivery. Richard Hooper wrote that Royal Mail uses cross-subsidisation to support the financial viability of the USO, and that cherry picking undermines that cross-subsidy:

    The USO's financial viability is built on cross-subsidies from higher volume cheaper-to-deliver areas of the UK to lower volume more expensive-to-deliver areas of the UK. Cherry picking happens when an alternative carrier such as Whistl direct delivers to the higher volume, cheaper-to-deliver areas and requires Royal Mail to take the rest of their letters to the lower volume, more expensive-to-deliver areas.[38]

Moya Greene told the Committee that conditions should be placed on competitors who offer Direct Delivery:

    In other countries we have seen Governments put conditions on end-to-end players, saying things like, 'they must cover at least 80% of the land mass in all of the regions within a very finite period of time'. That helps, because it signals that you shall not be allowed to just cherry-pick the high-volume, high-density, low-cost-to-serve areas at the expense of the universal service.[39]

Royal Mail's written evidence explained in more detail the principle of cherry picking:

    The UK's economic geography makes the Universal Service challenging to sustain. It also creates an attractive environment for cherry picking. In the EU, the UK has the highest concentration of large, dense urban areas. These are very attractive to a cherry-picking strategy: the densest 15% of the population live in just 1% of UK landmass. Conversely, the UK has a significant proportion of costly-to-serve rural areas: just 15% of the population live in low density areas equating to 63% of the total UK landmass. Direct Delivery is not, therefore, level playing field competition. It is cherry picking arbitrage that both exploits the Universal Service and puts its future at risk.[40]

27. However, others refuted the significance of action described as 'cherry picking'. The Citizens Advice Service wrote that the current level of Direct Delivery is of such insignificance that the Universal Service could not be under threat:

    The slower growth rate of end to end competition means that these operators deliver less than 1% of total addressed mail and Ofcom estimates that end to end competition is less than 0.4% (although acknowledging that the number of items carried by alternative operators represents a six-fold increase on 2011 mail volumes). Royal Mail still remains the largest player in the UK postal market and retains market power in the letters delivery market and in the delivery of lower weight parcels, although it is becoming less preponderant in relation to the market as a whole and delivery of higher weight parcels is generally more competitive.[41]

ROYAL MAIL'S SUBMISSION TO OFCOM

28. Royal Mail wrote to Ofcom in June 2014, highlighting its concerns over the future of the Universal Service. Its letter, Direct Delivery: a threat to the Universal Postal Service, stated that, as a result of unfair competition from companies offering Direct Delivery, the Universal Service was in danger, and that "Direct Delivery is in reality not level playing field competition that brings benefits to consumers.[42] Royal Mail's written evidence stated that "the Universal Service is precious. But, it is also fragile and is becoming more so".[43]

29. Royal Mail's submission highlighted what it believed to be the impact of Whistl's[44] plan to deliver letters to around 43% of UK addresses by 2017:

    Direct delivery could undermine our ability to finance the USO: Direct delivery entails cherry picking urban areas, easier-to-handle mail and offering a less frequent service. This removed from Royal Mail revenues that are currently deployed to support the costs of the USO. It puts at risk the current system of funding the USO.[45]

However, Nick Wells, the CEO of Whistl, refuted the claim of cherry-picking:

    We are also a by-product of the liberalisation of the postal market and we signed an access agreement in 2004. Where we started to do the collection, trunking and sorting, but we handed over all our mail to Royal Mail. In 2012 we started doing our own end-to-end deliveries. […] It is impossible for us to cherry-pick because of an arrangement we made four years ago with Royal Mail called zonal pricing.[46]

30. In its June 2014 letter, Royal Mail asked Ofcom to carry out a full review of Direct Delivery and its impact on the USO, and wrote that regulatory changes would be needed in order to protect the Universal Service.[47] In evidence to us, Moya Greene set out the reasons behind this position:

    We are not asking for subsidy; we are asking for the underlying economics of the universal service to be recognised and for the rules of the game to be fair.[48]

However, Citizens Advice Service did not believe that Royal Mail had made a sufficient case for action to be taken:

    Although Royal Mail's recent regulatory submission to Ofcom suggested that the USO is under threat on the basis of end-to-end competition in the market, this submission does not provide compelling, robust evidence based reasons for immediate intervention to protect the sustainability of the USO.[49]

Ofcom's response

31. On 2 December 2014, Ofcom published its Review of end-to-end competition in the postal sector, setting out the results of its review of whether the Universal Service was in danger. It stated that "at the heart of Royal Mail's submissions is its claim that that unless Ofcom takes regulatory action in relation to end-to-end competition, Royal Mail's ability to finance the Universal Service will be undermined".[50] It described the Review in the following terms:

    In this review, we have considered the evidence available to us, including the most recent information from Royal Mail's 2014 Business Plan, the latest results from our ongoing monitoring programme and Whistl's rollout plans. We have also considered the argument in Royal Mail's June 2014 Submission. We have assessed whether, in light of the evidence, the impact of end-to-end competition from Whistl is likely to pose a threat to the provision by Royal Mail of a financially sustainable and efficient universal postal service. To this end, we have assessed the forecast financial position of the universal service, and the arguments which Royal Mail and other stakeholders have put to us about the likely impact of end-to-end competition on that financial position.[51]

32. Through its ongoing monitoring of the postal sector, Ofcom receives formal notifications from Whistl, under the Notification Condition, which requires any operator to give three months' notice of its intention to enter or expand its letter delivery service. Such operators are also required to provide Ofcom with their future volume forecasts, operational and business plans, and any future geographical areas to be entered, with a timetable for such entry or expansion, subject to minimum additional volume requirement of 2.5 million items per quarter.[52] Ofcom's review stated that it had "informed itself of the developing position regarding end-to-end letter competition since Whistl commenced its trial".[53]

33. While assessing the evidence, Ofcom wrote that it considered "whether the legal tests in the Postal Services Act 2011 for imposing regulatory conditions on end-to-end operators are met, and/or whether we should be undertaking any other work in light of our duty to secure the universal service".[54] The review document is littered with redacted paragraphs, due to commercial sensitivity. However, Ofcom stated that:

    While the significant majority of information provided to Ofcom by Whistl is commercially confidential, it has publicly stated that its rollout plan is behind schedule. By the end of 2014, it had expected to be delivering to around 15% of the country but it is currently only delivering to around 7%. (For example, it had planned to also be delivering in Edinburgh, Glasgow, Birmingham and East London by now). As set out in our annual monitoring update, Whistl only delivered around 0.5% of the total addressed letter mail market in 2013-14.[55]

34. Having considered the relevant evidence cited above, Ofcom decided that, for the time being, the Universal Service Obligation was not under threat:

    For the reasons set out in this document, we do not consider it necessary at this time to exercise our regulatory powers under the Postal Services Act 2011 to impose regulatory conditions on Whistl in order to secure the ongoing provision of a universal postal service. We do not consider that the provision of the universal postal service is under threat, and as a result we do not consider that the legal tests for imposing such regulatory conditions are met.[56]

However, Ofcom included the following caveat:

    Our decision not to intervene at this point does not imply that we are ruling out such a course of action at some point in the future, if circumstances change. As we set out in our March 2013 end-to-end Guidance, we consider we could implement GUSCs within six to nine months if it was necessary to secure the provision of a universal postal service. To this end, we will continue to monitor the situation closely.[57]

REGULATORY INTERVENTION

General Universal Service Obligation

35. Although Ofcom concluded that the viability of the USO was not under immediate threat, it was not beyond the remit of Ofcom to place conditions on other postal operators at any point in the future. Ed Richards told us of the two main conditions that could be imposed:

    There are two most obvious ones. One is an obligation to deliver over a specific geographic area and the other is to deliver on a specific number of days. In other words, there are service obligations, which would have an impact upon the underlying cost structure of the new entrant. Those are the two most obvious and clear ones.[58]

36. In supplementary evidence, Ofcom wrote that such a General Universal Service Condition could be imposed on any postal operator (under Section 42 of the Postal Services Act 2011) within six to nine months:

    In our March 2013 guidance on end-to-end competition we said that the most likely requirements of such a GUSC would be to require new entrants to deliver mail more days per week and/or over a greater geographic than it had planned.

    However, a GUSC cannot replicate the requirements of the Universal Service i.e. they may not require a person to:

·  Deliver or collect letters six days per week (packets five days per week);

·  Provide a service throughout the UK; or

·  Provide a service at an affordable price which is uniform throughout the UK.[59]

Universal Service Compensation Fund

37. The other regulatory intervention available to Ofcom, in accordance with Section 44 of the Postal Services Act 2011, is the creation of a Universal Service Compensation Fund. Ofcom's supplementary evidence described the longer process required to create such a fund:

    First, prior to October 2016, the Secretary of State for Business would need to direct Ofcom to review the net cost of the universal service (after this time, we could choose to undertake a review at our discretion);

    Second, Ofcom would need to review the net cost of the universal service;

    Third, if that review established that complying with its universal service obligations imposes a financial burden on Royal Mail, Ofcom would have to determine whether it considered that financial burden to be unfair, and if so, to what extent it was unfair;

    Fourth, if Ofcom did determine that the universal service imposed an unfair financial burden on Royal Mail, it would have to report to the Secretary of State setting out recommendations as to the action, if any, that Ofcom consider should be taken to deal with the burden;

    Fifth, the Secretary of State would have to direct Ofcom to set up a fund; and

    Finally, Ofcom would have to design, consult and then establish the fund.[60]

38. However, Royal Mail was not convinced that Ofcom could intervene as quickly as it had suggested:

    Ofcom has said that it could intervene quickly if needed. However, even to undertake a review of direct delivery could take a year or more. Any subsequent interventions could take many years to design, implement and take effect.[61]

    In particular, Royal Mail argued that any compensation fund "could take at least 3-4 years to put in place" and would be of "doubtful value thereafter".[62] This point was supported by techUK, which argued that a universal service compensation fund would take too long to set up and "does not effectively mitigate the threat to the USO".[63]

39. Cherry picking is a phrase often used in postal services to describe the easy, most profitable sections of mail services taken by Royal Mail's competitors. Cherry picking is available to Royal Mail competitors but, at the moment, affects only a very small percentage of Royal Mail's total business. This could change quickly, given the ambitions of some of Royal Mail's rivals in the market. Both Royal Mail and Ofcom need an evidence base upon which to gauge the potential threats to the sustainability of the USO in the event of a higher level of market penetration by other providers. We note the decision by Ofcom that, currently, the level of the threat does not justify intervention. We also note that Ofcom is mandated to monitor the situation.

40. Ofcom has the power to impose a General Universal Service Obligation on postal operators other than the Universal Service Designated Provider (Royal Mail), in order to protect the Universal Service. We have yet to be convinced that Ofcom could impose the General Universal Service Obligation within the predicted six to eight months. We recommend that Ofcom publish a more detailed timeline for its implementation and an assessment that the timescale is fast enough to avoid a failure in the Universal Service, even in the short term.

41. The alternative regulatory condition—the Universal Service Compensation Fund—involves a lengthy delay in implementation. To avoid such a delay, we recommend that the Secretary of State directs Ofcom to review the net cost of the Universal Service, in accordance with the Postal Services Act 2011.

Views of the Universal Service-should it change?

42. A number of our witnesses saw some scope in reviewing or changing the requirements of the Universal Service Obligation. Nick Wells, the CEO of Whistl, had an open-minded view:

    Most countries in the modern world are currently reviewing their universal service obligations. For example, Italy and the Netherlands have reduced that to five days a week. I am not advocating this. In Moya's own country, Canada, they will stop delivering to letterboxes in the next five years and only go to community post-boxes. That is certainly not something that we would want to see, but the point here is that it will need reviewing.[64]

43. Adam Scorer, Director of Consumer Futures at Citizens Advice, also saw the possibility of reducing the current six days a week service,[65] while Alan Halfacre, Chairman of the Mail Users Association, argued that the first-class postal service was not as important as some would suggest:

    If you need to get something to an individual the following day, there are mechanisms. They are expensive for physical items, but are they the only way the citizen can communicate? We come down to, 'I want to send my birthday card'. Well, try to remember to do it the day before rather than the last day. You have been getting round to it for a long time, but, no, you have to do it two days before instead of one day before. […] It is not a social stigma to put a second class stamp on a letter.[66]

44. However, despite emphasising the cost of the USO to Royal Mail, Moya Greene said that Royal Mail was "very committed to the universal service in its current form" and did not see the need to change it.[67]

45. There has already been an extensive debate about the requirements of the Universal Service Obligation. The Committee strongly believes that it would be inappropriate to change the current requirements of the Universal Service Obligation.

Price to customers

46. In March 2012, Ofcom introduced a new regulatory framework and provided Royal Mail with greater freedom on pricing for the majority of its services. Ofcom's Royal Mail Access Pricing Review described the intention and risks attached to this decision:

    Our objectives were to grant Royal Mail sufficient pricing flexibility to ensure it could continue to provide the universal service on a sustainable basis and sufficient commercial freedoms to adapt to the changing market environment. We also aimed to maintain the benefits of competition in supporting the efficient provision of the universal service.

    We recognised that removing price controls would come with serious risks. We considered the most significant of these to be the risk that Royal Mail would not take on the challenge of improving efficiency and would rely solely on pricing to return itself to profitability, potentially excluding vulnerable customers and precipitating a more rapid decline in the mail market.[68]

47. Safeguards were therefore put in place by Ofcom, including capping the price of second class letter stamps at 55p, and capping large letters and small parcels (up to 2kg) at a 53% increase, to ensure a basic universal service is available to all.[69] In its latest annual monitoring update, Ofcom wrote that customers were generally satisfied with the cost of stamps and service, stating that "the latest ONS data shows weekly household expenditure on postal services to around 0.1% (60p) of total expenditure based on 2012 prices. This is a little less than the current price of a single First Class stamp".[70] It also wrote that:

    In terms of customers and consumers, our research indicates the vast majority of consumers are satisfied with their postal services and that prices remain affordable for almost all consumers. Whilst First and Second Class stamp letter and large letter prices did not increase in 2013, prices of these increased above inflation in 2014. However the safeguard cap on Second Class stamps will continue to protect vulnerable consumers in the future. Royal Mail significantly improved its quality of service, following a number of failed targets in the last year. First and Second Class national targets were met, however the Postcode Area (PCA) target was missed, albeit narrowly. We will nonetheless continue to monitor Royal Mail's progress on quality of service performance.[71]

48. Ofcom's Annual Report also highlighted its monitoring of affordability in the future:

    We will continue to use our quantitative consumer survey for residential consumers and businesses […] to enable us to monitor use of postal services, and to assess the affordability of services in the universal service, value for money and satisfaction with post and postal prices.[72]

49. We note that Royal Mail has again increased its prices this year. Royal Mail should not increase prices in an attempt either to increase its own profit levels or to protect the Universal Service Obligation, without continuing to increase the efficiency of its operations, thereby reducing its costs and enabling it to improve its standards of service.


36   techUK (USO 30) para 4.6 Back

37   Ofcom, Royal Mail access pricing review, 2 December 2014, page 20 Back

38   Richard Hooper (USO 06) para 3 Back

39   Q41 Back

40   Royal Mail (USO 37) paras 1.15 and 1.16 Back

41   The Citizens Advice Service (USO 20) para 3.4 and 3.5 Back

42   Royal Mail plc, Direct Delivery: a Threat to the Universal Postal Service Regulatory Submission to Ofcom, June 2014, extracts from executive summary Back

43   Royal Mail (USO 37) 1.9 Back

44   Royal Mail's letter used the name of TNT Post, which was the former name of Whistl and the correct name at the time of Royal Mail writing to Ofcom. Back

45   Royal Mail plc, Direct Delivery: a Threat to the Universal Postal Service Regulatory Submission to Ofcom,, June 2014, executive summary Back

46   Q4 Back

47   Royal Mail plc, Direct Delivery: a Threat to the Universal Postal Service Regulatory Submission to Ofcom,, June 2014, executive summary Back

48   Q26 Back

49   The Citizens Advice Service (USO 20) para 6.4 Back

50   Ofcom, Review of end-to-end competition in the postal sector,, 2 December 2014, executive summary Back

51   Ofcom, Review of end-to-end competition in the postal sector,, 2 December 2014, para 1.7 Back

52   Ibid, para 2.17 and footnote 11 Back

53   Ibid, para 2.17 Back

54   Ofcom, Review of end-to-end competition in the postal sector,, 2 December 2014, para 1.8  Back

55   Ibid, para 2.18 Back

56   Ibid, para 1.9 Back

57   Ibid, para 1.12 Back

58   Q153 Back

59   Ofcom (USO 54) Back

60   Ofcom (USO 54) Back

61   Royal Mail (USO 37) para 1.4 Back

62   Ibid Back

63   techUK (USO 30) para 4.15 Back

64   Q37 Back

65   Q115 and 116 Back

66   Q119 Back

67   Q37 Back

68   Ofcom, Royal Mail access pricing review, 2 December 2014, paras 3.24 and 3.25 Back

69   Ofcom, Royal Mail access pricing review,, para 3.25 and Annual monitoring update on the postal market, 2013-14, para 5.9 Back

70   Ofcom, Annual monitoring update on the postal market, 2013-14, para 5.30 Back

71   Ofcom, Annual monitoring update on the postal market, 2013-14, para 1.6 Back

72   Ibid, para 5.31 Back


 
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© Parliamentary copyright 2015
Prepared 12 March 2015