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

4  Competition and efficiency

Royal Mail is the dominant incumbent and has huge efficiencies of scale. It has a massively trusted brand. It has so much going for it. The extent to which it will maintain that level of dominance or market power will depend on how it is able to deliver products […] that will enable it to win in what will become a very competitive market. [Adam Scorer, Citizens Advice Service][73]

Competition in the postal sector

50. The third Postal Services Directive 2008 requires all EU postal markets to be opened to competition, and the Postal Services Act 2011 reflects that requirement. Our written evidence highlighted the benefits of such competition. BBC TV Licensing wrote that:

    Continued development of competition with the proviso the universal service is not impacted, will lead to continued improvements in quality of service, continued downward pressure on prices, greater choice and continued product innovation. As a mailer who mails across the UK on a regular basis such developments are vital to our activity and can go some way to protecting our budgeted expenditure on mail. Such a development is extremely important as our activity is funded from the public purse.[74]

The Mail Users' Association wrote that competition in the postal sector had enabled sustainability in the market and that competition had benefited "an otherwise declining commercial scenario".[75] Not surprisingly, this view was supported by Royal Mail's competitors. Nick Wells, the CEO of Whistl, argued that without competition there was "no catalyst to keep prices low",[76] while UK Mail believed that competition was "a vital spur to improved choice for mail users, and to increased efficiency by all operators, including Royal Mail".[77]

51. Ofcom also highlighted the benefits of competition in the postal sector:

    There are a number of potential benefits from other postal operators competing with Royal Mail in the delivery of mail. Most importantly entry can strengthen the incentives on Royal Mail to improve efficiency and reduce its costs.

    In addition, if end-to-end competition results in lower prices for certain types of users, it may reduce the rate at which volumes decline for the whole industry. Competition may also benefit customers through increased innovation and value added services.[78]

Royal Mail efficiency

52. Under Section 29 of the Postal Services Act 2011, Ofcom has to have regard to: "the need for the provision of a Universal Provider Service to be efficient before the end of a reasonable period and for its provision to continue to be efficient at all subsequent times".[79] In its discharge of that duty, Ofcom monitors both those services provided by the USO and Royal Mail's so-called 'Reported Business', which means that it has a duty to comment on the efficiency of services that are in Royal Mail's Reported Business, but not necessarily within the USO.

53. In evidence to us, Ofcom clarified what the term 'Reported Business' covered:

    The 'Reported Business' is that part of Royal Mail Group that uses the universal service network (also known as the core network) for collection, sortation, transportation or delivery of postal packets (both letters and parcels). As such it includes both Universal Service products such as First and Second Class letters and parcels, Special Delivery Next day, etc. and non-Universal Service products such as Royal Mail retail bulk mail, access mail, unaddressed mail, etc. The Reported Business is part of Royal Mail's UK Parcels, International and Letters (UKPIL) business unit but excludes the activities and products of ParcelForce International and Royal Mail Estates Ltd.[80]

54. Royal Mail's regulatory financial statements for 2013/14 provides a graphic of its products included in the Reported Business:

Royal Mail Group Regulatory Financial Statements 2013-14 [81]

55. In its Report, Review of end-to-end competition in the postal sector, published in December 2014, Ofcom returned to the matter of Royal Mail's efficiency in relation to the viability of the Universal Service:

    Beyond the next few years, our assessment of the sustainability of the universal service becomes less certain. However, to a significant extent, this uncertainty is due to factors other than end-to-end competition, including Royal Mail's ability to reduce its costs to reflect the reduced workload, and deliver efficiency savings, and the success of its parcels strategy. Relatively small changes in parcel volumes, hours worked, pay increases or pension costs could significantly affect its future EBIT margins by as much as, or more than, the impact of end-to-end competition.[82]


56. Ofcom described the three priorities contained in Royal Mail's overall strategy: being a successful parcels business; managing a decline in letters; and being customer focused.[83] The chart below, included in Ofcom's written evidence, highlights the competitive nature of the UK parcel market:

UK domestic parcel revenue market share

Source: UBS / Triangle, 2014[84]

57. Ofcom cited RBC Capital Market in July 2014 describing 'parcels, not Ofcom, as its biggest concern'[85] and described Royal Mail's own uncertainty surrounding parcel revenues:

    As noted by Royal Mail, the parcels market is very competitive and competition has recently intensified, particularly from UK Mail, DPD, Hermes and Amazon's roll-out of its own delivery service, which started in January 2014. […] Parcel operators compete with Royal Mail both on price, and technological and service innovations. Many operators are using digital technology to drive innovation. Royal Mail notes, in its June 2014 submission, that innovation is a key feature of the UK parcels market. For example, earlier this year, Parcelforce launched an interactive service enabling customers to arrange for a parcel to be delivered on a different day or to a different address by SMS or email. In March 2014, parcel operator DPD also announced enhancements to its 'Predict' service, which notified recipients of the time of delivery to within a 15 minute window.[86]

58. But Royal Mail's competitors have gone further, as explained by evidence from the Mail Competition Forum:

    Competitors to Royal Mail have also brought innovation to mail services in vital areas such as hybrid (physical-to-electronic) mail. Hybrid mail combines electronic communication (including mobile telephony and the internet) with physical communication to allow business and social users to send items using the electronic devices common in everyday life. [...] The MCF believes these benefits from competition have had an important (if unmeasurable) impact in mitigating the decline in mail volumes, by encouraging continued or even new use of mail.[87]

59. Royal Mail is free to respond to competition in the bulk-mail market and the parcel market (over 20kg) in any way it sees fit, as those areas are not included in the Universal Service Obligation. However, in November 2014, Royal Mail published its Financial Report for the half year (from April to September 2014), and highlighted the fact that parcel revenue was down by 1 per cent:

    At £1,461 million, UKPIL parcel revenue was down one per cent. This was primarily due to the impact of a change in the mix of the parcels we carry and the highly competitive environment in the UK parcels market. We estimate Amazon's own delivery network will reduce the annual rate of growth in the UK addressable market to 1-2 per cent for approximately two years. UKPIL parcel volume grew by two per cent.

Its trading update for the nine months ended 28 December 2014 showed an increase in volume of UK parcels by 3%, but revenue stayed flat.[88]

60. Written evidence from the Mail Competition Forum (MCF) stated that:

    The Mail Competition Forum believes and provides evidence that Royal Mail has persistently failed to achieve reasonable productivity improvement and it is that inefficiency, rather than the commercial effect of efficient competition, which represents the major threat to USO provision.[89]

61. The Citizens Advice Service told us:

    Competition has not benefitted all groups of social consumers equally, particularly those in rural and remote areas who have limited choice and are more reliant on the USO. We have a significant body of evidence of detriment to rural and remote consumers in a parcels market including non-deliveries, delivery surcharges and lengthy journeys to collect undelivered items.[90]


62. Ed Richards, the then CE of Ofcom, told us that bulk mail was not supervised by the regulator and that it was "a commercially-determined service",[91] which was determined by business decisions:

    When they go to Whistl, for example, or others, they say, 'We are content with a three-day-a-week service', which is precisely why Whistl has offered a three-day service. If business users wanted a six-day service for their bulk mail, Whistl would have to offer it, so there is a big difference.[92]

Chris Rowsell, Competition Policy Director at Ofcom, highlighted the fact that this approach worked efficiently in the Netherlands and Denmark, where the USO items are delivered on the required days, but non-USO items were delivered in larger quantities, on fewer days.[93] Ed Richards summarised this point:

    Business users can determine their needs in the way that normal commercial arrangements are determined, and we need to make sure that developments in that area are consistent with the USO and the six-days-a-week delivery.[94]

63. The evidence that we received suggest that Royal Mail still has to match the technical innovations introduced by many of its competitors. These innovations more clearly match the expectations of consumers, as well as contributing to the efficiency of competing postal operators.

Royal Mail's price structure for national average prices and zonal prices

64. Royal Mail's price structure varies depending on whether the postal operator asks Royal Mail to deliver the Final Mile, across the United Kingdom, or whether the postal operator asks Royal Mail to deliver to certain parts of the United Kingdom only. Written evidence from Ofcom explained the difference between the pricing:

    Royal Mail offers two types of pricing plan for access: national average prices and zonal prices. To qualify for national average prices an access operator must be asking Royal Mail to deliver mail across the whole of the UK, in the same geographical pattern as Royal Mail delivers. If an access operator is asking Royal Mail to deliver in just certain areas or geographies of the UK, Royal Mail can set zonal prices which reflect the costs in those geographic areas.[95]

65. Zonal pricing helps to protect Royal Mail against any artificial competitive advantage from its competitors. For example, it ensures that Whistl must have a genuine source of competitive advantage over Royal Mail in the areas it chooses to enter. While this is a useful safeguard, Adam Scorer, from Citizen's Advice, cautioned that it should not be used for restrictive reasons and that "Royal Mail does not protect its incumbent position in unfair ways".[96]

66. In January 2014, Royal Mail proposed several changes to its zonal charges which reduced the charges for the Urban and London Zones, while significantly increasing charges for the Suburban and Rural Zones. Moya Greene, the CEO of Royal Mail, told the Committee:

    What I will say about the zonal pricing that we had attempted to put into the market is that it was meant to partially offset this threat of siphoning off the very, very high-volume urban mail, siphoning it out of the Royal Mail system, so that neither that traffic nor the revenues that go along with it would be available to underpin the economics of a Universal Service.[97]

67. On 2 December 2014, Ofcom announced that it would be reviewing Royal Mail's proposed increase in zonal access pricing because it was concerned that the changes could "act to discourage and potentially prevent entry and expansion into bulk mail delivery by another operator" and therefore have a negative impact on consumers.[98] Ed Richards told us that Royal Mail's proposed zonal pricing had the potential to skew its access prices in order to inhibit competition:

    What we have said on zonal pricing is that Royal Mail has the freedom to set its margin as it chooses. However, what we have said to ensure that, that is consistent with a fair approach for the market overall, is that that should be consistent from zone to zone, and that the prices should be reflective of the costs in the zones. That seems, to us, to be a reasonable and fair basis. In other words, where Royal Mail has higher costs, it is able to charge a higher price, but it is not able simply to select a price that suits its ability to inhibit, or to risk inhibiting, competition when that competition can offer something useful for consumers and the market.[99]

68. We support Ofcom's consultation on the level of zonal pricing set by Royal Mail. Any recommendations arising from that consultation must balance the need for Royal Mail to retain the freedom to set its prices, dependent on the cost of delivering in that area, with the benefits of retaining an open market and increasing competition. Royal Mail are free to set zonal pricing, but it should be based on actual costs of delivering to those zones, and not as a device to deter, or even stifle, competition. There is a fine balancing act to be set. Ofcom must set out the timetable for this consultation, and when a decision will be made.

Labour costs

69. The major part of the costs in the postal sector are labour costs because letters and parcels have to be delivered by a person. Adam Scorer, from Citizens Advice, was concerned that recent developments could lead to a "race to the bottom" in terms of services:

    We have seen it in lots of other markets on the customer services side. [It] inevitably leads to a lower level of service, higher degrees of complaint and a lack of trust and confidence in engaging in those markets. I could see clear detriment, if that was done as a necessary, kneejerk, fast response to the growth of competition.[100]

That said, greater competition does not necessarily require cutting labour costs. As supplementary evidence from the CWU highlighted:

    All the evidence is that if you pay people well and if you have a collaborative approach to solving problems, it makes for a successful company. Decent terms and conditions of employment will help to maintain a committed, motivated workforce leading to higher productivity and a better quality postal service for customers.[101]

70. Evidence from Royal Mail also highlighted these points about labour terms and conditions:

    Royal Mail believes that industry standards need to be improved and that this can be best achieved through either an industry-wide quality standard and/or regulation. We believe that current basic requirements would help to ensure the parcels industry delivers a better service for consumers.[102]

Royal Mail's written evidence then went on to highlight differences in terms and conditions between their own staff and staff from other companies:

Royal Mail written evidence[103]

71. CWU's written evidence contrasted the terms and conditions of Royal Mail employees with those of its competitors:

    In the parcels sector, several carriers including Hermes and Yodel use low-cost lifestyle couriers who are treated as self-employed and are therefore not entitled to the National Minimum Wage. They are routinely paid a rate per successfully delivered item which often makes it impossible to earn a reasonable rate of pay. In one company, rates are as little as £0.20-£1.20 per successful delivery, equating to only £3.70-£5.30 per hour.[104]

72. However, supplementary evidence requested by the Committee from Royal Mail's competitors would seem to question Royal Mail's assertion. TNT UK Ltd has one employee on a zero-hours contract, out of a total of 9,000 staff.[105] UK Mail wrote that they have no employees on zero-hours contracts.[106] Whistl gave detailed information on its staff's terms and conditions: at the time of writing, there were: 6.9% of staff who had contracts for under 13 hours per week (predominantly Saturday workers and students); all employees who had completed three months' service were paid above the adult national minimum wage (excluding some apprenticeships); employees' basic pay range is £6.50 to £6.57 (outside London) and £7.10 to £7.37 (London); CRB checks are made either when staff are engaged or on a random basis after employment; Nearly half of all Whistl employees (48%) are on zero hour contacts.[107] In reference to those on zero-hour contracts, Whistl's supplementary evidence stated that:

    Whistl has recently reached agreement in principle with its recognised Trade Union, Community, that an employee will be offered an alternative, fixed hours contract after the end of an appropriate probation period. The employee may elect to remain on a flexible (zero hours) contract.[108]

73. However, as Ed Richards, pointed out, Ofcom has no responsibility in this area::

    Labour costs, and employment law and the regulation of the price of labour—the minimum wage and all those sorts of things—are clearly not part of our remit. We cannot deal with that. We are very much a creature of statute. We do what the statute tells us to do, and it is very clear that that is not part of our duties.[109]

When he was asked whether Ofcom would study the quality of service across the entire postal industry, not just those of Royal Mail, he replied:

    Quality of service is something that we look at, and we will, I am sure, have a further discussion with Royal Mail about whether there are issues to do with quality of service or mail integrity—all those kinds of things—that we need to look at on a forward-looking basis. We would be very happy to do that.[110]

74. Ofcom has rules on mail integrity, which require regulated postal operators to ensure that their mail is protected against loss, damage or theft, and is delivered to its intended destination. We asked the different postal operators who gave oral evidence about the number of prosecutions and complaints they had experienced. TNT Express UK could not answer the Committee's question about the number of formal complaints relating to staff, for the following reason:

    TNT UK Ltd does not hold data to record the number of complaints specifically relating to its staff which it receives from its customers and is therefore unable to assist the Committee with this question.[111]

In the year to March 2014, Whistl received 1,627 complaints about their delivery services, which represents one complaint for every 49,000 letters delivered.[112] Royal Mail handled 14.3 billion items of mail in 2013-14, and received 735,637 consumer complaints,[113] which represents one complaint for every 19,439 items of mail delivered.

75. We are opposed to a 'race to the bottom' of postal sector employees' wages, terms and conditions, and such a race should not be an inevitable result of greater competition in the sector. Indeed, Royal Mail's negotiations with the CWU have resulted in pay increases and job security. Our evidence suggests that, while Royal Mail's criticism of its rivals' treatment of their staff is not wholly proven, there are certainly examples of where the wages, terms and conditions offered by other companies in the sector fall short of the standards offered by Royal Mail, including what appears to have been a disproportionate use of zero-hours contracts by Whistl.

76. If standards of pay in the postal sector, as in other sectors, fall short, then the taxpayer is left to pick up the difference, because in-work state benefits will cost more. Furthermore, it is unacceptable that delivery of the Universal Service Obligation should require downward pressure on the terms and conditions of staff delivering that service. We recommend that Ofcom investigates the impact on customers and the service provided to customers of any downward pressure on terms and conditions of postal sector staff. We further recommend that the Government considers extending Ofcom's remit to include consideration of labour costs, conditions and standards in the postal sector.

73   Q135 Back

74   BBC TV Licensing (USO 16) paras 3.1.1. and 3.1.3 Back

75   Mail Users' Association (USO 23) para 2 Back

76   Q27 Back

77   UK Mail (USO 27) para 1.4 Back

78   Ofcom, End-to-End competition in the postal sector: final guidance on Ofcom's approach to assessing the impact on the universal postal service, 27 March 2013, paras 3.15 and 3.16 Back

79   Section 29, 3b, the Postal Services Act 2011 Back

80   Ofcom (USO 57) Back

81   Royal Mail, Regulatory financial statements, 2013-14


82   Ofcom, Review of end-to-end competition in the postal sector, 2 December 2014, paras 3.105 to 3.107 Back

83   Ofcom (USO 29)  Back

84   BIS Committee analysis of UBS data, Ofcom (USO 29) Back

85   Ofcom (USO 29) Back

86   Ofcom, Review of end-to-end competition in the postal sector, 2 December 2014, paras 3.84 and 3.86 Back

87   Mail Competition Forum (USO 01) paras 2.4 and 2.5 Back

88   Royal Mail trading update for the nine month ended 28 December 2014 Back

89   Mail Competition Forum (USO 01) executive summary Back

90   The Citizens Advice Service (USO 20) para 4.4 Back

91   Q178 Back

92   Q174 Back

93   Q183 Back

94   QQ 186 and 187 Back

95   Ofcom (USO 29) Back

96   Q137 Back

97   Q34 Back

98   Ofcom, Royal Mail access pricing review, 2 December 2014, para 1.4 Back

99   Q162 Back

100   Q132 Back

101   CWU (USO 55) para 2 Back

102   Royal Mail (USO 37) para 4.7 Back

103   Royal Mail (USO 37) table 1 Back

104   CWU (USO 18) para 24 Back

105   TNT UK Ltd (USO 51) Back

106   UK Mail (USO 50) Back

107   Whistl (USO 49) Back

108   Ibid Back

109   Q200 Back

110   Q201 Back

111   TNT UK Ltd (USO 51) Back

112   Whistl (USO 49) Back

113   Royal Mail (USO 52)  Back

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Prepared 12 March 2015