The PRC decides the rate case: What’s in Santa’s bag for the mailers?

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On Monday or Tuesday of this week, the Postal Regulatory Commission will issue an order on the Postal Service’s renewed request for an exigent rate increase.  If it’s granted in full, postal rates will go up about 4.3 percent.  That’s on top of the 1.7 percent increase already granted under the CPI cap, so the total increase would be about 6 percent.

According to the exigency provision in the federal regulations, the PRC’s decision on the rate increase must be issued within ninety days of the request.  The Postal Service submitted the request on September 26, so the ninetieth day would be Tuesday, December 24.  The decision will probably be issued on Christmas Eve.  Will the mailers find a nice gift in their stockings, or will they find a lump of coal?

 

Arguing the case

For the average customer who may spend a few dollars a month on postage, a 4 percent increase won’t mean much (Canadians are looking at a 30 percent increase).  But for small businesses that mail a lot, nonprofits and periodical publishers with tight budgets, and big mailers looking at their bottom line, even a relatively small increase would be significant.  Not surprisingly, the mailers have been putting up quite a fight in the Commission’s proceedings.

It’s anybody’s guess what the PRC will say, but judging by the tone of the Commissioners’ comments and questions during the oral cross-examination of the Postal Service’s three witnesses a few weeks ago, it doesn’t seem likely that the Commission will grant the request in its entirety.

During the hearings, the Commissioners seemed very skeptical about the Postal Service’s basic claim that most of the losses in mail volumes were due to the Great Recession, both during the official period of the recession in 2008 and 2009 and in the years after.  They seemed to feel that technological changes like smartphones, tablets, Facebook, Twitter, and the Cloud were having a much larger effect than the Postal Service was acknowledging.

A recurring phrase during the hearings was “the new normal,” the implication being that while the Great Recession may have been an “extraordinary” and “exceptional” circumstance justifying a rate increase, things can’t go on being extraordinary forever.  The Postal Service must adjust to lower mail volumes and not expect its customers to pay a permanent rate increase to help cover losses that occurred during a limited period of time.

The mailers have filed hundreds of pages of comments opposing the rate increase.  They have called the Postal Service’s econometric estimates of volume lost due to the recession “implausible,” they have presented alternative analyses showing that diversion to the internet is much more significant than the Postal Service admits, they have argued that price elasticities are greater than in the past so that a rate increase will drive away much more volume than the Postal Service estimates, and they say that if an increase must be granted it should be much smaller than requested and it should be rescinded after a specified period of time.

The Postal Service argues that it has done just as the Commission has previously ordered and presented a reasonable “sources of change” analysis showing how much of its losses are due to the recession, it has made every reasonable effort to be efficient and economical in its operations, and it needs the additional revenue in order to maintain liquidity.  The Postal Service has also presented an exhaustive counter-critique of the testimony presented by the mailers and tried to show that their alternative sources-of-change analysis is implausible.

A compromise for Christmas?

It’s now up to the Commission to determine which side has presented a more plausible explanation for events and to decide whether or not the Postal Service has fulfilled the requirements of the exigency provision of the Postal Accountability and Enhancement Act.

If the Commission were to grant the request in full, the case could end up in court.  The mailers would have nothing to lose and plenty to gain, and they have deep pockets for legal fees, technical experts, and the like.  They will be able to cite the letter from Senator Susan Collins saying that “approval of an exigent rate increase under these circumstances would be inconsistent with the law” (which she helped write), and they will also cite the Postal Service’s own business plan, which says quite clearly, “The Economy is NOT the Main Cause of Diversion.”

If the Commission rejects the request as it did the first time around, the Postal Service may decide to go back to court.  The Commission would need to explain how it had expressed a willingness to grant an increase if the Postal Service did a reasonable job quantifying how much was lost due to the recession and then subsequently decided that no increase was merited at all.

It’s possible that the Commission will look for some sort of middle ground between total approval and total rejection.  A compromise might not please either side very much, but it might put an end to the process, which has been going on since 2010, and it would at least make the future of rates less uncertain.

One compromise that’s easy to imagine is giving the Postal Service a smaller increase than requested and putting a time limit on it.  Many of the comments submitted by the mailers seemed headed in this direction.  The Commission might grant an increase of one or two percent rather than 4.3 percent requested, and it might rescind the increase after two years.

The Postal Service would end up with $1 or $2 billion in additional contribution revenue over the next two years, which would help with the liquidity problem, one of the main reasons cited for the request.  That’s not nearly the $1.78 billion in annual contribution that the 4 percent increase would generate, but rather than wasting more time with a protracted legal proceeding, the Postal Service might just take what it can get.

The mailers might just put up with an increase like that, figuring that it’s not as bad as it could have been and that it’s a reasonable amount and likely to hold up in court.  At least now they can move on and stop worrying about an increase.

Whatever the Commission rules this week, the order will contain a lengthy discussion of the main issues in the case.  Here’s a review of some of them.

 

Sources of change

The main question on the table is how to explain the volume losses suffered by the Postal Service over the past five years.  What portion can be said to be due to the recession, and what portion is due to other causes, the most obvious of which is electronic diversion to the Internet?  Only losses due to the recession merit a rate increase since only the Great Recession can be considered an “extraordinary or exceptional circumstance.”

That’s the question that was not answered in a satisfactory way when the Postal Service initially submitted an exigent rate increase, which is why the Commission rejected the first request, and that’s the question the Postal Service attempted to answer this time around.

The Postal Service’s expert witness on the question, Mr. Thomas Thress, submitted hundreds of pages discussing the matter in his initial testimony, in answers to Presiding Officer Information Requests (which included numerous questions passed on from the mailers), and in his detailed reply statement to the mailers’ comments.

His analysis shows basically the following.  (This table is derived from a table presented by the Postal Service in response to POIR No. 6, question 14, which can you see here.)

As of 2012, the Postal Service believes it had suffered a cumulative loss in contribution of $22 billion — $6.6 billion in 2012 alone.  And the losses continue to mount — to nearly $40 billion in contribution by the end of 2014.  That is obviously a staggering amount.

In this context, then, a rate increase that would bring in about $1.78 billion a year in contribution does not seem at all excessive.  That is, unless you are a big mailer.

 

Implausible and unsupportable

In their opposition to the rate increase, the mailers have argued that Mr. Thress and the Postal Service are grossly over-exaggerating how much volume and revenue have been lost due to the recession as opposed to diversion.  Unfortunately, in their fervor to make their case, the mailers have misinterpreted and misrepresented Mr. Thress’s analysis.

In their comments to the PRC, as well as in the media, the mailers have repeatedly claimed that the Postal Service has said that all of its losses are due to the recession and not acknowledged that some of the losses are due to the Internet.  One finds this claim in the comments submitted by a large group of mailers that includes powerhouse stakeholders like the Association for Postal Commerce, the Direct marketing Association, Quad/Graphics, and R.R. Donnelly.  They state the following:

“The central question in this case is the extent to which the Postal Service’s losses are due to the 2007-2009 recession rather than Internet diversion and other non-recession causes.  The Postal Service claims that essentially all of its decline in mail volume from Fiscal Year 2007 to 2012 resulted from the former, and none from the latter.  This extraordinary claim is implausible and, on closer inspection, unsupportable.”

The American Bankers Association says the same thing in its comments:  “The Postal Service has suggested that virtually all of the volume losses since 2007 are attributable to the Recession.”

Tony Conway of the Alliance for Nonprofit Mailers repeated the line in a press release: “If you take the Postal Service’s study at face value, then all of the mail volume losses since 2007 are the result of the 2007-2009 recession, and none result from digital diversion.”

Last week James Cregan of the Association of Magazine Media repeated it in a letter to the editor in Post & Parcel: “In its most recent exigency filing, the US Postal Service (USPS) attributes all financial losses since 2007 to the ‘Great Recession’ (which ended several years ago) and none to the dramatic increase in email, electronic bill payments and other ‘digital diversion.’”

This past week, Mary Berner, president and CEO of the Association of Magazine Media, repeated it again in a piece in Roll Call: “What effect did digital diversion — such as email ubiquity and electronic payment of bills — have on mail volumes during the recession?  According to the Postal Service, the answer is none.  Zero.”

The problem with these claims is that the Postal Service never said any such thing.  Here’s the probable origin of the misinterpretation.

In 2007, total mail volumes for market-dominant products were about 209 billion pieces; in 2012, total volumes were 156 billion pieces.  That represents a decline of 53 billion pieces.  According to Mr. Thress’s calculations, in 2012, 53.5 billion pieces were lost to the recession.  It thus might appear that the Postal Service is saying that all of the losses were due to the recession.

But that’s not true.  Here’s a table showing how Mr. Thress breaks down the losses.  (These numbers come from his testimony, Table 2, page 8.).

As this table shows, Mr. Thress says that in 2012, 53 billion pieces were lost to the recession but he also says that over 12 billion pieces were lost due to diversion.  That adds up to 66 billion pieces lost to these two causes.  The sum is more than the 53 billion piece decline from 2007 to 2012 simply because it’s based on the reasonable premise that were it not for these two factors, volumes would have increased from 2007 to 2012, just as they had been constantly increasing for many years before, to about 222 billion.

Mr. Thress’s testimony shows that over the five-year period 2008 through 2012, the Postal Service lost nearly 40 billion pieces of mail to diversion.  His analysis also points out that some of the volume lost due to the recession includes volume losses associated with the acceleration of diversion in response to the recession.  His analysis, in other words, does not say that all of the declines resulted only from the recession.

It would of course be ridiculous to make such a claim, but the mailers nonetheless insist on mischaracterizing what the Postal Service is saying in order to make the Postal Service’s econometric analysis appear “implausible.”  But in making a claim that is itself patently false, the mailers end up undermining their own argument.

 

The x-factor

The main argument against the rate increase is that the Postal Service has failed to acknowledge how much mail volumes have been impacted by changes in the digital world.  During cross-examination of the Postal Service’s witnesses, the Commissioners seemed to share this view.  It’s not hard to see why.

People look around and they see everyone with a smartphone in their hands and a laptop on their desk.  Twitter and Facebook have become ubiquitous.  Documents end up in the Cloud instead of in the printer.  We stream movies on Netflix instead of having DVD disks mailed to us.  More and more people are paying bills and sending greeting cards via the Internet.

And this has all happened so quickly.  How could mail volumes not be seriously impacted by these changes?  And don’t these technological changes seem much more significant in our lives than what happened in the economy?

The Postal Service is itself largely responsible for propagating this view.  Every time a postal representative attends a community meeting to talk about closing a post office or reducing its hours or consolidating a processing plant — and there have been over 10,000 such meetings since 2011 — the explanation is that mail volumes are falling due to the Internet, email, online bill paying, and the changing habits of customers.  This explanation is then repeated in the news report about the meeting.  The Postal Service doesn’t like to mention the recession because economic downturns are temporary, but closing a post office is permanent, and it needs a permanent explanation, like the Internet.

While blaming the drop in mail volumes on technological changes may make sense on an intuitive level, if you’re doing an econometric analysis, you have to find variables to plug into the equations and the equations have to come out right.  Feelings aren’t enough.  You need numbers.

At one point in her cross-examination of Mr. Thress, PRC Chairman Ruth Goldway asked if it weren’t possible for his equations to include a variable that reflected the technological changes we’ve been witnessing.  (See the transcript, p. 92ff.)

Broadband availability used to be a decent variable, but it doesn’t work anymore because the market became saturated and broadband stopped expanding so fast.  But what about something else?  There seems to be a “missing piece” in the equations, suggested the Chairman, something that would capture these profound changes in the technology of communication.

In making their case against the rate increase, the mailers, their experts, and the Public Representative have thus gone searching for this x-factor.  They have pointed to variables like the number of email accounts, the number of emails sent, the volume of wireless data traffic, data on Internet-based payment methods like PayPal, the number of smartphones and tablets sold, and so on.

For an explanatory variable to be useful, however, it has to track with mail volumes over time, it must represent an innovation that’s significantly different from previous innovations, and it has to make sense as something that would drive away a significant amount of mail volume.  None of the x-factor innovation variables fulfills these criteria.

As Mr. Thress points out in his reply comments, it’s not always the case that new and expanding technologies lead to more diversion.  During the 1990s and early 2000s, for example, the Internet, broadband, and the presence of computers were all expanding, yet Standard mail and workshared First Class mail continued to grow.

Thus, notes Mr. Thress, the number of Facebook users may have multiplied twenty times since 2007 and the number of tweets per day may have multiplied approximately 90,000 times, “but how much mail is really being diverted by Facebook or Twitter?”

 

Finding a plausible explanation

The Commission has essentially been presented with two conflicting scenarios about what has caused mail volumes to fall.  The Postal Service says that about 80 percent of the losses are due to the recession and 20 percent are due to diversion.  The opponents of the rate increase would essentially invert this distribution of responsibility and assign just a small portion of the losses to the recession.

The mailers rely on the analysis provided by their expert witness, Dr. Christian Lundblad, to refute Mr. Thress’s testimony.  Dr. Lundblad suggests that the Postal Service’s recession-related losses will be about $400 million in 2013 and $300 million in 2014, a tiny faction of what the Postal Service estimates.

One can see the implications of this alternate scenario by looking at a graph created by Mr. Thress to illustrate the implications of Dr. Lundblad’s analysis (from Thress’s Reply Statement).

In this graph, the blue line shows how total market dominant mail was going before 2007, and the purple line shows Mr. Thress’s estimate of how it would have gone if there hadn’t been a recession.  As you can see, volumes would have continued at roughly the same level.   Losses in First Class mail due to diversion would essentially be offset by continuing increases in Standard mail (which wasn’t showing signs of being impacted by diversion).  The green line shows how mail volumes actually fell starting in 2008.

The red line shows what market-dominant mail volumes would have been in the absence of the recession, according to Dr. Lundblad’s analysis.  For this analysis to have validity, then, mail volumes would have needed to plummet in 2008 due to diversion, independently of the economy.  The rate of electronic diversion of market-dominant mail would need to nearly quadruple from 2007 to 2008.

For such a large portion of the losses to be due to diversion thus means that the rate of diversion had to jump in an unprecedented way and then later return to roughly pre-recession levels — all because of changes in the digital realm and not because of the recession.  It is hard to imagine what could have happened at that time in terms of technologies of communication that could explain such a phenomenon.  Mr. Thress is thus led to return the compliment paid to his analysis by the mailers.  He calls Dr. Lundblad’s alternate scenario “implausible” and “absurd.”

The PRC’s Public Representative also tried playing around with Mr. Thress’s variables, and he came up with results similar to Dr. Lundblad’s.  His comments contain a table showing that FY 2012 losses due to the recession were about 14 billion pieces, as opposed to the 53 billion pieces estimated by Mr. Thress.  This analysis would also require a huge spike in the rate of electronic diversion.  Mr. Thress observes that the PR’s analysis “simply makes no sense.”

 

Quantifying the subjective

In the end, the question of how much mail volume has been lost due to the recession and how much has been lost due to diversion may ultimately not be amenable to precise quantitative analysis.  There are too many unknowns and too many subjective issues.

If you decide to switch over to online bill paying for a credit card, for example, did you do that because you want to be green, avoid the cost of a stamp, or simply because you could?  Which of these reasons may have been related to the economy?  Did the credit card company encourage you to go green because the recession pushed it to look for ways to save money or simply because technology made it possible?

With each side calling the other side’s analysis “implausible,” it will be up to the Commission to figure out what it considers to be the more credible explanation.  Mr. Thress’s analysis has at least two things going for it.  His analysis starts with the simple assumption that diversion trends that pre-existed the recession would have continued at the same rate were it not for the recession.  He doesn’t need to look high and low for the x-factor because it’s so clear that the drop in mail volume coincides with the recession.  His approach makes even more sense when you see how volumes seem to be returning to pre-recession rates of diversion now that the economy is improving.  The alternate scenarios depend on unusually large and unprecedented spikes in the rate of diversion occurring at the same time as the recession but for reasons unrelated to the recession.

Mr. Thress’s analysis has something else going for it.  Dr. Lundblad is a very distinguished scholar with an extensive list of publications, but none of them has anything to do with mail volumes or postal systems.  Mr. Thress, on the other hand, has been working on mail volumes for twenty years, and the Postal Service’s team has been working it the matter for thirty years.

As the Postal Service points out in its reply comments, accurate volume forecasts are essential to doing business and making plans.  “Therefore,” the Postal Service states, “instead of reliance on vague generalizations or conclusory statements about ‘official’ recession dates, new gadgets, and the like, the Postal Service employs sophisticated estimation procedures, constantly refined to attempt to respond to the ever-changing postal environment, with the sole objective of providing the best possible volume forecasts.”

The Postal Service has been modeling volumes for a long time, and it constantly compares predictions with what actually unfolds.  While its analysis deserves close scrutiny, one must also acknowledge, as the Postal Service points out, that it has the “experience and perspective and, quite frankly, accountability, that others who start looking at these matters on an ad hoc basis may be lacking.”

 

The new normal

Aside from the question of how much of the losses are due to the recession, there’s the question of how long should the rate increase be in place.  The Postal Service wants a permanent rate increase because the Great Recession had such a profound effect.  We could be talking about the recession’s effects twenty years from now.  But does it make sense to increase rates permanently when the recession, as bad as it may have been, was not itself permanent?

The docket on the increase is filled with references to “the new normal.”  Asked to explain what that might be, Mr. Thress said that during the “old normal,” back in the early 2000s, First Class mail was gradually declining at about 3 or 4 percent a year, Standard mail was tracking with the economy and growing at 3 to 5 percent, total mail volume was increasing, and there was no reason to expect that this trend wouldn’t continue, even with the steady diversion of single piece First Class.

Then the Great Recession hit and a new normal emerged — First Class mail declining at the rate of 5 billion pieces a year, Standard mail not growing much at all and not tracking with the rest of the economy either, and a new baseline for total mail volumes 20 percent lower than before the recession.

Even if one were to accept the Postal Service’s argument that the recession was primarily responsible for creating this new normal, there’s the question of what to do about it.  The mailers and the Public Representative argue that rather than looking for a permanent rate increase, the Postal Service should be adjusting to the new normal by further downsizing and cost cutting.

For its part, the Postal Service says it has already done a considerable amount of cost cutting and its five-year plan contains more plans for more cost savings, but some of the proposals require Congressional approval.  Plus, some of the cost-cutting ideas advocated by others may not be in the best interests of the Postal Service or the country.

There’s another reason the phrase “new normal” kept coming up in the proceedings.  The exigency provision says a rate increase is justified by “extraordinary or exceptional circumstances.”  But if we are in a “new normal,” what’s so extraordinary about the circumstances?  The opponents of the rate increase thus invoke the “new normal” as a rhetorical device.  It makes it seem as though there’s nothing exceptional about what’s happened.

 

The peanut butter approach

Another issue that may come up in the Commission’s ruling on the rate increase has to do with the fact that the Postal Service has requested an across-the-board 4.3 percent.  In its first exigent request, the Postal Service asked to raise First Class by 5.4 percent, Standard by 5.6 percent, and periodicals by 8 percent, which would have gone some way toward getting periodicals to cover their costs.

During cross-examination of the Postal Service witnesses, Commissioner Taub described spreading the increase evenly across the board as the “peanut butter approach.”  He wanted to know if the Board of Governors had considered alternatives, as it had done the first time around.  (Transcript, p. 11)

The Postal Service’s witness Mr. Taufique suggested that this approach — matching rate increases for each class of mail to how much damage that class had done — would be to “punish the survivors.”  Instead, the BOG decided it would be more “reasonable” and “equitable” to spread the burden out evenly among all classes of mail.

Many of the comments submitted in the proceedings address this issue.  They argue that an across-the-board price increase is not “reasonable and equitable” as required by the exigency provision.  Some, like Valpak, believe that the exigent request should be used as an opportunity to correct existing problems, like underwater products and workshare discounts that are losing money.  The Postal Service argues that this is not the way to fix these problems.

It will be interesting to see what the Commission has to say about the issue.  Will it propose its own set of rate increases and try to address some of the long-standing problems it’s cited in annual compliance reviews?  That doesn’t seem likely.  Will the Commission cite problems with the across-the-board approach as a reason for rejecting the increase?  That too doesn’t seem likely.  It is likely, however, that the Commission’s ruling will have something to say about peanut butter.

 

The effects of an increase

The main focus of the Commission’s ruling will be on whether or not the rate increase request complies with the exigency provision.  But another important question that has come up in the proceedings is how a rate increase — or the absence of an increase — might affect things.

The mailers argue that a rate increase would have many negative effects, the most obvious of which is that it will drive away mail volumes.  The Postal Service knows that it will lose some volumes and revenue, but it believes that elasticities being what they are, it will still gain in contribution.  The Greeting Card Association brought forward an expert to contest that view, but the Postal Service has plenty of experience seeing how past rate increases have affected volumes, and even in the “new normal,” its estimates of price elasticities are probably fairly reliable.  The estimates would have to be way, way off for the price increase not to bring in at least some additional contribution.

An increase would also make life difficult for mailers who are already struggling, like the periodicals and newspaper publishers, nonprofits, and small businesses.  It might lead to cutbacks in the mailing industry, like the paper manufacturing and printing businesses.  It’s that concern which is partly behind the opposition to an increase expressed by Senator Collins in her letter to the Commission.  It’s an important concern, but not many of the comments submitted by the mailers address this issue, perhaps because “the effect on mailers and the industry” is not a criterion mentioned in the exigency provision.

Another danger, which is pointed to by Valpak in its comments, is that an increase would give Congress an excuse for further postponing postal reform legislation.  That’s a revealing comment, since it shows how the rate increase is being used as a tool to motivate Congress to act.  The Postmaster General has been fairly explicit about his position that a rate increase might not be necessary if Congress passed legislation.  The mailers have undoubtedly been lobbying elected officials in the hope that legislation would obviate the need for a rate increase.  Still, one has to wonder, will a rate increase have much impact on getting Congress to do anything?  Nothing seems able to do that.

Valpak points to another potential effect of the increase, but this one probably says more about Valpak than anything else.  For the postal worker unions, says Valpak, every dollar of increased revenue from rate increases is simply another “dollar up for grabs in the next wage negotiations.”  In other words, the new money won’t help with the bottom line because workers will take it.

That is probably how many of the mailers see the world: Postal rates are too high because postal workers get paid too much.  If there were fewer postal workers earning those big salaries and getting big benefits, and if there were more part-time postal workers earning Walmart salaries, then there wouldn’t be a need for a rate hike to begin with.

 

Time for the customers to step up

There’s not much in the docket about what would happen if the rate increase were rejected, but Valpak’s comments point the way.  The Postal Service would be forced to make more cuts, some of which even it does not find advisable.  There would be more pressure to shift customers to cluster boxes, for example, even without their permission, which current law permits but which postal management seems reluctant to do.  There would be more pressure to close postal facilities, even with all the public protest that elicits.  There would be more cuts in service, more reductions in the workforce, more use of low-paid workers.

No one likes a postal rate increase (except perhaps the Postal Service’s competitors), and the only participant in the case actually to argue in favor of the increase was the National Postal Mail Handlers Union.  It’s an unpopular position, and the NPMH deserves credit for having the courage to make the case.

As the union points out in its comments, the Postal Service “cannot make up its losses solely through more efficient and economical management, but must either raise rates or cut service yet again.”   It has already reduced the number of processing plants from 673 to 250, which is slowing down delivery times, and since 2006 it has reduced the career workforce by nearly 30 percent.  The unions have made their sacrifices, agreeing to replace large numbers of career jobs with part-time positions earning low wages with no benefits.

“In contrast,” concludes the NPMH, “during this same time period, the Postal Service’s customers have largely been spared this pain, with rate adjustments limited to simple CPI increases.  As many of the participants in this proceeding have pointed out, the economy is beginning to recover in many sectors, and it is time for the general public, including commercial mailers, to begin to carry their fair share of the load in ensuring that the Postal Service is able to continue to provide the level of service that the American public wants and rightfully expects.”

There’s the issue in a nutshell.  As it’s always been in the history of the post office, it comes down to a question of rates versus service.  You can only squeeze so much inefficiency out of the system.  Eventually one has to make a choice.  Do we want to see the quality of service reduced even further — more mail delays, more post office closures, more cuts to window hours, longer lines, more cluster boxes, fewer days of delivery, later delivery times, fewer collection boxes, and all the rest — or are we willing to pay a little more to maintain a decent level of service?

The big mailers have made their position on the question pretty clear.  Unfortunately, average citizens don’t have much of a voice in the PRC’s proceedings.  Hopefully their interests, as well as those of the commercial mailers, are on the minds of the Commissioners as they decide what to do about the request for an exigent rate increase.

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