PRC rejects Discover NSA and the Postal Service’s “subjective intuition”

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For the first time since they were created in 2002, a Negotiated Service Agreement (NSA) has been rejected by the Postal Regulatory Commission.  Yesterday the PRC turned down the Postal Service’s request to add a NSA with Discover Financial Services to its market-dominant list.

This is quite an unusual event.  Since the 2006 Postal Accountability and Enhancement Act, the PRC has reviewed about 500 NSA requests.  (According to this PRC presentation about NSAs, as of May 2014, that number included 446 competitive and 24 market-dominant NSAs.) 

Every one of the requests was approved, including previous NSAs with Discover.  In yesterday's order on the Discover NSA, the Commission pointed out that this was the first NSA it had been unable to approve, “and it is not a decision the Commission takes lightly.”

As the order notes, while PAEA granted new flexibility to the Postal Service in setting postal prices, “it also made clear that only NSAs that improve the net financial position of the Postal Service or enhance the performance of certain postal operations may be approved.” 

According to the Commission’s analysis, the Discover NSA “would not improve the net finances of the Postal Service.”  In other words, it would lose money. 

The Postal Service disagreed.  It said that the problem was not that the deal would lose money but that Commission was using the wrong methodology to analyze the finances.  Using an appropriate alternate methodology, argued the Postal Service, the deal would in fact yield a significant profit.

Under the “accepted methodology” previously used by the Commission, the Postal Service calculated that the net benefit from the Discover NSA would be a negative $6,180,863 in the first year of the Agreement.  Over its three-year term, the deal would cost the Postal Service $18 million.

The only scenario within the proposal that provided a positive impact on net contribution was if Discover missed the NSA’s volume threshold and paid a penalty.  The Commission concluded that this was unlikely.

The Postal Service, along with Discover, criticized the accepted methodology for analyzing the finances and argued that an alternative approach was in order.  The criticisms are too complicated to explain here, but they involve issues of price elasticities and the potential impact of the incentives offered by the discount on how much mail Discover sent. 

The Postal Service’s alternative approach to analyzing the deal came up with completely different results.  Rather than losing money, the NSA would have a net positive value of over $25 million in the first year and over $91 million over three years.

The Commission was not persuaded.  It could not accept the Postal Service’s alternative approach as a viable methodology, and it stuck by the accepted methodology. 

According to the Commission’s analysis, “the Postal Service’s calculation of the net benefit of the Agreement was based on a number that neither the Postal Service can justify nor the Commission can verify.”

“Without acceptable objective data,” the order proceeds to state, “the Commission must conclude that the Postal Service’s analysis relies on subjective intuition.”

The Commission’s concerns about this proposed NSA with Discover were exacerbated by its analysis of a previous Discover NSA approved in 2011, which resulted in a net loss of $25 million to the Postal Service over the three years of the contract. 

This prior NSA was similar to the proposed NSA in that in both deals Discover received rebates for all volume mailed, provided that a revenue threshold was reached.  (There's an analysis of the prior NSA with Discover in the PRC's 2013 Annual Compliance Report.)

As yesterday’s ruling noted, the Commission had approved the prior NSA partly on “the premise that the Postal Service would use the experience as an opportunity to observe and attempt to measure the specific factors affecting Discover’s mailing behavior.”  In the Commission’s estimation, however, the Postal Service “does not appear to have availed itself of this opportunity.”

At some point during the proceedings, when it was becoming clear that the NSA was in trouble, the Commission says it “proactively solicited potential additional rationales under which the Discover NSA could be approved under existing statutory and regulatory requirements.” 

Nineteen information requests were issued by the Commission and its Chairman, asking the Postal Service to offer different rationales for the benefits of the Discover NSA.  No fewer than seven such rationales were proposed by the Commission.  “Each was rejected by the Postal Service,” observes the order.

Overall, it seems that the Commission was rather frustrated with the Postal Service.  The PRC filed numerous information requests trying seeking clarification of various elements of the deal, and it even looked for ways to help the Postal Service find a rationale upon which the deal could be approved.  Apparently the Postal Service wanted the NSA approved on its own terms.

It’s not clear what will happen next, but given how unusual it is for the PRC to reject a NSA request, and given the nature of the Postal Service’s arguments, the case may well end up in court.

(Photo credit: Discover sign)

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