What’s up with the cost savings for phase 2 of Network Rationalization?

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For over three years, the Postal Service has been saying that phase 2 of its Network Rationalization plan would save $750 million annually, but now that many of the plant consolidations have been fully or partly implemented, it appears that the initiative may not be saving anything like that.  In fact, phase 2 may be losing money.  

As reported by Dead Tree Edition, last week the Postal Service shared some numbers on phase 2 with the Postal Regulatory Commission as part of the annual compliance review.  In a Chairman’s Information Request, the Commission asked, “Has the Postal Service realized all the savings from its Network Rationalization Initiative? … If not, please explain why the full amount of projected savings has not been realized.”

Since phase 2 didn't really get started until January 2015, when the service standards were changed, the Commission had to know there was no way the Postal Service could have realized all the savings for FY 2015, so the wording of the question is a bit curious.  So is the Postal Service’s response:

No. The Network Rationalization Initiative is being implemented using a multi-phase approach in order to ease the impact of the changes to the Postal network and to allow time to respond to changing conditions. The first phase of implementation has been completed with the Postal Service realizing annualized savings of $865M. The second phase, which began in January 2015, is still being implemented. During FY 2015, the Postal Service tracked 3 quarters of savings for this initiative. As part of this tracking, workload adjustments were applied to account for the increases experienced from the unplanned package growth and workload shift. In FY 2015, the initiative posted additional net savings in labor and parts of $64.3M. As an offset, there was a planned increase in transportation due to Network Rationalization expected to cost the Postal Service $124.9M annually. The actual increase in transportation costs associated with this initiative during FY 2015 was $130.2M.

The explanation beats around the bush, but one reasonable interpretation is that phase 2 saved about $64 million in parts and labor but caused an increase in transportation costs of $130 million.  That led Dead Tree Edition to calculate that phase 2 has resulted in a net cost increase of $66 million.  "The U.S. Postal Service’s aborted attempt to save money by consolidating its processing facilities backfired," writes DTE.  Because the plan has led to slower service and higher costs, it's become a "debacle." 

The Postal Service may have been saying something different in its response, but if it has in fact lost $66 million during the first stage of phase 2, that would indeed be a debacle, and the Commission ought to look deeper into how this could have happened.  In its Advisory Opinion on Network Rationalization, the Commission warned the Postal Service that phase 2 was very problematic, but in January 2015 the Postal Service began implementation anyway.  

The Postal Service's explanation for why it hasn't realized the full savings it projected doesn't shed much light on the situation.  The fact that the initiative wasn't fully implemented during FY 2015 or that transportation costs increased $6 million more than expected or that labor cost savings exceeded expectations does not reveal anything about the central question: How much, if anything, has the Postal Service saved so far with phase 2?  

 

Status of the consolidations

In its 2015 Annual Report to Congress, the Postal Service stated that during FY 2015, it completely consolidated 15 facilities on the phase-2 list, partially consolidated 21, and did not begin consolidations at 44 other facilities.  In addition, every plant in the country changed its operations to take advantage of the new, slower service standards that went into effect in January 2015.

As for how much money phase 2 was saving, the Postal Service said only this in the Annual Report: “We will not fully realize the projected cost savings of this consolidation effort until we are able to fully implement it as planned” (p. 21).

Based on this statement, one might conclude that phase 2 was at least beginning to show some cost savings, even if it was too soon to "fully realize" all of the projected savings.  As suggested by the number of completed and partial consolidations, phase 2 was just getting started.  

That's a bit misleading.  In fact, phase 2 was well underway by mid-April 2015, about halfway through the fiscal year, so the Postal Service should have been seeing some significant cost savings.

One can see the status of the consolidations in the regular update reports that the Postal Service shares with its business customers on the RIBBS website.  To make it easier to see how the implementation progressed during 2015, we've combined the reports for January 23, May 1, and October 2; you can see this merged report here.  It also includes the latest report for February 19, 2016, which shows that not much has changed since May.  (These and other update reports are archived here.)

The October 2 report shows the consolidation progress for the 81 plants in phase 2 as of the end of fiscal year 2015.  As the Postal Service stated in the Annual Report, 15 of the plants were completely consolidated, but the report also shows that consolidation activity had begun in about 44 other facilities — more than twice the number stated in the Annual Report.

It’s not clear why there’s such a large discrepancy between the October 2 status report and the Annual Report.   Even the May 1 report shows that most of the consolidation activity had already taken place midway through the fiscal year, before the consolidations were put on hold.

Overall, it looks as though about a third of phase 2 had been implemented by May 2015. That should have resulted in a large portion of the $750 million in annual savings being realized.  

 

Estimated savings

One can get a clearer sense of where the projected savings were supposed to come from by looking at the Area Mail Processing (AMP) studies done for the phase-2 plants.  

The AMP studies can be found here, and a spreadsheet we made back in 2012 summarizing the results for over 200 of the AMP studies is here.  An Excel sheet showing the cost-saving numbers from the AMP studies for all phase-2 plants can be found here, and another sheet showing only the 59 plants where some consolidation activity took place during FY 2015 can be found here.

The AMP studies showed that cost savings for all of the 229 plants approved for consolidation added up to about one billion — about half of the $2.1 billion the Postal Service was projecting at the time.  This discrepancy came up repeatedly during the PRC’s Advisory Opinion process, and the Postal Service never offered a satisfactory explanation, although it did eventually downsize its projections.

The AMP studies for the phase-2 facilities shows a total savings of about $570 million — again, significantly less than the $750 million projected by the Postal Service.  As noted in an OIG report about phase 2, the other $120 million was supposed to come from "other planned operational changes."  Since most of these operational changes went into effect in January 2015, one would expect that some of this savings would have been realized in FY 2015.

The AMP studies for the 59 plants where some consolidation activity had taken place by May 1, 2015, show a total savings of about $410 million.  That includes about $300 million for the partially consolidated plants and $110 million for the 15 completed consolidations.  

Of course, it was not possible for the Postal Service ever to realize anything like $400 or $500 million in savings during FY 2015.  The fiscal year began on October 1, 2014, and the phase-2 consolidations did not begin until January 2015, so only three quarters of the fiscal year were impacted, as the Postal Service pointed out to the PRC in its response to the Chairman's Information Request.  

Plus, much of the consolidation activity occurred in April 2015, so it could produce savings for only the second half of the fiscal year.  Many of these consolidations remained incomplete when the fiscal year ended on September 30, so they too could not realize anything like a full year of savings.

But given that about a third of phase 2 had been implemented midway through the fiscal year, it seems reasonable to expect some savings, maybe something on the order of $150 million.

In its response to the Chairman's Information Request, the Postal Service doesn't say anything about the one-time costs for the consolidations (for moving equipment, renovating space in the gaining facilities, etc.), but the AMP studies provide these estimates too.  

For the 59 facilities in phase-2 where some consolidation activity took place during FY 2015, the AMP studies projected one-time costs of about $160 million. (About $75 million of that was for the consolidation of the Houston P&DC to the North Houston P&DC.)  

Let's say that the Postal Service incurred $100 million in one-time costs for the consolidation activity last year.  That would still leave $50 million in cost savings.

As these guesstimates suggest, the Postal Service should have been able to post at least some cost savings for FY 2015, and it should be able to provide a real estimate for what's happened so far.

 

Transportation costs

To explain why phase 2 had not realized the projected savings, the Postal Service told the PRC that the savings in labor and parts were “offset” by an increase in transportation costs.  That explanation also deserves closer scrutiny.

In testimony (p. 16) submitted during the the PRC’s Advisory Opinion process, USPS witness Michael Bradley estimated that after both phases of Network Rationalization were fully implemented, the initiative would save $58 million in transportation costs.  That included an increase of $124.9 million for air transportation costs — the number mentioned in the Postal Service's response to the Chairman's Information Request submitted last week.

The PRC concluded that the Postal Service had overstated the potential for transportation cost savings, and put its own estimate at about $24 million.  In a footnote on page 29 of the Advisory Opinion, the Commission observed that “the small amount of ground transportation costs that the Postal Service believes would be saved in Phase 2 is almost exactly offset by increased air transportation costs.” 

In other words, for phase 2, transportation costs were supposed to be a wash — no savings, and no additional costs.

The fact that air transportation costs were actually $130.2 million rather than $124.9 million means only that air transportation cost $6 million more than projected.  This would have had a relatively small effect on the total savings realized from phase 2 in FY 2015.  By providing this information, the Postal Service has not given any indication of what it has actually saved (or not) from phase 2.

 

Labor impacts

Most of the projected $750 million in savings from phase 2 of Network Rationalization was supposed to be achieved by eliminating jobs.  In a fact sheet on Network Rationalization, the Postal Service said phase 2 would impact 15,000 employees.

The AMP studies show that the phase-2 consolidations would result in a loss of about 6,600 jobs, so it's clear where the rest of these job cuts are supposed to come from.  Maybe some will be made possible by the changes in operations that have taken place in all the other facilities as a result of the changes in service standards that took place in January 2015.

As for the 59 plants where some consolidation activity took place during FY 2015, the AMP studies show that about 3,600 jobs would eventually be eliminated when these consolidations were completed.  One might expect that some jobs would have been cut at these facilities, but that too is not certain.

According to the USPS financial report for September 2015 (the last month of FY 2015), mail processing workhours for the year-to-date totaled about 201.9 million, as compared with 199.1 million for the same period in FY 2014.  Total workhours increased by about 1.8 million, or about 1.4 percent. 

The total number of mail handler employees also doesn’t seem to have been impacted by phase 2 either.  The HAT Report (Employee Statistical Summary) for the first pay period of January 2016 says that there were 38,259 mailhandlers.  The HAT report for the same pay period last year said there were 38,282, almost the same number.

Given that 15,000 positions were supposed to be eliminated by phase 2, one would expect that the progress made on phase-2 plants would have led to some significant job cuts.  But that does not appear to have happened — which may explain why there may have been no significant cost savings either.

 

Advice unheeded

Overall, it’s hard to know what to make of the Postal Service’s comments about phase 2 of Network Rationalization.  The Annual Report to Congress provides very few details.  The number concerning how many plants were partially consolidated during FY 2015 looks like it was incorrect, and the Postal Service provided no data on cost savings. 

The Postal Service’s Annual Compliance Report to the PRC included no discussion of cost savings from phase 2, and when it responded last week to the Chairman’s Information Request, the Postal Service provided numbers about labor and transportation costs that may indicate the plan is losing money.  

If the numbers mean something else, which is certainly possible, the Postal Service has not really provided any information about the bottom line on cost savings.  The Postal Service says it has tracked three quarters of savings, but what has it found?

The Postal Service has also had little to say about how much damage phase 2 has done.  As discussed in the PRC’s Advisory Opinion on Network Rationalization, market research studies done when the consolidation initiative was in the planning stages showed that reducing service standards could cost the Postal Service anywhere from $1.3 billion to over $5.2 billion a year.  Much of that lost revenue was associated with the change in service standards that occurred in January 2015 in order to make the phase-2 consolidations and operational changes possible.

The Commission was generally satisfied that phase 1 would end up with significant savings, but it was skeptical about phase 2.  Here’s how the Advisory Opinion put it:

The Commission cannot conclude that the benefits of eliminating most overnight delivery of First-Class Mail, and deferring a substantial amount of current 2-day mail an additional day, outweigh the risks of exacerbating declining volume trends or harm to the Postal Service brand based on the evidence provided in this docket (Phase 2 implementation). The Commission encourages the Postal Service to consider the advice in this opinion and study the effects of the service standard changes implemented on July 1, 2012, before going forward with Phase 2, and its further reductions in service.  (p. 46)

The Postal Service ignored this advice and proceeded to change the service standards in January 2015.  We’ll never know how much volume and revenue were lost as a result.  The declines in mail volumes experienced over the past year were not due only to the economy or the Internet.  Some of the harm was self-inflicted.  The Postal Service has yet to show that what is has saved in operational costs exceed what it has driven away by slowing down the mail.  

Given how much time and work the Commission and participants in the Advisory Opinion process put into analyzing the Network Rationalization initiative, the Commission ought to pursue this issue more vigorously as part of the compliance review.  

The Postal Service should provide a detailed explanation of how much it saved — or not — as a result of the phase 2 consolidation activities that took place during FY 2015.  It would also be interesting to see some estimates for how much was lost due to the changes in service standards.

(Photo credit: Mail processing facility in Asheville, NC, consolidation completed)

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