Below is a copy of the CWU's 2nd submission to the review of Royal Mail liberalisation.  This refers to the request from Richard Hooper's review team for submissions specifically on the future of the universal service obligation.

CWU SUBMISSION TO GOVERNMENT REVIEW OF LIBERALISATION

Introduction

• On 17 December 2007, John Hutton Secretary of State for Business, Enterprise and Regulatory Reform announced a comprehensive review of the postal service market. The terms of reference are to: assess the impact of liberalisation on Royal Mail, alternative carriers and consumers; explore trends in future market development and the likely impact of these on Royal Mail, alternative carriers and consumers; and consider how to maintain the universal service obligation in the light of trends and market developments identified.
• The Communication Workers Union’s initial submission set out our arguments, supporting evidence and key recommendations in relation to all three areas of the Review Team's published terms of reference though we made clear we intended to submit further supporting arguments on issues relating to terms of reference 3 - "to consider how to maintain the universal service obligation in the light of trends and market developments identified".
  
• The CWU are concerned that, to date, few of the submissions have yet been placed in the public domain. In its Approach to the Review document published in March 2008, the Panel said it wanted to "generate an active debate across stakeholders", "establish a body of evidence" and "reach conclusions based on an objective analysis of various options". 
• As an organisation representing the interests of tens of thousands of employees of Royal Mail, the CWU have a direct interest in participating in a genuine debate about the impact of liberalisation and the future of Royal Mail and the UK's universal service.  Since Royal Mail is Government-owned, we believe there is an overwhelming public interest case for the Review Team to publish all the submissions provided to date and we hope the Panel will look at ways of providing access to all the evidence to allow for the data-based analysis the Review Team has committed to.

Interim Report

• On 6th May 2008, the Review Team published its interim report  'The Challenges and Opportunities Facing UK Postal Services' which set out the Panel's initial response to the main points of evidence received on terms of reference 1 and 2.
• The CWU welcome the fact that much of the analysis presented by the Panel in the interim report endorses the arguments put forward by the union in our first submission.
  
• Against a backdrop of historic underinvestment in Royal Mail, a currently declining mails market and a restrictive regulatory and pricing regime, the Report acknowledges that competition has worsened service provision for millions of business and domestic users, stifled product and service innovation and created a financial crisis for Royal Mail which has raised serious questions about the company's long-term commercial future and its ability to sustain the universal service.  
  
• While the Review Team share much of the CWU's analysis about what's happened since liberalisation was introduced, we recognise there is less consensus among industry stakeholders about what needs to be done to secure the long-term financial future of Royal Mail and the UK's universal postal service. What is clear, as the Report rightly acknowledges, is that the status quo is "untenable" and that "a better balance needs to be struck between protecting the universal service obligation and promoting competition".
• The CWU believe the damage currently being inflicted on the USO provider by unfair competition rules and a draconian pricing and access regime must be addressed in line with the priority contained in the Postal Services Act.  Since no other rival competitor is in a position to offer a service which could sustain an alternative USO, we believe the review must recommend additional support for the current provider, Royal Mail.
• We have called for immediate changes to the current pricing and access regime that will spread the financial burden of the USO across all licensed operators and allow Royal Mail to sustain the national delivery, sortation and distribution network on which the entire postal market depends.

 Universal service

• The universal service plays a vital economic and social role in the UK - underpinning the country's postal service provision.  It offers an end- to-end service for all mail users and a national delivery network for customers, connecting over 28 million addresses to the broader UK economy.  As the Review Team notes "it helps social cohesion by linking rural communities with more densely populated areas of the country and ensures that older people and those with disabilities have an accessible reliable means of communication and the capacity to send and receive mail".   
  
• From the outset of liberalisation we have consistently argued that the future financing of the UK's universal service was being threatened by the form and timing of competition introduced by the Regulator, Postcomm.  The way liberalisation has been introduced means competitors which face no obligation to price uniformly or to maintain a fixed network to deliver next day to every point have been encouraged to target cheap to deliver urban areas,

 leaving Royal Mail with low volumes in high density areas and low density (and unprofitable) areas which are putting the economics of the USO at risk.

• Royal Mail's regulatory accounts show that the profitability of the universal service has declined from £215m in 2005/06 to £27m in 2006/07.   The company's total regulated business plan made a loss of £29 million in 2006/07 compared to Postcomm's forecast of a £779m operating profit (which was predicated on false assumptions about likely market developments).
• The company's latest preliminary accounts show that - for the first time - the universal service made an estimated loss of around £100m in 2008 with the overall price controlled area of Royal Mail's business making a loss of around £200m.  Against this financial backdrop we find it hard to square the evidence with Postcomm's assertion that "the early experience in the UK is that competition has strengthened the universal service".
• In line with the Government's explicit manifesto commitment and the requirements of the UK Postal Services Act, the CWU believe the question of how best to support and finance the universal service should be central to the Review Team's future deliberations and final report.  Supporting the universal service must be the primary concern - how competition develops should be subject to and consistent with this end.
• The CWU believe that future provision of any universal service is dependant on delivering a healthy and profitable Royal Mail with the finances to sustain the vast postal infrastructure on which the universal service and all mail users ultimately depend.  It is not possible to support the USO without having a network capable of delivering it.  Since Royal Mail is the only organisation which can deliver the USO it must have the physical capacity and long-term financing to sustain it.
• The CWU are therefore calling for a number of immediate changes to the current pricing and access regime that will end Royal Mail’s effective subsidy of the competition on access products and ensure that the real cost of maintaining the USO - and the fixed infrastructure that supports it - is met by all those who use it.

The cost of the USO

• Traditionally universal service obligations have not required explicit financing.  A monopoly and a uniform price enable national operators to cross-subsidise losses where costs are above average and profits where costs are below average.
• But liberalisation has encouraged competitors to concentrate only on areas of lower costs where the biggest profits are to be made.  The result is the national postal operator loses its more profitable business and is forced to deliver mail for its competitors at a reduced price.  Ultimately, liberalisation undermines the system of cross-subsidisation which had previously supported universal service provision.
• Postcomm in its Strategy Review document say it's “a source of concern that Royal Mail claims its ability to finance the universal service is under threat when it has only lost less than 1% of its mail volumes to end-to-end competition". But this misses the crucial point, namely that the distorted form of competition introduced via downstream access has seen rival competitors target and cream off Royal Mail's most lucrative bulk mail work.  As a result the company's revenues and profitability have fallen sharply while it's still been left to finance it’s wider (loss making) universal service obligations.
• Postcomm's approach to the question of financing also ignores the consequences of its own failures to accurately forecast likely market developments (on which Royal Mail’s current pricing framework was predicated), which has the company with far lower revenues than the Regulator predicted.
• At present there is no single agreed methodology for determining the cost of universal service provision. A report by consultants Omega Partners rightly noted that "the appropriate methodology for assessing the cost of the universal service obligations is controversial". There are two main methodologies Entry Pricing (EP) and Net Avoided Costs (NAC).  The latter measures the net savings (costs saved minus lost revenue) that a national postal operator could make by withdrawing services under current market conditions.  The EP methodology estimates the additional cost of providing the current universal service after the introduction of competition.
• The EP approach addresses the practical question of the effect on profitability of introducing competition while maintaining universal service obligations.  The NAC method concerns a purely theoretical issue, the cost that could be saved by abolishing universal service obligations while retaining the current market situation of monopoly or near monopoly.  The NAC has the further disadvantage that estimated savings depend very much on overall profitability in the period for which it's calculated.
• Many observers have pointed to the limitations of the NAC methodology.  A NAC study for the European Commission stated that "the EP approach (to measure the loss of a national postal operator's profits in a liberalised market) would provide an estimate of the reduction in the ability of the postal administrations to fund its USO burdens, but not an estimate of the total costs of these burdens.  It is therefore more appropriate for consideration of how the USO burden should be funded, rather than with the question of the overall size of the burden”. In short the NAC is said to be the appropriate method to estimate the current cost of universal service obligations, EP is relevant to funding universal service obligations in a liberalised market.
• In 2001 Postcomm published a NAC study of the cost of Royal Mail's universal service obligations which measured the cost of universal service given a market with "limited or no competition".  It acknowledged that the analysis "does not address how Royal Mail could support and finance its licensed activities…. in the context of reduced volumes through the introduction of further competition."  We therefore believe that the relevance of the study and other NAC studies is questionable to a debate on financing universal service obligations in a liberalised environment.
• For Royal Mail the cost of the USO "is meant to measure the extent to which a universal service requirement constrains a postal operator's financial performance". It says "a relevant interpretation is the net cost of providing the level of service specified by the USO against which can be offset the revenues obtained for those products defined as being in the universal service".
• The company points to the following scale of activities specified by the universal service requirement and the resources involved in supplying them:
  
  -           Daily collection from 115,000 pillar boxes and 13,000 post offices;
  -           Daily delivery to 28.4 million addresses, with less than 3,000 delivery
             exceptions;
  -           167,000 people;
  -           69 mail centres, 1400 delivery offices, one national hub;
  -           Around 31,000 vehicles, 2 trains and 42 flights per day.
  

• Royal Mail says the accounting cost of providing the range or products currently deemed universal service products is £3.4 billion.  But the "true economic cost" - which relates to the level of costs that would be incurred if only the USO products were being supplied is "higher".
• The one price goes anywhere principle of the current USO prevents Royal Mail from introducing fully cost reflective pricing. Royal Mail’s current losses reflect the artificially low price Royal Mail can charge competitors for access to its downstream pipeline and because of the unfair constraints of Postcomm’s access headroom regulation. This prevents Royal Mail from lowering the price it can charge retail customers for its bulk end to end service without also lowering the access price by the same proportion.
• Instead of asking small businesses, social mailers and our members to pay the price of competition, we believe the Review Team should recommend additional financial support for the USO provider which ensures that all other operators which use the USO infrastructure help pay for its upkeep.

The scope of the USO

• Under the terms of the EU Directive, member states must ensure "that users enjoy the right to a universal service involving the permanent provision of a postal service of specified quality, at all points in their territory at affordable prices for all users".  The Directive says the universal service must guarantee, as a minimum, one clearance and one delivery every working day and not less than 5 days a week.  It also specifies that the universal service should include the following minimum facilities:-
  
  -           the clearance, sorting, transport and distribution of postal items up
             to 2 kg;
  -           the clearance, sorting, transport and distribution of postal packets
             up to 10 kg;
  -           services for registered and insured items.
  

• The universal service obligation imposed through the EU Directive is a legal obligation on member states which can only be altered through another Directive or other form of EU legislation.
• In the UK, the Postal Services Act sets out the minimum activities needed to fulfil the universal service requirement.  This goes further than the EU Directive in requiring six day (Monday to Saturday) collections and delivery for letters.  Part 1 (Section 4) of the UK Act says a universal service is provided if:-
  
  "(a) except in such geographical conditions or other circumstances as the Postal Services Commission considers to be exceptional -
  
  (i) at least one delivery of relevant postal packets is made every working day to the home or premises of every individual or other person in the United Kingdom or to such identifiable points for the delivery of relevant postal packets as the Commission may approve; and
  
  (ii) at least one collection of relevant postal packets is made every working day from each access point;
  
  (b) a service of conveying relevant postal packets from one place to another by post and the incidental services of receiving, collecting, sorting and delivering such packets are provided at affordable prices determined in accordance with a public tariff which is uniform throughout the United Kingdom."
  

• The Postal Services Act thus requires the universal service to be provided at affordable prices determined in accordance with a uniform public tariff.  We note that the third EU Postal Services Directive says a uniform tariff requirement will be permissible under domestic law only for services provided at a single piece tariff (i.e. individual items).
• The CWU want a debate about safeguarding and developing the current USO to meet the changing needs of postal users.  We want the USO strengthened to ensure the elements of the postal service most valued by mail users are protected with particular attention given to the needs of small and medium sized enterprises (SMEs) and the UK's most vulnerable and disadvantaged groups.
• The CWU agree with Royal Mail that degrading the quality of universal services is not the answer.  Market research conducted jointly by Postcomm, Postwatch and Royal Mail has shown customers would be reluctant to accept significant change to current postal service provision and that changes regarded as a serious degradation of service could hasten moves from mail to other media.
• The current level and quality of the universal service not only contributes to social and economic cohesion but is the key to mails longer term competitive advantage.  We do not believe that worsening universal service provision in respect of delivery, collection and service specifications will either help grow the market or be acceptable to the millions of social customers and small businesses who rely on mail.
• The CWU are not convinced that reducing universal service provision will be in the long term interests of Royal Mail or mail users.  While we accept that decisions about the future scope of the USO rest on a clearer understanding of the necessary cost information (to which we don't have access), we are concerned that any cost savings enjoyed by Royal Mail from reducing current specifications would be more than offset by the damage the changes could have to mail users (particularly the vulnerable) and the negative impact this could have on overall mail usage.
• The CWU believe a national integrated postal service is essential for the continued provision of the UK's universal postal service and the long-term success of the Post office network.  Post Office Ltd. (POL) plays an integral role in the provision of a universal postal service in the UK and its future success, along with that of the Royal Mail Group, depends on the maintenance of an integrated national postal service.  Any move to separate POL from the rest of the Royal Mail Group would be unnecessary, threaten the future of the network and undermine Royal Mail’s ability to meet its Universal Service Obligation (USO).
• Postcomm’s primary statutory duty, as dictated by the Postal Services Act 2000, is to ensure the maintenance of the USO. Since separation of POL would undermine universal service provision the proposal runs counter to Postcomm’s legal duty. POL plays an essential role in the provision of the USO and its separation from the rest of the Royal Mail Group would threaten the successful maintenance of this obligation. POL cannot be seen in isolation from Royal Mail, nor can POL’s social obligations be seen as separate from Royal Mail’s USO.
• Mail products accessed by social customers and small businesses are overwhelmingly Royal Mail universal service products and are likely to remain so. Competition is unlikely to develop for much of this business. In providing universal service products Royal Mail is operating a public service and POL plays an essential role in product distribution. Together they are providing a service that the market alone would not provide.

Product coverage

• It is clear that the impact of liberalisation has reduced Royal Mail's ability to offset the cost of USO products with contributions from others, leaving the company with a more significant net USO burden (which will increase as current market conditions develop).  To address this Royal Mail have said the current USO should be narrowed to a smaller range of products reflecting minimum legal requirements under the EU Directive, namely stamped mail, standard parcels, a registered and insured product and international surface and airmail.
• This option has also been floated by Postcomm in its recent Strategy Review document which identified the universal service obligation and the costs of providing it as one of its key "emerging themes". It argued that "between now and 2010 it is necessary to decide whether - and if so how - the current scope and service specification of the universal service should in due course be changed to meet the evolving needs of postal users”.
• Postcomm says it “recognises the case” for the prices of bulk services being increasingly set by market forces and cost conditions without what it calls "the regulatory constraint of enforced price uniformity."  For this reason it accepts there may be advantages in bulk services not having to be offered as part of the uniformly priced universal service.
• We recognise that a key reason for considering the removal of bulk mail products from the constraints of the USO is to pave the way for more cost reflective pricing models such as zonal pricing. The end result of removing these products needs to be clear. While we see the logic of this argument we have concerns about its potentially damaging impact, particularly on small and medium sized businesses that still rely on the remaining universal service bulk mail products.  Since there are far fewer competitive alternatives to standard tariff franked mail and PPI mail and these are used extensively by small and medium sized businesses who greatly value the one price goes anywhere nature of the universal service, this change could have potentially costly and damaging consequences – something Postcomm itself has recognised.
• To address these potential risks Postcomm has proposed a two stage approach in which first the uniform tariff for bulk mail is removed, with consideration given to the services to be taken out of the universal service at a later date.
• The CWU want a debate about the future of the USO based around the needs of customers rather than the needs of competition. Competition needs to be shaped around the needs of the USO, not the other way round. However you ultimately define the product coverage of the USO, the CWU believe the real priority is to ensure that the financial burden of providing the USO is spread fairly across all licensed operators. Deciding which products are regulated misses the crucial point – whether regulated or not all mail products rely on the use of Royal Mail’s national postal infrastructure. Even if products are taken out of the USO, the cost of the service and the network should be borne by all mail users on the simple principle that those who use the USO help pay for its upkeep.
• The CWU therefore believe there is a strong argument, particularly given Postcomm's mistaken market assumptions, for the Regulator to revisit the current access and pricing regime and introduce a price control mechanism that ensures all those who use Royal Mail’s USO infrastructure pay a fair and proportionate contribution towards its maintenance.

Future financing

• For the CWU, the question of how best to safeguard the future financing of the UK's universal service is urgent and critical to the industry's long term future.  Long delays in addressing this crucial question will only exacerbate Royal Mail's current financial difficulties and ultimately threaten further the scope and financing of the future USO.
  
• In its Strategy Review Postcomm says it has considered two main options for future financing of the universal service.  External financing mechanisms such as subsidies and industry compensation funds; and requiring Royal Mail to contract out, or franchise parts of the service through a process of competitive tendering.
• In our earlier submission the CWU raised the option of a universal service support fund to help Royal Mail meet its current universal service obligations, an idea which is provided for under the terms of the EU Postal Services Directive.
• We note that other countries in Europe have sought to compensate national postal operators directly for universal service obligations or to consider some form of compensation fund or ‘pay or play’ system.  While Postcomm have selectively identified the experience from Sweden, Germany and Holland they have ignored developments in other countries like France, which is looking at a 'pay or play' system which would force new market entrants either to spread their operations evenly between profitable urban areas and costly rural areas, or to pay a fee to the incumbent operator.
• However we recognise that a universal support fund may create further market distortions and may not be best suited to the competitive environment Postcomm has created. That is why the CWU favour a change to the current pricing and access regime that will ensure all operators pay a fair contribution to support the USO infrastructure on which they depend.

Ownership

• The CWU made clear in our earlier submission that we believe the question of Royal Mail’s ownership was ‘ultra vires’ and falls outside the Review Team’s published terms of reference and the explicit policy of the UK government to keep Royal Mail in the public sector. We therefore condemn Postcomm’s decision to call for the privatisation of Royal Mail.
• The ownership of Royal Mail is a matter for Government and ultimately for the British people to decide. Since the current government was elected with a manifesto commitment to retain full public ownership of Royal Mail we believe the Regulator is overstepping its remit to seek to overturn it. The Regulator should be the instrument of policy not determine it. Postcomm’s proposal is another example of it elevating the pursuit of competition above its primary statutory duty to defend the USO and honour its public service obligations.
• Privatisation of Royal Mail would not only be a clear breach of Government policy but prove a disaster for our members and for postal users, creating more uncertainty and upheaval within the industry. Since Postcomm’s policies on competition have created the financial crisis Royal Mail now faces, we believe it is the least equipped to make recommendations about Royal Mail’s future ownership and financing. The Regulator should concentrate on delivering a regulatory and pricing regime that genuinely supports Royal Mail’s universal service obligations rather than pushing policy options that are outside its remit and legal duties.

Separation

• The CWU believe any proposal for major reorganisation of the business via separation would only serve to compound Royal Mail's current problems by requiring it to focus its energies on internal organisational matters which are likely to disrupt operational efficiency rather than improving the services offered to customers, something the Review Team say is paramount in their deliberations.  We note that the biggest advocates of separation are Royal Mail’s competitors who have a material interest in its development.
• In our earlier submission we argued that splitting Royal Mail's retail and wholesale activities would be costly, damaging and time consuming and is unsupported by the vast majority of industry stakeholders.  "The nature of Royal Mail's operations (the fact workers, premises and equipment are used interchangeably for upstream and downstream activities) does not make the company a good candidate for separation".  We believe Royal Mail's modernisation and efficiency drive is dependent on greater cross-functional activity, not less.
• Royal Mail themselves have also argued that separation would disrupt the business and lead to greater complexity in its operations, reduced efficiency, price increases, volume reductions and a worsening USO.  Since maintenance of the USO should be the Panel's primary focus we fail to see how any form of separation or franchising/contracting out part of Royal Mail's operations (thereby ending Royal Mail's position as a national, integrated postal operator) can support this wider objective.
• After five years of massive change Royal Mail desperately needs a period of stability (without major additional regulatory, competition or organisational changes) to address the current issues it faces, put it on a firmer financial footing and concentrate fully on meeting the needs of its customers.
• In the light of the evidence presented to date we believe it would be a mistake to embark on further experiments with Royal Mail's management and operational structures.  This will not only be damaging for Royal Mail but the customers it wishes to serve.

Contracting out

• The CWU also strongly oppose Postcomm's other model - franchising out parts of Royal Mail's service through competitive tendering.  We believe this would undermine Royal Mail's capacity to deliver the universal service, threaten quality of service standards and seriously undermine any wider improvement the company is trying to make. 
  
• Contracting out would not only constitute the piecemeal break up of a vital integrated national provider but complicate the efficient operation of the business.  Experience of contracting out in other industries like the NHS has shown it can seriously undermine the integrated operation of the business and the level and quality of overall service provision to customers. Moreover, we oppose contracting out as a means of ‘wage dumping’ used to undercut the terms and conditions of Royal Mail employees.

Summary

• The Interim Report from the Review Team endorses all the key arguments put forward by the CWU about the impact of liberalisation to date. The form and timing of competition introduced by the Regulator has worsened service provision for small businesses and domestic users, stifled product and service innovation and created a financial crisis for Royal Mail which raises serious questions about its long term commercial future and its ability to support the UK’s universal service.
• The cherry picking by Royal Mail’s competitors which face no obligation to price uniformly or maintain a fixed network to deliver next day to every address point has led to a black hole in Royal Mail’s finances and put the economics of the USO at risk – the company’s latest accounts for 2008 show that, for the first time, the universal service made a loss of around £100m.
• The CWU believe the question of how best to safeguard the future financing of the UK's universal service is urgent and critical to the industry's long term future.  Long delays in addressing this crucial question will only exacerbate Royal Mail's current financial difficulties and ultimately threaten further the scope and financing of the future USO. How best to support and finance the universal service should thus be central to the Review Team's future deliberations and final report.
• We believe that future provision of any universal service is dependant on delivering a healthy and profitable Royal Mail with the finances to sustain the vast postal infrastructure on which the universal service and all mail users ultimately depend.  Since Royal Mail is the only organisation which can deliver the USO it must have the physical capacity and long-term financing to sustain it.
• The CWU believe the damage currently being inflicted on the USO provider by unfair competition rules and a draconian pricing and access regime must be addressed in line with the priority contained in the Postal Services Act.  Since no other rival competitor is in a position to offer a service which could sustain an alternative USO, the review must recommend additional support for the current provider, Royal Mail.
• The CWU are therefore calling for a number of immediate changes to the pricing and access regime that will secure the future financing of universal service provision. Royal Mail can only be successful and profitable if its pricing arrangements genuinely reflect the value of the products and services it provides and the real cost of the network needed to deliver them. We therefore support: a reopening of the current price control; ending Royal Mail’s effective subsidy of the competition on access; and introducing a price control mechanism that ensures the real cost of maintaining the USO (and the fixed infrastructure that supports it) is met by all those who use it.
• The question of Royal Mail’s ownership is ‘ultra vires’ and falls outside the Review Team’s published terms of reference. The ownership of Royal Mail is a matter for Government and ultimately for the British people to decide. Since Postcomm’s policies on competition have created the financial crisis Royal Mail now faces, we believe it is the least equipped to make recommendations about Royal Mail’s future ownership and financing. The current government was elected with a manifesto commitment to retain full public ownership of Royal Mail and we believe the Regulator is overstepping its remit to seek to overturn it.
• Privatisation of Royal Mail would be a disaster for our members and for postal users, creating more uncertainty and upheaval within the industry. Postcomm should concentrate on delivering a regulatory and pricing regime that genuinely supports Royal Mail’s universal service obligations rather than pushing policy options that are outside its remit and legal duties.
• Separation of Royal Mail would be costly, damaging and time consuming. It would undermine operational efficiency and compound Royal Mail’s current problems by requiring it to focus its energies on internal organisational matters instead of improving the service to its customers.
• After five years of massive change within the industry we believe Royal Mail needs a period of stability to address the issues it faces and concentrate fully on meeting the needs of its customers. Since maintenance of the USO should be the Review Team’s primary focus we fail to see how separation or franchising/contracting out part of Royal Mail’s operations can support this wider objective.
• We believe the Review Team should make interim changes to the pricing and access regime, allow a period of time for these to bed down and conduct a further review of the industry in two to three years time ahead of the date for full liberalisation across the EU.
  

Any further information regarding this submission should be addressed to:

Billy Hayes
General Secretary
Communication Workers Union
150 The Broadway
London SW19 1RX
Tel: 0208 071 7251

E-mail: bhayes@cwu.org