The House Subcommittee on Federal Workforce, Postal Service, and the District of Columbia held a hearing on May 12, 2010 on "The Price is Right, or is it? An Examination of USPS Workshare Discounts and Products that Do Not Cover Their Costs." Those who gave testimony at the hearing included:

• Maura Robinson, Vice President of Pricing, U.S. Postal Service;

• John Waller, Director of Office of Accountability and Compliance, Postal Regulatory Commission;

• William Burrus, President, American Postal Workers Union;

• Michael Riley (former USPS chief financial officer and rate case witness for APWU);

• James O'Brien Vice President, Distribution and Postal Affairs, Time Inc.;

• Lawrence Buc, President of SLS Consulting who appeared in behalf of the Direct Marketing Association, Parcel Shippers Association, the Alliance of Nonprofit Mailers, the National Postal Policy Council, the National Association of Presort Mailers, and the Association of Postal Commerce; and

• Hamilton Davison, Executive Director, American Catalog Mailers Association.

The following is a summary of some of the key points made by each of the witnesses.

Maura Robinson:

• Among the many financial challenges that the Postal Service faces are products that fail to cover their attributable costs. In FY2009, the revenue from 14 market dominant products and services fell short of the costs of providing them by a total of $1.7 billion. Notably, three products (Periodicals, Standard Mail Flats, and Standard Mail Parcels/NFMs) amounted to $1.4 billion, or 84 percent, of the shortfall. This is clearly a cause for concern. No business can afford to lose, on an ongoing basis, billions of dollars on a few products; however, by the same token, no business can afford to take short-term actions that will create long-term irreparable damage to an entire industry.

• If we raise the price on money-losing products to a degree that mailers reduce their volumes significantly, it is not likely that we could reduce costs quickly enough to account for the volume decline. Thus, a moderate approach is the best way to address these type of issues.

• As we develop price recommendations for the Postal Service Governors' consideration, we are working to strike a balance between addressing cost coverage issues and maintaining our customer base. It is easy to suggest "just close the gap with prices," if you do not need to live with the consequences of that pricing prescription. "Just closing the gap" would require price increases of 20 to 30 percent for some customers.

• Inherently, price increases are a double-edged sword. While they may improve contribution from the mail pieces that remain in the system, a substantial price increase has the potential to cause a devastating volume reduction.

• Retail catalog merchants (who mail Standard Mail Flats) have made tough decisions on the number of catalogs they will mail based on the expected return on the cost of a catalog. If they do not expect to sell enough merchandise to justify the cost of mailing one more catalog, that catalog will not be mailed. From a postal perspective, we saw a 22 percent decline in Standard Mail Flats volume in FY2009.

• Periodicals publishers face market conditions that have changed the characteristics of the magazines and newspapers that are mailed. The general decline in advertising has put increased financial pressure on publishers. When you look at a magazine today, it is typically lighter that it was a few years ago. Because we charge postage based on weight, a reduction in advertising pages also decreases the per piece postage revenue from mailed Periodicals. In addition, the remaining higher share of editorial pages pay lower rates, reflecting Congressional policy decisions to grant preferred status for mailing editorial content.

• If a sudden and dramatic volume reduction resulted from a significant price increase for money-losing products, the Postal Service would not be able to reduce costs quickly enough to account for the volume reduction. Prices for below-cost products will be increased to address the cost challenges; however, we intend to do so in a judicious and measured way to improve financial performance over time. Accelerating volume declines may just exacerbate the cost coverage concerns, reducing efficiencies and increasing costs for the volume that is left.

• The Postal Service has long offered its customers choices through the worksharing program. Beginning in 1976, the Postal Service developed an array of prices based on how our customers prepare mail. Worksharing has stimulated growth in mail volume. Increases in volume have often followed the introduction of new worksharing discounts or changes in the discount structure. Workshare discounts result in volume growth, in part, because price increases are kept smaller than they otherwise would have been. If a customer presorts and prebarcodes mail, transports it closer to its ultimate destination, or performs other functions that reduce the Postal Service's costs, they pay a lower price to reflect the Postal Service's reduced workload.

• Workshare mail is profitable. There are many myths about worksharing, including an oft-cited observation that if discounts are greater than avoided costs then it must be unprofitable. Nothing could be further from the truth. Despite the sometimes vocal rhetoric, workshared mail is among the most profitable mail for the Postal Service to handle.

• Another common myth is that the Postal Service could simply raise the price of workshare mail without any substantial consequences. Unfortunately, this does not reflect the reality of the choices our customers are making on a day-to-day basis. For the vast majority of customers, the choice to retool and redesign processes to enable worksharing was made long ago.

• When a discount is discussed in pennies, it is easy to portray changes as minor. However, when you view those pennies in terms of the postage actually paid by our customers, a clearer view of the effect of changes in workshare discounts emerges.

• Another in the litany of worksharing myths is the assertion that worksharing harms small customers. This is not true. The Postal Service's workshare prices are available to customers mailing as few as 250 pieces at a time. Today, 80 percent of volume is workshare mail.

• A pricing structure that has the perverse effect of driving mail out of the system is not consistent with any reasonable understanding of the new statutory system.

• As a matter of policy, it simply makes no sense to assert that the foundation for the entire workshared First-Class Mail pricing structure must be based solely on avoided costs relative to single-piece mail.

• Large customers affect large volumes of mail and in the face of double-digit mail volume declines, we cannot afford to take actions that will accelerate the diversion of mail volume to electronic and other means. If we focus entirely on increasing the revenue per piece by a few tenths of a cent to offset an estimated cost avoidance figure, we will risk losing the entire per piece contribution from a very profitable mail stream, as that volume leaves the system.

John Waller:

• The Postal Service is no longer able to depend on volume growth to counterbalance the large amount of fixed costs in postal operations. It has had to explore ways to modify its business model, generate new sources of revenue, and modify methods of operation to accelerate the reduction of costs. The need is to bring total costs and revenues into line.

• Worksharing has proven to be a very successful initiative for the Postal Service. Each new workshare discount has been followed with an increase in volume.

• Worksharing can also benefit the overall economy and society at large. When workshare discounts equal avoided Postal Service costs, mailers can choose to do the work themselves when it is cheaper to do so, or let the Postal Service do it.

• When discounts exceed avoided costs, the mailer has price incentives to perform postal functions that the Postal Service can perform at a lower cost. In that instance, the discount can introduce inefficiencies in the mail process.

• For Fiscal Year 2009, the Commission found that 30 of 189 workshare discounts exceeded avoided costs, and that 17 of these were justifiable under current law. For the other 13 discounts, the Postal Service did not provide adequate justification for the discounts exceeding avoided costs.

• Once a determination is made that a workshare discount that exceeds avoided costs is not justified by one of the four exceptions in the PAEA, the Commission is authorized under section 3653(c) to order appropriate remedial action.

• On March 2nd of this year, the Postal Service stated that a notice of an exigent price adjustment for early 2011 would be forthcoming. The Commission determined that the adjustment of all or some of the 13 questionable discounts could be best addressed at that time.

• Nearly $1.5 billion of the loss from products not covering attributable costs comes from just three products: Periodicals, $642 million; Standard Mail Flats, $616 million; and Standard Mail Non-Flat Machinables (NFMs) and Parcels, $205 million. Losses for the two Standard Mail products have significantly increased from the prior year.

• Also, there is an important cost causing factor common to these three products. Specifically, they all involve the handling of flats for which the Postal Service has long standing cost control problems. The flats handling cost problem has continued.

• The new Flats Sequencing System equipment now being deployed is frequently cited by the Postal Service as a future source of cost savings. This remains to be seen.

• The Commission in recent Annual Compliance Determinations has cautioned against less than average increases for loss making products without a plan or justification for demonstrating how net revenue is helped over the long run.

• Standard Mail NFMs and Parcels consist of approximately 1.3 million NFMs and 5.5 million parcels both of which are costlier to handle than letters and flats. If these products were handled through Parcel Select, a competitive product, the price to the mailer can approximately double that of the Standard Mail rate.

• Periodicals Mail revenue has not covered attributable costs since 1997. For fiscal year 2009, revenue covered only 76.1 percent of the costs directly attributable to Periodicals Mail.

• The Commission directed the Postal Service to address the issue of products that were found to not cover costs in its next general market dominant price adjustment. In instances where a problem cannot be fully resolved at that time, the Postal Service is to provide a detailed plan for future resolution.

William Burrus:

• The egregious abuses of workshare discounts have finally been deemed important enough to warrant congressional attention.

• The Postal Service, encouraged by major mailers, has implemented discounts that violate the standard of universal service at uniform rates. This is not only illegal, it is also self-defeating: It deprives the USPS of revenue that is essential to maintain the nation’s mail network.

• With the transition to automated mail processing essentially complete, workshare discounts have become unnecessary.

• Today, workshare discounts artificially reduce the mailing costs of favored customers – large mailers – at the expense of individual citizens and small businesses.

• When discounts exceed the postal costs avoided, the result is that individuals and small businesses who pay the unreduced rate contribute a larger share of the institutional cost. This shifting of postal work from the public to private sector through excessive workshare discounts is inefficient and violates sound economic policy for the mailing industry.

• As the Postal Service confronts reduced mail volume and the crushing burden of pre-funding future retiree healthcare liabilities (imposed by Congress in Postal Accountability and Enhancement Act of 2006), some have opined that postal workers governed by collective bargaining agreements must make wage- and benefit concessions to help the USPS address its financial difficulties.

• If rates can be reduced in the amount of 10.5 cents per letter for affixing five-digit barcodes, let postal employees perform that work, and we will guarantee reduced costs.

• History shows that rate increases equal to or below the rate of inflation have only a marginal effect on volume. The record shows that volume has declined by more than 30 percent at a time when postage rates, when adjusted for inflation, are at their lowest level in 50 years.

• The use of workshare discounts, drop shipments, summer sales, Negotiated Service Agreements and other give-away programs have peaked at the same time that mail volume has plummeted. If rates indeed drive volume, we would expect the opposite to be true.

Michael Riley:

• Congress should stick to the requirement, already in law, that postal workshare discounts may not exceed the costs that the work-sharing activity saves the Postal Service. Recent actions by the Postal Service that violate that standard are misguided and are damaging the institution by depriving it of much needed revenue and, more importantly, money needed to cover fixed costs.

• There was a management change at the end of the 3rd quarter of 1998. Many in the mailing community expressed their feelings that the Postal Service was earning too much money and that the profits were excessive. New management promised to solve that problem, and solve it they did. Billion dollar profits were replaced by billion dollar losses.

• Instead of emphasizing the value of its products and prioritizing revenue protection, management focused on cost reduction—not just through further automation and streamlining of postal networks, but through cuts in service.

• There are numerous opportunities for improvement to delight customers and thereby increase mail volume. Unfortunately, the Postal Service lacks the money to implement these initiatives in its current state.

• Rather than forecast dramatic losses, it would be far better to devote the energy to a dramatic change in direction to achieve long-term success. The Postal Service can be profitable, customers can be delighted, and the employees can be managed well. All it takes is the right leadership, leadership that thinks it can succeed.

• The Postal Service needs a business strategy that works.

Lawrence Buc:

• Efficient worksharing can only occur if Postal prices are set to ensure that the work actually is performed by the party that can perform it at least cost. The way to do this is to have prices that reflect, as closely as possible, the Postal Service’s cost savings that result from worksharing. Economists call this Efficient Component Pricing.

• Even the PES monopoly allows competition “upstream services” such as sorting and transporting mail. Worksharing promotes this competition, which in turn promotes the efficient, affordable provision of postal services.

• Worksharing allows postal services to be performed at the least cost possible, which allows the Postal Service to compete more effectively in all of these markets and thereby increase total mail volume.

• Economist Edward Pearsall, a consultant to the Postal Regulatory Commission (PRC), has published studies showing that the introduction of worksharing discounts induced huge growth in mail volume: worksharing is responsible for almost half of all Postal Service volume.

• Without worksharing discounts, there would be only about half as much mail as there is today.

• Worksharing actually drives jobs for postal workers who have twice as much mail to handle.

• Worksharing is a profit center for the Postal Service.

• Reducing First-Class Mail worksharing discounts would hurt Postal Service finances. Workshared First-Class Mail is more price sensitive than Single-Piece mail. This means that increasing prices for workshared mail by reducing worksharing discounts would drive away more volume than the lower resulting Single-Piece prices would generate.

• Because worksharing results in lowest cost production, it supports universal service by making mail more affordable. It does this by allowing the large fixed costs of the Postal Service to be spread across the far larger volumes that worksharing discounts have induced.

• Estimating product costs is a complex multi-step process relying on both data collection systems and methodology. After forty years of litigation at the PRC, there are still disagreements between the Commission, the Postal Service, and other interested parties on the exact methods that should be used in particular areas and on data collection issues.

• Because costing is a complex topic and it underlies pricing and ratemaking,Congress, correctly, has established an expert body—the PRC—to consider cost coverage, market demands, rate shock, and the effect of rate increases on the mail and the economy. Congress wisely removed itself from costing and from rate making in 1970 when it passed the PRA. And it did so again in PAEA, wisely leaving costing and pricing to the experts.

James O'Brien:

• Time Inc. and other MPA members have made many changes to our magazines and preparation processes over the years to make our mail easier and less expensive for the Postal Service to handle. Despite our best efforts, however, the Postal Service’s reported cost of Periodicals mail has continued to rise.

• Magazines are extremely valuable to the Postal Service and the public, as the Postal Service and Congress have long recognized. More than one Postmaster General has called magazines “the anchor in the mailbox”—i.e., mail that consumers really look forward to receiving and that draws them to their mailboxes every day.

• Congress has repeatedly recognized the value of magazines to educate, elucidate, and inform the citizens of this nation. Periodicals have received special consideration under postal laws since the founding of the nation.

• The importance of Periodicals to the Postal Service extends beyond the hard copy magazines we mail. The Postal Service profits greatly from Periodicals publishers’ use of other classes of mail—especially First-Class Mail and Standard Mail. To generate subscriptions and provide customer service, Periodical publishers send large volumes of subscription promotions, gift subscription offers, acknowledgments of subscriptions, invoices, renewal notices, reminder notices, ancillary and cross-product promotions, and other correspondence with customers.

• Despite our significant investments to improve efficiency and reduce costs for the Postal Service, Periodicals costs – as measured by the Commission – have once again begun to outpace inflation.

• A key problem facing the Postal Service – and a major reason for the continuing increase in Periodicals costs – is excess capacity. This excess capacity has been created by the failure of the Postal Service to reduce its workforce when its workload has declined. The excess capacity problem that we noticed early for Periodicals has worsened and broadened in the past few years with significant declines in mail volume.

• Machines are idled while manual processing occurs in order to absorb the available labor capacity, and classes that had nothing to do with the automation see their costs go up.

• Extensive manual processing survives because the Postal Service has not succeeded in reducing its workforce enough to match reduced processing needs. The costs of excess capacity should not be charged to Periodicals and other similarly situated classes – either directly because of unnecessary manual handling or indirectly because of increased overhead costs.

• The Postal Service’s existing cost systems overstate the costs attributed to Periodicals. Charging periodicals for the extra costs of manual processing that periodical publishers did not request and do not need, is unjust and unreasonable. And it is inconsistent with the policy of the law that postal rates should reflect the costs of honest, economical and efficient operations.

• Existing methods overstate attributable costs by making unrealistic assumptions about the extent to which costs vary with changes in mail volume. For mail processing costs, the Postal Regulatory Commission has assumed for many years that virtually all costs are variable, and therefore should be attributed to individual mail classes. This assumption has led to protracted debate.

• After twelve years, many of the problems we identified are still unaddressed, and many of the questions we asked are still unresolved. The Postal Service and the Postal Regulatory Commission are currently looking at many of the same issues again.

Hamilton Davison:

• Just as the rate-setting process has changed with the Postal Accountability and Enhancement Act of 2006, it is also time to change the cost accounting approach.

• The setting of prices and the allocation of costs is a complex issue properly placed with USPS management with the review and concurrence of its Regulator. We still struggle with a legacy of cost-based rate setting. Old habits die hard.

• Today, technology provides a variety of non-mail communication substitutes. This is particularly important in a high fixed cost system operating well below its available capacity. As more volume leaves the system, the cost on all remaining pieces goes up. Using a non-standard cost justification to push the prices up further just perpetuates the downward spiral.

• One of the most significant keys to the future survival of the Postal Service, centers around the total customer segment contribution to operating the Postal Service. Taking decisions in a single product category can lead to changes in volumes in other categories from that same customer segment and thus affect the total financial standing of the entire system either positively or negatively, depending on how the customer segment is managed.

• A customer-segmented approach allows the USPS to manage the content proportion of the mail stream—the amount of highly valued mail from the recipient’s point of view. With all the communications alternatives today, it is critical to keep Americans engaged and interested in mail. Managing the content in the mail does that.

• We must resist the temptation to have Congress function as a 538-person board of directors for the USPS. We already have a structure for appropriate supervision of the Postal Service. USPS managers should be responsible for running their business. The Board of Governors should provide oversight. The Postal Regulatory Commission should provide checks and balances to a government-sponsored agency with what are effective monopoly powers. Congress should allow this established mechanism to do the heavy lifting unless it is clear the structure is breaking down.