Managing Decline in a Marketing Depression

By Alan M. Robinson

March, 2002

With just about one-third of the Postal Service's fiscal year over, the Postal Service's revenue picture appears stuck in a rut. Revenues continue to fall behind last year's figures and well below plan. While it is easy to blame the current difficulty on terrorism, examination of volume statistics since 1972 indicates that other factors are at work.

For many years, Postal commentators have raised the specter of electronic diversion so often that listeners now react like the townspeople at the end of the story of the boy who cried wolf. Unfortunately, the wolf is now here. The diversion trend is clearest for the Postal Service's retail business.

While electronic diversion may have affected the Postal Service's commercial business, the immediate challenge facing the Postal Service in this market segment is the economic slowdown. The Postal Service's commercial customers began experiencing declines in business in late 2000 that accelerated in the first half of 2001. In response to this decline, printers of all types have streamlined their operations to reflect the lower levels of business. One printer and the largest envelope manufacturer, Mailwell, described the challenge as an "advertising depression."

An examination of the volume trends of the Postal Service's retail and commercial businesses clearly illustrates the secular and cyclical trends.

The Retail business

The Postal Service's retail business provides the collections, sortation and delivery of single piece mail. Most of the revenue in the retail business comes from handling single piece First Class mail but includes Priority, Express, and Parcel mail as well.

Figure 1 illustrates that the retail business primarily serves business customers. Business mailers send two-thirds of the Postal Service's single-piece First Class mail. Thirty-eight percent of this mail is strictly business communications. The Postal Service's other big retail products, Express and Priority mail, also serve primarily business customers.

Source: Response of USPS Witness Tolley to UPS interrogatories UPS/USPS T7-7 through UPS/USPS T7-12 in R2000-1. Numbers rounded to total 100%.

Given the growth in electronic and facsimile communication in business applications, a long-term decline in the retail business would be expected. Figure 2 illustrates that the single-piece First Class peaked in 1991 and began a precipitous decline in 1999. This decline accelerated as e-mail became the primay means of business communications in the waning days of the millenium. The decline came even though electronic diversion of both consumer and business financial transactions is still quite small. This figure also illustrates the trend and indicates that single piece mail could fall below 1972 levels by 2003.

Source: Quarterly RPW reports between 1972 and 2002.

The monthly comparisons of retail revenue to plan illustrate the Postal Service's ability to forecast this decline in its retail business. Figure 3 indicates that the Postal Service's retail revenue forecasts since 1998, the period of steepest decline in single piece volumes. This figure illustrates that the Postal Service has continuously overestimated retail revenue. On average, the Postal Service has overestimated retail revenue by 5.6% in 1998, 0.7% in 1999, 0.6% in 2000, 1.0% in 2001 and 2.0% in 2002. The similarity of the errors in 1998 through 2002 indicates that the Postal Service's forecast models may need a slight adjustment to handle the decline in the retail business. The increase in the error in 2001 and throughout 2002 indicates the impact of the economic challenges and terrorism. At most terrorism could have doubled the forecast error in 2002 and reduced retail revenue by $12 million per accounting period. However, much of the decline in forecast accuracy in 2002 is likely due to the economy.

Source: USPS Accounting Period Reports 1998 through 2002.

Combined these two charts indicate that the retail business is in a secular decline and that the Postal Service has a reasonable handle on the rate of the decline. However, in the future it should adjust its retail revenue forecasts by about $150 million annually below the levels that current models generate in order to reduce the chance that budgets are over-optimistic.

The single-piece First Class volume trend has significant implications on Postal operations. The trend illustrated indicates that originating single piece mail volume could fall 25% below 1994 levels in two years. At that level, the Postal Service's collection, canceling and origination sortation operations will have substantial over-capacity in terms of facility space, machines and manpower.

The Commercial Business

The Postal Service's commercial business includes all mail that is tendered to the Postal Service in bulk. Two-thirds of this business involves the delivery of advertising as direct mail or within periodicals. Therefore, the state of the Postal Service's commercial mail business is closely tied to advertising expenditures in general and the relative competitiveness of the Postal Service as means of advertising delivery.

Figure 4 illustrates the long-term trend for all mail except single piece First Class, which roughly matches volumes of commercial customers. As the figure illustrates, the Postal Service has experienced strong growth in its commercial business over the last three decades. Over this period, the Postal Service has continually offered its commercial customers, and in particular its advertising mailers new mail preparation and drop-shipment programs that have allowed mailers to effectively keep the advertiser's mail distribution costs under control. As such, delivering advertising viah the mail offered a good value proposition as compared to other delivery modes in spite of postage increases.

Source: USPS RPW reports 1972 through 2002

Figure 4 also illustrates two trend lines. The spread between the trend lines illustrates a range of commercial volumes that the Postal Service should expect over the short term.

The Polynomial trend line illustrates a worst-case scenario. This scenario assumes that in addition to the economic slowdown the above inflation rate increases implemented in 2001, agreed to for 2002, and expected in 2003 cause advertisers to seek alternative delivery modes. The more pessimistic scenario appears more plausible for three reasons. First, new worksharing options that could counter postage rate increases are much more limited than at any time in the past. Second, competitive newspaper, radio, television and internet advertising delivery modes are cutting rates and operating costs in an effort to attract whatever advertising that may be available. Third, the worse case scenario tracks the Postal Service's experience in the single-piece mail market.

The linear trend line represents an optimistic scenario. In this scenario, the Postal Service should see volumes return to trend once the current economic slowdown ends. This scenario minimizes the potential impact of above inflation rate increases commercial mailers have experienced.

Source: United States Postal Service Accounting Period Reports 1998 - 2002.

While the Postal Service appeared to have a reasonable handle in the long-term trend in retail revenue. The same is not true for commercial revenue. Figure 5 illustrates the trend in forecast error.

Over this period the Postal Service's forecast became increasingly overly optimistic, suggesting that the commercial business's growth rate was slowing and their projections missed this slow erosion in growth. In 1998, the Postal Service underestimated revenue by 0.2%. Subsequently, the Postal Service overestimated revenue by 1.2% in 1999, 1.6% in 2000, 3.0% in 2001, and 5.6% in 2002. The Postal Service's greatest forecasting difficulties coincided with the beginning of the downturn in commercial volume, which occurred in the second quarter of fiscal year 2001. The downturn in forecasting accuracy also coincided with the rate increases in 2001.

The forecast error chart further illustrates that the impact of terrorism was substantially less than the impact of the slowing economy. Given the similarity in the forecast error trend both before terrorism and three months later, it would appear that the Postal Service might have lost no more than $200 million that could be directly attributed to the economic impact of terrorism.

Conclusion

The Postal Service faces significant challenges as it adjusts to its competitive environment. The trends illustrated above indicates that the Postal Service serves a retail market that is declining rapidly and its commercial market could sour if competing advertising delivery modes offer a better value proposition. The trends further indicate that the Postal Service needs to make a concerted effort to cut costs.

The decline in the retail business creates over-capacity in originating operations. A concerted effort in conjunction with the American Postal Workers and Mailhandlers Unions needs to be made to see if the originating operations can be streamlined in order for the Postal Service to better compete with pre-sorters. Otherwise, the Postal Service needs to plan how it will dispose of this capacity and excess plants, equipment and employees.

In terms of the commercial market, the Postal Service needs to carefully delineate what portion of the volume stagnation is due to the economic slowdown and what portion is due to the rapid rise in commercial postage rates. The Postal Service needs to track how its competitors are cutting costs in order to ensure that the mail value proposition remains strong.

The trends reinforce concerns of the General Accounting Office and others about the future viability of the Postal Service. In particular, the ability of the Postal Service to pay its sizable debt and unfunded liabilities are at risk if the negative trends continue.

This discussion also illustrates what is at stake in the debate about postal reform and postal transformation. The Postal Service is primarily an important means of business communications. The decline in Postal volumes places this business communications mode at risk and if not reversed could have a deleterious affect on the economic recovery. The decline also illustrates that the window available to transform the Postal Service into a competitive enterprise is short. Neither Congress nor the Postal Service can waste any time in their efforts.