RMP 07

Written evidence submitted by Royal Mail Group

1.                Introduction

1.1    Royal Mail is pleased to respond to the Select Committee for Business, Innovation and Skills on its short inquiry into the Government’s intention to conduct a sale of shares in Royal Mail. The Government’s intention is to dispose of a majority stake, taking into account shares sold and those transferred to employees as part of the employee share scheme. The Government will retain flexibility around the size of stake to be sold, as this will be influenced by market conditions at the time of the transaction, investor demand and the objective to ensure that overall value for money for the taxpayer is achieved. Royal Mail welcomes the Government’s decision. The company needs to be flexible, responsive, and have future access to capital.

1.2    Royal Mail is also pleased that the Government has decided to allocate 10% of the shares in the company to all eligible employees free of charge. Employees of the Group will have a real stake in the company and a significant voice in its future. This is the largest free stake of any major UK privatisation. More employees will be able to participate in the Royal Mail Free Share scheme than in any other UK privatisation for almost 30 years.

1.3    Royal Mail is the sole provider of the Universal Postal Service in the UK, serving more than 29 million addresses, 6 days a week. Our Universal Service obligations are outlined in the Postal Services Act 2011. They are set out in detail in the Universal Service Order. This statutory document is set and regulated by the communications regulator Ofcom.

1.4    As the Universal Service provider, Royal Mail has a legal obligation to provide a uniform-priced Universal Service across the UK, including remote and rural areas. We maintain a substantial network across the UK – a network with the ability to deliver to every household and collect from every collection point, six days a week.  Any change to this obligation would require an affirmative vote in both Houses of Parliament.

1.5    Post Office Ltd has been formally separated from Royal Mail Group since April 2012. We continue as sister companies with substantial shared interests. Post Office is an important retail outlet for Royal Mail services under a long term commercial distribution agreement. The mutual commercial success of both companies is best served by Royal Mail and Post Office working closely together for the benefit of customers. A successful, commercially viable Royal Mail can generate more business for the Post Office and help secure its nationwide network of branches.

2. Rationale underpinning privatisation

2.1         In December 2008, Richard Hooper published an independent report into the UK postal services sector. His report outlined steps to make the Universal Service sustainable. Hooper made four key policy recommendations:

• Modernisation should be accelerated. Hooper said that “the company urgently needs commercial confidence, capital and corporate experience to modernise quickly and effectively.”
• Industrial relations needed to be improved: “The CWU must accept the scale of transformation required and show that it can tackle the behaviour and internal processes which at present result in confrontation and obstruction…Royal Mail must develop a more constructive working relationship in which both are engaged in the long-term strategic future of the company.”
• The Government should tackle the historic pension deficit, “amongst the largest of any UK company.”
• The regulatory framework needed to be reformed, and that “a new regulatory regime is needed to place postal regulation within the broader context of the communications market.”

2.2         Hooper made clear that his “recommendations are a package…Each element of the package is needed if the universal service is to be sustained.” Hooper updated his review in the summer of 2010. His update argued that “private sector capital would inject private sector disciplines into the company and would reduce the risk of political intervention in commercial decisions, thus accelerating modernisation.” Hooper also considered alternative not-for-profit and not-for-dividend models, but concluded that these would not be “appropriate or workable.”

2.3         The Government facilitated the implementation of Hooper’s recommendations through the Postal Services Act 2011. This allowed the transfer of the Group’s pension liabilities for pre-April 2012 service and certain pension assets relating to the Royal Mail Pension Plan, to Government. The Government also appointed Ofcom as the new postal services regulator. Ofcom has since reformed the regulatory framework for postal services in the UK. The Government aims to complete the implementation of Hooper’s package of reforms through a sale of shares in Royal Mail in this financial year. The Secretary of State for Business, Innovation and Skills has said that “now the time has come for Government to step back from Royal Mail and allow its management to focus wholeheartedly on growing the business and planning for the future.”

2.4         Privatisation will give Royal Mail flexible access to private capital. This will be a positive step for Royal Mail and the Universal Service. Royal Mail wants to combine the best of the public and private sectors. For Royal Mail to innovate and remain competitive in the marketplace, it needs to continue its transformation. Deutsche Post has invested more than £20bn in its business since it was floated in 2001 whilst delivering one of the highest quality universal services in Europe. In comparison, since Royal Mail began its modernisation programme in 2006/7, it has invested c.£2.8bn on modernisation. Royal Mail needs to increase revenue from the growing parcels market. This is a competitive market and investment in new technology will be crucial. Having flexible access to capital would help to deliver our long term strategy, leading to a sustainable Universal Service.

3. Customers

The Universal Service

3.1         Royal Mail is the designated provider of the universal postal service, committed to providing the high quality Universal Service that the Government and regulator have set down. We are honoured to provide the universal service. Royal Mail Group’s strategic vision is to be recognised as the best delivery company in the UK. We believe that the nationwide network we maintain in order to deliver the Universal Service puts us in a strong position to compete and meet emerging customer demand. The ability to visit every address in the UK, six days a week provides commercial advantages to Royal Mail.

3.2         The Postal Services Act 2011 protects the high-quality Universal Service enjoyed by customers across the UK. Its protections would continue to apply following any sale of shares in Royal Mail. The protections include a uniform service to rural areas, to which Royal Mail must continue to deliver the same high-quality service or risk large fines.  It also protects specific services, such as the Articles for the Blind scheme, which provides free postal services to blind or partially sighted people.

3.3         The Postal Services Act 2011 sets down the minimum requirements of the universal postal service in law. These minimum requirements include the collection of letters every Monday to Saturday and a delivery service at affordable prices in accordance with a uniform tariff throughout the UK.  The requirements are set out in Section 31 of the Postal Services Act 2011.  Any change to these minimum requirements would require the approval of both houses of the UK Parliament. The requirements are:

3.4         First and Second Class stamped and franked mail, and Royal Mail First and Second Class parcels to 20kg, are part of the Universal Service.  That means they have to be offered on a universal (“one-price-goes-anywhere”) tariff at affordable prices.  Ofcom have recently concluded that these services meet the needs of the vast majority of postal users and there is no case for changing the terms of the Universal Service (Ofcom Review of postal users’ needs, 27 March 2013).

Prices

3.5         In 2012, Ofcom said that Royal Mail’s financial position meant there was “a risk to the financial sustainability of the Universal Service”. Ofcom recognised the need for Royal Mail “to materially increase prices in order to support the sustainability of the universal service.” Royal Mail increased stamp prices in April 2012 to help to address the threat to the sustainability of the Universal Service. Royal Mail also reconfigured its parcels tariffs in 2013.

3.6         Stamp prices, whether set under public or private ownership, are subject to significant competitive pressures. Customers have many alternatives to the post. Ofcom have reported that more than 37 billion text messages were sent in 2012. More than half of adults own a smart phone, and 49% regularly use smart phones to access the internet [Ofcom Communication Markets Report, August 2013]. Households and businesses increasingly use e-mail to communicate in preference to post. These are just a few examples of the proliferation of alternatives to the post, which naturally mean that Royal Mail must be cautious in its pricing and customer strategies.

3.7         UK stamp prices are among the best value in the EU. In five of the six weight steps for First Class and Second Class mail, the cost of UK stamps are ranked in the bottom half of prices when compared with other EU countries. In some cases, the UK is the cheapest.

3.8         Ofcom is legally obliged to ensure an affordable postal service and can reintroduce regulation on any Universal Service product. Ofcom concluded in March 2013 that Royal Mail’s services were affordable to consumers and small and medium sized businesses. Ofcom said (in their report on the affordability of postal services, published 19 March 2013):

“The evidence we have collected indicates that universal postal services are affordable for both residential consumers (including low income and other vulnerable consumers) and businesses (including small and medium businesses) at current prices. We have reviewed the price changes that are due to take effect from 2 April 2013 (as announced by Royal Mail in March 2013), and consider that universal postal services will continue to be affordable following these changes.”

3.9         In 2013 there was no increase in the price of first class or second class stamps for letters. Ofcom has also set safeguard price caps on Second Class stamped mail in 2012, which also covers Second Class parcels up to 2kg. The cap calculation is set for seven years (from April 2012).

Quality of service

3.10     Royal Mail is regulated by Ofcom.  The regulator sets a minimum delivery standard for the whole of the UK.  Currently the target for First Class mail is 93% delivery the next working day.  For Second Class mail the target is 98.5% delivery within three working days. Royal Mail has amongst the highest service specifications of any major EU member state. These include:

3.11     Royal Mail’s Quality of Service report for 2012/13 reveals that the vast majority of mail was delivered in line with its targets. Royal Mail narrowly missed the 93.0 per cent First Class mail target with 92.4 per cent of this mail delivered the next working day, when taking into account disruption from external events.

3.12     In a very competitive market, Quality of Service is one of the key drivers of success. That would not change if Royal Mail were privatised. The Quality of Service regime that applies to Royal Mail under public ownership will continue to apply under private ownership - Ofcom has specified the minimum standards under the Universal Service Order. We are the only postal operator in the UK who has to meet these high standards and regularly publish performance results.

3.13     Evidence from elsewhere in Europe shows that postal operators maintain or improve their quality of service following privatisation. Both Deutsche Post and Austria Post deliver more than 95% of letters the day after posting.

4. Colleagues

4.1         Over the past decade, the postal services sector has changed dramatically. A decline in mail volumes has coincided with the liberalisation of the market and the emergence of competition. In recent years, we have seen a significant increase in the number of parcels being sent. All of this has meant a difficult process of change for our people. Many of Royal Mail’s employees have seen changes to their working practices as the company has adapted its operations to the changed mix of mail. More than 50,000 people have left the business since March 2003. Change will continue and the company will employ fewer people in the future, whoever owns it. The company remains committed to the overarching objective of achieving this without compulsory redundancies.

4.2         Royal Mail Group’s vision is to be recognised as the most successful delivery company in the UK. Our strategy is underpinned by three priorities: capitalising on growth in online retailing to grow our parcels businesses; continuing to manage structural decline in the letters market by maximising the value of mail; and by being customer-focused. We believe we can drive sustainable, profitable growth that will enable us to obtain ongoing access to external capital and secure a sustainable future for our Company. The company will need to be smaller and more efficient in the future regardless of ownership. Delivering this strategy will require significant change. We will consult on any changes with the CWU, Unite, and our people.

Employee terms and conditions

4.3         All terms and conditions and collective agreements that apply to employees would remain in place were there to be a change in ownership of the company, on the same basis that they apply to employees now. Royal Mail will continue to have a predominantly full time workforce, supported by part time workers, with a national split of around 75% full time workers to 25% part time.

4.4         These job security, and other, commitments are part of current agreements with the Communication Workers Union. If and when any changes are proposed, Royal Mail will, as now, and where appropriate, discuss these with the unions with a view to reaching agreement.

4.5         We have proposed a three year agreement with the CWU, protecting terms and conditions and committing to significant pay rises for employees in the core business. The agreement would include a pay increase of 8.6% over the three year period. This is highly competitive, and is believed to be one of the best pay deals on offer from any major UK company at this time.

4.6         Royal Mail is also seeking to create a legally binding and enforceable contract with the CWU. The proposed contract would mean pay and protections for employees could not be changed for the three-year period of the contract without CWU agreement. Royal Mail believes that this has not been done before for any major UK privatisation.

4.7         In addition, as part of the proposed agreement, Royal Mail is committed to provide and enhance existing services to customers using the current workforce and there will be no change to the current structure of the company in relation to these services.  No additional outsourcing of services is expected during the period of the agreement.

Employee shares

4.8         The Government has said that it intends to give 10% of the shares in Royal Mail to eligible employees free of charge at the time of the Initial Public Offering. This will be the biggest free share offer of any major privatisation for almost 30 years.

Employee share offers in previous privatisations

4.9         Royal Mail welcomes the Government’s decision on free share allocation. Eligible employees will automatically have a meaningful stake in the company and the potential to benefit from its future success. Academic studies have shown that most UK employees who engaged with their employee share ownership plan were more motivated and committed to their employer, and many felt that participating in an ESO gave them a greater sense of personal ownership for their job or a greater sense of personal ownership for the company. (Loughborough University four-year study into the human impact of HMRC-approved all-employee share plans, 2012).

4.10     Shares will be allocated to all eligible staff equally, regardless of grade or pay levels. The allocation will be pro-rated based on an employee’s paid hours to differentiate between full and part time workers.

4.11     Employees will be able to see the value of their shares any time that the stock market is open. They will also be able to vote in key decisions on how the company is run. The company will use this opportunity to engage with employees even more, as well as actively communicating the benefits of free shares. We will conduct major internal communications programmes around the company’s results and commercial strategy.

4.12     The overwhelming majority of Royal Mail Group employees in the UK, including employees working in Parcelforce Worldwide, will be eligible for free shares if they meet certain criteria. Employees of GLS and other subsidiaries and joint ventures are not eligible to receive free shares. The free employee shares will be of the same class as those available for wider sale. Employees will therefore obtain voting rights and will be eligible to receive dividends like other shareholders.

4.13     Royal Mail employees who are eligible for an automatic free share allocation under the employee share scheme will also have the option to buy additional shares through the Employee Priority Offer. Eligible employees will be given priority when those shares are allocated.

4.14     The free shares to be offered on a flotation are not related to section 31 of the Growth and Infrastructure Act 2013. The free shares are to be awarded under the long-standing, HMRC approved share plan known as a Share Incentive Plan. Further details have yet to be announced but, under HMRC rules, employees cannot be asked to pay anything or give anything up, including employment rights, to receive free shares. Royal Mail will write to all employees nearer the time of the issue. Employees will be given the option to opt-out of the employee share offer if they do not wish to participate for any reason.

Working with our unions

4.15     Working together with our colleagues and unions is the best way to be successful. We work together with both the CWU and Unite on a range of issues, including reform of the regulatory regime, new ways of working, our Agenda for Growth, workplace safety, and the issue of dangerous dogs. Whilst we do not agree on everything, we value the input our unions give us and the work that they conduct throughout the business. We will continue to work closely with our union colleagues during the on-going transformation of the company.

4.16     Royal Mail is currently negotiating a legally binding agreement on pay, terms and conditions for employees. The CWU have said that they will ballot for industrial action should progress not be made by September 2013.

4.17     Even the suggestion of industrial action is not in the best interests of the company, its customers, or its employees. Royal Mail’s revenue is increasingly generated by parcels – 48% of total revenue in 2012-13. This is a very competitive sector. Our customers have many choices and can easily switch their business to competitors. Any disruption to our service is not helpful.

Pensions

4.18     Royal Mail’s main pension plan – the Royal Mail Pension Plan (RMPP) – was closed to new members in March 2008. At the same time, members’ benefits ceased to build up on a final salary basis and switched to Career Salary Defined Benefit. Despite these changes, the Plan remained one of the largest defined benefit schemes in the UK (based on membership and assets). The company made significant pension deficit cash contributions on top of its ongoing pension costs. It recognised a deficit on its balance sheet which ranged from £2.7bn to £7.5bn. This meant Royal Mail faced issues with respect to Going Concern, it was balance sheet insolvent and it carried material pension risk and volatility.

4.19     The European Commission granted State Aid approval on 21 March 2012, allowing the transfer of almost all of the pension liabilities and assets of RMPP built up until 31 March 2012 to be transferred to Government. The transfer left RMPP fully funded on an actuarial basis at the time of the transfer, and immediately removed the requirement for the company to make further deficit cash contributions.

4.20     Defined benefit pensions are becoming increasingly costly for all the remaining employers who offer such a scheme because of conditions in the financial markets, including very low gilt yields. The proportion of companies that closed their defined benefit schemes to existing employees climbed to 31 per cent in 2012. This is an increase of more than a third from 23 per cent in 2011 (Source: NAPF).

4.21     Following the transfer of the majority of the assets and liabilities in the RMPP to the Royal Mail Statutory Pensions Scheme, the Government now stands behind the benefits Royal Mail Pension Plan members built up until 31 March 2012. The Government is legally responsible for the pension members of the Plan built up until that date. However, the predicted cost of the Plan going forward has been affected by falling gilt yields, as outlined above.

4.22     Royal Mail has a proposal to keep the Royal Mail Pension Plan open for existing members, subject to certain conditions, at least until the end of the Company’s next periodic review in March 2018. The consultation on the proposal closed on 25 August 2013. The company is now considering / reviewing member feedback and continuing discussions with its unions.

4.23     The proposal would use some of the c.£2 billion of assets left in the Plan at the time of the transfer to Government last year to keep the Plan open until at least the conclusion of the next periodic review in 2018, and subject to conditions. Compared to many other defined benefit pension schemes, the Company is in a strong position. Many employers have announced they are closing their schemes. We have a proposal to keep the Plan open. Plan members will not have to pay more, and retirement age and accrual rates will not change.

4.24     Members’ pension benefits are important. Royal Mail knows how much members value the benefits provided. Royal Mail already puts approximately £400 million in cash into the Plan every year and will keep doing so. We believe this is the largest ongoing contribution of any UK company. An agreement on our pension proposal would, subject to its conditions, be legally binding on the Company. The agreement would be binding on new owners of the Company. This has been confirmed by Government. It would be reconfirmed by Government at the time of privatisation.

5. Communities

Post Offices

5.1         The Post Office is the nationwide network of branches offering a range of Government and financial services, as well as the sale of Royal Mail’s services on its behalf. It plays a key role in many local communities. Royal Mail and Post Office Ltd have signed a long term agreement, which provides the framework around which the two businesses work since they became sister companies in April 2012.

5.2         The long-term commercial agreement ensures that Royal Mail services will continue to be available through all post offices in the future. In January 2012, then Postal Services Minister Edward Davey said:

“Concerns people had about the Post Office becoming independent from Royal Mail were always misplaced as that separation is part of our cure, but the ten year deal struck between Royal Mail and the Post Office will give subpostmasters and others greater confidence.”

5.3         In Post Office Ltd’s Network Report 2013, it said that there has been “greater stability over recent years than has been the case for the previous quarter of a century.”

5.4         It is in both Royal Mail and Post Office Ltd’s interest to ensure a strong, comprehensive post office network. Combined with Government funding of the Post Office and allowing Royal Mail to access external capital, separation will safeguard the future of both companies and the commercial relationship between them. Separation has also given Post Office management greater freedom to focus on its customers and growing its revenue base.

5.5         Continued transformation of Royal Mail would result in more business – particularly from the growing parcels market - going through post offices, and a stronger post office network. At the same time, the Post Office Network Transformation programme will result in longer opening hours at post offices, and greater flexibility for postal services users. This will allow Royal Mail’s customers greater access to parcels services and benefit both companies.

5.6         Royal Mail, working with the Post Office, will later this year launch the UK’s largest ‘click and collect’ network to support online shopping growth by providing greater choice of convenient parcel delivery options for online retailers and their customers. Post Office has the largest retail network in the UK, making branches the ideal locations to provide convenient, secure parcel collection facilities. 99 per cent of the population lives within three miles of a Post Office branch. Around 10,500 Post Offices will be taking part in the initiative which will enable online retailers to offer shoppers the opportunity to order items for collection at their local post office branch.

Heritage

5.7         Royal Mail is proud of its heritage. It is one of the best known and trusted brands in the country. There would be no incentive to rebrand or change its iconic visual symbols like post boxes. To do so would require very significant expenditure and would risk alienating our customers.

5.8         The Sovereign will continue to approve all stamp issues. The Secretary of State has the power to ensure her image, and the image of subsequent Monarchs, appears on stamps. This process is safeguarded in the Postal Services Act 2011 (Section 62 – “UK postage stamps bearing an image of Her Majesty” and Section 10, Interpretation Act 1978 – “References to the Sovereign”).

5.9         Royal Mail established the British Postal Museum and Archive in 2004 to manage the public records of The Royal Mail Archive. Stamps form part of the public record and could only be sold with the agreement of the National Archive and other Government bodies. The long-term funding agreements signed between Royal Mail and the BPMA will continue beyond privatisation. Royal Mail has also gifted Calthorpe House, the site of the BPMA’s new storage and exhibition centre, to the museum.

6. Conclusion

6.1         The Government’s recent reforms have put Royal Mail back in a position to compete and grow. The transfer of the to the Government of the Group’s pension liabilities for pre-1 April 2012 service and certain assets relating to the Royal Mail Pension Plan, and reform of the regulatory framework, alongside an acceleration in the company’s transformation programme, have returned Royal Mail to profit.

6.2         The challenge is now to maintain this positive momentum. Privatisation will allow the company to innovate, invest, improve our services, win new business, deliver the high quality Universal Service, and continue to be a very substantial employer in the UK.