Written evidence submitted by the Communication Workers Union (CWU) (USO 18)

SUMMARY

• The universal postal service is highly valued by the British public and widely recognised as essential to a fully functioning economy and society.  Ofcom’s primary statutory duty is to secure the provision of a universal postal service, and this takes priority over its duty to promote competition.  However, Royal Mail’s competitors are currently unrestrained in their ability to cherry pick profitable city locations and this is undermining the economics of the universal service. 

• End to end competition has led to a reduction in Royal Mail letter volumes of approximately 15% in profitable urban areas.   Royal Mail’s profit margins are currently at 3.0% and we believe revenue loss from growing end to end competition[1] poses a material threat to Royal Mail ever hitting the 5-10% margin consistent with financial sustainability of the universal service[2].

• Competition in parcels is growing and competitors including Amazon are concentrating their activities in profitable delivery areas.  This restricts Royal Mail’s ability to rely on parcels growth to offset the financial impact of structural letter volume decline and cherry picking in the letters market. 

• The fixed costs of providing the universal service mean there is a limit to the efficiency improvements Royal Mail can make without compromising quality of service.  Royal Mail must deliver to a growing number of households whilst mail volumes decline, and this puts pressure on the universal service even before accounting for the impact of competition. The combination of rising delivery points and declining volumes also has the effect of reducing Royal Mail’s efficiency even where its underlying performance improves.  It is therefore unrealistic to compare Royal Mail’s efficiency with its competitors who are free to choose what, when and where to deliver.  They can keep costs low by resourcing to a set workload and channeling any surplus or unwanted traffic back to the universal service provider for onward delivery. 

• There is a connection between the good pay and conditions for front-line staff at Royal Mail and the company’s strong record on quality of service.  Ofcom’s focus on efficiency should therefore not be at the expense of decent employee pay and conditions, and we do not believe the regulator should have a right to set efficiency expectations based on employment standards. In particular, the low cost employment model used by many of Royal Mail’s competitors must not be seen as a benchmark for the UK if we are to avoid a race to the bottom on postal pay and service quality.  Rather than creating additional jobs, end to end competitors are replacing decent postal jobs with insecure employment on poverty pay.  The CWU supports payment of the Living Wage as a minimum for postal workers and the leveling up of employment and quality of service standards across the sector.

• The CWU believes Ofcom should introduce an immediate cap on competition at its current level to secure the provision of the universal postal service.   This will help to support a healthy, sustainable level of competition in the postal sector.  It will also benefit the many competitors who depend upon the universal service to maintain flexibility in their own services and pass on responsibility for delivering high cost mail.    

INTRODUCTION

The Communication Workers Union is the largest trade union in the communications sector, representing over 200,000 workers in the postal, telecoms and financial services industries.  We are the recognised union for around 140,000 non managerial staff at Royal Mail.

We welcome the launch of the BIS Select Committee inquiry into postal competition and the universal postal service.   This submission highlights the CWU’s concerns about the threat of unchecked postal competition to the economics and future sustainability of the universal service. 

The CWU believes the regulator should use its powers to intervene at this stage in order to fulfil its primary statutory duty to secure the provision of the universal postal service.   We call on the BIS Select Committee to pursue any action it believes necessary to bring about such an intervention, and to hold Ofcom to account in carrying out its primary duty in relation to postal services. 

The threat of competition to the FINANCIAL SUSTAINABILITY OF THE universal postal service

1.      The Universal Service Obligation (USO) requires Royal Mail to deliver to all 29 million UK addresses at a uniform price, six days a week for letters and five days a week for parcels.  There is strong support across the political spectrum for the maintenance of the universal service and this was reflected in recent debates on this issue in the Scottish Parliament and the Northern Ireland Assembly. The Postal Services Act 2011 makes clear that Ofcom’s primary duty is to secure the provision of a universal postal service and this takes precedence over its duty to promote competition. 

Competition threatens the economics and the financial sustainability of the universal postal service 

2.      The universal postal service depends on Royal Mail being able to use revenues from easier to serve areas to cover the cost of a nationwide network.  Postal competition is undermining the economics of the universal service because Royal Mail’s competitors are free to cherry pick the low cost areas for delivery, thereby reducing the revenues required to fund services in higher cost areas. 

3.      Ofcom states that Royal Mail’s EBIT[3] margins for its reported business[4] should be between 5% and 10% in order to be able to finance the universal postal service on a sustainable basis[5].  Royal Mail’s profit margin was significantly below this at 3.0% in the year to March 2014[6], only slightly improved from 2.6% in the year to March 2013.  Royal Mail therefore has significant progress to make in order to reach the financial sustainability target identified by Ofcom, and growing competition makes this challenging.

Downstream Access competition constitutes a bridgehead to end to end delivery

4.      Royal Mail has a legal obligation to allow access to its network to other mail companies.  This enables Royal Mail’s competitors to collect and sort mail from businesses, and then give it to Royal Mail to deliver the final mile. The proportion of access mail has increased from 25% of total mail volumes in 2008 to 49% in 2013[7].  This situation is different from most EU countries, where access is at the discretion of the universal service provider.  In other EU countries, access mail represents no more than 25% of all mail[8].

5.      Whilst access mail forms a significant proportion of mail volumes, access operators retain only around 2.2% of overall mail revenues[9]. However, as Royal Mail has argued, access volumes constitute a bridgehead to direct delivery[10], meaning that access operators can simply divert access mail into their own end to end delivery networks.  The prevalence of downstream access competition in the UK postal market therefore provides a broad platform from which access providers can swiftly build an end to end business in profitable high density areas.  

End to end competition in the letters market has increased rapidly since 2012

6.      Whistl (formerly TNT Post UK) is the main competitor to Royal Mail in the end to end market for letters.  Whistl launched an end to end delivery trial in West London in 2012 and since then it has expanded rapidly into Central and South West London, Manchester and Liverpool.  Its rollout plans show that it aims to be operating in Birmingham, Edinburgh and Glasgow in 2014.   Whistl plans to cover over 42% of addresses in only 8.5% of the UK’s total area by 2019[11]. 

7.      At the end of November 2013, Ofcom’s annual monitoring update on the postal market reported a 200% increase in letters delivered by alternative operators to Royal Mail compared to the previous year. At the time this represented around 0.2% of addressed letter mail market volumes but by December 2013 this figure had increased to 0.4%.  This is likely to have grown further given Whistl’s 2014 roll out of operations to Camden, Willesden, Colindale and Harrow and its opening of six depots in Liverpool.  

Unrestrained cherry picking in the letters market is undermining the universal service at a local level

8.      Whistl’s national market share figure may be relatively low, but its cherry picking of the more profitable city locations has already seen a 15%[12] reduction in Royal Mail volumes in local areas where it operates.  This figure is supported by feedback from CWU members in delivery offices in areas covered by Whistl, with reports of up to 19% volume decline in some parts of London.  It is in these local, profitable urban areas where the financial sustainability of the universal service is being undermined, and therefore local market shares are critical when considering the impact of competition on the universal postal service.

Whistl can swiftly increase market share by switching its access volumes to direct delivery

9.      Royal Mail’s submission to Ofcom states that Whistl has switched ‘over half’ of its Downstream Access (DSA) volumes into its direct delivery operations. This suggests that, even without expanding its network into new parts of the country, Whistl has the potential to swiftly and significantly increase its end to end market share by switching over even more of its DSA mail to its direct delivery network.

The growth of end to end letters competition will have a significant impact on Royal Mail revenues and profits

10.  End to end competition has a dramatic impact on Royal Mail’s revenues because, unlike access mail, Royal Mail receives no income at all on mail competitors are delivering.  Therefore whilst access mail represents 49% of volumes and only 2.2% of revenues, volume and revenue share of end to end mail are likely to be far more approximate to each other. 

11.  Furthermore, Whistl is only delivering business mail which is easier to handle and valuable to the universal service provider.  Therefore, as Whistl’s end to end delivery network expands, it will remove more of the most profitable mail revenues needed to support the cost of the USO.  Royal Mail recently estimated that Whistl’s growth strategy could result in over a £200m reduction in Royal Mail revenue in 2017/18.

12.  Such a loss would represent in excess of 2.7% of Royal Mail’s £7.4bn turnover (on reported products) for 2013-14.   Given that the universal service imposes relatively fixed costs on Royal Mail, it is difficult to see how such a revenue loss would not impact on profits.   As we have mentioned, Royal Mail’s operating profit on the reported business was 3% last year, which is well below the 5% to 10% profit margin consistent with financial sustainability of the universal service.  We believe current and projected revenue loss from end to end competition poses a material threat to Royal Mail ever hitting this target.

Royal Mail’s commercial response to mitigate the impact of cherry picking has been suspended by Ofcom for up to two years

13.  Ofcom stated in 2013 that Royal Mail’s flexibility in setting zonal access prices would help it to mitigate the impact of cherry picking on the universal service[13].   However, when Royal Mail attempted to change its access prices for this purpose, Ofcom suspended the changes following a complaint from Whistl.  This means the one viable commercial response Royal Mail has to mitigate the impact on the universal service of cherry picking low cost areas for delivery, will potentially be unavailable for up to two years.

Cherry picking by parcel competitors will restrict Royal Mail’s ability to offset declining letter volumes

14.  Parcel volumes are forecast to rise by around 3% per annum from 2013-2018 according to PricewaterhouseCoopers, compared with a 5% decline in letter volumes for the same period[14].  Royal Mail aims to focus on growth in parcels in order to offset the revenue impact of a declining letters business.[15]

15.  Royal Mail delivers around a third of parcels in revenue terms, but it has said that growing its share of parcel revenues will be challenging in the face of intensifying competition[16].    Royal Mail’s first quarter results announced in July 2014 have illustrated this challenge, showing a 1% fall in parcel revenues despite volumes rising by 1%.   This has been partly due to Amazon’s expansion of its own delivery network, as well as Amazon cutting the minimum order required to qualify for free delivery.  

16.  Amazon is currently Royal Mail’s single largest parcel customer, accounting for 6% of the company’s parcel volumes, or around 60m items per year.    However, Amazon has built its own parcel delivery network to the scale of Parcelforce Worldwide in the space of two years and this reduces its reliance on Royal Mail.  Furthermore, it is cherry picking the same profitable urban areas as Whistl and continues to grow.  CWU members in Royal Mail have reported parcel volume declines of up to 20% in areas where Amazon operates its own network.  The expansion of Amazon’s network threatens to curb Royal Mail’s ability to grow its parcels business and offset the impact of declining letter volumes on revenues and profits.

EFFICIENCY OF THE UNIVERSAL SERVICE

17.  Ofcom has stated that it will not intervene on direct delivery if Royal Mail’s inability to deliver an EBIT margin of 5% to 10% on its reported business is due to a failure to improve its efficiency.   However, the probability that Royal Mail will not meet the EBIT margin target is not a result of the company failing to take steps to improve efficiency.  Royal Mail has made significant progress in improving its efficiency in recent years, and the workforce and the CWU have been central to this achievement by embracing large-scale modernisation and transformation.

18.  Nevertheless, the relatively fixed costs of providing the universal service mean there is a limit to the efficiencies Royal Mail can make without damaging the quality of the universal service.   Furthermore, continued structural letters volume decline of 4-6% per annum[17], and a growing address file[18] mean that the provision of the universal service faces a serious challenge even before accounting for the impact of unchecked competition.  Increasing delivery points and declining volumes will also have the effect of reducing Royal Mail’s efficiency even where its underlying performance improves.  

19.  It would therefore be unrealistic to compare Royal Mail’s efficiency with its competitors who are free to choose what, when and where to deliver.  They are not constrained by the burden of fixed costs and can respond to peaks and troughs in mail volumes by resourcing to a set workload and injecting any surplus or high cost mail back into Royal Mail’s network for onward delivery.  This passes volume variability risk and associated costs to Royal Mail[19], putting further pressure on the sustainability of the universal service.

20.  Furthermore, the low cost employment model used by many of Royal Mail’s competitors must not be seen as a benchmark for efficiency if quality of service standards are to be maintained.  Ofcom’s focus on efficiency should not be at the expense of decent employee pay and conditions, and we do not believe the regulator should have a right to set efficiency expectations based on employment standards.

QUALITY OF SERVICE AND EMPLOYMENT STANDARDS

21.  As the universal service provider, Royal Mail must meet a number of quality of service standards, including the requirement for 93% of first class mail to arrive next day.  Royal Mail is committed to achieving these standards and reports high levels of customer satisfaction[20].  This is reflected in Ofcom’s research which has found that the postal service is meeting the reasonable needs of users and that it is highly valued by residential users and businesses across the UK[21].  Royal Mail recognises the need to ensure people feel valued in order for it to succeed[22], and we believe there is a clear connection between the good pay and conditions for front-line staff at Royal Mail and the company’s record on quality of service. 

22.  Conversely, Royal Mail’s end to end competitors in letters and parcels are not held to any quality of service targets or reporting responsibilities. There have been numerous media reports of serious delivery failures by Whistl, including thousands of letters being dumped or delivered late, resulting in missed hospital appointments and lost council tax bills.  The CWU has also received many reports from Royal Mail workers about poor working practices by Whistl and the impact this has on customers and their perception of postal services.  Furthermore, Whistl has focused exclusively on catering to bulk business mailers with no services offered for mail originating from residential customers. 

23.  Our understanding is that Whistl pays its front line staff below the level of a living wage and that it employs workers on zero hours contracts.  This low cost employment model contributes to poorer quality of service, including by creating a higher turnover of staff and less opportunity for training and development. 

24.  In the parcels sector, several carriers including Hermes and Yodel use low-cost lifestyle couriers who are treated as self employed and are therefore not entitled to the National Minimum Wage.   They are routinely paid a rate per successfully delivered item which often makes it impossible to earn a reasonable rate of pay.  In one company, rates are as little as £0.20-£1.20 per successful delivery, equating to only £3.70-£5.30 per hour. 

25.  The prevalence of low paid, insecure work at many of Royal Mail’s competitors threatens to lead to a race to the bottom on pay, conditions and service quality in the postal sector.   Rather than creating additional postal jobs, end to end competitors are replacing decent postal jobs with insecure employment on poverty pay.   The CWU supports an increase in pay throughout the postal sector to the level of the Living Wage, which we believe will help to raise quality of service standards across the sector. 

THE NEED FOR REGULATORY ACTION

26.  End to end letters competition has had the freedom to develop unchecked to a level that threatens the financial sustainability of the universal service.  In addition, Ofcom’s suspension of Royal Mail’s access price changes has curbed Royal Mail’s ability to mitigate the impact of cherry picking on the universal service.  These factors represent a double disadvantage for the universal service in favour of competition, and regulatory action is now required to secure the universal service for the future.

27.  The most effective way to address the threat of end to end competition is for Ofcom to set a limit for competition that would be consistent with the universal service being financially sustainable. Given (1) that Royal Mail’s EBIT margin is below the 5-10% level Ofcom identified as being consistent with financial sustainability, (2) the extent of volume loss that is being projected over the coming years, (3) the market share Whistl has been able to achieve locally and (4) the fixed costs that Royal Mail faces from the USO, we believe that the limit for competition has been reached.

28.  Therefore we believe Ofcom should act now to introduce a cap on competition at its current level in order to secure the provision of the universal service.  This will help to support a healthy, sustainable level of competition in the postal sector.  It will also benefit the many competitors who depend upon the universal service to maintain flexibility in their own services and pass on responsibility for delivering high cost mail.    

29.  Further, Ofcom should bring forward a full and urgent review of the direct delivery market to establish the longer term remedies needed to secure the future of the universal service.

30.  Finally, Ofcom should review regulation in relation to mail integrity and common operational procedures to ensure that all competitors face the same industry standards in the interests of protecting consumers against the loss and mis-delivery of mail.  Ofcom should also require all postal operators to report on quality of service targets to help raise standards across the postal sector.

Billy Hayes

General Secretary

Communication Workers Union

24 October 2014