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Net costs of elements of the universal service A REPORT PREPARED FOR POSTCOMM

May 2008

© Frontier Economics Ltd, London.

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Frontier Economics | May 2008 | For research purposes only

Net costs of elements of the universal service Executive summary.......................................................................................1 TU

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List of abbreviations.................................................................................... 13 TU

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1 TU

Introduction ....................................................................................... 15

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Overview of the approach .................................................................. 17

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2.1 TU

Methodology.............................................................................................. 17

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2.2

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Identification of scenarios for comparison ........................................... 18

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2.3

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Period of analysis ...................................................................................... 19

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2.4

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Model architecture .................................................................................... 20

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2.5

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Summary .................................................................................................... 23

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Key inputs to the analysis...................................................................25

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3.1 TU

Estimation of base case............................................................................ 25

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3.2

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Estimation of the volume effect ............................................................. 28

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3.3

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Pipeline cost changes................................................................................ 34

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3.4

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Restructuring costs ................................................................................... 40

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3.5

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Efficiency ................................................................................................... 41

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3.6

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Pricing rule ................................................................................................. 42

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3.7

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Key risks and uncertainties ...................................................................... 42

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Results ................................................................................................45

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4.1 TU

Net cost of first class quality of service ................................................. 46

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4.2

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Net cost of Saturday collections and deliveries .................................... 51

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4.3

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New universal service two day mail product ........................................ 55

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4.4

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Collection and delivery times .................................................................. 63

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4.5

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4.6 TU

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Removing bulk mail from the universal service ................................... 66

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Evening packet delivery service .............................................................. 67 TU

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Summary, implications and next steps ..............................................69 TU

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Annexe 1: The methodological basis of the NAC approach ......................73 TU

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Annexe 2: Estimating demand effects ........................................................79 TU

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Annexe 3: The cost module of the universal service model ..................... 123 TU

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Annexe 4: Estimating quality of service changes ..................................... 153 TU

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Contents

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Net costs of elements of the universal service Figure 1: Key building blocks of analysis .................................................................. 20 TU

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Figure 2: Overview of model architecture ................................................................. 21 TU

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Figure 3: Net cost savings from reducing first class quality of service.................. 46 TU

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Figure 4: Quality of Service by region (delivered mail) for first class Stamp/Meter mail ......................................................................................................................... 48 TU

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Figure 5: Net cost savings from removing Saturday deliveries and collections ... 51 TU

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Figure 6: Target delivery days for mail posted by day of the week ........................ 52 TU

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Figure 7: Net cost savings from introducing a single two day product, before fundamental restructuring of mail centres and delivery offices – 2006-07.. 55 TU

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Figure 8: Target delivery days for mail posted by day of the week ........................ 56 TU

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Figure 9: Net cost savings from changing delivery times ........................................ 63 TU

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Figure 10: Net cost savings from changing collection times .................................. 64 TU

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Figure 11: USO cost methodologies .......................................................................... 74 TU

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Figure 12: Acceptability of a single two day service ................................................. 89 TU

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Figure 13: Acceptability of five deliveries per week ................................................. 90 TU

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Figure 14: Redistribution of cost savings to products by broad pipeline component .......................................................................................................... 110 TU

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Figure 15: Current service specification – six deliveries and collections ............ 130 TU

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Figure 16: Current service specification – six deliveries and collections ............ 130 TU

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Figure 17: No Saturday deliveries or collections .................................................... 131 TU

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Figure 18: No Saturday deliveries or collections .................................................... 131 TU

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Figure 19: Single two day product – six days .......................................................... 132 TU

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Figure 20: Single two day product – six days .......................................................... 132 TU

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Figure 21: Single two day product – no Saturday service ...................................... 133 TU

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Figure 22: Single two day product – no Saturday service ...................................... 133 TU

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Tables & figures

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Table 1: Alternative universal service scenarios ...........................................................2 TU

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Table 2: Annual cost and revenue changes and the NAC under different scenarios, relative to Royal Mail’s actual revenues and costs in 2006-07 ........3 TU

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Table 3: Implications of different scenarios, relative to Royal Mail’s actual revenues and costs in 2006-07...............................................................................4 TU

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Table 4: Annual NAC under different demand scenarios, relative to Royal Mail’s actual revenues and costs in 2006-07 ...................................................................5 TU

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Table 5: Quality of Service with and without air services ..........................................9 TU

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Table 6: Annual cost and revenue changes and the NAC under alternative universal service specifications, relative to Royal Mail’s actual revenues and costs in 2006-07. ................................................................................................... 11 TU

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Table 7: Comparisons analysed ................................................................................... 18 TU

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Table 8: Royal Mail volumes under the three market scenarios ............................. 26 TU

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Table 9: Estimated demand and switching effects for universal service modifications ........................................................................................................ 32 TU

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Table 10: Projected delivery profiles by day of the week ........................................ 37 TU

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Table 11: Mail volumes handled by mail centres ...................................................... 40 TU

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Table 12: Rules of thumb for transition costs .......................................................... 41 TU

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Table 13: Key risks and uncertainties ......................................................................... 43 TU

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Table 14: Quality of service with and without air services, based on 2006-07 data ................................................................................................................................. 47 TU

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Table 15: First round change in volumes and revenues with a reduction in first class quality of service to 85%............................................................................ 48 TU

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Table 16: Special Delivery with no air network for first class mail ........................ 50 TU

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Table 17: Potential redundancy costs when removing Saturday collections and deliveries ................................................................................................................ 54 TU

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Table 18: Change in revenues with a single two day product ................................. 57 TU

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Table 19: Summary of net savings with a two day mail product – without major restructuring of the mail centre and delivery office network......................... 59 TU

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Table 20: Potential redundancy costs based on projected typical redundancy payments and employee numbers in 2009-10 (using access scenario) ......... 62 TU

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Table 21: Outdoor delivery costs and bulk mail revenues ...................................... 66 TU

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Table 22: Cost of an evening packet delivery service .............................................. 67 TU

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Table 23: Impact on Royal Mail of changes in the universal service specification ................................................................................................................................. 69 TU

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Tables & figures

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Table 24: Potential efficiency savings with a cost base of £6.5bn ......................... 71 TU

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Table 25: Stated ‘preference impact’ for universal service modifications ............. 85 TU

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Table 26: Stated preference index and estimated demand effect for universal service modifications ........................................................................................... 86 TU

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Table 27: Estimated demand and switching effects for universal service modifications ........................................................................................................ 93 TU

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Table 28: Special Delivery volumes and revenues, 2006-07 ................................... 94 TU

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Table 29: First round volume changes, 2006-07....................................................... 96 TU

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Table 30: First round revenue changes, 2006-07 ...................................................... 97 TU

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Table 31: First round effects for 12 universal service modifications, 2006-07 .... 98 TU

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Table 32: First round effects for 12 universal service modifications, 2006-07, under alternative multiples of parameters ...................................................... 100 TU

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Table 33: First round effects under alternative Special Delivery switching assumptions, 2006-07 ........................................................................................ 101 TU

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Table 34: Baseline volumes and revenues under three market scenarios ........... 102 TU

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Table 35: First round volume changes, 2009-10 ‘access’ scenario ....................... 103 TU

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Table 36: First round revenue changes, 2009-10 ‘access’ scenario ...................... 104 TU

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Table 37: First round volume changes, 2009-10 ‘end to end entry’ scenario ..... 105 TU

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Table 38: First round revenue changes, 2009-10 ‘end to end entry’ scenario .... 106 TU

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Table 39: First round effects for the single two day service scenario under alternative switching assumptions, 2006-07 ................................................... 108 TU

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Table 40: Estimated price changes, 2006-07 ........................................................... 113 TU

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Table 41: Second round volume changes, 2006-07 ................................................ 114 TU

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Table 42: Second round revenue changes, 2006-07 ............................................... 114 TU

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Table 43: Estimated price changes for 12 universal service modifications, 2006-07 ............................................................................................................................... 116 TU

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Table 44: Second round volume changes for 12 universal service modifications, 2006-07 ................................................................................................................ 117 TU

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Table 45: Second round effects for Special Delivery, 2006-07............................. 118 TU

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Table 46: Estimated price changes, 2009-10 ‘access’ scenario.............................. 119 TU

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Table 47: Second round volume changes, 2009-10 ‘access’ scenario .................. 119 TU

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Table 48: Estimated price changes, 2009-10 ‘end to end entry’ scenario ........... 120 TU

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Table 49: Second round volume changes, 2009-10 ‘end to end entry’ scenario 120 TU

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Tables & figures

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Table 50: Summary of net savings with no Saturday collections or deliveries ... 136 TU

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Table 51: Summary of net savings with a two day mail product – without major restructuring of the mail centre and delivery office network....................... 140 TU

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Table 52: Summary of net savings with a two day mail product – without major restructuring of the mail centre and delivery office network....................... 142 TU

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Table 53: Additional costs with one hour later collection time ............................ 146 TU

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Table 54: Additional costs with one hour earlier delivery times .......................... 148 TU

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Table 55: Additional costs with one hour later collection time and one hour earlier delivery time ............................................................................................ 149 TU

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Table 56: Costs of an evening packet delivery service, based on volumes of 19m items per year. ..................................................................................................... 152 TU

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Table 57: Achieved first class quality of service in 2006-07.................................. 155 TU

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Table 58: Quality of service multiple regression parameters ................................ 159 TU

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Table 59: Achieved first class Quality of Service in 2006-07 ................................ 160 TU

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Table 60: Achieved first class Quality of Service in 2006-07 ................................ 161 TU

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Table 61: Quality of service with a two day network – stamped/meter mail .... 163 TU

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Table 62: Quality of service with a two day network – PPI ................................. 163 TU

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Tables & figures

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Executive summary The universal service shapes Royal Mail’s service offering by establishing minimum levels of provision across a number of mail products and service features. Postcomm has asked Frontier to consider: “What impact do particular elements of the current universal service have on Royal Mail’s costs and revenues?” It is not the intention of this report to give a view on the future scope of the universal service, but it is intended that this report can become an important source of information which Postcomm and other stakeholders may draw upon to inform at least three broad policy areas of interest. | Constraints: some elements of the universal service are broadly aligned with

Royal Mail’s commercial incentives and in some cases (such as the number of collections per day) Royal Mail exceeds the minimum service provision required. Other elements may impose greater constraints and costs on Royal Mail, requiring it to offer services and products it would have limited commercial incentives to provide, and it is relevant to understand the significance of these constraints on Royal Mail. | Prices: if the universal service affects Royal Mail’s cost base and the demand

for mail, it will affect prices. Changes in the universal service may therefore contribute to changes in relative prices or the overall price level. | Scope: our work identifies areas where the universal service imposes net

costs on Royal Mail. An understanding of these net costs can contribute to an assessment of whether the shape of the universal service continues to be consistent with customers’ needs, although we take no view on the appropriate scope of the universal service in this report. It is worth noting at the outset that a study such as this does not necessarily begin from the presumption that the universal service needs to be changed. Postcomm has a statutory duty to ensure the provision of a universal service and Royal Mail is the operator currently obliged to provide the service. An evaluation of the net costs of particular elements of the universal service is useful to understand the extent to which the obligation is an onerous one on Royal Mail. It is also relevant to set this work on net costs alongside other work undertaken by Postcomm on customers’ needs for different elements of the postal service.

MAIN RESULTS Our analysis uses a net avoided cost (NAC) methodology to evaluate the materiality of the obligations imposed on Royal Mail. In implementing this approach we recognise that: • the aim of this project is to assess the impact on Royal Mail of particular elements of the universal service and not to estimate the total cost of the universal service;

Executive summary

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• Royal Mail operates an integrated operational pipeline and demand for mail products is linked and so the analysis needs to take account of all Royal Mail’s costs and revenues, not just those products that are legally part of the universal service; and • the focus of this project is on Royal Mail’s costs and revenues, rather than those of a hypothetical efficient operator. With Postcomm, we identified six universal service elements to consider in detail, shown in Table 1. In each case, we assessed potential changes in mail demand, Royal Mail’s costs and market entry. The results show how Royal Mail’s net costs could change under alternative service specifications and what further impact this might have on prices, revenues and market shares. Universal service element

Today

Compared to

First Class quality of service (QoS)

93%

85%, 90%

Collection and Delivery times

Delivery by 14:00 (urban), 15:00 (rural)

Up to two hours earlier or later

Six days

No collections or deliveries on Saturday

First class (D+1)

Single mail class

Second class (D+3)

Target: 94% delivered two days after posting (D+2)

Mailsort 1400 1 & 2

Remove from universal service

Collections and deliveries per week Class of mail

Bulk mail

Cleanmail 1 & 2 Evening packet delivery service

No requirement

universal service requirement for one delivery a week

Table 1: Alternative universal service scenarios Source: Postcomm, Frontier Economics

The largest net costs (both positive and negative) are associated with: • the cost of providing Saturday collections and deliveries; • the cost of providing the current 93% first class quality of service; and • a universal service two day mail product in place of the current two classes. Table 2 shows the annual cost savings and revenue loss relative to Royal Mail’s actual costs and revenues in 2006-07 under our baseline set of assumptions for these three universal service scenarios. We discuss each of these scenarios in more detail later in this Executive Summary. In short, however, it is clear that the largest net cost arises from the requirement for Saturday deliveries and collections. If the requirement were removed, Royal Mail could be expected to X

X

Executive summary

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save over £320m of costs, but only suffer a revenue reduction of around £55m. In contrast, there would be a significant revenue reduction associated with a switch to a two day mail product. Without a radical re-structuring of Royal Mail’s operations it is unlikely that Royal Mail would be able to reduce its costs in line with the reduction in revenues, and as a consequence Royal Mail could be expected to be between £44m and £278m worse off under such a move. We discuss below the major changes in Royal Mail’s pipeline operations that might yield the scale of cost savings that would be required to make Royal Mail no worse off under these arrangements. Analysis

Cost of Saturday collections and deliveries Cost of current 1st class QoS

Cost change

Revenue change

NAC

Annual

Annual

First round

-£326m

-£55m

£271m

-£116m

-£40m

£76m

-£355m

-£633m

-£278m

-£589m

-£633m

-£44m

85% stamp/meter; 78% PPI instead of 93%

Single two day mail product 94% QoS

Single two day mail product with no Saturday collections or deliveries

Table 2: Annual cost and revenue changes and the NAC under different scenarios, relative to Royal Mail’s actual revenues and costs in 2006-07 Excludes impact on Special Delivery – see discussion below Cost reductions in the single two day product scenarios are before re-optimisation of the mail centre network Source: Frontier Economics, PLCWW

It is worth noting that we have focused on providing an estimate of the costs and revenues associated with each scenario, and we have not assessed the detailed transition path that would be required since this lies outside of the scope of this work. We do, however, show the likely scale of potential redundancy and pension costs associated with each scenario in Table 3, along with a range of other implications of these estimates. X

X

| The capitalised NAC shows the net present value of the NAC (assuming it

persists at the same level) illustrated on the basis of an 8% cost of capital (used for Royal Mail’s last price control). | The redundancy costs show the estimated maximum redundancy costs

(including pension adjustments) based on average redundancy payments provided by Royal Mail, making no allowance for savings from staff turnover. | The price changes are indicative and show overall average changes and the

change for a basic weight stamp price that would result if the NAC were passed through to customers (keeping Royal Mail’s profits at the same level).

Executive summary

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| The “Efficiency target” shows the efficiency savings that Royal Mail would

have to achieve in each year of a four year price control in order to reduce costs by the same amount as the NAC (before any increase in revenues that could result from lower prices). For comparison, Royal Mail’s target for efficiency savings in the current price control is 3% per year. 1 TPF

Analysis

Cost of Saturday collections and deliveries

Capitalised NAC

Estimated Redundancy costs

Price impact

Stamp price

Efficiency target

@ 8%

(Maximum)

(overall)

1C stamp 2C stamp

p.a. for four year price control

-1.7p

1.0%

£3,389m

Cost of current 1st class QoS

£946m

£300m

Small

-4.8%

-1.4%

Change from 93% to 85% stamp/meter; 78% (PPI)

Single two day mail product

FPT

-1.0p

-0.0p

0.3%

-1.0p

-£3,470m

£235m

6.3%

+2.9p (2C)

-£549m

£508m

1.7%

+1.8p (2C)

N/A

94% QoS

Single two day mail product, no Saturday collections or deliveries

N/A

Table 3: Implications of different scenarios, relative to Royal Mail’s actual revenues and costs in 2006-07 Source: Frontier Economics/PLCWW

KEY UNCERTAINTIES This project examines the impact on Royal Mail’s operations, costs and revenues of elements of the universal service. As a consequence, it relies on making an assessment of how the behaviour of Royal Mail, its competitors and its customers will change in different scenarios. Since this cannot be known precisely, there is a range of uncertainty around the estimates. In some cases our view is that this range is small, in others it is larger. We have identified where the range is particularly significant and highlighted further work that Postcomm may wish to undertake to give itself greater confidence in the estimates.

1 TP

PT

“Royal Mail’s Price and Service Quality Review 2006-10, Licence Modifications Proposals March 2006” available at http://www.psc.gov.uk/postcomm/live/policy-and-consultations/consultations/ price -control/Licence_modifications_proposals.pdf. HT

Executive summary

TH

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Impact on customer demand Most of the changes that have been analysed have not been observed in the UK before and there is no direct historic evidence to suggest how mailers would react. Our estimates of demand responses therefore combine available information from econometric data, market research and discussions with mailers but remain best guesses derived from limited information. In general, the greatest uncertainty concerns switching between mail products, including the size of any shift from first class to second class mail with lower first class quality of service and the extent to which Special Delivery volumes might increase if the first class service were changed. Table 4 shows the NAC associated with alternative estimates of demand responses based on a higher degree of sensitivity to service specification (see Annexe 2 for more details). It shows that the higher demand response would erode a large part of the net cost saving associated with reducing 1st class QoS, and would further worsen Royal Mail’s financial position if a two day mail product were introduced. By contrast, even a larger demand response leaves significant net costs associated with Saturday deliveries. X

X

P

Estimated NAC with:

P

Central Estimate

High Estimate

No Saturday deliveries

£271m

£227m

Reduced 1st class QoS

£76m

£35m

-£278m

-£351m

P

P

Single two day mail product

Table 4: Annual NAC under different demand scenarios, relative to Royal Mail’s actual revenues and costs in 2006-07 Excludes impact on provision on Special Delivery – see discussion below Source: Frontier Economics

Other uncertainties | Baseline costs and volumes: Royal Mail operates in a changing market and

is in the midst of a transformation plan. Its cost base is therefore changing over time. As well as our base case results calibrated to reflect Royal Mail’s actual costs, volumes and revenues in 2006-07, we show indicative results for 2009-10 under alternative assumptions for market entry and baseline costs. Further changes in baseline costs will affect our NAC estimates although the magnitude and relative sizes of savings are unlikely to significantly alter in the absence of major market changes. | Cost changes: Our estimates of the counterfactual cost levels that could arise under different scenarios are based on a model of postal operations developed with PLCWW, a consultancy of mail operations specialists. PLCWW has estimated the cost base by taking a view on how Royal Mail’s operations could change. Quite clearly, a number of possibilities exist to reconfigure operations and whilst PLCWW has examined the most obvious candidates we do not rule out the possibility that other options exist that could be applied in practice. It is not the intention of this work to prescribe a particular strategic response to any change.

Executive summary

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| Special Delivery: The figures presented in Table 4 exclude the impact on X

X

Special Delivery provision. Although there is no legal requirement for Special Delivery to be a next day product (it fulfils the registered and insured functions of the European Directive) Royal Mail could choose to keep a next day service if first class QoS targets were reduced or a single two day mail product was introduced. If it were to do so, it would need to incur extra costs that may not be fully offset by revenue increases, meaning that the NAC estimates would be even lower than those shown in Table 4. Given that we do not wish to second-guess the Royal Mail’s commercial decisions and we have limited evidence with which to assess switching between first class and Special Delivery, we have presented the impact on Special Delivery separately throughout this report. However, in all cases we have presented the additional costs required to maintain a national next day delivery service. X

X

| Prices: We have presented indicative price changes that would be possible if

the changes were implemented. These are based on transparent rules that allocate cost and revenue changes back to product groups in line with the source of cost savings. However, in reality, Royal Mail’s pricing decisions will depend on more complex judgements. In particular, pricing decisions will use a more sophisticated assessment of product costing than it was appropriate to develop as part of this project. As a result, the estimated price changes provide an indication of the level of price changes and which products might be affected, but further work would be required to explore the full impact on volumes, revenues and market shares.

CONCLUSIONS Of all the scenarios we have considered, only the universal service requirement for Saturday collections and deliveries imposes a significant constraint on Royal Mail. Maintaining first class quality of service at its current level also imposes a constraint, but if the constraint were relaxed, it is likely that Royal Mail would continue to incur many of the same costs but these would instead be driven by the requirements of the Special Delivery product. Introducing a two day service would be likely to result in increased competition and provide an opportunity and incentive for Royal Mail to reduce costs significantly by optimising its mail centre and delivery office network. If it failed to do so it is likely that there would be a significant negative impact on the profitability of Royal Mail.

Executive summary

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AN ALTERNATIVE APPROACH This raises the question of whether the cost savings obtained by removing services or products from the universal service could be achieved through different channels. In this sense, it is useful to compare the potential savings with efficiency factors that are applied at price control reviews. Given a base level of costs of £6.5bn (actual costs in 2006-07 were £6.64bn) a 2% efficiency target a year for a four year price control would reduce overall costs by £505m a year after 4 years (keeping everything else equal). This is more than the cost reduction assumed in the single two day product scenario in the absence of significant structural changes. A 2% efficiency target is less than Royal Mail’s efficiency target in the current price control of 3% a year. We recommend that at the price control review, Postcomm may wish not only to consider generic productivity increases that could be applied, but also to interrogate particular aspects of Royal Mail’s pipeline. We understand that at the last review, the efficiency analysis took the number of mail centres and delivery offices as given and then evaluated the efficiency of those facilities. In our view, it would be worthwhile for Postcomm to also investigate whether the configuration of the network of delivery offices and mail centres is as efficient as it could be, and what time period would be required to move towards a more efficient network. As part of this exercise, it would also be relevant to explore whether Royal Mail is able to improve the flexibility of its working arrangements so that the universal service is provided efficiently.

SUMMARY In summary, this study is largely supportive of earlier work that suggests that the constraints imposed by the universal service are modest. In other words, Royal Mail is not significantly disadvantaged by the formal obligation placed upon it to provide the services we have analysed in this report and in some cases would choose to provide these as a matter of commercial interest. Although we have not considered the other main constraint – the universal geographic delivery coverage – our analysis and model could be extended to that dimension as well. That analysis would be relevant to inform Postcomm on the efficiency with which that particular element of the universal service is being undertaken. It would also be relevant to establish the extent to which significant end to end entry, which has not been observed to date, could leave Royal Mail with obligations it may be unable to internally finance.

Executive summary

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HEADLINES FROM THE ANALYSIS OF THE SCENARIOS

Cost of Saturday collections and deliveries The universal service requirement for deliveries and collections on Saturday creates the largest net cost and consequently adds most to current prices. Annual cost savings if the requirement were removed are likely to be around £326m, with a net avoided cost after allowing for volume reductions of £271m. If this net cost reduction was passed on to customers in the form of lower prices it would be likely to result in a decrease of 1p – 2p on basic stamp prices, around 4.8% overall. Moreover, if the historic relationship between price changes and volumes holds, lower prices could sustain higher volumes than under the current service specification. This result depends on relatively low revenue reductions: our base case assumes a £55m or 1% of revenues. 2 We believe this is plausible as: TPF

FPT

• Postcomm’s market research has found that only 1% of businesses identify Saturday as the most important delivery day and 48% claim it is the least important day; 3 TPF

FPT

• Mailsort 3, used by many direct mailers, is not delivered on Saturdays by many Delivery Offices; 4 and TPF

FPT

• mail has become better targeted and more integrated with wider marketing campaigns making weekend deliveries less essential and in some cases unattractive (for example, call centres, and so customer responses, are more expensive at weekends). This means that removing the universal service requirement for Saturday services has a potential capitalised benefit of around £3.4bn (before taking into account the second round volume increase) while redundancy costs are unlikely to be more than £300m. Without a universal service requirement, Royal Mail could therefore potentially profitably stop Saturday deliveries although its incentives to do so would depend on how the cost saving is treated within the price control.

Cost of current first class quality of service The most readily identifiable cost savings from lower first class quality of service (QoS) come from removing all or part of the air network for overnight mail. This would add a geographic dimension to quality of service.

If the volume effects were more significant, we estimate that the NAC could fall by another £44m to £227m.

2 TP

PT

Postcomm “2007 Business Customer Survey”, Quadrant/BMG.

3 TP

4 TP

PT

PT

For example, only 40 out of 418 Delivery Offices in Royal Mail’s East region always deliver Mailsort 3 on Saturdays and 249 Delivery Offices never do. Royal Mail information: “3.13 area Sat delivery M3 analysis.xls”.

Executive summary

9


Most mail would not be affected by this change and regional first class mail would still receive a next day service. However, long distance mail would take two days to arrive. Overall, Table 5 shows that removing the air service would reduce Stamp/Meter QoS by 7.6% and PPI QoS by 14.2%. The larger fall for PPI reflects its more national mailing profile with more long distance mail. However, the variation is not uniform. Relatively central areas, such as Birmingham or Bristol would see only small falls in quality of service. In contrast, Scotland and Northern Ireland would see a significant deterioration in service levels, particularly for PPI 5 . For example, almost two-thirds of stamp/meter mail delivered in Northern Ireland is local and would be received one day after posting, but most PPI mail is sent from Britain and only one quarter would be received within a day of posting. X

X

TPF

FPT

Actual 2006-07

No air services

Change

Stamp/Meter

94.0%

86.4%

-7.6%

PPI

93.0%

78.8%

-14.2%

Table 5: Quality of Service with and without air services The current quality of service target for first class mail is 93% Source: Frontier Economics/PLCWW

Removing the air network altogether would save around £116m although revenue losses (mainly a switch from first to second class mail) means the NAC would be around £76m. However, there is a risk that larger volume changes from first to second class could erode many of the savings. Further, the savings in this option depend on the treatment of Special Delivery, which is excluded from the NAC calculations above. Without a national next day Special Delivery service, Royal Mail would be exposed to further revenue losses. Maintaining the service would add back costs of £25m to cover 98% of mail flows or potentially as much as £60m to cover all mail flows as several marginal flight connections are required. Ultimately, changes to first class quality of service are likely to be more important in terms of changing the allocation of costs between first class and Special Delivery, and consequently relative prices, than in significantly altering Royal Mail’s financial position.

Introducing a two day universal service mail product At present Royal Mail has to provide two universal service mail classes for single piece mail with a significant price premium associated with first class next day delivery. If a single two day universal service product were introduced, it could provide Royal Mail with a significant opportunity to radically reform its mail centre, transport and delivery office network, with serious competitive disadvantages if it failed to do so.

5 TP

PT

PPI is Printed Postage Impressions and allows businesses to pre-print envelopes and pay for postage on account, rather than using stamps or franking machines.

Executive summary

10 Frontier Economics | May 2008 | For research purposes only

At present, first class mail is relatively uncontested by entrants who are unable to match Royal Mail’s national next day network at a competitive price. Removing the requirement for a first class product in the universal service would allow entrants to compete more vigorously for all mail. This could lead to considerably higher levels of market entry. The revenue loss in this scenario is therefore likely to exceed £600m, based upon the loss of the first class premium, falls in overall mail volumes and increased competition. In order to achieve cost reductions in line with these revenue reductions, a radical reform of the mail centre and transport network would be required. This would require large changes in operations at mail centres and delivery offices, and almost certainly reductions in the number of mail centres. The transformed operations would be facilitated by smoother workflows, longer time windows for mail processing and increased competitive pressure. These combined changes could secure the savings needed to offset the initial revenue loss. Without radical reform of the mail centre, transport and delivery office network, we estimate the maximum cost savings would only amount to around £355m, which would lead to serious financial and competitive disadvantage to Royal Mail. If Royal Mail proved unable to strip out further costs through radical restructuring over the required transition period, it would face a vicious circle of high prices leading to lost mail volumes and market share; revenues needing to be recovered from a small volume base; and further price rises. In addition, removing the universal service requirement for Saturday deliveries in this scenario would allow additional savings of £230m. The additional savings, in conjunction with the cost savings achievable under more radical reform options, should allow the two day product to be priced below current second class levels. This analysis suggests that Royal Mail would be likely to maintain a next day service even without a formal universal service requirement, especially if it feared that the required cost savings were unachievable. The main determinant would be the allocation of costs between a (universal service) two day product and a (non-universal service) next day product, given substantial economies of scope between the two. Special Delivery would also have a material impact on this scenario. Maintaining a full national next day Special Delivery service would be likely to add back costs of up £80m. The net impact depends on volume changes which are hard to predict with available information. With no change in volumes, this would erode part of the cost savings from introducing a new two day service, but a 25% volume increase in Special Delivery, which we consider is possible under such a big scenario change, would largely offset the increase in costs.

Other options considered The other options considered have a much smaller impact. Table 6 shows the NAC associated with changes to delivery and collection times. There is a range of uncertainty associated with these estimates as local factors will affect the degree to which extra time can be absorbed in mail centres or in local collections and deliveries. However, the overall conclusion is that changes to collection and delivery times offer very limited scope for price cuts while earlier deliveries or later collections would add to costs more than they would increase revenues. X

Executive summary

X


Cost change

Revenue change

NAC

Annual

Annual

First round

Delivery – two hours later

-£43m

-£27m

£16m

Delivery – two hours earlier

£141m

£27m

-£114m

Collection – one hour later

£71m

£3m

-£67m

Collection – two hours earlier

-£49m

-£36m

£12m

Analysis

Table 6: Annual cost and revenue changes and the NAC under alternative universal service specifications, relative to Royal Mail’s actual revenues and costs in 2006-07. Excludes Special Delivery Source: Frontier Economics, PLCWW

Finally, we assessed the cost and revenue implications of taking bulk mail out of the universal service (but keeping the constraints of a price control and a uniform geographic tariff requirement); and introducing an evening packet delivery service. | Royal Mail provides many bulk mail products today without a formal

universal service requirement, and has commercial incentives to continue providing the remaining bulk mail products on the same basis. The key question we considered was whether Royal Mail would continue to provide a service in all areas. Our analysis suggests that services would continue – as long as there remains a universal service obligation to deliver item mail. If item mail deliveries continue, the incremental costs of delivering bulk mail are less than the revenues that Royal Mail receives from bulk mail. | A universal service requirement for an evening packet delivery service once a

week would cost around £1 per item. Volumes would depend on take up but, based on the existing level of undelivered items, could be around 20 million items a year, with a total cost of around £20m. There is, however, no reason why Royal Mail could not introduce this service now if there was sufficient customer demand for it.

Executive summary


List of abbreviations 1C

First Class

2C

Second Class

3C

Third Class

BPM

Royal Mail’s Business Planning Model

CPMM

Frontier’s Competitive Postal Market Model

D2D

Door to Door

DMA

Direct Marketing Association

DO

Delivery Office

E2E

End to End

EP

Entry Pricing

FTE

Full Time Equivalent

ILTM

Royal Mail’s Inland Letter Traffic Model

LAT

Latest Acceptance Time

MC

Mail Centre

MUA

Mail Users’ Association

NAC

Net Avoided Cost

PLCWW

Postal and Logistics Consulting Worldwide

PO

Post Office

PPI

Printed Postage Impressions

QoS

Quality of Service

RDC

Regional Distribution Centre

RM

Royal Mail

SAWN

Saturday and weekend network

SD

Special Delivery

List of abbreviations


SME

Small and Medium Enterprises

SPM

Royal Mail’s Strategic Planning Model.

USO

universal service Obligation

USP

universal service Provider

Note on posting day terminology The day on which an item is posted is referred to as Day A. The following day is referred to as Day B, or D+1. The next day is referred to as Day C, or D+2.

List of abbreviations


1 Introduction In October 2007 Postcomm retained Frontier to undertake an analysis of the impact of elements of the universal service on Royal Mail. Specifically, the question Postcomm asked us to consider is: “What impact do particular elements of the current universal service have on Royal Mail’s costs and revenues?” In developing our assessment, we have sought to draw upon as much existing operational, statistical and anecdotal material as possible, and we have benefited greatly from meetings with the Direct Mail Association (DMA), the Mail Users’ Association (MUA) and Postwatch. In addition, Royal Mail met us on several occasions and provided helpful comments on the background methodological papers that shaped the assumptions and analysis used to derive our results. Royal Mail has also provided a significant amount of information in response to formal information requests from Postcomm. We are grateful to these stakeholders for their input into this report. However, Frontier and PLCWW retain full responsibility for the content and conclusions and the approach, assumptions and results have not been endorsed by any of the stakeholders. In particular, the possible operational changes and redundancy figures presented in this report are Frontier and PLCWW’s assessment of what may be possible under alternative service specifications and are not Royal Mail’s projections. In undertaking our analysis, we have been guided by the terms of reference provided to us by Postcomm, of which the following are particularly relevant to identify at the outset. First, it is not the intention of this report to give a view on the scope of the universal service in future, but it is intended that this report can become an important source of information on which Postcomm and other stakeholders may draw in the future debate on the universal service. Second, this exercise is not intended to calculate the “cost of the universal service”. Instead, it is intended to estimate the cost and revenue impact on Royal Mail of particular aspects of the universal service. Third, as a consequence, this work relies on making an assessment of how the behaviour of Royal Mail, its competitors and customers would change under different scenarios. Since this cannot be known with certainty in advance, there exists a range of uncertainty around the estimates. In some circumstances our view is that this range is small, in others it is larger. We have identified where the range is particularly significant and highlighted further work Postcomm may wish to undertake to gain greater confidence in the estimates. Fourth, this exercise is not an efficiency review. Our model is calibrated to the Royal Mail cost base, not that of a hypothetical efficient operator. Nevertheless, in the course of our analysis we have identified areas of the pipeline that would benefit from further scrutiny at the next price control review. We have also run a specific scenario in which we identify the potential for major changes to Royal Mail’s mail centre network relating to the introduction of a new two day universal service mail product for single piece mail.

Introduction


Fifth, a study such as this does not necessarily begin from the presumption that the universal service needs to be changed. Postcomm has a statutory duty to ensure the provision of a universal service and Royal Mail is the operator currently obliged to provide the service. An evaluation of the net costs of particular elements of the universal service is useful to understand the extent to which the obligation is an onerous one on Royal Mail. It is also relevant to set this work on net costs alongside other work undertaken by Postcomm on customers’ needs for different elements of the postal service. In developing our answer to Postcomm’s core question, we have developed a detailed model of mail costs and revenues, which enables us to flex key aspects of the universal service specification to evaluate the net impact on Royal Mail. In order to render this exercise as accessible as possible, we have chosen to structure this report as follows. | In section 2 we provide an overview of our approach that addresses the X

X

fundamental issues of methodology, universal service scenario definition, period of analysis under consideration and model architecture. | In section 3 we provide a qualitative description of our approach to X

X

determining the key inputs to the analysis and the degree of uncertainty associated with each of these inputs. | In section 4 we present the results of our analysis. X

X

| Finally, in section 5 we provide a summary of our findings, their implications X

X

and next steps that Postcomm may wish to take. In addition, four Annexes provide further details on elements: • Annexe 1 situates our work in the context of the academic literature; • Annexe 2 provides more information about the way we have estimated volume effects and presents additional scenario analysis; • Annexe 3 describes elements of the cost modelling in more detail; and • Annexe 4 describes the way we have estimated quality of service changes.

Introduction


2 Overview of the approach In this section we provide an overview of our approach that addresses the overarching issues of methodology, universal service scenario definition, period of analysis under consideration and model architecture.

2.1

METHODOLOGY

The fundamental question we have been asked to consider by Postcomm is: “What impact do particular elements of the current universal service have on Royal Mail’s costs and revenues?” Answering this question requires an understanding of the net cost impact on Royal Mail of changing the specification of the universal service by, for example, changing the frequency of deliveries, changing the quality of service standards, or moving to a single class of mail. Consequently, the appropriate methodology is the Net Avoided Cost (NAC) approach which seeks to estimate the following: • revenues foregone by modification of the universal service; • costs avoided by modification of the universal service; and • (ideally) the change in the value of indirect benefits that result from the modification of the universal service. The NAC is the sum of the costs avoided, minus the revenues foregone, plus any change in the value of indirect benefits. It therefore measures the impact on the operator’s profits of changes to the specification of the universal service. The other candidate methodology – the Entry Pricing or EP model – measures the cost of liberalisation to the incumbent, by estimating the loss in contribution that would arise from entrants taking away profitable business. This is not the same as the cost to the business of the universal service, although it could be relevant in other settings, for example by assessing whether the business can finance its functions in a competitive environment. However, it is not relevant to the key question that Postcomm has asked us to answer. Our analysis therefore follows the NAC approach. However, whilst the NAC approach is the right one in principle, the way in which the NAC approach has typically been applied in the past to universal service costing questions is not particularly helpful in answering Postcomm’s questions. The essence of this traditional approach is to use an accounting measure of costs on a product, route or alternative basis to evaluate those products or routes that are unprofitable, given the prevailing prices. 6 This TPF

TP

6 PT

FPT

For example, past exercises to estimate the cost of the universal service to Royal Mail have used Royal Mail long run marginal cost estimates (LRMC) at various levels of disaggregation including product, routes or Sales Product Handling Characteristic Combinations (SPHCC) - around 1,000 combinations of product, class format etc.

Overview of the approach


generic approach, whilst widely used, is limited for the purposes of answering Postcomm’s fundamental question. The reason is that the approach simply provides a particular estimate of the cost of the universal service under certain assumptions – and in particular the current service specification – and not an estimate of how the cost is driven by particular elements of the universal service. Consequently, it is necessary to develop a different modelling approach to answer Postcomm’s questions. This approach works backwards from the key questions that are being asked and requires us to evaluate and cost the postal network with different universal service commitments and different levels of demand for the universal service Provider’s mail products. Methodologically therefore, it has much in common with counterfactual modelling that is often used to estimate the marginal cost of serving new demand or the incremental cost of providing an entire service. The methodology is discussed in more detail in Annexe 1.

2.2

IDENTIFICATION OF SCENARIOS FOR COMPARISON

The identification of the universal service scenarios to compare is a crucial element of the model-building process, since the specifications represent the counterfactual states of the world for which the model must be capable of costing and estimating demand. Postcomm has identified the comparisons to be evaluated in Table 7 below. X

X

universal service element

Today

Compared to

First Class quality of service

93%

85%, 90%

Collection and Delivery times

Delivery by 14:00 (urban), 15:00 (rural)

Up to two hours earlier or later

Six days

No collections or deliveries on Saturday

First class (D+1)

Single mail class

Second class (D+3)

Target: 94% delivered two days after posting (D+2)

Mailsort 1400 1 & 2

Remove from universal service

Collections and deliveries per week Class of mail

Bulk mail

Cleanmail 1 & 2 Evening packet delivery service

No requirement

Table 7: Comparisons analysed Source: Postcomm, Frontier Economics


universal service requirement for one delivery per week


The legal position of these service elements varies. Collection and delivery times are not formally regulated by Postcomm but form part of Royal Mail’s custom and practice. The other elements (with the exception of a potential evening packet delivery service) are all regulated either as part of Royal Mail’s licence or as part of the Postal Services Act. These comparisons were identified as representing potentially the most likely elements that, if changed, would impact on Royal Mail’s costs and revenues. The list was narrowed down from an original longer list including the following options. | Second class quality of service: the current second class quality of service

target is for 98.5% of mail to be delivered three days after posting. In 200607, over 94% of stamped/meter mail was delivered within two days. Given this achieved level, we considered it unlikely that material savings could be made with acceptable reductions in quality of service. | Collections and deliveries per week: stopping collections and deliveries on

days other than Saturday may not be legally possible (the European Postal Directive requires collections and deliveries every working day); is more complex operationally (stopping Saturday collections and deliveries allows much of the service to shut down for the weekend); and appeared less attractive to customers. We therefore restricted our attention to Saturdays. | Other classes: keeping first class but not second class would lead to a

marked increase in costs with very little apparent customer benefit and was not considered further. Conversely, Royal Mail’s achieved second class quality of service suggested that a single two day service would not be significantly more expensive than a single three day service. We therefore examined a two day service rather than a second class (three day service) equivalent. | Heavy packets: Royal Mail’s licence requires it to carry packets up to 20kg

while the European Postal Directive only requires packets of less than 10kg to be carried. Revenues associated with heavier packets were estimated to be only £800,000 in 2006-07; 7 this amount was considered de minimis and we did not explore the cost implications further. TPF

2.3

FPT

PERIOD OF ANALYSIS

We undertake this analysis under three base scenarios. The first is the actual position of Royal Mail in 2006-07, and consequently the results relate to the costs that would have been saved or additionally incurred had the universal service been different in that year. However, since Royal Mail operates in a changing market, we have also considered whether our results are sensitive to the particular level of costs or market conditions faced by Royal Mail in 2006-07. As a result, we establish

TP

7 PT

Source: Royal Mail.



another base year, 2009-10, incorporating expected changes in Royal Mail’s operations and market conditions, including market entry. Our analysis aims to recognise these changes, including planned investment and continued market entry. This base year is associated with two market scenarios: one where entry is primarily through access, and one where there is a more significant element of entrant end to end entry. The purpose of these three cases is therefore to establish whether differences in the commercial, operating and market environment faced by Royal Mail lead to significantly different estimates of the net cost avoided by modifying the universal service. The development of the 2009-10 scenarios does not represent a forecast of the environment that will prevail in 2009-10 but rather two quite different market environments for the purpose of evaluating how these different environments affect the estimated NAC. We discuss the derivation of the base scenarios in more detail in section 3.1. X

X

It is also worth noting that our analysis does not attempt to model the transition path from one set of universal service requirements to another. Our analysis is focused on comparing one “steady state” with another. We do, however, provide an indication of the restructuring costs associated with re-optimising pipeline operations in the light of a modification (described in more detail in section 3.4), but do not provide an opinion on the length of time over which that re-optimisation will take place. X

2.4

X

MODEL ARCHITECTURE

At the highest level we seek to understand two questions. | What would Royal Mail do if it were relieved of some of its universal service

constraints? | What would customers do if the dimensions of the service offering were

altered? There are therefore three fundamental drivers of the answer to these questions, which are set out in Figure 1. X

X

COST MODEL

DEMAND

MARKET SHARE

Which operational activities would change? If volumes change, what happens to costs?

How will overall volumes vary with a new service specification? What will happen to product mix – across USO and non-USO products?

Will volumes move to more or less contestable products? Will Royal Mail become more or less attractive relative to other operators?

Likely scale of restructuring costs? Potential to unlock efficiency savings?

Figure 1: Key building blocks of analysis

In order to assess the effect of alternative scenarios, we have chosen to bring these three fundamental drivers together within a model architecture that is depicted in Figure 2. It explicitly takes into account the interaction of volumes, revenues and costs to derive the first round net avoided cost (NAC). It then X

X



reallocates this NAC (benefit or cost) back to prices via a simple pricing rule and the model is re-run to capture the second round effects on changes in the level of entry in response to new prices, further changes to the pipeline costs and processes and possible changes in the value of brand and other intangibles.

Figure 2: Overview of model architecture

The model is designed to estimate two sets of costs, revenues and volumes: • the costs, revenues and volumes that Royal Mail would carry under the existing universal service specification; and • the costs, revenues and volumes that Royal Mail would be expected to carry if the service specification changed. The first set of costs, revenues and volumes are those for the relevant base year – either 2006-07 actual data, or projected levels for 2009-10.



In order to establish the second set, we need to estimate changes to the base position under a different set of universal service constraints. The change in service will affect the level and mix of mail volumes, the cost of handling mail and possibly Royal Mail’s pricing decisions. Ultimately, our model has to estimate volumes, revenues and costs that are consistent with each other and with Royal Mail’s commercial incentives. However, it is not possible to model all the elements simultaneously. Instead, the model uses an iterative process to find a new consistent set of volumes, revenues and costs as follows.

2.4.1 First round – before price changes The first round assesses changes in volumes and costs before considering any possible price changes. Given unchanged prices, the change in volumes also implies a change in revenues. | Volumes. Starting with the baseline volumes, we estimate how all non-price

factors affect demand. This means estimating the market shares, level and mix of volumes consistent with a different service specification. For instance, a fall in first class QoS is likely to lead to a drop in first class mail volumes, a shift from first class to second class mail, and a reduction in Royal Mail’s market share. We discuss the volume inputs to the model in section 3.2. X

X

| Costs. The next stage is to estimate costs. Costs may change in two ways.

First, the changed universal service specification allows mail to be handled in a different way leading to a new set of costs. Second, the change in volumes will have a direct impact on the overall cost level as more or less activity will be required. For example, a reduction in first class QoS allows greater use of road transport instead of air transport with an associated step change in costs (first type of cost change) but also reduces mail volumes and hence delivery costs somewhat (second type of cost change). These two types of cost change are reflected in the model structure. To assess the step change in costs associated with different scenarios, we have developed an operational model of several major parts of Royal Mail’s pipeline. This enables us to evaluate the impact on costs of new universal service requirements. This is described in more detail in section 3.3. For the second type of cost change we have made use of an existing Royal Mail model, the Business Planning Model (BPM) which embodies a set of cost elasticities relating costs to volumes. We discuss the application of the BPM in section 3.1. X

X

X

X

| First round NAC: the model contains costs and revenues with and without

the new service specification. The NAC is the difference between: • revenues minus costs in the base case; and • revenues minus costs under the revised service specification. This NAC indicates the total savings (or incremental costs) that would, in the first instance, accrue to Royal Mail following a change in the specification of universal services. There is then a further consideration as to how much of those savings or costs would still accrue to Royal Mail taking into account changes in prices. This leads us to examine a series of second round effects.



2.4.2 Second round – after price changes | Prices and revenues: for any given NAC derived from the first round, it is

relevant to consider the impact on prices. In general, Royal Mail’s choice of prices will be a complicated process that takes into account competitive pressures and cost changes and it is not our intention to second-guess the commercial decisions of Royal Mail. However, we can use some simple pricing rules to give indicative price changes. We assume that the full NAC is passed through to customers in the form of lower prices (mimicking a price control that allows Royal Mail a constant level of profits) and assume that costs and revenues are recovered from groups of products according to the broad pipeline component in which costs were incurred. The pricing rule we have adopted is described in more detail in section 3.6. X

X

| Further iterations on volumes and costs: the new prices will have a

demand impact of their own as customers respond via a price elasticity effect. In turn, the new demand levels will affect costs (only via a volume effect in this case). In the second round, the interest lies not in the estimated NAC (which is roughly zero) but in the new set of volumes, prices, revenues and market shares following the revised prices. These can be interpreted as the level that could occur following a change in the universal service if the price control allowed Royal Mail to earn broadly the same level of profits as now. The model also indicates whether the specification change is likely to trigger a series of changes in revenues, prices and costs or whether the market is likely to adapt relatively easily to a new equilibrium.

2.5

SUMMARY

The overview of the modelling approach set out in this section illustrates that this exercise is essentially one of developing a set of counterfactuals for how Royal Mail and customers would behave if the universal service were modified. Given that these behaviours are unknowable, since many of the modifications have not been observed before in the UK, it is necessary to populate the model with assumptions relating to how Royal Mail may choose to re-optimise its operations and customers their demand in response to these changes. In the next section we describe how we have developed our view on these assumptions for the key inputs to the model.



3 Key inputs to the analysis As noted in the previous section, the model requires us to establish how Royal Mail and customers would behave differently under different specifications for the universal service: • What would Royal Mail do if its universal service constraints changed? • What would customers do if the dimensions of the service offering were altered? These are not straightforward questions to answer and inevitably there is a range of uncertainty around the estimates we have developed for the inputs to the model. In this section we provide a summary of our approach to these key areas: • estimation of the base cases; • estimating the volume effect associated with each universal service specification, which then feeds into both volumes and costs; • the change in pipeline costs that arises as a consequence of the modification of the universal service in addition to the effect on costs associated with different volumes; • restructuring costs associated with changing the pipeline costs; • the extent to which the costs saved associated with a modification to the universal service are related to efficiency opportunities; and • the pricing rule required to convert the NAC into a price change. We conclude by summarising the key areas of uncertainty.

3.1

ESTIMATION OF BASE CASE

In order to assess the impact of altering the specification of the universal service, we first need to establish a consistent set of volumes, costs and revenues for each of the three base scenarios. For 2006-07, we use actual data provided by Royal Mail. For 2009-10, we use projections derived from the set of volumes, revenues, prices and costs developed by Royal Mail for use in their “Investment Case” which dates from February 2007. These were combined in its Strategic Planning Model and used in negotiating investment from the Shareholder. Frontier has made some changes to this data to allow consideration of alternative market shares in 2009-10.

3.1.1 Market Scenarios The net costs of the universal service may vary over time and with market conditions. We have therefore considered three market scenarios: • Scenario 1: 2006-07 actual market volumes, revenues and market shares; • Scenario 2: 2009-10 forecast market volumes and ‘access’ scenario market shares; and • Scenario 3: 2009-10 forecast market volumes and ‘end to end entry’ scenario market shares.

Key inputs to the analysis


The two 2009-10 market scenarios use the same forecasts of overall mail volumes and mix developed by Royal Mail for its “Investment Case” 8 but they differ in the level of market entry. The two scenarios contain Frontier projections of market shares. They are not intended to be revised market forecasts for that year but are intended to illustrate the impact that alternative market conditions have on our NAC calculation. The ‘access’ market scenario reflects Postcomm’s assumption that by 2009-10, access volumes are likely to plateau at around 6bn items, with very little mail delivered via alternative end to end networks. 9 The ‘end to end entry’ scenario, with around 1.7 billion mail items delivered by entrants, examines whether our NAC calculations are sensitive to the type, as well as the level, of entry. In each case, we estimate the level and mix of entry using Frontier’s Competitive Postal Market Model (CPMM). This model estimates market shares based on price and non-price differences between Royal Mail and alternative operators. The volumes assumed across each of the three cases are set out in Table 8 below. TPF

FPT

TPF

X

X

2006-07 RM E2E

FPT

2009-10 access

Access

RM E2E

2009-10 end to end

Access

RM E2E

Access

Item 1C*

4,067m

2m

3,424m

144m

3,427m

148m

Item 2C*

4,490m

127m

3,383m

1,048m

3,481m

877m

Bulk 1C

[excised]

[excised]

[excised]

[excised]

[excised]

[excised]

Bulk 2C

[excised]

[excised]

[excised]

[excised]

[excised]

[excised]

Bulk 3C

[excised]

[excised]

[excised]

[excised]

[excised]

[excised]

Special Delivery

[excised]

[excised]

[excised]

[excised]

[excised]

[excised]

4,121m

0m

4,242m

0m

4,242m

0m

21,321m

2,442m

18,501m

5,743m

18,735m

3,942m

Other# P

Total

P

Table 8: Royal Mail volumes under the three market scenarios * Includes Stamp, Meter, PPI and Cleanmail # P

Includes Door to Door mail, international mail and other (e.g. redirections) P

Source: Royal Mail, Frontier Economics

Source: Royal Mail.

8 TP

TP

9 PT

PT

Postcomm: "Access Review: A Consultation Document" (January 2008).



3.1.2 Costs Having chosen a baseline level of volumes, we need to establish a baseline level of costs for Royal Mail operating under the existing universal service specification. In establishing baseline costs, we have made use of Royal Mail’s Business Planning Model (BPM).

Cost calibration in 2006-07 For the purpose of calibrating the model for 2006-07, Royal Mail provided an allocation of Royal Mail’s actual costs in 2006-07 to the 23 pipeline components within the BPM. 10 The BPM estimates total costs for Royal Mail with a breakdown into twenty-three pipeline components, such as network (transport), indoor delivery or outdoor delivery. It also contains a series of cost elasticities (measuring the extent to which costs vary with volumes) which mean that the model is able to estimate the cost impact of alternative volume forecasts by pipeline component. These elasticities are important for this work because it enables us to evaluate the cost impact of different volumes associated not only with each market scenario, but also each specification change. 11 TPF

FPT

TPF

FPT

Although we update the BPM with actual volumes, the predicted cost base is not precisely equal to actual 2006-07 costs for a variety of reasons. We therefore scale the incremental costs by a factor reflecting the difference between predicted BPM and actual costs.

Cost calibration in 2009-10 For each of the volume scenarios in 2009-10 we run the model on two sets of cost information: • the level of costs assumed by Royal Mail in its Investment Case; and • the level of costs assumed at the time of the price control. For the second set of costs, we can use the BPM output without making any adjustment. For the first set, we need to scale the BPM output to reflect the Investment Case cost level, as Royal Mail did not develop a BPM for the Investment Case. We derive the scaling factor from the difference between the BPM cost output and the Investment Case cost base with Investment Case volumes. 12 We then apply this scaling factor to the BPM output with the different market shares in our two market forecasts for 2009-10. The results presented in this report are scaled to Royal Mail’s Investment Case forecasts – as embodied in its Strategic Planning Model (SPM). TPF

Source: Royal Mail.

10 TP

PT

All estimates of the incremental costs associated with volume changes are based on an immediate phasing assumption. This reflects the focus of the project on changes in the level of costs rather than estimating transition paths.

11 TP

TP

12

FPT

PT

PT

Source: Royal Mail.



3.1.3 Revenues The revenue information used is consistent with the information sources for volumes and costs. For 2006-07, we have used Royal Mail’s actual outturn revenues, from which we also derived average revenues. 13 For 2009-10, we have used Royal Mail’s predictions of average revenues for the Investment Case for both the access and end to end entry scenarios. 14 These average revenues are applied to the predicted level and mix of volumes (discussed above) to provide an estimate of Royal Mail’s total revenues. TPF

TPF

3.2

FPT

FPT

ESTIMATION OF THE VOLUME EFFECT

Having established the base case volumes and revenues, we need to establish how these would change in response to a different specification. There are three possible effects. | Non-price demand effect: mail volumes and mix may vary directly in

response to a modification of the universal service specification. | Non-price market share effect: the proportion of mail being carried by

Royal Mail end to end, under access agreements and by alternative end to end bypass providers may vary. This will reflect the following considerations: • aggregate market shares may change as mail volumes switch between more- and less-contested mail routes 15 ; and TPF

FPT

• market shares for individual routes may change in response to modifications to the non-price characteristics of the universal service. | Price effects: volumes, product mix and market entry may vary further in

response to price changes resulting from changes in costs. The demand effect and market share effect are estimated in the first round of the NAC model. The price effect is estimated in the second round following redistribution of any first round net cost savings being reflected in lower prices.

3.2.1 Demand effects In evaluating the demand effect associated with a change in the universal service we are realistic about the degree of accuracy that is possible. The service specification changes have generally not been experienced before in the UK. In most cases, therefore, there is no directly relevant historic information that we can use to estimate demand effects. Instead, we have integrated information from a range of sources. In doing so, we have been guided by an approach proposed by Royal Mail: the “pyramid approach”. We also provide a range of

Source: Royal Mail.

13 TP

PT

Source: Royal Mail.

14 TP

15 TP

PT

PT

Routes are the most disaggregated unit of analysis used by Royal Mail. The volume information provided by Royal Mail divides mail into over 50,000 routes, with separation by product, format, weight and delivery zone.



sensitivities around our base case estimates to reflect the uncertainty. This section provides a summary of the key issues. Further information can be found in Annexe 2. The pyramid approach suggests a ranking of alternative information sources: • where there is direct evidence of revealed preference, such as econometric or other statistical evidence of demand changes, this should be given a strong weighting; • the next strongest weighting should be given to quantified market research with stated preferences which can be scaled using insights from the revealed preference data; and • in the absence of direct quantitative evidence, a reasonable assessment needs to be made from qualitative information sources.

Econometric evidence In order to estimate the impact on market volumes and revenues as a result of the demand, market share and price effects, we first draw on available econometric evidence. This is the ‘top tier’ of the pyramid. Royal Mail’s Inland Letter Traffic Model (ILTM) describes econometric evidence based on historic mail volumes. It provides revealed preference evidence in two particular areas. | Price elasticities: the ILTM contains estimates of own- and cross-price

elasticities – these are used to estimate the price effect in the second round. | Quality of Service elasticities: the ILTM reports estimates of how mail

demand varies in response to changes in quality of service. These are used to estimate the demand effects relating to quality of service changes. We can use the evidence on price elasticities to estimate the effect of the second round price changes on mail volumes. In addition, we assume that Special Delivery volumes exhibit similar sensitivity to that exhibited by 1C (as the nearest substitute) and that the cross price effects for bulk mail (not estimated in the ILTM) are not significant. We also make use of the estimates of elasticity of demand with respect to quality of service that are estimated in the ILTM. However, some care has to be taken in applying the quality of service parameters directly. The ILTM parameters, taken at face value, suggest that when first class quality of service has improved by one percentage point, first class mail volumes have not changed while second class mail volumes have increased by around [excised].



However, intuitively we would expect changes in first class quality of service to affect first class volumes as well as second class. The econometric evidence of flat first class volumes and changing second class volumes is also consistent with an alternative interpretation along these lines, as has been noted by Royal Mail. 16 This interpretation is that for equal changes in first and second class quality of service: TPF

FPT

• reductions in first class quality of service lead to a reduction in first class mail volumes and a switch of some volumes to second class; but • reductions in second class quality of service lead other second class volumes to switch to first class mail; so that overall • first class mail volumes remain neutral while second class volumes fall. In our modelling, we have parameterised the demand effect using this second interpretation: reductions in first class quality of service lead to reductions in first class mail volumes with most volumes switching to second class but some being lost altogether. The final point to note from the econometric evidence is that the ILTM does not find QoS to be a significant determinant of bulk mail volumes. We have therefore used a bulk mail elasticity of zero for the purposes of this project.

Survey evidence In the absence of any further econometric/revealed preference evidence, following the pyramid approach we turn to available stated preference evidence, drawn primarily from the “Needs of Postal Users – Customer Survey 2006” report prepared by Roland Berger/Synovate on behalf of Postcomm, Postwatch and Royal Mail. We have also taken into consideration evidence from the “Needs of Users of the Postal Service – Customer Survey 2007” prepared by FDS and the “2007 Business Customer Survey” undertaken by Quadrant/BMG, and we note where these sources have been used to support our assumptions. The stated preference evidence suggests that some elements of the universal service are more important than others from a customer perspective. Moreover, different types of customer place a different value on various service features. For example, businesses value early deliveries and later collections more than residential customers, but value Saturday deliveries and collections less.

TP

16 PT

This alternative interpretation is possible due to multicolinearity in the underlying quality of service data. Historically, first and second class quality of service have tended to move in parallel. Most of the historic change in quality of service was associated with the introduction of automation which resulted in a step change in both first and second class QoS. This makes it very hard to identify the impact of first and second class quality of service separately, although the total elasticity of demand (with respect to both first and second class quality of service) is likely to be more reliable.



We use the survey evidence as an index, representing the relative (un)attractiveness of potential universal service modifications. This is combined with the econometric evidence on responsiveness to quality of service changes in order to scale this index to the best available evidence. 17 For these purposes, since the Roland Berger evidence provides a direct comparison point for most of our scenarios, and its findings are broadly supported by the other market research, we have based our index on its findings. The results of combining the revealed and stated preference evidence are presented in Table 9 below. TPF

X

FPT

X

Other qualitative information sources Given the limited evidence available to estimate demand responses, we have also benefited from interviews with a number of mail users which we used to gauge their reactions to potential changes. We had useful discussions with the Mail Users Association, the Direct Marketing Association and Postwatch. The discussions took part before our demand estimates were finalised. The final demand estimates are therefore Frontier’s and should not be taken to represent the views of any of the stakeholders we met. It is also important to note that the focus of our analysis is on volume changes, not customers’ valuation of particular service features. Consequently, our view that volume changes may be limited in response to a service change does not necessarily indicate that the service feature has no value to customers. The interviews gave us a qualitative sense of how some mailers could react to changes in service specification. The discussions tended to support the view that service changes were more likely to alter the way in which mail was sent (e.g. switching class or moving to an alternative operator) than in the total volume of mail sent. Further details of these meetings are provided in Annexe 2, but in general, the meetings did not contradict the first two tiers of the pyramid, that were used to develop the switching estimates in Table 9. X

17 TP

PT

X

Effectively, we assume that customers’ survey responses overstate the preference impact of universal service modifications in a consistent way.



Estimated (Own-) Demand Effect

Estimated Switching Effect

Modification

Stamp

Meter/PPI/CM

Bulk

Stamp

Meter/PPI/CM

Bulk

Deliveries/Collections: drop Saturday

-1.79%

-1.59%

-0.40%*

None

None

None

1C: -0.21%** 2C: 0.00% SD: 0.00%

1C: -0.02%** 2C: 0.00% SD: 0.00%

0.00%

1C: 0.37% switch to 2C (0.40% of 2C) 0.02% switch to SD (1.00% of SD)


None

Deliveries: per hour later

-0.48%

-0.48%

0.00%

None

None

None

Deliveries: per hour earlier

0.48%

0.48%

0.00%

None

None

None

Collections: per hour earlier

-0.40%

-0.79%

0.00%

None

None

None

Collections: per hour later

0.00%

-0.20%

0.00%

None

None

None

5.00% of 1C vols. lost


5.00% of MS1 vols. lost

1C QoS: per % pt decrease

Single two day service

20% increase in SD vols. switching from 1C, all other 1C volumes switch to D+2. 100% of 2C volumes switch to D+2.

Remaining 95% of 1C volumes and 100% of 2C volumes switch to D+2.

Table 9: Estimated demand and switching effects for universal service modifications Source: Frontier Economics * exact value varies in relation to the ratio of 1C to 2C volumes (which accounts for the difference in Stamp and Meter/PPI/CM) – the sum of 1C volume effects is 0.60% ** one quarter as responsive as Meter/PPI/CM volumes



3.2.2 Market share In addition to estimating non-price demand effects, the first round of our model estimates non-price market share effects. If demand for a particular product switches in response to a modification of the universal service, then the new mail product may be more or less contestable than the mail product the customer was originally using. Consequently, Royal Mail faces not only a product switching effect but also a market share effect. For example, if our product switching analysis suggests that 10 million first class PPI mail items switch to second class PPI, and Royal Mail’s market share for second class PPI is 80%, then we assume Royal Mail loses 10 million first class PPI mail items and gains 8 million second class PPI items, with 2 million items switching to entrants. Of those 2 million items, if 90% are delivered through access and 10% are delivered by an end to end entrant, then Royal Mail’s access volumes will increase by 1.8m items. We have also considered the possibility that some universal service modifications may cause a more profound effect upon Royal Mail’s position in the market. This might be characterised either as: • major changes that fundamentally alters the perception of Royal Mail relative to competitors; or • changes that disproportionately affect Royal Mail’s service quality relative to rivals. An example of the first is a switch to a single two day product, which could fundamentally alter the brand position of Royal Mail relative to entrants, and make switching more likely. However, the change would be on top of two other factors that are likely to be more material: the change in service specification to a product with which alternative operators will find it easier to compete; and price changes relative to the current second class price. Thus, while we accept the principle that changes in perception can affect market share, we have not tried to quantify the effects in this case. Moreover, to the extent that such effects are captured by greater market switching, we have undertaken scenario analysis, described in Annexe 2, to assess the likely impact of such a fundamental shift in consumer behaviour. An example of the second change might be a modification to Royal Mail’s collection times. In this case we would not anticipate a fundamental shift in the nature of competition, though we might see a higher degree of switching than would be suggested by the estimated volume responses proposed in Table 9. X

X

3.2.3 Scenarios Given the degree of uncertainty around the demand responses to changes in the universal service, we have undertaken a number of scenarios around the base case: • altering the estimated demand effects by doubling and halving the magnitude of the estimated demand effect;



• considering additional changes for Special Delivery, given potential variation in how it will be treated and switching relative to first class; and • risk scenarios, where demand responses may be outside the range we have considered. Full results for each case are presented in Annexe 2.

3.3

PIPELINE COST CHANGES

The next key input to our model is to estimate a new set of costs given the volumes that have just been estimated and the changed universal service specification. We provide an outline of our approach here. Further detail is available in Annexe 3. To estimate the new costs, we consider the impact of two effects: • a change in universal service restrictions: the new service specification may have a direct impact on costs by allowing changes in the way in which mail is handled; and • a change in volumes: the revised level and mix of volumes will imply a different level of costs even for parts of the pipeline not directly affected by the service changes. For example, earlier delivery times are likely to increase overall volumes slightly. The pure volume effect will increase collection costs while mail centre costs are likely to increase in order to process mail faster to meet the earlier delivery times. In order to capture both these effects, we use two stages in our modelling. | The first stage is to use Royal Mail’s Business Planning Model (BPM) to

estimate the impact of new volumes on costs. By feeding in different volume forecasts, we can estimate how overall costs (in total and by pipeline component) would change in response to the demand effects we have estimated. | The second stage is an operational cost model developed with PLCWW. The

model assesses how Royal Mail’s activities might change in response to alternative universal service constraints and estimates the cost implications of the changes. The model contains four modules for different parts of the pipeline although the modules are linked by volumes and other operational constraints. • Collections: changes in the universal service potentially affect the timing of collections, the number of collection rounds per day and the number of collections per week. The constraints may be direct (e.g. at least one collection per day) or indirect (e.g. collections are required throughout the day to enable smooth workflows at mail centres). • Mail centres and transport: the constraints of having to provide a first class network with a set quality of service may require Royal Mail to have a larger number of mail centres and more use of air transport than would



otherwise be the case, while removing the universal service requirement for Saturday deliveries and collections would affect the days on which the network needs to operate. • Feeder services: these are connecting services between collection hubs (where collections are aggregated) and mail centres, or between mail centres and delivery offices. The cost of services will depend on the number of days that collections and deliveries take place. • Deliveries: changes to the universal service determine the number of days on which deliveries operate and (indirectly) the number of delivery routes. Both these factors will affect indoor (i.e. mail preparation) and outdoor delivery costs. Timing constraints may also force shorter or more frequent delivery runs than Royal Mail would wish. In addition, the modules take into account the impact of changes in mail volumes and geographic constraints such as density (for delivery) of the current location of mail centres (for transport). As noted above, the focus of our cost modelling is a comparison of steady state operations: that is, Royal Mail’s annual operating costs under the current universal service and Royal Mail’s annual operating costs under a revised universal service. We are not developing detailed plans for a transition between the two, although in section 3.4 we estimate the scale of transition costs required using rules of thumb for the number and size of redundancy and pension payments. X

X

Our cost model is based on the expert view of PLCWW, a consultancy of mail operations specialists. PLCWW has estimated the cost base under each scenario by taking a view on how Royal Mail’s operations could change in response to a change in the definition of the universal service. Quite clearly, a number of possibilities exist to reconfigure operations in the light of a changed universal service specification, and whilst PLCWW has examined the most obvious candidates, we do not rule out the possibility that other options exist that could be applied in practice. It is certainly not the intention of this work to prescribe a particular strategic response to a change in the universal service. In order to support the analysis here and in the model, Annexe 3 presents a reasonably detailed commentary of how the workplan could change in each of the scenarios. In this section, we provide an overview of where in the pipeline we expect the major cost savings to occur in each scenario. We also describe the interactions that we expect between different pipeline components. The detailed cost calculations for individual pipeline components are described in the next section.

3.3.1 First class quality of service Royal Mail’s current licence target is for 93% of first class item mail to be delivered next day. In 2006-07 Royal Mail achieved 94.0% quality of service (QoS) for stamped and meter mail and 93.0% for PPI mail. Almost all mail, 99.9%, is scheduled for delivery the next day (i.e. would be delivered next day if all processes worked perfectly). The lower actual QoS arises for a variety of reasons, such as mis-sorting in mail centres or vehicle delays and breakdowns.



The most readily identifiable cost savings from a lower QoS target come from reductions in scheduled connections associated with a smaller air network. Although there are potential savings from allowing a larger gap between scheduled and achieved QoS, from reducing spare vehicle cover or tolerating more mis-sorts in mail centres for example, the savings could be difficult to secure in practice. For example, reducing the QoS target indiscriminately could allow a change in culture that made mistakes more tolerated in general, eroding any potential savings. Consequently, we have investigated the cost savings available from reductions in scheduled connectivity by reducing the size of the air network. By adding or removing flights, we can investigate the change in quality of service on a postcode by postcode basis, along with the associated flight cost savings. These cost savings are offset against additional costs associated with the road and ferry services that have to carry the mail instead. Because all the changes are internalised within the mail centre and transport network, we consider that there would be no other direct impact on costs for collections, deliveries or feeder services.

3.3.2 Removing the universal service requirement for Saturday deliveries and collections Removing the universal service requirement for Saturday deliveries and collections is expected to have two principal benefits: • direct cost savings in reduced labour costs, most significantly in outdoor delivery; and • potentially allowing a more even flow of mail through the network throughout the week, allowing more regular staffing patterns and reducing peak capacity requirements. In Annexe 3 to this report, we present detailed projections of workflow requirements throughout the pipeline on different days of the week, based on a five or a six day service. Table 10 presents a summary of daily delivery volumes in each scenario, based on our projected network workplans. At present, Tuesday is a very light delivery day as no Access or Mailsort 2 mail is posted at the weekend. As access mail increases to 2009-10, variation in mail volumes across the week is expected to be even more pronounced than today. X

X



Scenario Posting profile* Actual delivery profile: 2006-07 6 day service:#

Mon

Tue

Wed

Thu

Fri

Sat

19.0%

19.2%

19.7%

18.6%

18.8%

4.9%

15%

12%

18%

19%

19%

17%

15.8%

12.2%

18.8%

19.4%

19.7%

14.1%

16.1%

11.9%

19.2%

19.5%

19.7%

13.5%

17.4%

21.0%

21.2%

19.8%

20.6%

-

17.1%

21.5%

21.0%

19.8%

20.6%

-

P

2006-07

6 day service:# P

P

2009-10

No Saturday:# P

P

2006-07

No Saturday:# P

P

2009-10

Table 10: Projected delivery profiles by day of the week * Excludes Mailsort 3 # P

P

Assumes Mailsort 3 delivered equally across the week

Source: Frontier Economics/PLCWW projections, Royal Mail

These projections do not exactly match Royal Mail’s current delivery profile although they are close. We think the discrepancies are most likely due to processing patterns for Mailsort 3, about which Royal Mail has been able to provide little information. In particular, we have assumed that no Mailsort 3 is delivered on Saturdays, in line with practice at most delivery offices. 18 We understand that Royal Mail’s delivery profile shows mail dispatched from mail centres which may therefore contain some Mailsort 3 which is not delivered. TPF

FPT

Ultimately, we would expect the following cost savings to be achievable following the introduction of a five day service. | Outdoor delivery: labour savings are possible as no rounds would be

undertaken on Saturday, although more staff are required on other days. A more even delivery profile is likely to make scheduling shifts easier. | Indoor delivery: smaller labour savings as most indoor processing costs vary

directly with volumes although there are some fixed daily costs associated with preparing each delivery round. | Feeder services: one day’s feeder services can be dropped although increases

are required for the higher average volumes on other days. An even volume profile should also allow better use of vehicle capacity.

TP

18 PT

Source: Royal Mail.



| Mail centres: mail centre costs are unlikely to change significantly as

processing time will generally shift to alternative days, although a more even workflow may make work scheduling easier. | Transport: savings on air costs from better use of road capacity on Friday

nights and over the weekend.

3.3.3 Collection and delivery times Changing collection and delivery times alters the time window within which mail can be conveyed from end to end. There is therefore some scope to take additional time or less time at any point in the pipeline, rather than in the part of the pipeline directly affected. The principal areas where costs could be reduced with extra time are: • Collections: longer collection runs, which allows a greater proportion of time to be spent collecting mail rather than on stem journeys, and potentially allows less intensive use of vehicles; • Mail centres: extra time for inward or outward processing could reduce the peak capacity needed in mail centres or allow smoother workflows; • Transport: longer time spans would allow reductions in the air network although mail would then arrive later in mail centres; and • Delivery: depending on shift patterns, longer delivery runs could allow more time to be spent on outdoor deliveries relative to stem times. These scenarios are significantly affected by short run/long run considerations. In a greenfield network, small changes in timing would have small impacts on costs. Equally, cost changes are likely to be approximately symmetrical with respect to increases or decreases in time (within a range). However, Royal Mail does not operate a greenfield network and would make modifications to existing practices in response to time changes, resulting in asymmetric cost changes with respect to increases or decreases in available time. We have therefore treated cost changes in this light. In response to reduced available time, we assume that Royal Mail would absorb the time reductions by increasing processing capacity in mail centres; with more time we assume that Royal Mail would reduce the size of the air network. We also consider the extent to which changes to delivery staffing patterns could absorb more or less time.

3.3.4 Introducing a two day universal service mail product In all the service specification changes presented so far, our estimated cost savings are based closely on Royal Mail’s actual cost base. They include factors such as Royal Mail’s efficiency level and existing network structure. However, when estimating the costs that could be saved by moving to a single two day product for item mail, we look at two options:



• first, as before, the savings that Royal Mail could be expected to achieve given its current efficiency levels and mail centre network; and • second, the potential savings that could be achieved if introducing a two day universal service mail product allowed radical reform of the mail centre and transport network. In both cases, we believe the same work patterns could be used, but the savings are greater in the second case as more re-optimisation is possible. | Collections: at present, several collection rounds are necessary throughout

the day to provide mail centres with a flow of work ahead of the evening peak. With longer processing periods in mail centres, the constraint on collections would be capacity in mail boxes and post offices. We have assumed that only two collections would be needed per collection point per day in urban areas rather than three or four today. | Mail centres: savings in mail centres would come from not having to

segregate mail classes and, more importantly, by avoiding switching back and forth between inward and outward processing. Looser time constraints would also reduce peak capacity and staffing required and allow a much more even throughput of mail throughout the day. • Outward mail would be processed on the night of posting from 19:00 to 04:00 to meet two waves of road despatches at around 02:00 and 04:00. • From around 04:00 until 19:00, mail centres would focus on inward mail. By 04:00, mail from the home mail centre would be available. Throughout the morning, mail from other mail centres, Mailsort 2 and 3 and access mail would arrive and in almost all mail centres, all mail would arrive well in advance of the 19:00 cut off. 19 TPF

FPT

| Transport: with an extended time window, most air services could stop

although we have allowed for air services to Northern Ireland, the Highlands and Islands, the Isle of Man and the Channel Islands. In addition, Royal Mail would be able to make more use of large vehicles operating closer to capacity, as it does on the second class and weekend network today. | Delivery: by 19:00, all mail would have been inward sorted and would be

ready for distribution to Delivery Offices. This would allow walk sequencing to take place overnight with other mail preparation taking place early in the morning. The principal constraint on delivery times would be staff recruitment.

19 TP

PT

In the few remaining mail centres, the volumes of mail that would arrive close to or after the cut off are very small and the mail centres concerned would be able to make alternative arrangements at limited additional cost.



Radical reform option Moving to a single two day product potentially allows radical reform of the mail centre network. Additional savings are likely to be possible by reducing the number of mail centres from the 2009-10 level of 65 to around 25. Having fewer, larger mail centres could allow Royal Mail to exploit greater economies of scale, particularly in terms of investment in sorting machines, including packet machines. With 25 mail centres, most delivery offices remain within 60 minutes of a mail centre. The more distant delivery offices are, in almost all cases, more than 60 minutes away from the nearest mail centre with the current network configuration. Geographic constraints mean that not all mail centres would be able to grow, those in remote areas may need to remain to serve their catchment areas, but there are several regions that are currently served by multiple mail centres where delivery distances are less of a constraint. Table 11 shows that there would continue to be five relatively small mail centres while there would be eleven mail centres equivalent to or larger than the largest existing mail centre. X

X

Annual volumes handled by MC (inward and outward)

Number of MCs – current network

Number of MCs – reduced network

1bn

1

11

Table 11: Mail volumes handled by mail centres

3.4

RESTRUCTURING COSTS

The focus of this project is on the change in the annual level of operating costs that would be achievable under different universal service specifications. However, we have also used rules of thumb to estimate the level of redundancy and pension costs that could be incurred in the transition to alternative operating states. Our estimates rely on two inputs: • output from our operational modelling showing the number of FTEs required in different parts of the pipeline under different universal service specifications; and • estimated redundancy and pension costs and staff turnover rates.



Typical values

2009-10 estimate

Attrition rates

9%

Effective Attrition rate after allowance for regional variation*

6%

Voluntary redundancy payments

£15,600

Additional pension costs at redundancy

£8,400

Table 12: Rules of thumb for transition costs Source: Royal Mail

We have not included estimates of other transition costs including: • additional costs or wage increases that might arise in relation to reaching agreement with staff on new working arrangements; • contractual changes to the air network (which should be cost free at break points in contracts, believed to be every 3-4 years); or • property costs, as costs will vary significantly depending on the value of land being released or additional land that needs to be purchased.

3.5

EFFICIENCY

As noted in the Introduction, this exercise is not an efficiency review. Our model is calibrated to the Royal Mail cost base, not that of a hypothetical efficient operator. Nevertheless, in the course of our analysis we have identified areas of the pipeline that would benefit from further scrutiny at the next price control review. We have also run a specific scenario in which we identify the potential for major changes to Royal Mail’s mail centre network relating to the introduction of a two day product. We have also, throughout the course of our modelling, appreciated the trade-off between efficiency and the size of the NAC associated with modifications to the universal service. For example, at present, a peaky mail flow and a fixed number of people in delivery offices leads to periods when labour is relatively under-utilised. One of the impacts of removing the universal service requirement for Saturday deliveries is that it enables a more consistent utilisation of labour throughout the week. However, similar cost savings could be realised under flexible shift patterns that allowed the labour input to match the peakiness of mail volumes day by day. In summary, as we discuss in more detail in sections 4 and 5, a significant proportion of the NAC of modifying the universal service is driven by the existing set of working practices, as well as by the inherent service requirements implied by the universal service. X


X

X

X


3.6

PRICING RULE

For any given NAC derived from the first round of analysis, it is relevant to consider the impact on prices if this benefit were returned to customers. In general, this calculation will be a complicated process that takes into account competitive pressures and the presence of substitutes, and it is not our intention to second-guess the commercial decisions of Royal Mail. Consequently, our model allocates all the cost changes through to prices, using relatively simple rules to allocate costs back to individual products to provide an indication of how prices might change if those benefits were returned to customers. Further details about the pricing rule are contained in Annexe 2. There are two main considerations for our rules: • the proportion of costs that should be passed through in prices; and • the prices that should vary following cost changes. Given the existence of the price control, Royal Mail has, in expectation, to pass through 100% of any net cost saving in terms of lower prices. Equally, any increase in net costs will ultimately have to be borne by customers in the form of higher prices. This means that in our model, we pass through 100% of the NAC we have estimated in the form of higher or lower prices. Our cost information is generated by pipeline component. In developing new prices, we have therefore been guided by the principle that the NAC should be allocated to products that use that part of the pipeline. For instance, all prices (including access prices) will be affected by changes in delivery costs. Conversely, changes in collection costs will only affect item mail and not bulk mail or access products. We allocate the change in costs to the relevant products in proportion to their share of revenues. In the absence of a detailed model to estimate product level costs (which is outside the scope of this project), this should provide a robust indication of the direction of price changes in response to a changed universal service specification.

3.7

KEY RISKS AND UNCERTAINTIES

We identified several key risks and uncertainties for this project in the executive summary. Table 13 summarises the factors we have identified in this chapter of the report. These risks and uncertainties are a natural consequence of a project such as this that attempts to envisage what market conditions, operator behaviour, and customer demand would be like in several different states of the world. In managing these uncertainties, we have made the best use of available information and we have benefitted from discussions with major stakeholders in refining our views. We accept that some of our conclusions are necessarily speculative and could be updated as and when additional information becomes available that inform our assessments. Therefore, in interpreting the results of our analysis in the next section, the point estimates presented in the tables should be read in conjunction with the surrounding commentary which explains the operational or economic motivation behind the results, and highlights the information we have relied on. X

X



PROBLEM

REMEDY

2009-10 cost projections are uncertain

Cost projections from Royal Mail’s Investment Case forecasts are compared with projections from the time of the Price Control

Alternative operating costs are unknown

The avoided costs are referenced to a robust operational model developed with PLCWW

Evidence on possible demand responses is weak and sometimes contradictory

The market environment could affect the estimated NAC

The analysis uses available statistical evidence plus information from stakeholders including large mailers and Royal Mail We undertake a battery of sensitivity analysis to check robustness of conclusions

The analysis is carried out using actual 2006-07 volumes, expected volumes in 2009-10, and a “high bypass” scenario in 2009-10 to assess sensitivity of the results This is not an efficiency study but it does identify areas:

The potential savings depend on Royal Mail’s efficiency

where greater flexibility in working arrangements impacts on the results (up to £50m in some cases); and

The restructuring costs are unknown

Estimated redundancy and other restructuring costs are shown based on rules of thumb

where Postcomm could focus at the price control review (e.g. mail centre and delivery network)

Table 13: Key risks and uncertainties Source: Frontier Economics



4 Results In this section of the report, we present the results from our analysis, showing: • the expected changes in costs, revenues and NAC; • indicative price changes and second round effects; and • the scale of the operational changes needed to secure the NAC, including estimated redundancy and pension costs. Three aspects of the current universal service have the most significant net costs associated with them and we therefore devote most time to considering their implications. These are the net cost of: • the current first class quality of service (section 4.1); X

X

• the requirement for Saturday collections and deliveries (section 4.2); and X

X

• introducing a new universal service two day mail product (section 4.3). X

X

We also present shorter sections for the other elements of the current universal service that have been analysed in sections 4.4 to 4.6. X

X

X

X

This section is supported by: • Annexe 3, which contains further information on the cost modelling in these scenarios; and • Annexe 4, which describes how we have calculated changes in quality of service.

Results


4.1

NET COST OF FIRST CLASS QUALITY OF SERVICE Key points

| First Class QoS falls to 85% (Stamp/Meter); 78% (PPI) | First round NAC: £76m (Revenue loss: £40m; Cost saving: £116m) | Wide geographic variation in achieved QoS | Special Delivery is also reduced unless Royal Mail incurs extra costs | Other options (87%, 90% QoS for Stamp/Meter) produce scaled down results

of the main scenario

CHANGE IN REVENUES Item mail

1C QoS - 90%

1C QoS - 87%

1C QoS - 85%

-£15m

-£31m

-£41m

Bulkmail Access

£0m £0m

CHANGE IN COSTS Transport & MCs

-£48m

Collection & Delivery Other

-£1m -£1m

-£15m

£0m £0m

-£30m

-£89m

-£49m

-£2m -£2m

£0m £1m

-£40m

-£112m

-£92m

-£2m -£2m

-£116m

NET AVOIDED COST

£34m

£62m

£76m

Capitalised NAC (@ 8%)

£426m

£775m

£946m

INIDICATIVE PRICE CHANGE (%, pence per item) 1C item -0.3% 2C item -1.6% Bulk -0.5% Access -0.1%

Total

-0.6%

-0.1 -0.4 -0.1 0.0

-0.3% -3.1% -0.9% -0.2%

-0.1 -0.7 -0.2 0.0

-0.1% -4.1% -1.2% -0.3%

0.0 -1.0 -0.2 0.0

-0.1

-1.2%

-0.3

-1.4%

-0.3

FURTHER EFFECTS FOLLOWING PRICE CHANGES Volumes: 19m Revenues: £4m Market share Neutral

35m £5m Neutral

35m £3m Neutral

Figure 3: Net cost savings from reducing first class quality of service 2006-07 actual data scenario Source: Frontier Economics/PLCWW

Regional impact of modifying QoS targets As discussed in more detail below, the most readily identifiable cost savings from lower first class quality of service come from removing all or part of the air network for overnight mail, introducing a geographic dimension to quality of service. Removing the air network altogether would save around £116m although revenue losses (mainly a switch from first to second class mail) means the NAC would be around £76m.

Results


Most mail would not be affected by this change and regional first class mail would still receive a next day service. However, long distance mail would not be delivered next day. Overall, Table 14 shows that removing the air service would reduce Stamp/Meter QoS by 7.6% and PPI QoS by 14.2%. The larger fall for PPI reflects its more national mailing profile with more long distance mail. X

X

However, the variation is not uniform. Relatively central areas, such as Birmingham or Bristol would see only small falls in quality of service. In contrast, Scotland and Northern Ireland would see a significant deterioration in service levels, particularly for PPI. For example, almost two-thirds of stamp/meter mail delivered in Northern Ireland is local and would be received one day after posting, but most PPI mail is sent from Britain and only one quarter would be received within a day of posting. Stamp/Meter

PPI

With Air

No Air

With Air

No Air

Birmingham

93.7%

91.3%

93.5%

85.5%

Bristol

94.2%

90.5%

94.6%

80.7%

Newcastle

94.5%

75.8%

93.7%

67.8%

London

94.1%

89.7%

92.5%

85.0%

Edinburgh

93.8%

63.3%

92.9%

23.1%

Cardiff

93.8%

85.8%

93.0%

74.4%

Belfast

92.9%

63.4%

90.7%

26.2%

Total

94.0%

86.4%

93.0%

78.8%

Table 14: Quality of service with and without air services, based on 2006-07 data Based on delivered first class QoS in postcode areas B, BS, NE, SE, EH, CF, BT Source: Frontier Economics/PLCWW

Moreover, all changes that tried to reduce quality of service by removing the air network will lead to varying geographic standards of quality of service. Figure 4 shows the predicted QoS for different regions (based on the local airport each mail centre would use) under various intermediate levels of quality of service. The figure also shows a plausible QoS target, as well as achieved QoS, taking into account Royal Mail’s outperformance in 2006-07. In all cases, parts of the country receive a significant degradation in service. In addition, there are no significant “quick wins” when reducing quality of service. In fact, the cost reduction per quality of service reduction is relatively constant across the different scenarios. This reflects the fact that Royal Mail carries reasonably high volumes on most flights and also that connecting flights are often required to deliver more distant mail (e.g. to Northern Ireland) with the quality of service reduction occurring as soon as the first flight is dropped. X

Results

X


QoS Target

85.5%

87.1%

90.1%

93.0%

National

86.4%

88.1%

91.1%

94.0%

Aberdeen Northern Ireland Solent South West Central Scotland Midlands, Yorks, N West Devon & Cornwall Inverness North East South East

63.3% 63.4% 89.5% 88.0% 61.5% 90.0% 75.3% 64.7% 81.3% 90.0%

63.3% 63.4% 89.5% 90.3% 73.1% 91.3% 75.3% 64.7% 81.3% 90.8%

63.3% 63.4% 89.5% 92.0% 88.6% 92.6% 90.2% 64.7% 88.4% 92.9%

93.1% 93.0% 94.0% 94.0% 93.6% 94.0% 92.0% 90.5% 94.2% 94.4%

Figure 4: Quality of Service by region (delivered mail) for first class Stamp/Meter mail Source: Frontier Economics/PLCWW

Revenue effects Overall net revenue changes in response to reductions in first class quality of service are likely to be the result of larger underlying changes in product mix as customers switch from first class to second class products. Our central case scenario is that first class volumes could fall by around 5%, with most of the volumes switching to second class products. Since entrants compete more successfully for second class mail, this switch is also likely to lead to a small reduction in Royal Mail’s market share. Bulk volumes are unlikely to be significantly affected, and are set to zero for simplicity. Change in volumes

Change in revenues

Total RM

-53m

-£40m

RM Access

+3m

+£1m

RM E2E

-56m

-£41m

1C Item

-201m

-£87m

2C Item

+145m

+£46m

1C Bulk

0m

£0m

2C Bulk

0m

£0m

3C Bulk

0m

£0m

Table 15: First round change in volumes and revenues with a reduction in first class quality of service to 85% Source: Frontier Economics, PLCWW

Results


In addition to the central case scenario illustrated above, we estimated alternative demand scenarios to assess the sensitivity of the results to the demand assumptions. Under a higher sensitivity scenario, the estimated revenue loss is £81m. These alternative scenarios indicate only a marginally positive first round NAC, implying that a high national quality of service target imposes only a small net cost on Royal Mail. In discussion, Royal Mail indicated that it believes demand is more sensitive to universal service modifications than in our central estimate, suggesting that this element of the universal service imposes less of a constraint upon Royal Mail than indicated in the tables above.

Cost effects Almost all the cost changes in this scenario come from transport. Currently, the air network costs £86m per year in direct flight costs. In addition, there are further flight related costs of £17m per year, which include the cost of dedicated road services to airports, mail screening, and other hub costs. These could all be saved by removing the air network. In general the costs are variable and removing part of the air network would remove that share of costs, but there are some fixed costs associated with air hubs that would not vary unless the whole network is shut down. There are some additional volume related savings in other parts of the pipeline. There would be only limited increases in costs related to making alternative provisions for mail that was previously conveyed by air. Replacement road services are likely to cost around £9m while total ferry costs could be £6m for services to Northern Ireland, the Scottish Islands, the Channel Islands, and the Isle of Man. Savings for these latter locations would also potentially be subject to negotiation with the operators and regulators concerned.

Impact on prices The positive NAC in this scenario translates into price cuts for item mail. However, as Figure 3 shows, our simple price allocation rules predict that second class prices would fall by 1.0p with no real change in first class prices. This possibly counter-intuitive result comes from volume changes in this scenario. Removing the air network saves 5% of first class costs, but we also assume that volumes fall by 5%. On the other hand, second class volumes rise with no directly attributable increase in costs. X

X

The actual prices estimated in our model are an artefact of the rules we are using. In reality, at least some price cuts are likely to be possible for first class. However, the rules do illustrate that volume reductions may erode much of the first class price reduction that could otherwise be achieved by reductions in QoS.

Second round effects Second round effects are likely to be limited in this scenario. Overall, the price reductions will support mail volumes and should boost revenues. However, the impact would depend on relative changes in first and second class prices. A reduction in the second class price relative to first class could lead more volumes to switch to second class, depressing revenues. Similarly, the changes are not likely to have a major impact on entry. So far, alternative operators have made limited inroads into the first class mail market. Given the expense, it is unlikely

Results


that any other operator would try to replace the national next day product. However, losing a national next day service would remove a key feature differentiating Royal Mail from other operators, and could in the longer run make first class entry more likely.

Transition costs There are only small transition costs associated with a reduction in first class quality of service. As long as changes can coincide with break clauses in Royal Mail’s air contracts, believed to be every three to four years, there are no substantial transition costs, as few staff are affected and the transition would not require substantial changes to infrastructure.

Impact on Special Delivery and Royal Mail’s potential reaction The cost savings presented above would also imply that Special Delivery suffers a reduced quality of service, since the same flights are used to carry Special Delivery as first class mail. There is no requirement in the European Directive for Special Delivery to be a next day service, only for it to be a registered and insured service. However, Royal Mail could maintain Special Delivery as a national next day product (albeit not as part of the universal service), although doing so would erode many of the potential cost savings. Re-introducing an air network (including associated infrastructure) to cover around 98% of mail flows would cost around £25m. However, to provide a network that covers 100% of mail flows would require significantly higher expenditure, which could conceivably be up to £60m. The reason is that there are several marginal connections between peripheral mail centres that potentially need air connections in order to meet a next day delivery requirement but only carry small volumes of mail. The £60m cost is a conservative estimates assuming it is impossible to combine mail flows, or find space on commercial freight aircraft, given the overnight time constraints in which the Special Delivery service operates. Standalone SD Network

Connectivity*

Incremental cost

Price increase at constant volumes

Basic

98%

£25m

7%

Full

100%

£60m

17%

Table 16: Special Delivery with no air network for first class mail Scheduled next day delivery before QoS failures. Current Special Delivery QoS target is 99%, based on 100% connectivity. Source: Frontier Economics, PLCWW

Special Delivery also increases the uncertainty around revenues in this scenario. The revenue estimates presented above assume no change in Special Delivery volumes. However, with a fall in line with the fall in first class volumes, Royal Mail would lose further revenue, reducing the NAC. Ultimately, this suggests that changes to first class quality of service are likely to be more important in terms of changing the allocation of costs between first class and Special Delivery – and consequently relative prices – than in significantly altering Royal Mail’s financial position.

Results


4.2

NET COST OF SATURDAY COLLECTIONS AND DELIVERIES Key points

| First round NAC: £271m (Revenue loss: £55m; Cost saving: £326m) | Cost reductions in delivery implies broad based price cuts | Price cuts of around -4.8% or 1.7p for a first class stamp, 1.0p for 2C | Price cuts could boost volumes above their current level, with limited impact on

market entry

No Saturdays

CHANGE IN REVENUES Item mail Bulkmail Access

Figure 5: Net cost savings from removing Saturday deliveries and collections

-£49m -£5m -£1m

-£55m

Source: Frontier Economics/PLCWW


-£36m


-£281m -£9m

-£326m

NET AVOIDED COST

£271m


£3,389m

INIDICATIVE PRICE CHANGE (%, pence per item) 1C item -5.0% 2C item -4.3% Bulk -5.0% Access -4.7%

Total

2006-07 actual data scenario

-4.8%

-1.7 -1.0 -1.0 -0.7

-1.1

FURTHER EFFECTS FOLLOWING PRICE CHANGES Volumes: 336m Revenues: £103m Market share Neutral

Impact of Saturday services Removing the requirement for Saturday collections and deliveries to be part of the universal service would be part of a broader move to operate a mail service over five days, in line with a typical working week. Mail processing and operations that are currently carried out at the weekend would be delayed until the start of the following week. Consequently, for example, Friday’s second class mail which is currently delivered on Monday or Tuesday would under this scenario be delayed and delivered on Tuesday or Wednesday. Figure 6 shows the target delivery days for first and second class mail under the current universal service, and with a five day service. X

Results

X


Posting day

Delivery - Current

Delivery - No Saturday

1C

2C

1C

2C

Monday

Tuesday

Wed/Thu

Tuesday

Wed/Thu

Tuesday

Wednesday

Thu/Fri

Wednesday

Thu/Fri

Thursday

Fri/Sat

Thursday

Fri/Mon

Friday

Sat/Mon

Friday

Mon/Tue

Friday

Saturday

Mon/Tue

Monday

Tue/Wed

Saturday

Monday

Tue/Wed

Tuesday

Wed/Thu

Wednesday Thursday

Figure 6: Target delivery days for mail posted by day of the week Product specification for second class is three days after posting but over 90% was delivered within two days in 2006-07 Source: Frontier Economics/PLCWW

Revenue effects The research we have done suggests changes in market volumes are likely to be limited in response to removing the requirement for Saturday services. Our base case estimate is that revenues would fall by £55m, or just under 1% of total revenues. The falls are likely to be relatively even across classes but to affect item mail more than bulk mail. In addition, particular groups, such as publishers, may be more affected. The results may appear somewhat surprising, as Saturday has traditionally been understood to be an important day for mailers and in particular for advertisers, due to the perception that people are more likely to read mail at the weekend. However, a number of pieces of evidence suggest this may not be the case. | Many direct mailers use Mailsort 3. However, this product is not delivered

on Saturdays in many areas today. For example, a recent snapshot suggests that only 40 out of 418 Delivery Offices in Royal Mail’s East region always deliver Mailsort 3 on Saturdays and 249 Delivery Offices never do. 20 TPF

FPT

| Postcomm’s 2007 Business Customer Survey found that only 1% of

businesses identify Saturday as the most important delivery day and 48% claim it is the least important day. 21 TPF

FPT

| Anecdotal evidence suggests that mail has become better targeted and more

integrated with wider marketing campaigns. For instance, call centres are more expensive at weekends which can discourage mailers who expect customer responses.

Source: Royal Mail.

20 TP

TP

21 PT

PT

Postcomm “2007 Business Customer Survey”, Quadrant/BMG.

Results


Cost effects The largest cost savings in this scenario come from delivery. Savings of around 12% of costs, or £190m, are likely to be achievable from outdoor delivery. A large part of outdoor delivery costs are fixed, and associated with the time taken to walk or drive along a fixed delivery route every day, suggesting the savings could be as high as one sixth, or 16%. However, increased mail volumes on other days mean that the number of delivery routes might need to increase by around 2,000, or 3-4% in order to keep the same average working times. Further savings are possible in indoor delivery (mail preparation). A large part of preparation costs vary directly with volumes, but there are also fixed daily costs associated with preparing individual walks (e.g. clearing down frames). Total savings could be around 6% of costs or £68m, after allowing for the increased number of delivery routes in this scenario. There are more modest savings available in collections and transport. | It may be possible to save collection costs of around £11m as Saturday

collections would no longer be required. This is around 6% of total collection costs. Fewer collections take place on Saturdays than other days (many large firms are closed and there is a single collection round), and some collection rounds are combined with deliveries. | Reductions in transport costs may be possible by removing the current Friday

night flights and increasing utilisation on the transport weekend network. Assuming Belfast mail continues to be flown, total flight savings would be around £15m, assuming contracts can be renegotiated to avoid fixed costs, or £6m if Royal Mail is only able to avoid operating costs but still has to pay to lease the plane on Friday nights to ensure availability on other weeknights. Road costs could save a further £8.5m by taking advantage of the additional time to boost vehicle utilisation rates to the estimated level achieved in the SAWN network at present. Other changes are smaller, but could in total save another £30m. These cost savings include around £45m in savings from smoother workflows. At present, Tuesday has predictably lower mail volumes than other days – a result of the low volumes of second class and access mail posted at weekends. However, similar staff numbers are required in delivery offices for preparation and delivery walks, and Royal Mail has only limited ability to pay staff less on quiet days. For example, we understand that union agreements limit the maximum variation in delivery span to 30 minutes, which is unlikely to be enough to respond fully to volume changes. By moving to a five day service, the postal network would be more aligned with a typical five day working week and, as a result, delivery volumes are likely to be smoother over the course of the week (see section 3.3). This would reduce variations in workload over the week and therefore limit the amount of unproductive time that needs to be paid for. These savings are, however, dependent on existing workplans, and could be accessed to at least some extent by allowing staffing levels or shifts to vary over the week. X

Results

X


Impact on prices The cost and revenue changes are likely to support broad-based price cuts. Most of the cost savings come in delivery which affects all products, including access products. There would only be limited variation in price reductions from upstream cost savings in transport and collections. Price cuts are likely to be 4% to 5% across all products. This would translate into a cut in the basic stamp price of 1.7p for first class and 1.0p for second class.

Second round effects Broad based price cuts would be expected to lead to volume increases. In time, these could increase Royal Mail’s volumes by around 336m items, and increase revenues by £103m a year. If volume and revenue increases of this level are achieved, they would be sufficient to outweigh the initial loss in revenue assumed at the start of this section. In other words, volumes could increase after removing Saturday deliveries if the price cuts can be realised. The change would probably have a limited impact on market entry. Given the cost reductions in delivery, access prices would fall slightly, but in line other mail volumes. With small changes in upstream costs, the headroom between retail and access prices would remain approximately constant. The reduction in access price could make end to end entry slightly less likely.

Transition costs The transition costs could be material if the requirement for Saturday deliveries and collections was removed. The change could reduce the number employees required by around 9,300. We estimate that this could expose Royal Mail to a maximum redundancy charge of £300m. However, this level of charge could be significantly reduced with one or two years staff turnover. Two years’ staff turnover could reduce redundancy costs to around £26m. Remove Saturday Change in FTEs

-9,300

Maximum redundancy costs

£300m

With 1 year’s attrition

£132m

With 2 year’s attrition

£26m

Results

Table 17: Potential redundancy costs when removing Saturday collections and deliveries Source: Frontier Economics, PLCWW


4.3

NEW UNIVERSAL SERVICE TWO DAY MAIL PRODUCT Key points

| Large initial drop in revenue, at least £600m, mostly from the loss of first class

premium on prices | Royal Mail would need to strip out £600m in costs to be able to price at or

below the existing second class price as it would otherwise risk volume and market share losses | Maximum cost savings of around £350m without fundamental restructuring | Additional cost savings require fundamentally restructuring the mail centre

network or reducing the number of delivery offices | Significantly increased entry and competition for second class mail likely | Key question: How would Royal Mail react to very strong incentives for

efficiency gains? Analysis suggests that Royal Mail would be likely to maintain a next day service even without a formal universal service requirement if it feared that the required cost savings were unachievable.

Single two day - 6 days


-£535m

Bulkmail Access

-£128m £30m


-£211m


-£107m -£38m

Single two day - 5 day

-£535m

-£633m

-£128m £30m

-£633m

-£211m

-£355m

-£340m -£38m

-£589m

NET AVOIDED COST

-£278m

-£44m


-£3,470m

-£549m

INIDICATIVE PRICE CHANGE (%, pence per item) 1C item 0.0% 2C item 12.2% Bulk 3.3% Access -11.0%

0.0 2.9 0.6 -1.5

0.0% 7.3% -0.1% -15.3%

0.0 1.8 0.0 -2.1

Total

1.4

1.7%

0.4

6.3%

FURTHER EFFECTS FOLLOWING PRICE CHANGES Volumes: Revenues: Market share

-92m -£27m Increase in entry

Figure 7: Net cost savings from introducing a single two day product, before fundamental restructuring of mail centres and delivery offices – 2006-07 Source: Frontier Economics, PLCWW

Results


Mail changes with a single two day product This scenario examines the option for a new single class of mail which is delivered two days after posting. We also include the option of removing the requirement for Saturday collections and deliveries and moving to a five day operation which would mean mail is delivered two working days after posting. Delivery days in each case are shown in Figure 8. A two day product could achieve a quality of service standard of 95% for stamped/meter mail and 94% for PPI, based on Royal Mail’s existing quality levels. Royal Mail currently outperforms its first class quality of service target by around 1% for stamped mail and so a revised QoS target for the two day mail product could be set at 94%. This is slightly higher than quality of service for first class and reflects the additional time available to process mail and greater use of road rather than air services; both effects can be shown to improve QoS within the existing network. A two day product would also have minimal constraints on delivery times. Almost all mail (except in some peripheral mail centres) would be inward sorted at the local mail centre by 19:00 the day before delivery. This provides the opportunity for walk sequencing and mail preparation to take place overnight, with staff recruitment essentially determining the earliest feasible delivery times. As with reductions in first class quality of service, the cost and revenue effects depend on whether Special Delivery remains a next day service. Maintaining a complete national network could cost up to £80m, but failure to invest in such a network would potentially expose Royal Mail to further revenue losses. X

X

Delivery - Current

Posting day

Two day product

1C

2C

Six days

No Saturday

Monday

Tuesday

Wed/Thu

Wednesday

Wednesday

Tuesday

Wednesday

Thu/Fri

Thursday

Thursday

Thursday

Fri/Sat

Friday

Friday

Friday

Sat/Mon

Saturday

Monday

Friday

Saturday

Mon/Tue

Monday

Tuesday

Saturday

Monday

Tue/Wed

Tuesday

Wednesday

Wednesday Thursday

Figure 8: Target delivery days for mail posted by day of the week Product specification for second class is three days after posting but over 90% was delivered within two days in 2006-07 Source: Frontier Economics/PLCWW

Revenue effects Royal Mail currently charges a large premium for first class mail relative to second class mail which it would lose with a single two day product. (For the purposes of estimating revenue changes in the first round, we assume Royal Mail charges the current second class price for the new product. We investigate in the assessment of second round effects whether that assumption is realistic.) This effect alone would cost Royal Mail over £500m based on 2006-07 data, although this is projected to fall below £500m by 2009-10 as Royal Mail predicts first class volumes will decline. Table 18 shows this effect. X

Results

X


The new product is also likely to see Royal Mail lose volumes and market share. | In our base case scenario, we have assumed that Royal Mail would lose 5% of

first class volumes, equivalent to £80m. This is based on the consensus from interviews that questions of how to send letters tend to dominate over questions of whether to send letters. However, there is a risk that the change could be more significant. A risk scenario in which 25% of first class volumes are lost would cost Royal Mail around £400m. | Also, entrants will be able to compete much more effectively for a two day

product than first class (which could have beneficial effects for those customers who have yet to experience the benefits of liberalisation). Based on entrants’ expected market shares for the equivalent second class products, the additional market share loss would have cost Royal Mail £23m in 200607. However, with greater market entry, this figure rises to £59m by 2009-10. The potential development of alternative end to end networks would mean that Royal Mail loses all the revenue associated with each product, not just the upstream component. With end to end entry, the revenue loss could reach £109m by 2009-10. 2006-07

2009-10 – Access

2009-10 – E2E

Revenues – two classes

£5,616m

£5,643m

£5,258m

1C volumes at 2C prices

-£527m

-£484m

-£488m

5% of 1C volumes lost?

-£83m

-£80m

-£78m

Market share loss

-£23m

-£59m

-£109m

Overall revenue loss

-£633m

-£623m

-£675m

20% increase in SD?

+£60m

+£70m

+£70m

Table 18: Change in revenues with a single two day product First round revenue effects before price changes Source: Frontier Economics, PLCWW

The final change in revenues depends upon the impact on Special Delivery. Our estimate is necessarily speculative, but removing first class altogether could lead to around £60m to £70m increase in revenues, based on a 20% increase in Special Delivery. This would only require a small switch of first class volumes. However, these revenue gains are speculative, may not materialise, and are dependent on Royal Mail investing a similar level of costs to maintain a national next day Special Delivery service.

Results


Cost effects Total revenue losses are therefore likely to exceed £600m. Royal Mail would be unlikely to achieve a similar level of cost reductions in the absence of radical reform of the mail centre, transport and delivery office network. Without radical reform, we estimate the maximum cost savings are around £355m, resulting in an overall NAC increase of £278m after revenue losses. The breakdown of savings is shown in Table 19. However, removing the requirement for Saturday deliveries could save a further £234m. The additional savings are largely in indoor and outdoor delivery and are similar to the savings outlined in the no Saturday service scenario above. X

Results

X


Pipeline

Description

Included in model?

Saving

Collection

Opportunity to reduce number of collection waves and reduce number of collection hubs

Only one relief collection per day for boxes and two per day for counters in urban areas, compared to three or four today. 20% better vehicle utilisation for feeder services to MCs

£56m

Outward processing

Longer processing time and no need to segregate mail

Based on current processing costs for second class mail taken from BPM

£65m

Transport

No night air network and associated costs, partly offset by road hub feeder services and hub costs – but opportunity to combine bulk and standard road networks

Small residual air network and improvement in road vehicle capacity to level achieved on second class network today. No services needed for airports, but higher volumes on road. No benefit assumed for combining bulk and standard networks

£99m

Inward processing

Two non-overlapping blocks of work – inward and outward – reduce costs by reducing changeover costs


£47m

Constant head of work improves processing productivity Feeder runs to DOs

Opportunity to reduce number of delivery waves and reduce number of delivery offices

20% better vehicle utilisation for feeder services to MCs

£30m

Indoor delivery (preparation)

More time available for indoor processing

Considered in more radical change option. Base model assumes small change due to volumes

£10m

Outdoor delivery

More time available for outdoor delivery


£11m

Overheads and nonpipeline costs

Based on elasticities in the BPM

£38m

Other

Table 19: Summary of net savings with a two day mail product – without major restructuring of the mail centre and delivery office network Source: Frontier Economics/PLCWW

Results


Potentially offsetting these cost reductions would be increases in costs associated with Special Delivery. Introducing a two day product would remove the national next day mail network for first class mail. If Special Delivery remains a next day product, the additional air costs would be similar to those needed under the first class quality of service reduction scenario, i.e. £25m for a network covering 98% of mail flows and up to £60m for a network covering 100% of mail flows. However, since there is no longer a national next day road network, the existing Safenet network (which carries Special Delivery volumes in central regions) would need to be extended to cover the whole country. We estimate that this would approximately double the existing Safenet costs of £17m. The total incremental costs of a next day Special Delivery service for the whole country would therefore be in the region of £80m.

Impact on prices With the limited cost savings available in the absence of radical reform, the single product price is likely to be above the existing second class price, even before additional Special Delivery costs. This could lead to: • reductions in mail volumes from customers currently using second class mail; and • considerably higher levels of market entry, as the headroom between access prices and second class mail prices would increase. Based on the volumes and revenues predicted above, the new single product price would be around 12%, or 3 pence per item above the current second class price. This is unlikely to be sustainable in the absence of a similar change in the access price. As a result, without the protection of first class, Royal Mail would have strong incentives to undertake a more radical reform of the mail centre and transport network. There are a number of areas where Royal Mail might look to take costs out but savings in property costs should be achievable. | The number of mail centres could be cut to around 25 (from 69 today), still

keeping most delivery offices within a 60 minute drive time (remaining distant delivery offices are generally no further away than today). This would increase the number of large mail centres and reduce the number of small ones. Historically, Royal Mail has had difficulty extracting economies of scale in mail centres, its large ones tend to be more costly per unit, but substantial changes in working practices and larger sites could provide the impetus needed. Annual property opex is estimated at £158m in 2009-10. 22 A reduction to 25 mail centres could potentially halve property costs, saving around £70m - £80m, although property costs are likely to vary on a case by case basis, requiring a more detailed assessment. TPF

TP

22 PT

Source: Royal Mail.

Results

FPT


| Similarly, substantial changes in mail preparation would be possible with a

new two day product, extending the existing changes that Royal Mail is making to delivery. Inward processing would be complete at mail centres by 19:00 the day before delivery. This would allow mail preparation and walk sequencing to be carried out overnight and concentrated in a smaller number of Delivery Offices than Royal Mail is currently planning. By completing most mail preparation overnight, the role of the remaining delivery offices could change, with reduced space for preparation, and more of a role as simple collection points. Annual property opex for DOs is estimated at £238m in 2009-10. With the same caveats as for mail centres, a substantial reduction in the size and number of DOs could save one third of this cost – a further £70m - £80m. | An increased reliance on preparation centres also means that increased

distribution costs are less of a worry with fewer mail centres. Mail centres no longer need to be connected by several waves of relatively small vehicles to almost every local Delivery Office. Instead, local preparation centres can act as local hubs with distribution to final DOs, with delivery waves able to wait until all mail is ready for delivery. Further savings are likely to come from operating costs in mail centres and mail preparation. In both cases, transformed operations with dedicated staff would allow further cost savings. | There are at least three areas where costs could be reduced in mail centres:

• smooth workflows throughout the day will minimise time spent switching from inward to outward processing; • longer time spans mean that machines would always be able to operate with a head of work increasing their overall productivity; and • consolidating first and second class mail streams and increasing the time available would allow the use of different sorting plans which minimise the total number of mail passes (inward and outward) required. | The pattern of working associated with a two day product should also assist

in achieving the maximum benefit from walk sequencing technology. Walk sequencing can only operate effectively once all the mail due for delivery has been received. There are currently time constraints on this process. Since all inward mail would be ready to leave the mail centre by 1900 on the evening before delivery, this effectively leaves a window of at least 11 hours for the remaining mail to be walk sequenced at the proposed preparation centres and subsequently conveyed to the delivery office. The increased time window may provide an opportunity to maximise the use of the walk sequencing machines planned for mail centres thus reducing the reliance on preparation centres. In theory, it should be feasible to sequence sort 100% of the mail at mail centres or at nearby locations providing sufficient machines could be sited there.

Results


These two areas could confidently be expected to allow cost savings of 5-10% relative to 2009-10 base costs based on operational assessments from PLCWW. This would translate into a saving of around £150m. These changes, combined with the property savings would secure the savings needed to offset the initial revenue loss, allowing Royal Mail to match the current second class price. If these savings can all be made to offset the initial revenue loss, removing the requirement for Saturday deliveries could save an extra £234m. This would result in a positive NAC and broad-based price cuts of around 5% relative to the existing second class price.

Transition costs Transition costs are likely to be significant in the move to a single two day product. Based on the limited achievable cost savings that we have modelled, redundancy costs could be £235m under a six day service or £508m with no Saturday deliveries or collections. As before, delaying redundancies to get the benefit of one to two years’ natural staff turnover significantly reduces total liabilities. However, it would also be important to understand other transition costs in more detail including the time scale over which changes in mail centre size and location are possible and the contingency plans required to continue mail processing during transition (e.g. running dual mail centres for a time). Scenario

Change in FTEs required

Maximum redundancy costs

After 1 year’s attrition

After 2 year’s attrition

Single two day – six day service

-7,300

£235m

£124m

£48m

Single two day – no Saturdays

-15,700

£508m

£263m

£67m

Table 20: Potential redundancy costs based on projected typical redundancy payments and employee numbers in 2009-10 (using access scenario) Source: Frontier Economics

Assessment The outcome of this scenario depends to a large extent on how Royal Mail would be expected to react to its changed environment and its strong incentives to cut costs. At present, first class mail is relatively uncontested by entrants who are unable to match Royal Mail’s national next day network at a competitive price. Removing first class would allow entrants to compete more vigorously for this mail and would remove the first class price premium. If it proved unable to strip out costs, Royal Mail could face a vicious circle of high prices leading to lost mail volumes and market share; revenues needing to be recovered from a small volume base; and further price rises. In addition, there is a question about how fast Royal Mail would be able to adapt to the changed market conditions by reducing its legacy cost base which means that transition effects would be essential to understand in more detail if this were to be adopted

Results


as a policy option. But the consequences of failing to adapt should provide strong incentives to reduce costs to a level at which Royal Mail could maintain mail volumes and compete effectively with alternative operators. This analysis also implies that Royal Mail would be likely to maintain a next day service even without a formal universal service requirement, especially if it feared that the required cost savings were unachievable. The main determinant would be the allocation of costs between a (universal service) two day product and a (non- universal service) next day product, given substantial economies of scope between the two.

4.4

COLLECTION AND DELIVERY TIMES Key points

| Not legally part of the universal service, but part of Royal Mail’s custom and

practice that may affect costs | Earlier deliveries/later collections would increase costs by more than they

increase revenues | Later deliveries/earlier collections would not allow significant cost reductions | Limited restructuring or second round effects

Delivery 1 hour earlier

CHANGE IN REVENUES Item mail Bulkmail Access

£13m

£27m

£13m

£0m £0m


£97m


£4m £2m

£7m £5m

Delivery 2 hours later

-£13m

£27m

£0m £0m

-£27m

-£13m

-£12m

£141m

-£4m -£2m

£0m £0m

-£27m

-£32m

-£18m

-£7m -£5m

-£43m

-£90m

-£114m

£5m

£16m

-£1,425m

£59m

£205m

1.6%

0.5 0.3 0.3 0.2

1.6% 1.6% 2.4% 2.4%

0.6 0.4 0.5 0.3

-0.2% 0.3% -0.2% -0.1%

-0.1 0.1 0.0 0.0

-0.6% 0.5% -0.5% -0.2%

-0.2 0.1 -0.1 0.0

0.3

2.0%

0.4

-0.1%

0.0

-0.3%

-0.1

FURTHER EFFECTS FOLLOWING PRICE CHANGES Volumes: -118m Revenues: -£36m Market share Neutral

-156m -£47m Neutral

Figure 9: Net cost savings from changing delivery times Source: Frontier Economics, PLCWW

Results

Delivery 1 hour later

-£1,119m

INIDICATIVE PRICE CHANGE (%, pence per item) 1C item 1.4% 2C item 1.4% Bulk 1.8% Access 1.8%

Total

£0m £0m

£129m

£103m

NET AVOIDED COST Capitalised NAC (@ 8%)

Delivery 2 hours earlier

10m £5m Neutral

25m £13m Neutral


Collection 1 hour later


£3m

Bulkmail Access

£0m £0m


£69m


£1m £1m

Collection 1 hour earlier

-£18m

£3m

-£36m

£0m £0m

-£18m

£0m £0m

-£21m

-£10m -£6m

-£13m

£71m

Collection 2 hours earlier

-£36m

-£33m

-£5m -£3m

-£49m

NET AVOIDED COST

-£67m

£3m

£12m


-£842m

£34m

£156m

INIDICATIVE PRICE CHANGE (%, pence per item) 1C item 1.2% 2C item 1.1% Bulk 1.3% Access 1.2%

Total

1.2%

0.4 0.3 0.2 0.2

-0.1% 0.4% -0.2% -0.1%

0.0 0.1 0.0 0.0

-0.5% 0.8% -0.6% -0.2%

-0.2 0.2 -0.1 0.0

0.3

0.0%

0.0

-0.2%

0.0

FURTHER EFFECTS FOLLOWING PRICE CHANGES Volumes: -85m Revenues: -£26m Market share Neutral

11m £5m Neutral

28m £13m Neutral

Figure 10: Net cost savings from changing collection times Source: Frontier Economics, PLCWW

Revenue effects Incremental changes to delivery times seem unlikely to lead to material shifts in mail volumes. Our base case estimates, derived from market research, suggest that changing mail deliveries by an hour would cause a change in revenues of around £13m, based entirely on changes in item mail. However, even this may be an over-estimate; we are not aware of research that links recent changes in actual and perceived delivery times to mail demand. Changes in collection time may be more significant, although we assume they only affect item mail, and that bulk mail collected via the RDC network is unaffected. The impact is likely to be asymmetric: • earlier collection times are disliked by businesses and are estimated to reduce revenues by £18m for every hour they are advanced; • later collection times are not valued by households, and are of only marginal benefit to businesses; implying a net revenue increase of £3m.

Cost effects We identify the various places in the mail pipeline where cost changes may be made in response to time changes in section 3.3.3. As we discussed, Royal Mail does not operate a greenfield network and we therefore consider incremental changes to its existing pipeline. X

Results

X


We assume that additional time is taken within the transport network. Two hours extra time allows around one third of volumes that currently use air services to switch to road services. However, this translates into a relatively small reduction in costs – around £26m with two hours and £10m with one hour. This is because air services cannot be stopped completely until all mail centres using an airport are able to connect by road. In almost all cases, a two hour increase in time is insufficient to allow all mail centres to connect. Consequently, some planes can be withdrawn where there is spare capacity, but few network links can stop. Alternatively, extending delivery spans beyond the current 3.5 hours could secure cost savings by allowing more time to be spent delivering mail relative to travel to and from delivery routes (“stem times”). Longer delivery spans would also allow fewer delivery routes which could reduce mail preparation costs. Overall, increasing delivery spans by an hour could reduce costs by around £30m. Given concerns around fatigue/impact of longer walks on sick leave, we have based our NAC calculations on the cost reductions available from the transport network. Conversely, it would not, in general, be possible to absorb less time in the transport network, even if extra air services were included as the time window is too short for flights to be quicker, once travel to airports and mail screening are taken into consideration. Equally, delivery schedules are based around an eight hour shift from mail arriving from the mail centre to final delivery times. Reducing the time period for deliveries without altering the time at which mail arrives from mail centres risks complicated negotiations in trying to move labour shifts away from an eight hour day. Consequently, we have examined the cost implications of reducing processing time in mail centres. In this, we are limited by the fact that local factors, such as the mix of local and non-local mail, or the regional characteristics of collection and delivery areas will affect the ease with which individual mail centres are able to respond to the reduced time available. A full assessment would therefore require relatively detailed information for a wide range of mail centres. This detailed assessment would not be appropriate for the purposes of this project. Instead, we have made an in depth assessment of how one particular mail centre – Milton Keynes – would be affected. While recognising the limitations of this approach, it provides an indication of the scale of the costs that are likely to be incurred in reducing time windows. Scaling up to reflect all mail centres, we estimate that reducing the outward processing window by one hour would cost £69m, reducing the inward processing window by one hour would cost £94m and reducing both by one hour would cost £124m.

Results


4.5

REMOVING BULK MAIL FROM THE UNIVERSAL SERVICE

Royal Mail already provides many bulk mail products without a formal universal service obligation. For example, Mailsort 2 1400 is part of the universal service while Mailsort 2 700 is not. Royal Mail has asked for the remaining bulk mail products within the universal service – Mailsort 1400 1 & 2 and Cleanmail 1 & 2 – to be withdrawn now as well. We have approached the assessment of Net Avoided Cost somewhat differently in this scenario from the others. There is no immediate set of costs unique to Mailsort 1400 and Cleanmail that Royal Mail could avoid by stopping providing these two products. Moreover, if a “NAC” were found to be associated with particular bulk mail products, it would be more likely to be the result of pricing misalignment meaning that a product was priced below the appropriate level than any genuine effect of universal service constraints. However, one key policy question that our analysis answers is: Would Royal Mail continue to provide a bulk mail service in all areas, in the absence of zonal prices? Our analysis suggests that – as long as Royal Mail retains a universal service obligation to deliver other mail in all areas – the answer is yes. Table 21 shows the potential cost savings for Royal Mail if it stopped bulk deliveries but maintained deliveries for other mail types. It shows that the potential savings are small relative to the revenues it receives from bulk mail. The revenue loss significantly outweighs the cost saving, even allowing for costs other than delivery. Our analysis suggests that this is true in all of Royal Mail’s current delivery zones. X

X

Value Outdoor delivery costs Cost saving with no bulk mail Current revenues from bulk mail

Results

£1,470m

Table 21: Outdoor delivery costs and bulk mail revenues

£250m

Source: Frontier Economics, PLCWW

£2,035m


4.6

EVENING PACKET DELIVERY SERVICE

An evening packet delivery service is likely to cost around £1 per item. This would be for a service one evening a week that delivers any items that were undelivered in earlier rounds – primarily packets but also Special Delivery or other items requiring a signature. There is nothing to prevent Royal Mail from introducing a service along these lines at the moment, but additional provisions around packets could form part of a future universal service. Royal Mail has only limited information about the volume of undelivered items which makes it hard to assess the total cost of an evening packet service. Based on a two week sample in fifty Delivery Offices in September 2006, Royal Mail has extrapolated that around 38m items were undelivered in 2006-07, of which 31m were packets and 7m were Special Delivery items. | An evening delivery service would be in addition to other ways to pick up

parcels. 84% of customers pick up items from a Delivery Office today and if most customers pick up items quickly – ahead of the weekly round – volumes could be as low as 5m items per year, with an annual cost of £6m. | If more customers take advantage of the new service and do not use

alternative pick up facilities, total volumes using the service could be 19m items per year, or £18m per year. The average cost in this case would be £0.93 per item. | Packets and fulfilment traffic are expected to grow strongly in the future.

Allowing for substantial growth to an annual level of 50m items, the annual cost would grow to £40m per year with an average cost of £0.80. We have not investigated the options for revenue recovery in detail, although existing Royal Mail research is sceptical about the ability to raise revenue, and it may be hard to charge recipients for mail, or senders for a service they do not know will necessarily be needed. Mail volumes (p.a.)

Annual cost

Cost per item

5m

£6m

£1.22

19m

£18m

£0.93

50m

£40m

£0.80

Table 22: Cost of an evening packet delivery service Source: Frontier Economics, PLCWW

Results


5 Summary, implications and next steps We noted in the Executive Summary to this report that the results of this exercise could feed into three broad areas of interest to stakeholders. | Constraints: some elements of the universal service are broadly aligned with

Royal Mail’s commercial incentives, whilst other requirements impose greater constraints, and costs, on Royal Mail. | Prices: changes in the universal service may contribute to changes in relative

prices or the overall price level. | Scope: an understanding of the net costs of aspects of the universal service

can contribute to an assessment of whether the scope of the universal service continues to be consistent with customers’ needs. Table 23 presents a summary of the key outputs for the main scenarios. X

X

Cost change

Revenue change

NAC

Capital’d NAC

Price impact

Stamp price

Annual

Annual

First round

@ 8%

(overall)

1C/2C stamp

-£326m

-£55m

£271m

£3,389m

-4.8%

85% (S/M) 78% (PPI)

-£116m

-£40m

£76m

£946m

-1.4%

Single two day product

-£355m

-£633m

-£278m

£3,470m

6.3%

+2.9p (2C)

Single two day product, no Saturday collections and deliveries

-£589m

-£633m

-£44m

-£549m

1.7%

+1.8p (2C)

90% (S/M)

-£49m

-£15m

£34m

£426m

-0.6%

Delivery times two hours later

-£43m

-£27m

£16m

£205m

-0.3%

Delivery time two hours earlier

+£141 m

+£27m

-£114m

£1,425m

+2.0%

Evening packet deliveries

+£18m

small

-

-

Specification change

No Saturday collections and deliveries Reduce 1C QoS

Reduce 1C QoS

Summary, implications and next steps

-1.0p -0.0p -1.0p

-0.1p -0.4p -0.2 +0.1p +0.6p +0.4p

Approx £1 per item

Table 23: Impact on Royal Mail of changes in the universal service specification Source: Frontier Economics, PLCWW

-1.7p


Of all the scenarios we have considered, only the universal service requirements for Saturday collections and deliveries imposes a significant constraint. Maintaining first class quality of service at its current level also imposes a constraint, but if the constraint were relaxed, it is likely that Royal Mail would continue to incur many of the costs currently caused by first class QoS, but these would instead be driven by the requirements of the Special Delivery product. Thus, in these two cases, and for different reasons, removing the constraints of Saturday delivery and 93% QoS would have an impact on prices. The first would be a 1-2p reduction on the stamp price arising out of a fall in the cost base. The second would lead to a modest decrease in the stamp price (less than 1p) but this would be likely to be offset by an increase in the price of Special Delivery, arising out of a re-attribution of costs. The efficiency of Royal Mail and the flexibility of its working arrangements also have a bearing on the net costs of the universal service. One of the benefits of removing the requirement for Saturday deliveries, for example, is the smoothing of mail flows over the week that result in a smoother work profile. However, this could equally be achieved by more flexible work patterns that accommodated the current, peakier, work profiles. We estimate this benefit to be worth c£45m, around 16% of the NAC of removing the requirement for the Saturday delivery. This raises the question whether the relatively modest cost savings obtained by removing services or products from the universal service could be accessed through different channels. This point is particularly significant when considering whether there should be a shift to a two day mail product. As we have seen, this will have a significant revenue impact on Royal Mail, but equally there could also be a very large cost reduction if Royal Mail were able to re-optimise its mail centre and delivery office network. However, the view of our operational experts is that many of the cost savings could be achieved without modifying the universal service, since the current configuration of mail centres and delivery offices is a legacy of previous decisions and would not be necessary even under current service specifications. This is particularly the case in the Delivery Office network where investments in walk sequencing and part-time employment may offer opportunities for change. The key challenge for Postcomm is how to access these savings without a change in the universal service that would also have an offsetting revenue impact. In this sense, it is useful to compare the potential savings with efficiency factors that are applied at price control reviews. Given a base level of costs of £6.5bn (Royal Mail’s actual costs in 2006-07 were £6.64bn) then, with everything else equal, a 2% efficiency target per year for a four year price control would reduce overall costs by £505m p.a. after 4 years. This is more than the cost reduction assumed in the single two day product scenario.



1% p.a.

2% p.a.

3% p.a.

Base

£6,500m

£6,500m

£6,500m

Year 1

£6,435m

£6,370m

£6,305m

Year 2

£6,371m

£6,243m

£6,116m

Year 3

£6,307m

£6,118m

£5,932m

Year 4

£6,244m

£5,995m

£5,754m

Total efficiency

-£256m

-£505m

-£746m

Table 24: Potential efficiency savings with a cost base of £6.5bn Source: Frontier Economics

We recommend that at the price control review, Postcomm may not only wish to consider generic productivity increases that could be applied, but also to interrogate particular aspects of Royal Mail’s pipeline. We understand that at the last review, the efficiency analysis took the number of mail centres and delivery offices as given from Royal Mail’s SPM, and then evaluated the efficiency of those facilities. In our view, it would be worthwhile for Postcomm to also investigate whether the configuration of the network of delivery offices and mail centres is as efficient as it could be, and the time required to move towards a more efficient network. As part of this exercise, it would also be relevant to explore whether Royal Mail is able to improve the flexibility of its working arrangements so that the universal service is provided efficiently. In summary, this study is largely supportive of earlier work that suggests that the constraints imposed by the universal service are modest. Although we have not considered the other main constraint – the universal geographic delivery coverage – our analysis and model could be extended to that dimension as well. That analysis would be relevant to inform Postcomm on the efficiency with which that particular element of the universal service is being undertaken. It would also be relevant to establish the extent to which significant end to end entry, which has not been observed to date, could leave Royal Mail with obligations it may be unable to internally finance.



Annexe 1: The methodological basis of the NAC approach This annexe sets out how our approach to the costing of specific universal service obligations (USO) fits in the academic literature. It reviews our approach from two perspectives in two sections. | Methodology: this section recaps the methodologies that were developed for

costing the USO in the late 1990s and finds that Frontier carries out a net incremental cost analysis as recommended by academics for this type of exercise. | Application: this section confirms that Frontier’s analysis allows an

assessment of the USO from a different regulatory angle to other applications in the literature and appears to be the first application to use an engineering cost model to estimate overall costs.

COSTING THE USO METHODOLOGY

Two approaches emerged in late 1990s Two overarching approaches for costing the USO in post emerged in the late 1990’s – the NAC and the EP approaches as depicted in Figure 11 23 . X

XTPF

FPT

| The Net Avoided Cost (NAC) approach measures the difference between a

company’s profits associated with the provision of the USO and the profits without the provision of the USO under a given market environment (monopoly or competition). The focus of this approach is on the unprofitable services that the universal service provider (USP) has to provide under the USO. | The Entry Pricing (EP) approach measures the difference between the profits

associated with the provision of the USO under monopoly (or a reserved area) with the profits associated with the provision of the USO under competition. The focus of this approach is on the extent to which the profitable services, which are currently priced above costs, can be expected to contribute less to the USP as the market is being liberalised.

But each approach addresses a different set of policy questions The EP and NAC approaches aimed to support the same debate on the progressive abolition of the reserved area at the time, but addressed different questions.

23 TP

PT

We concentrate our review on approaches for costing the USO for the universal service provider rather than the welfare approaches for costing the USO for society (Dobbs et al (1995); Cremer, De Rycke and Grimaud (1997) and Crew and Kleindorfer (1998).

Annexe 1: The methodological basis of the NAC approach


| A NAC measure of the USO cost answers the question: “how much should

the USP be paid for providing the USO?” This approach to the postal sector was put forward by Nera (1998) and by Cave (1995) in the telecoms sector. | An EP measure of the USO cost answers the question: “Will the incumbent be financially viable whilst continuing to provide the USO in a more liberalised market?” This approach was proposed by Rodriguez et al (1999).

p mu NAC under monopoly

With full USO (X dimensions)

Competition EP

p cu NAC under competition

Monopoly

Without full USO pm

p cc

Figure 11: USO cost methodologies

NAC under competition: the recommended methodology for the cost of USO There is general agreement nowadays that the NAC approach is appropriate to assess the net burden of the USO on the USP. The literature has clarified the terminology whereby one needs to distinguish the “cost of the USO” as given by a NAC approach, from the “cost of liberalisation” as given by the EP approach. (Cremer et al (2000), Panzar (2001), Crew and Kleindorfer (2005) and Ambrosini et al (2006). In addition, Gallet et Toledano (1997), Panzar (2001) and Cremer et al (2000) stressed that a NAC exercise ought to take account of the competitive postal market environment that prevails or will prevail at the time a USO cost needs to be estimated. This point led Cremer et al (2000) to introduce the concept of “Profitability Cost” so as to distinguish a NAC under competition from that of a NAC under a monopoly.



Frontier’s approach: the net incremental cost of changes in the universal service specification Our work measures the difference between the profits associated with the provision of a service under all universal service obligations with the profits of a service with an alternative set of universal service obligations under an assumed level of competition. This net incremental cost analysis matches that of the NAC methodology. A positive net incremental cost implies that the USP is better off in providing the obligation commercially whereas a negative net incremental cost implies that the obligation is a financial burden on the USP. Frontier’s work does not measure “the net cost of the universal service” as defined above but measures “the net cost of changing the universal service specification” – which perhaps could be more conveniently described as ∆ USO. We measure the net incremental cost of one obligation rather than the net incremental cost of the overall universal service. Here we measure the costs that could be saved if all of the USP’s customers were deprived of the element of the universal service in question 24 . TPF

FPT

Our measure seeks address three regulatory questions: • Which universal service elements most significantly constrain Royal Mail? • How much are Royal Mail’s price levels driven by universal service constraints? • Are the costs of the universal service consistent with customer needs? The analysis also contributes to the more recent academic literature that suggests regulators may be called upon to take one of two decisions following market entry: either establishing a funding mechanism to maintain the existing universal service; or narrowing the scope of the universal service such that the burden can be met with internal funds. (Rutgers’ conference, “Liberalisation of the Postal and Delivery Sector” (2007)).

APPLICATION The undertaking of a USO costing type exercise presents some challenges. Overall for any net incremental costs analysis, one needs to obtain the dataset that depicts the USP with its current USO provision and the hypothetical dataset that depicts the USP without the USO altogether or with a modified USO. Each dataset is concerned with demand features (volumes, mix, mail destination) and supply features (prices and costs of both USP and entrants). In this section, we review Frontier’s approach and those published in academic journals.

24 TP

PT

For an estimation of the “cost of the universal service”, one needs to measure as expressed by Panzar (2001), the costs saved of the USP no longer providing delivery to a subset of customers, or no longer providing service to a subset of customers at a loss.



Features of Frontier’s application of the NAC under competition A bottom up approach to the calculations of costs of USPs An innovation in our application is the development of an engineering cost model capturing both operational standards and economic principles applying in post. This tool allows us to evaluate the costs that could be saved with the removal of one particular obligation. Our engineering model captures the current features of Royal Mail operations in terms of number of Mail Centres, delivery offices, planes used for First Class products, etc. We then attempt to establish the optimal/best operational changes that would follow the removal of a USO and derive its associated costs. As a result our counterfactual scenario of a USP with a modified USO is made of a consistent hypothetical dataset: volumes, prices (with simple allocation of cost saving rules) and costs are adjusted to capture demand and supply responses.

Features of USO estimations in the academic literature Overall and specific obligation costing The quantifications of the USO cost have mainly been concerned with the provision of the full USO (i.e. with all its elements) under both the EP and NAC methods. These have been undertaken in various countries: Bradley and Colvin (2000) for USPS; Cremer, De Rycke and Grimaud (1997) and Cremer, Grimaud et Laffont (1999) for La Poste (France); Elsenblast, Peiper and Stumpf (1995) and Kowalski and Muller (1995) for Deutsche Post (Germany); Rodriguez, Smith and Storer (1999) for Royal Mail (UK) and Castro and Maddock (2000) for Australia, and Santos et al (2006) for the Portuguese Post (CTT). Boldron et al (2006) appear to be the only authors seeking to quantify the costs of specific obligation of the universal service so far. They elicit the extent of the constraint of six deliveries as opposed to five on the USP through an international comparison. Their exercise does not take account of revenue effects, nor competitive behaviour and no re-optimisation of the number of deliveries is undertaken.

Engineering models, historical accounting data and econometrics For these estimations of the cost of the USO, economists have typically been left with relying upon historical accounting data. These have two main shortcomings for such exercise: historically they are unlikely to be good proxy of costs in a full liberalised market, and they cannot be flexed to capture the costs of the USP without the USO. LRIC models have mainly been developed for part of the networks and been used for outdoor delivery costs (Roy (1999). A number of econometric pieces of analysis of parts of the network have also been carried out by Cazals et al (2005, 2006) and Bradley et al (1995, 2001). A proposal for LRIC models covering the full pipeline, with similarities to that of Frontier Economics, has been presented by Soares et al (2002).



SUMMARY The approach to estimating the cost of modifying the USO is, judging by the literature, relatively novel. However, the application is consistent with the principles of NAC costing established in the USO literature, and the increasing use of LRIC models used in other sectors and for other purposes.

REFERENCES Bradley, M. D., and Colvin, J. (2000), “Measuring the Cost of the universal services for Posts”. In M.A. Crew and PR. Kleindorfer (eds), Current Directions in Postal Reform , , Boston MA: Kluwer Academic Publishers. Bradley, M. D., and Colvin, J. (2001), “The Role of the Monopoly Product in the Cost of universal service”. In M.A. Crew and PR. Kleindorfer (eds), Future Directions in Postal Reform , Boston MA: Kluwer Academic Publishers. Bradley, M. D., and Colvin, J. (1995), “An Econometric Model of Postal Delivery” In M.A. Crew and PR. Kleindorfer (eds), Commercialization of Postal and Delivery Services , Boston MA: Kluwer Academic Publishers. Boldron F., Joram D., Martin L. and Roy B. (2006), “From the Size of the Box to the Costs of universal service Obligation: A cross-Country comparison”, In M.A. Crew and PR. Kleindorfer (eds), Liberalisation of the Postal and Delivery Sector , Boston MA: Kluwer Academic Publishers. Castro, M., and Maddock, R. (1997), “The universal service Obligation for Post: Some Australian Calculations”. In M.A. Crew and PR. Kleindorfer (eds), Managing Change in the Postal and Delivery Industries, Boston MA: Kluwer Academic Publishers. Cazal, C., Florens, J-P. and Roy, B. (2006), “An Analysis of Some Specific Cost Drivers in the Delivery Activity”. In M.A. Crew and PR. Kleindorfer (eds), Future Directions in Postal Reform, Boston MA: Kluwer Academic Publishers. Cazal, C., Feve, F. and Florens, J-P. (2005), “Delivery Costs for Postal Services in the UK: Some Results on Scale Economies with Panel Data”. In M.A. Crew and PR. Kleindorfer (eds), Regulatory and Economic challenges in the Postal and Delivery Sector, Boston MA: Kluwer Academic Publishers. Cazal, C., Feve, F. and Florens, J-P. and Roy, B. (2005), “Delivery Costs II: Back to Parametric Models”. In M.A. Crew and PR. Kleindorfer (eds), Regulatory and Economic challenges in the Postal and Delivery Sector, Boston MA: Kluwer Academic Publishers. Cazal, C., Feve, De Rycke, R., Florens, J-P and Rouzaud, S. (1997), “Scale Economies and Natural Monopoly in the Postal Delivery”. In M.A. Crew and PR. Kleindorfer (eds), Managing Change in the Postal and Delivery Industries, Boston MA: Kluwer Academic Publishers. Cave, M. (2000),“Meeting universal service Obligations in Competitive Telecommunications Markets: Lessons for the Postal Sector”. In M.A. Crew and PR. Kleindorfer (eds), Directions in Postal Reform , Boston MA: Kluwer Academic Publishers.



Cremer, H., De Rycke, M., and Grimaud, A. (1997), “Costs and Benefits of universal service Obligations in the Postal Sector”. In M.A. Crew and PR. Kleindorfer (eds), Managing Change in the Postal and Delivery Industries, Boston MA: Kluwer Academic Publishers. Cremer, H., Grimaud, A., and Laffont J.J. (2000), “The Cost of the universal service in the Postal Sector”. In M.A. Crew and PR. Kleindorfer (eds), Directions in Postal Reform, Boston MA: Kluwer Academic Publishers. Dobbs, I., and Golay, J. “universal service Obligation and Reserved Sector”. In Cost of universal service, edited by Ulrich Stumpf and Wolfgang Elsenblast. Papers presented at the 3rd Kongswater Seminar, WIK Proceedings. P

P

Elsenblast, W., Pieper, M., and Stumpf, U. (1995), “Estimating the universal service Burden of Public Operators.” WIK Discussion Paper N. 150. Kowaleski and Muller. “The Cost of universal service Obligations – the German Perspective. In Cost of universal service, edited by Ulrich Stumpf and Wolfgang Elsenblast. Papers presented at the 3rd Kongswater Seminar, WIK Proceedings. P

P

Rodriguez, F., Smith, S., and Storer, D. (1999), “Estimating the Cost of the universal service Obligation in Postal Service”. In M.A. Crew and PR. Kleindorfer (eds), Emerging competition in postal and delivery services, Boston MA: Kluwer Academic Publishers. Robinson, R. and Rodriguez, F. (2000), “Liberalisation of the Postal Market bad the Cost of the universal service Obligation: some estimates for the UK”. In M.A. Crew and PR. Kleindorfer (eds), Current Directions in Postal Reform , Boston MA: Kluwer Academic Publishers. Santos R. G., Pimenta A.and Henriques S. B.,“Assessing (2006), “The Cost of the Portuguese Postal Network, Practical Cost Evaluation of a universal service Obligation and Other Applications”. In M.A. Crew and PR. Kleindorfer (eds), Progress Toward Liberalization of the Postal and Delivery Sector, Boston MA: Kluwer Academic Publishers. Soares J., Confraria J. and Pimenta A. (2002), “Postal Services Cost Modeling”. In M.A. Crew and PR. Kleindorfer (eds), Postal and Delivery Services – Pricing, Productivity, Regulation and Strategy, Boston MA: Kluwer Academic Publishers. Panzar, J.C. (2001), “Funding universal service Obligations: the costs of liberalization”. In M.A. Crew and PR. Kleindorfer (eds), Future Direction in Postal Reforms , Boston MA: Kluwer Academic Publishers.



Annexe 2: Estimating demand effects This Annexe describes the methodology we have used to evaluate the impact of modifications to the universal service on Royal Mail’s volumes and revenues.

OVERVIEW We have considered four possible changes to the universal service: • first class quality of service (QoS) targets (reduction associated with removing parts of the air network); • the number of collections and deliveries per week; • the timing of collections and deliveries (forward or backwards by up to two hours); and • the class of mail (current first and second class item mail classes or a single two day service). The overall structure of our analysis uses a net avoided cost (NAC) methodology in two stages, as discussed in section above. | First round: we hold prices fixed and allow volumes to change in response

to the modified universal service, giving new revenues and costs and thereby a first round NAC. | Second round: net cost savings, if achieved, are reflected through lower

prices – determined by attributing revenues and savings to broad pipeline components. Our model therefore contains three distinct effects through which a modification to the universal service might affect volumes and revenues. | Non-price demand effect:

mail volumes and mix may vary directly in response to a modification of the universal service specification.

| Non-price market share effect: the proportion of mail being carried by

Royal Mail end to end, under access agreements and by alternative end to end bypass providers may vary. This will reflect the following considerations: • aggregate market shares may change as mail volumes switch between more- and less-contested mail routes; and • market shares for individual routes may change in response to modifications to the non-price characteristics of the universal service. | Price effects: Volumes, product mix and market entry may vary further in

response to price changes resulting from changes in costs. The demand effect and market share effect are estimated in the first round of the NAC model. The price effect is estimated in the second round following redistribution of any first round net cost savings being reflected in lower prices.

Annexe 2: Estimating demand effects


In estimating the magnitude of these effects we have drawn on a number of information sources. Where possible we have used econometric evidence of customer behaviour, but have also drawn on survey evidence and discussions with mail users. However, the evidence available to assist in estimation of non-price demand effects is limited. Consequently, the volumes responses used in our model are somewhat uncertain. We have addressed this in a number of ways. | First, we have run a set of scenarios around our central estimates to assess the

sensitivity of our results to different assumptions. These scenarios are, simply, to double the magnitude of the demand effect on the one hand, and to halve the magnitude, on the other. | Second, we have undertaken specific scenario analysis around our

assumptions regarding Special Delivery. Since the average revenues received by this product are significantly higher than for other products, the impact of a universal service modification on Royal Mail’s revenues is sensitive to any changes in Special Delivery volumes. This is particularly relevant in the case of first class quality of service reductions and moving to a single class of mail. | Third, we have considered the possible impact of shifts in customer

behaviour which are larger and more fundamental than have been analysed within our model. Under such ‘worst-case scenarios’, the consequences of modifying the universal service may be greater than those estimated by our model.

MODELLING FRAMEWORK We estimate the impact of each of the three above demand effects separately. However, in each case we use a very similar model which captures the own- and cross-product effects in response to price/non-price changes. Further, to ensure consistent treatment of demand estimation, we follow the same approach (and undertake the same basic calculations) under each of the three market scenarios. We have made two simplifying assumptions that enable us to model demand effects in a straightforward but still robust way. | Limited substitutes: we assume that there are only limited substitutes for

each mail item. Specifically, in response to the changes in service specification that we are simulating, customers will consider alternative classes of mail and whether or not they wish to mail the item at all, but will not consider changing other mail characteristics, such as mail destination, format or weight. | Overall mail demand is based on Royal Mail’s service characteristics:

we have assumed that overall market volumes, and the mix of volumes between products, are determined by Royal Mail’s service specification. This implies that changes in the universal service affect demand for mail handled by entrants as well as demand for Royal Mail products. This assumption is realistic in the case of, for example, first class mail (where RM volumes are close to overall market volumes). In our view it is also a reasonable



simplifying assumption where RM volumes and market volumes are different (such as second class bulk mail), as we then revise our estimates of market shares (i.e. entry) in response to the change in universal service specification to take into account any differences in non-price characteristics between Royal Mail and entrants. This methodology means that market shares remain consistent with those predicted by our Competitive Postal Market Model (CPMM) for any given set of price and non-price characteristics. We consider that neither of these assumptions induces an unacceptable bias in the results and that the additional complexity required to model these switching effects in greater detail would not be appropriate for this project. The remainder of this Annexe is in three sections. First we present the methodology used to estimate the non-price demand effects (which occur in the first round) and the evidence from which we draw the parameters of our model. This section also discusses the non-price market share effects. We next present the results of these first round effects. Finally, we present the methodology and evidence used to estimate the second round price effects, and also the results of these effects.

FIRST ROUND (NON-PRICE) EFFECTS In evaluating the demand effect associated with a change in the universal service specification, we are realistic about the degree of accuracy which we are able to achieve. The service specification changes that we are considering have not been experienced before in the UK. In most cases, therefore, there is no directly relevant historic information that we can use in order to estimate demand effects. Instead, we have to integrate partial information from a range of sources. In doing so, we have been guided by an approach proposed by Royal Mail: the “pyramid approach”. The pyramid approach suggests a ranking of alternative information sources: • where there is direct evidence of revealed preference – such as econometric or other statistical evidence of demand changes – this should be given a strong weighting; • the next strongest weighting should be given to quantified market research with stated preferences which can be scaled using insights from the revealed preference data; and • in the absence of direct quantitative evidence, a reasonable assessment needs to be made from qualitative information sources. This section outlines the use we have made of the pyramid approach in estimating non-price demand effects in response to universal service changes.

Econometric evidence In order to estimate the impact on market volumes and revenues as a result of the demand, market share and price effects, we first draw on available econometric evidence. This is the ‘top tier’ of the pyramid. Here, we have used Royal Mail’s Inland Letter Traffic Model (ILTM) which provides revealed preference evidence in two particular areas:



| Price elasticities:

the ITLM contains estimates of own- and cross-price

elasticities. | Quality of Service elasticities: the ILTM reports estimates of how mail

demand varies in response to changes in quality of service. The price elasticities are used in the context of the price effects in the second round. First, we discuss the use of quality of service elasticities and other nonprice demand parameters. The quality of service elasticities contained within the ILTM provide evidence on the overall responsiveness of customers to changes in quality. However, historic data does not allow the econometric evidence to discriminate between quality of service changes in different classes of mail. The econometric estimates provided by the ILTM therefore need to be interpreted carefully for use in our simulation model. Taken at face value, the ILTM results suggest that when first class quality of service has (historically) improved by one percentage point this has led to no change in first class mail volumes and an increase in second class mail volumes of around [excised]. This suggests that, for example, a 10 percentage point reduction in first class quality of service would have no effect other than a [excised] decline in second class volumes. Though these effects may appear counterintuitive at first blush, we believe there is a natural explanation of this result. Most of the historic change in quality of service was associated with the introduction of automation. This caused first and second class quality of service to increase in parallel. More generally, first and second class quality of service have tended to move in similar directions making it very hard to identify the impact of first and second class quality of service separately – the econometric problem of multicolinearity. In general, multicolinearity can cause problems in econometric estimation, particularly in terms of which estimated variables are found to be significant. Consequently, the econometric evidence is consistent with another interpretation which we have used for the purposes of our modelling. This is that decreases in first class quality of service lead to a reduction in first class mail volumes and a switch of some volumes to second class. However, simultaneous reductions in second class quality of service lead other second class volumes to switch to first class mail, leaving first class mail volumes neutral overall and second class volumes lower. In other words, the most reliable information from the ILTM may be that simultaneous reductions in first and second class quality of service by 1% would reduce overall mail volumes by [excised]. 25 We have therefore parameterised the demand effect on this basis, as we discuss in more detail below. TPF

FPT

We have used the results from the econometric/revealed preference evidence in two ways.

25 TP

PT

Based on a [excised] reduction in second class volumes with a 1% reduction in first and second class quality of service, and assuming that first and second class volumes are approximately equal.



| First, this revealed preference evidence provides a valuable starting point in

estimating the switching effects one might expect when altering the quality of service of a single product class. | Second, the market-level relationship can be used in conjunction with stated

preference evidence (from survey data on the ‘middle tier’ of the pyramid) to estimate demand effects under modifications to the collection and delivery specification of the universal service. This approach is explained below. The final point to note from the econometric evidence is that the ILTM does not find quality of service to be a significant determinant of bulk mail volumes. We have therefore used a bulk mail elasticity of zero for the purposes of this project. As we discuss below, this does not appear at odds with the views of market participants for modest changes in quality of service.

Interpretation of the econometric evidence As noted above, the ILTM evidence needs to be interpreted carefully for use in our model. We have assumed that reductions in first class quality of service lead to falls in first class mail volumes, with most mail switching to second class products. This section explains this interpretation in a little more detail. The ILTM aims to parameterize the following demand equations for first class and second class item mail, where qi, QoSi and Zi relate to the demand, quality of service and other factors for first class and second class respectively: PPBB

B

B

B

B

B

B

q1 = α QoS1 + β QoS 2 + σ 1 Z1 q 2 = γ QoS1 + δ QoS 2 + σ 2 Z 2 The econometric parameters estimated within the ILTM are α = β = δ = 0 and that γ = [excised]. Taken at face value, this suggests that a one percentage point change in first class quality of service leads to a [excised] change in second class mail volumes. However, we interpret these parameters differently, noting that QoS1 and QoS2 may be noisy observations of a single underlying quality of service variable. This gives us the following restrictions: 26 B

B

B

B

TPF

26 TP

PT

FPT

•

α + β = 0 such that first class mail volumes do not change in response to a common increase in first and second class quality of service;

•

γ + δ = [excised ] such that second class volumes increase by [excised] in response to a common increase in first and second class quality of service;

•

(− β ) ≤ δ such that the overall increase in second class volumes is at least equal to the volume of mail switching from first class; and

•

(− γ ) ≤ α such that the overall increase in first class volumes is at least equal to the volume of mail switching from second class. These constraints are approximate and rely on two assumptions, which are broadly true: the historic change in QoS1 is broadly equal to the historic change in QoS2; and that first and second class mail volumes are broadly equal. B

B


B

B


Given these restrictions, the value of all the elasticities depends on two underlying parameters: the value we assign to δ and the difference between δ and β. Thus, if δ=1:

γ = [excised ] − 1 = [excised ] [excised ] ≤ α = (− β ) ≤ 1 For the purposes of our modelling, we have assumed that α = [excised], β = [excised], γ = -[excised] and δ = 1. These parameters imply that a one percentage point reduction in first class quality of service leads to: • stamp mail: [excised] of first class mail volumes switch to second class and a further [excised] are lost altogether; • meter/PPI mail: [excised] of first class mail volumes switch to second class mail and a further [excised] are lost altogether. The difference between the two is due to the different relative sizes of first and second class mail for stamp mail and meter/PPI. These parameters are more in line with the views expressed by market participants in discussions and we believe they provide a more natural story about changes in mail volumes than the unmodified ILTM parameters. Finally, there are no estimated elasticities for the cross effects between first class quality of service and Special Delivery volumes. We assume that each percentage point change in first class quality of service leads to a 1% change in Special Delivery volumes, with these volumes switching from first class mail. In addition, we have undertaken sensitivity analysis around this assumption.

Survey evidence There is no econometric evidence or historical data available to assist in estimation of demand effects for other universal service changes. In the absence of any further econometric/revealed preference evidence, following the pyramid approach we turn to available stated preference evidence. Here we present survey data drawn primarily from the “Needs of Postal Users – Customer Survey 2006” report prepared by Roland Berger/Synovate on behalf of Postcomm, Postwatch and Royal Mail. We have also taken into consideration evidence from the “Needs of Users of the Postal Service – Customer Survey 2007” prepared by FDS and the “2007 Business Customer Survey” undertaken by Quadrant/BMG and we note where these sources have been used to support our assumptions. The Roland Berger/Synovate market research contains evidence on the stated preferences of residential and SME customers in respect of modifications to quality of service, collection and delivery times and the frequency of collections and deliveries. These stated preferences are reported in terms of a pence per first class item “preference impact”, as summarised in Table 25. X


X


Preference Impact (pence) Modification

SME

Residential

1C QoS: 3% pts decrease

-5p

-5p

1C QoS: 8% pts decrease

-12p*

-11p*

Collections: remove the requirement for Saturday

-8p

-10p*

Collections: >7pm

+2p

0p

-4p

-2p

-11p*

-12p*

Deliveries: remove the requirement for Saturday

-8p

-9p

Deliveries: 4pm (one hour earlier)** Collections: 9am

(two/three hours later)*** Deliveries: >4pm

Table 25: Stated ‘preference impact’ for universal service modifications Source: Roland Berger/Synovate "The Needs of Postal Users - Customer Survey 2006" Note: a positive (negative) preference impact implies an increase (decrease) in willingness to pay * value extrapolated by Roland Berger/Synovate – price level slightly out of defined conjoined range **Collections: customers perceive current collections occur >5pm ***Deliveries: customers perceive current deliveries occur Midday

This stated preference evidence suggests that certain elements of the universal service specification are more important than others from a customer perspective. Moreover, different types of customer place a different value on various service features. For example, businesses value early deliveries and later collections more than residential customers, but value Saturday deliveries and collections less. For the purposes of our modelling we need to convert these “preference impact” results into estimated demand responses. Since the Roland Berger evidence provides a direct comparison point for alternative scenarios and its findings are broadly supported by other market research we use this survey evidence as an index, representing the relative (un)attractiveness of potential universal service modifications. It is not immediately obvious how a “preference impact” should be interpreted in terms of a change in volumes. We therefore use a base case scenario in which we take advantage of the fact that the econometric evidence



discussed above provides an independent assessment of how changes in quality of service affect demand. This gives us a scaling factor which we then apply to other stated preferences, as illustrated in Table 26. X

X

For example, residential customers report their preference impact of removing the requirement for Saturday collections as -10p. This is twice as large as the -5p preference impact of reducing quality of service by three percentage points. Our interpretation of the econometric evidence suggests that this quality of service deterioration would lead to a reduction in total market mail volumes of around 1% 27 ; therefore we estimate that removing the requirement for Saturday collections would lead to a reduction of around 2%. TPF

FPT

Stated Preference Index

Estimated Demand Effect

Modification

SME

Residential

Meter/PPI/CM

Stamp


-1.7

-1.7

-0.33%

-0.33%


1

0

-0.20%

0.00%


-4

-2

-0.79%

0.40%


2.4

2.4

0.48%

0.48%


-2.4

-2.4

-0.48%

-0.48%

-8

-10

-1.59%

-1.99%

Deliveries/Collections: remove requirement for Saturday

Table 26: Stated preference index and estimated demand effect for universal service modifications Source: Frontier Economics

We rejected an alternative possible interpretation of the “preference impact” figures, which assumes they are directly comparable to pence per first class item price changes. This interpretation, in conjunction with the best available econometric evidence, suggests larger demand responses than might be considered reasonable. For example, the stated preference evidence indicates that a decline in first class quality of service of three percentage points has a “preference impact” of -5p for both residential and SME customers. This could be interpreted as indicating that the decline in quality of service is perceived by customers as equivalent to a 5p (15.6%) 28 increase in stamp prices. However, TPF

Based on a 0.33% reduction in volumes per percentage point decline in quality of service.

27 TP

TP

28

FPT

PT

PT

Based on a 1C stamp price of 32p, applicable at the time of the Roland Berger/Synovate research.



econometric evidence suggests that such an increase in prices would lead to a fall in demand of around [excised] (using the first class own-price elasticity of [excised] contained within the ILTM). This demand response seems large. In discussions, Royal Mail shared the view that stated preference surveys can overstate the impact of particular changes to service specification. 29 TPF

FPT

A number of assumptions were necessary in order to estimate the demand effects illustrated in Table 26. X

X

| We assume that residential consumers represent demand for stamped mail

while SMEs represent demand for Meter and PPI mail. | In estimating the demand response associated with simultaneously removing

one delivery and collection per week, we have assumed that the preference impact would be equivalent to the larger of the preference impacts reported for these individual modifications (-8p for SMEs and -10p for residential customers). | We have used the preference impact reported for a 3% QoS change as the

scaling factor, converted into a price change per percentage point. The survey evidence suggests that the demand response may be slightly non-linear although the effect is not pronounced. | We make use of the evidence which is most relevant for the range of

scenarios being considered. In the case of delivery times, we therefore calculate the “per hour earlier/later” indices using only the preference impact of moving to 2-3pm; the evidence indicates an impact of -6p for this 2-3 hour delay (relative to customer perceptions), therefore we assume an impact of -2.4p per hour later, and assume this applies also to earlier delivery times. This approach allows us to estimate ‘own’ demand effects (i.e. increases/decreases in market volumes for each product class) for the universal service modifications under consideration. However, the survey evidence does not give any indication as to likely switching effects i.e. the extent to which mailers will switch between mail classes. In scenarios other than changes to first class quality of service, we have no evidence on likely switching effects. In these cases we assume the switching effects are zero. There are plausible reasons why mailers might switch up or down mail classes and no compelling reason to believe that one effect would be greater than another. For instance, stopping Saturday deliveries could lead more people to post first class (for mail to arrive a day earlier, given the same day of posting) or second class (as the time difference for first and second class mail posted on a Friday becomes less pronounced).

29 TP

PT

Effectively, we assume that customers’ survey responses overstate the preference impact of universal service modifications in a consistent way.



Single two day product Under the single two day scenario, our initial assumption is that the two day product would be offered at the second class price and that second class volumes would therefore remain unchanged (at least initially, we investigate later whether it would, in fact, be possible to price at this level). In terms of estimating the demand response, the key questions are: • how much first class mail will switch to the new two day product; • how much mail will switch to Special Delivery; and • how much mail will be lost altogether. While most first class volumes switch to the two day service, we assume some volumes will switch to Special Delivery and other volumes will be lost altogether. The Roland Berger survey did not ask directly about preferences for a single two day product. However, Figure 12 and Figure 13 show that the FDS “Needs of Users of the Postal Service – Customer Survey 2007” evidence suggests that a single two day service would, in general, be more acceptable to residential customers than moving to a five day delivery service. This could imply a similar reduction in volumes to that assumed for a five day delivery service above. We think this could underestimate the demand response, given the significance of the change and the fact that customers who find the change most unacceptable may account for a large volume of mail. X

X

X

X

Consequently, we have assumed the following based on Royal Mail charging a second class price for this product: • 100% of second class volumes will remain; • 5% of first class volumes would be lost altogether; • Special Delivery volumes would increase by 20% as volumes switch from first class; and • the remaining first class volumes would switch to the two day product. However, we accept that these assumptions are based on limited evidence. We have conducted some sensitivities around these assumptions but further market research would be valuable if this policy option were to be adopted.



Figure 12: Acceptability of a single two day service Source: FDS Market Research 2007 for Postcomm



Figure 13: Acceptability of five deliveries per week Source: FDS Market Research 2007 for Postcomm

Interviews with mail users Given the limited evidence available to estimate demand responses, we have also benefited from interviews with a number of mail users which we used to gauge their reactions to potential changes. We had useful discussions with the Mail Users Association, the Direct Marketing Association and Postwatch. The discussions took part before our demand estimates were finalised. The final demand estimates are therefore Frontier’s and should not be taken to represent the views of any of the stakeholders we met. It is also important to note that the focus of our analysis is on volume changes, not customers’ valuation of particular service features. Consequently, our view that volume changes may be limited in response to a service change does not necessarily indicate that the service feature has no value to customers. The interviews gave us a qualitative sense of how some mailers could react to changes in service specification. The discussions tended to support the view that service changes were more likely to alter the way in which mail was sent (e.g. switching class or moving to an alternative operator) than in the total volume of mail sent. In general, the discussions with mailers did not significantly contradict the direction of the demand estimates stated above and we have therefore relied primarily on the market research presented above.



The most significant demand response was anticipated from a new single two day product. Although there would be a change in total market volumes, the bigger change was felt to come from competition within the mail market. First class is seen as a feature that clearly differentiates Royal Mail from alternative operators. Removing first class would allow alternative operators to compete for item mail that is currently sent first class and which is sent almost exclusively via Royal Mail. With a single two day product, alternative operators would be likely to compete at the very least to the same extent as they do for second class item mail now. In the longer term, the greater mail volumes available and the ability of alternative operators to offer a similar range of products to Royal Mail could lead to much more vigorous competition for meter and PPI mail from SMEs than is currently the case. Collection times were also felt to be important, especially for SMEs who want to be able to clear all mail items at the end of a working day. Bringing collection times earlier would be inconvenient and require mail to be held over to the next day. By the same token, it was not felt practical to remove any collections midweek as mailers would want to get mail off the premises even if it would not be delivered until later. Delivery times and Saturday deliveries could have smaller impacts. | Delivery times are important for some companies receiving mail for whom it

is important to have all mail available early in the working day. Delivery times are less important determinants of volume for most business to consumer mail. | Saturday deliveries are most important for some publications. However, the

trend towards targeted (by recipient) and coordinated (across media) campaigns means that a predictable delivery day is in many ways more important than a specific delivery day, to make most effective use of television advertising and call centres. Postcomm’s most recent Business Customer Survey 30 found that: TPF

FPT

• only 1% of businesses reported that Saturday is the most important day for delivery (compared to 67% for Monday); • 48% claimed that Saturday is the least important day; • Saturday was the least-mentioned day (4%) where a specific delivery day is required. This is also in line with the fact that Mailsort 3, used by many direct advertisers, is not delivered on Saturday by Royal Mail from most Delivery Offices.

TP

30 PT

Quadrant/BMG 2007 Business Customer Survey



We came across a range of views as to how customers would react to changes in first class quality of service, in particular in relation to changes in class. This arose as, for many customers, the choice of class is a habit, not a decision that is taken with each mailing. Consequently, there was a high degree of inertia that meant many customers would be unlikely to respond immediately to changes in service. By the same token, however, there was a risk that big reductions in quality of service could cause many people to reassess their default choice of class. One mailer suggested that some mailers were already finding it hard to justify using first class, and a big drop in quality of service could crystallise an existing trend towards second class. Drawing together the above econometric, survey and interview evidence, we developed a set of assumptions that are listed in Table 27 below. X


X


Estimated (Own-) Demand Effect

Estimated Switching Effect

Modification

Stamp

Meter/PPI/CM

Bulk

Stamp

Meter/PPI/CM

Bulk

Deliveries/Collections: remove requirement for Saturday

-1.79%

-1.59%

-0.40%*

None

None

None

1C: -0.21%** 2C: 0.00% SD: 0.00%

1C: -0.02%** 2C: 0.00% SD: 0.00%

0.00%



None


-0.48%

-0.48%

0.00%

None

None

None


0.48%

0.48%

0.00%

None

None

None


-0.40%

-0.79%

0.00%

None

None

None


0.00%

-0.20%

0.00%

None

None

None



5.00% of MS1 vols. lost



20% increase in SD vols. switching from 1C, all other 1C volumes switch to D+2. 100% of 2C volumes switch to D+2.

Remaining 95% of 1C volumes and 100% of 2C volumes switch to D+2.

Table 27: Estimated demand and switching effects for universal service modifications Source: Frontier Economics * one quarter as responsive as Meter/PPI/CM volumes ** exact value varies in relation to the ratio of 1C to 2C volumes (which accounts for the difference in Stamp and Meter/PPI/CM) – the sum of 1C volume effects is 0.60%



Sensitivity analysis The estimated demand and switching effects reported in Table 27 draw on the best available evidence, following the “pyramid approach” discussed above. Nevertheless, the limited evidence available means that these demand responses are somewhat uncertain. We have therefore tested the sensitivity of our results to changes in these underlying parameters. X

X

Results for each of the possible universal service changes were obtained under two alternative sets of demand responses parameters. The first set of results was generated using response parameters that were halved in magnitude relative to those in Table 27. The second set of results was generated using parameters that were doubled in magnitude relative to those in Table 27. These results are reported below. X

X

X

X

Special Delivery The results obtained from our model are, under some universal service changes, particularly sensitive to the assumptions regarding Special Delivery. Given the high average revenues associated with this product, even modest changes in Special Delivery volumes lead to significant changes in revenues received by Royal Mail. This is illustrated in Table 28. X

SD Revenues

X

-20%

-10%

2006-07 base

+10%

+20%

£278m

£312m

£347m

£382m

£417m

Table 28: Special Delivery volumes and revenues, 2006-07 Source: Frontier Economics

Given the sensitivity of Special Delivery, we have presented results separately throughout this report. We have therefore implicitly assumed, in the first instance, that there would be no changes to Special Delivery volumes in response to universal service changes. The results presented below are generated under this assumption. However, as a check on the robustness of these results, we also generated an alternative set of results using the assumptions outlined in Table 27. X

X

The treatment of Special Delivery is of particular importance under the single two day service scenario and for large reductions in first class quality of service. It is in these cases that significant increases in Special Delivery volumes seem most plausible. We have evaluated the impact of our assumptions regarding Special Delivery in these specific scenarios, with results presented below.

Market share effects (first round) In addition to estimation of non-price demand effects, the first round of our model estimates non-price market share effects.



If demand for a particular product switches in response to a modification of the universal service, then the new mail product may be more or less contestable than the mail product the customer was originally using. Consequently, Royal Mail faces not only a product switching effect but also a market share effect. For example, if our product switching analysis suggests that 10 million first class PPI mail items switch to second class PPI, and Royal Mail’s market share for second class PPI is 80%, then we assume Royal Mail loses 10 million first class PPI mail items and gains 8 million second class PPI items, with 2 million items switching to entrants. Of those 2 million items, if 90% are delivered through access and 10% are delivered by an end to end entrant, then Royal Mail’s access volumes will increase by 1.8m items. We have also considered the possibility that some universal service modifications may cause a more profound effect upon Royal Mail’s position in the market. This might be characterised either as: • major changes that fundamentally alters the perception of Royal Mail relative to competitors; or • changes that disproportionately affect Royal Mail’s service quality relative to rivals. An example of the first is a switch to a single two day product, which could fundamentally alter the brand position of Royal Mail relative to entrants, and make switching more likely. However, the change would be on top of two other factors that are likely to be more material: the change in service specification to a product with which alternative operators will find it easier to compete; and price changes relative to the current second class price. Thus, while we accept the principle that changes in perception can affect market share, we have not tried to quantify the effects in this case. Moreover, to the extent that such effects are captured by greater market switching, we have undertaken scenario analysis, described above, to assess the likely impact of such a fundamental shift in consumer behaviour. An example of the second change might be a modification to Royal Mail’s collection times. In this case we would not anticipate a fundamental shift in the nature of competition, though we might see a higher degree of switching than would be suggested by the estimated volume responses proposed in Table 27. X

X

ESTIMATED FIRST ROUND DEMAND EFFECTS In this section we present the results of estimating first round effects, using the parameters reported in Table 27, under alternative specifications of the universal service. We present sensitivity analysis around these results, including discussion of the treatment of Special Delivery and the possibility of more fundamental shifts in customer behaviour. We also discuss how these results vary under alternative market conditions. X

X



The first round effects contained within our model affect: • the level of mail volumes; • the mix of mail between different classes; and • the extent of market entry. These effects can be identified under each of the universal service changes we have considered. We first illustrate the results under three universal service changes: the single two day product, removing Saturday deliveries and collections, and reducing first class quality of service to around 85%. 31 Table 29 illustrates the volume responses estimated for the first round in each of these scenarios. TPF

2006-07 Total RM RM Access RM E2E

FPT

X

X

Two day

No Saturday

1C QoS: 85%

19,570m

-265m

-166m

-53m

2,442m

+181m

-9m

+3m

17,128m

-446m

-158m

-56m

Table 29: First round volume changes, 2006-07 Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)

In the single two day product scenario we assume that 5% of first class volumes are lost entirely and that the remainder of first class volumes switch to the two day product. All second class volumes are retained in the two day product, which is (as a benchmark in the first round) offered at the second class price. Royal Mail loses 265m items overall. This is the level effect referred to above. Clearly there is also a change in the mix of mail, as first class volumes switch. Thirdly, the market share effect is indicated by the increase in access volumes of 181m items. This effect occurs as a direct consequence of moving volumes into the second class market, where entrants compete more successfully for market share. The level, mix and market share effects are also evident in the ‘no Saturday’ and reduced first class quality of service scenarios. Under the ‘no Saturday’ scenario Royal Mail loses 166m items across mail classes. Reducing first class quality of service leads to a smaller reduction in overall volumes, around 53m, partly because many lost first class volumes instead switch to second class products. This mix effect is indicated by the 145m increase in second class item mail. As a consequence of the estimated demand responses outlined in Table 27, there is no impact upon bulk volumes of reducing first class quality of service. X

X

The impact of these volume effects upon Royal Mail’s revenues (which, in the first round, takes prices as constant) is illustrated in Table 30. X

31 TP

PT

X

We assume the same demand effects for the single two day product with and without Saturday deliveries and collections.



2006-07 Base Total RM RM Access RM E2E

Two day

No Saturday

1C QoS: 85%

£5,270m

-£633m

-£55m

-£40m

£327m

+£30m

-£1m

+£1m

£4,943m

-£663m

-£53m

-£41m

Table 30: First round revenue changes, 2006-07 Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)

Moving to a single two day service would significantly reduce Royal Mail’s revenues. Total lost revenues are estimated at £633m, or 10% of revenues for the Letters business as a whole. This revenue loss can be decomposed into three components: £527m is lost as a result of sacrificing the first class price premium on all volumes switching from first class to the single two day product. A further £83m is lost as a consequence of 5% of first class volumes being lost altogether. Finally, since access competitors are more successful at contesting second class volumes, Royal Mail loses a further £23m as a result of competition. Revenue losses are smaller in the ‘no Saturday’ and reduced first class quality of service scenarios. In the quality of service scenario, the limited revenue loss is due in large part to the recycling of first class volumes into second class volumes. Table 31 summarises the first round effects estimated for each alternative universal service specification contained within the model. X

X



Change in Volumes Modification Remove requirement for Saturday Del/Coll

Total RM

RM End to End

Change in Revenues RM Access

Total RM

RM End to End

RM Access

-166.2m

-157.7m

-8.5m

-£54.6m

-£53.5m

-£1.2m

1C QoS: 85%

-53.3m

-56.4m

+3.1m

-£40.5m

-£41.0m

+£0.5m

1C QoS: 87%

-40.0m

-42.3m

+2.3m

-£30.4m

-£30.7m

+£0.4m

1C QoS: 90%

-20.0m

-21.1m

+1.1m

-£15.2m

-£15.4m

+£0.2m

Deliveries 2 hours later

-79.8m

-78.6m

-1.2m

-£26.9m

-£26.7m

-£0.2m

Deliveries 1 hour later

-39.9m

-39.3m

-0.6m

-£13.4m

-£13.4m

-£0.1m

Deliveries 1 hour earlier

+39.9m

+39.3m

+0.6m

+£13.4m

+£13.4m

+£0.1m

Deliveries 2 hours earlier

+79.8m

+78.6m

+1.2m

+£26.9m

+£26.7m

+£0.2m

Collections 2 hours earlier

-111.4m

-109.4m

-2.0m

-£36.4m

-£36.1m

-£0.3m

Collections 1 hour earlier

-55.7m

-54.7m

-1.0m

-£18.2m

-£18.1m

-£0.1m

Collections 1 hour later

+11.2m

+11.0m

+0.2m

+£3.5m

+£3.5m

+£0.0m


-264.5m

-445.7m

+181.2m

-£633.1m

-£662.7m

+£29.7m

Table 31: First round effects for 12 universal service modifications, 2006-07 Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)



Table 31 illustrates that the largest changes in volumes and revenues are anticipated under the single two day service and removing the requirement for Saturday deliveries and collections. X

X

The first round revenue changes in Table 31, compared relative to any change in the costs incurred by Royal Mail from meeting the universal service specification, determine the first round NAC within the model. X

X

Sensitivity analysis Given the degree of uncertainty around the demand responses to changes in the universal service, we have run a set of scenarios around the central estimates to assess the sensitivity of our results to alternative assumptions. These scenarios are, simply, to double the magnitude of the demand effect (creating a ‘higher estimate’) on the one hand, and to halve the magnitude (creating a ‘lower estimate’), on the other. For example, Table 27 indicates the following demand responses in the ‘no Saturday’ scenario: stamped mail falls by 1.79%, meter/PPI/Cleanmail volumes fall by 1.59%, bulk volumes fall 0.40%. These parameters were used to establish the ‘central estimates’ reported in Table 31. Under the ‘lower estimate’, these parameters are 0.90%, 0.80% and 0.20%, respectively. Under the ‘higher estimate’ they are 3.58%, 3.18% and 0.80%. X

X

X

X

The first round effects under these alternative assumptions are reported and compared to the central estimated effects, for the 12 universal service changes under consideration, in Table 32. X

X



Change in Volumes (Total RM) Modification

Lower estimate

Change in Revenues (Total RM)

Central estimate

Higher estimate

Lower estimate

Central estimate

Higher estimate

Remove requirement for Saturday Del/Coll

-83.1m

-166.2m

-332.4m

-£27.3m

-£54.6m

-£109.3m

1C QoS: 85%

-26.6m

-53.3m

-106.6m

-£20.2m

-£40.5m

-£81.0m

1C QoS: 87%

-20.0m

-40.0m

-79.9m

-£15.2m

-£30.4m

-£60.7m

1C QoS: 90%

-10.0m

-20.0m

-40.0m

-£7.6m

-£15.2m

-£30.4m


-39.9m

-79.8m

-159.6m

-£13.4m

-£26.9m

-£53.8m


-19.9m

-39.9m

-79.8m

-£6.7m

-£13.4m

-£26.9m


+19.9m

+39.9m

+79.8m

+£6.7m

+£13.4m

+£26.9m


+39.9m

+79.8m

+159.6m

+£13.4m

+£26.9m

+£53.8m


-55.7m

-111.4m

-222.7m

-£18.2m

-£36.4m

-£72.8m


-27.8m

-55.7m

-111.4m

-£9.1m

-£18.2m

-£36.4m


+5.6m

+11.2m

+22.4m

+£1.7m

+£3.5m

+£7.0m


-132.3m

-264.5m

-529.1m

-£590.5m

-£633.1m

-£718.2m

Table 32: First round effects for 12 universal service modifications, 2006-07, under alternative multiples of parameters Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)



Special Delivery The results presented above are based on the assumption of no change to Special Delivery volumes in response to universal service changes. It is not clear how Special Delivery would be treated under the revised universal service specifications, and in particular, whether it would remain a national next day product. To reflect the impact of these options, and to reflect the uncertainty around the level of volumes that could switch to Special Delivery, we have generated an alternative set of results using the assumptions outlined in Table 27. X

X

The treatment of Special Delivery is of particular importance under the single two day service scenario and for large reductions in first class quality of service. It is in these cases that significant increases in Special Delivery volumes seem most plausible if it remains a national next day product. The impact of assumptions regarding Special Delivery in these specific scenarios is illustrated in Table 33. X

Change in Volumes Two day Zero SD switching assumptions

Alternative SD switching assumptions

RM E2E

QoS 85%

X

Change in Revenues Two day

QoS 85%

[Excised]

[Excised]

-£663m

-£41m

1C Item

[Excised]

[Excised]

-£1,753m

-£87m

2C Item

[Excised]

[Excised]

+£1,218m

+£46m

SD

[Excised]

[Excised]

£0m

£0m

[Excised]

[Excised]

-£602m

-£17m

1C Item

[Excised]

[Excised]

-£1,753m

-£87m

2C Item

[Excised]

[Excised]

+£1,218m

+£46m

SD

[Excised]

[Excised]

+£61m

+£24m

RM E2E

Table 33: First round effects under alternative Special Delivery switching assumptions, 2006-07 Source: Frontier Economics

Table 33 reproduces the first round effects reported above, and compares them to alternative estimates using the switching assumptions given in Table 27. This comparison shows that the level of volumes switching from first class to Special Delivery can make a significant difference to the revenues received by Royal Mail. X

X

X

X

In the single two day product scenario, revenues are increased by £61m by assuming that Special Delivery volumes increase by [excised] as a result of mail switching from first class. 32 Assuming an increase in volumes of 1% for every 1 percentage point reduction in first class quality of service, Special Delivery revenues may increase by [excised] under an 85% quality target. TPF

32 TP

PT

FPT

This £61m increase is smaller than the indicative £80m increase shown in Table 28, since here we assume that volumes only increase for those Special Delivery products that are direct substitutes for first class stamped/metered/PPI products e.g. only Next Day products rather than Next Day 9am.



Alternative market scenarios The results presented above report estimated first round effects, reflected in changes in volumes and revenues. These were calculated relative to actual volumes and revenues from 2006-07. We have also considered two alternative market scenarios: • a 2009-10 ‘access’ scenario in which access entrant carry around 5.7bn items, with minimal end to end entry; and • a 2009-10 ‘end to end entry’ scenario in which access entrants carry around 3.9bn items and end to end entrants carry a further 1.7bn items. The baseline volumes and revenues under each of these market scenarios are given in Table 34. In the case of the 2009-10 scenarios, the market share projections are made by Frontier. X

X

Volumes

Revenues

2006-07

2009-10 ‘access’

2009-10 ‘E2E’

2006-07

2009-10 ‘access’

2009-10 ‘E2E’

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

19,570m

19,921m

18,354m

£5,270m

£5,244m

£4,859m

2,442m

5,743m

3,942m

£327m

£953m

£613m

17,128m

14,178m

14,412m

£4,943m

£4,291m

£4,246m

1C Item

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

2C Item

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

1C Bulk

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

2C Bulk

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

3C Bulk

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

[Excised]

Market Total RM RM Access RM E2E

Table 34: Baseline volumes and revenues under three market scenarios Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)

The first round effects estimated above for the 2006-07 market scenario were also estimated for each of the alternative 2009-10 market scenarios. As for the 200607 market scenario, the demand response parameters given in Table 27 were used. Also consistent with the 2006-07 analysis, these tables assume no change in Special Delivery volumes. Table 35 presents the first round volume changes estimated under the 2009-10 ‘access’ market scenario. X

X

X


X


2009-10 ‘access’

Two day

No Saturday

1C QoS: 85%

Total RM

[excised]

-232m

-161m

-36m

RM Access

[excised]

+699m

-32m

+28m

RM E2E

[excised]

-931m

-129m

-65m

1C Item

[excised]

-3,424m

-60m

-170m

2C Item

[excised]

+2,654m

-59m

+106m

1C Bulk

[excised]

-616m

-2m

0m

2C Bulk

[excised]

+455m

-8m

0m

3C Bulk

[Excised[

0m

0m

0m

Table 35: First round volume changes, 2009-10 ‘access’ scenario Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)

The volume changes in Table 35 are similar to those estimated in the 2006-07 market scenario, given in Table 29. Under the single two day service, total lost volumes total 232m items, compared to 265m items in 2006-07. However, with higher entrant market shares in second class, by 2009-10, a much higher volume of mail switching out of first class switches to alternative operators rather than Royal Mail. Whereas in 2006-07, 93% of lost first class RM end to end volumes were recycled as second class RM end to end volumes, under the two day service scenario, in the 2009-10 ‘access’ scenario this figure is just 78%. 33 X

X

X

X

TPF

FPT

The revenue changes estimated in the 2009-10 market scenario, given in Table 36, reflect the differing mail mix identified above. X

33 TP

PT

X

In 2006-07, 4,067m first class items are lost, of which 3,779m (93%) are retained as second class volumes; in 2009-10 ‘access’ market conditions, 3,424m first class items are lost, of which 2,654m (78%) items are retained as second class volumes.



2009-10 ‘access’

Two day

No Saturday

1C QoS: 85%

Total RM

[excised]

-£623m

-£46m

-£30m

RM Access

[excised]

+£133m

+£2m

+£13m

RM E2E

[excised]

-£756m

-£48m

-£43m

1C Item

[excised]

-£1,696m

-£30m

-£85m

2C Item

[excised]

+£1,043m

-£16m

+£40m

1C Bulk

[excised]

-£257m

-£1m

£0m

2C Bulk

[excised]

£154m

-£1m

£1m

3C Bulk

[excised]

£0m

£0m

£0m

Table 36: First round revenue changes, 2009-10 ‘access’ scenario Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)

Reflecting the greater market share held by access entrants, primarily among second class products, the change in access revenues as a result of universal service changes is much greater in the 2009-10 scenario than under 2006-07 market conditions, reported in Table 30. Royal Mail revenues suffer as it receives only the access average revenue for those volumes lost to competitors. However, Royal Mail’s revenue losses under 2009-10 conditions are a little smaller overall, primarily because predicted first class volumes are smaller in 2009-10 under the existing universal service. In the two day service and quality of service scenarios, the losses faced by Royal Mail are therefore lower. X

X

The first round volume effects under the 2009-10 ‘end to end entry’ scenario are given in Table 37. X

X



2009-10 ‘end to end’

Two day

No Saturday

1C QoS: 85%

Total RM

[excised]

-425m

-156m

-40m

RM Access

[excised]

+479m

-26m

+21m

RM E2E

[excised]

-904m

-130m

-62m

1C Item

[excised]

-3,427m

-60m

-171m

2C Item

[excised]

+2,723m

-60m

+109m

1C Bulk

[excised]

-659m

-3m

0m

2C Bulk

[excised]

+459m

-8m

0m

3C Bulk

[excised]

0m

0m

0m

Table 37: First round volume changes, 2009-10 ‘end to end entry’ scenario Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)

For the ‘no Saturday’ and first class quality of service scenarios, the volume changes estimated for the 2009-10 ‘end to end entry’ market scenario are similar to those estimated for the ‘access’ market scenario. However, for the single two day service the volume changes are significantly larger in the ‘end to end entry’ scenario. This is a consequence of end to end rivals competing mainly with access operators, primarily for second and third class bulk mail volumes. In the ‘no Saturday’ and quality of service scenarios, very little switching is anticipated between bulk mail classes. In the two day service scenario, significant volumes switch out of first class bulk mail products. On routes where these volumes would be contested for by access rivals under the ‘access’ scenario, under the ‘end to end entry’ scenario these volumes are lost from Royal Mail entirely. The first round revenue changes under the ‘end to end entry’ market scenario are given in Table 38. X

X



2009-10 ‘end to end’

Two day

No Saturday

1C QoS: 85%

Total RM

[excised]

-£675m

-£50m

-£36m

RM Access

[excised]

+£70m

-£1m

+£6m

RM E2E

[excised]

-£745m

-£49m

-£42m

1C Item

[excised]

-£1,695m

-£30m

-£84m

2C Item

[excised]

+£1,066m

-£17m

+£41m

1C Bulk

[excised]

-£270m

-£1m

£0m

2C Bulk

[excised]

+£154m

£0m

+£1m

3C Bulk

[excised]

£0m

£0m

£0m

Table 38: First round revenue changes, 2009-10 ‘end to end entry’ scenario Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)

Consistent with the volume changes identified in Table 37, revenue losses are larger in the two day service scenario than under the scenario where the requirement for Saturday collections and deliveries was removed and under 85% first class quality of service. X

X

Assessing the universal service changes under alternative market scenarios provides two key insights: | First, given the lower volumes of first class mail forecast for 2009-10, the

volume and revenue losses faced by Royal Mail are reduced in 2009-10 under those changes in specification that primarily affect first class volumes (i.e. the single two day service and large reductions in first class quality of service). | Second, since second class volumes are expected to be more successfully

contested by rival operators in 2009-10, any market volumes switching into second class are more likely to be competed away from Royal Mail end to end, thereby exacerbating the estimated volume and revenue changes. In the ‘access’ market scenario, these volumes are mostly retained to Royal Mail, albeit at the lower average revenue received from the access operator; in the ‘end to end entry’ market scenario, volumes and revenues are lost completely from Royal Mail.

Fundamental shifts in customer behaviour The volume responses illustrated in Table 27, in line with the best available evidence, suggest fairly modest shifts in customer demand as a consequence of universal service modifications. In addition to testing the sensitivity of our results to these demand responses, to our assumptions regarding Special Delivery and to alternative market conditions, we considered the possible impact of more fundamental shifts in customer behaviour. X

X



It is plausible that more significant shifts could occur in response to certain modifications of the universal service. Indeed, the mail associations we interviewed remarked that “large-enough changes” in service can make mail users more likely to reassess their overall mailing practices. The introduction of PiP may be an example of this, as is overall market liberalisation and the greater awareness of mail options it has brought users. As a result, some service specification changes could catalyse existing trends in the mail market and bring about a step change in volumes or product mix. The two most likely scenarios in which this could happen are changes in first class quality of service or introducing a two day product. If large volumes of first class item mail are sent out of courtesy or habit/inertia, significant changes to the service specification (or the removal of first class entirely) may force customers to re-think their postal options. The fall in revenues could therefore be significantly larger than our base case scenarios assume. Similarly, under the single two day service scenario we have our central estimate suggests that 5% of first class volumes may be lost entirely, with the other 95% switching to the new two day product. However, it is conceivable that Royal Mail could lose much larger volumes, perhaps 25% of current first class volumes altogether, with only 75% switching to the two day product. This fundamental shift might reflect a marked change in customers’ perception of Royal Mail and/or a widespread reassessment of mailing behaviour. The likely impact upon volumes and revenues is given in Table 39. It shows that such a fundamental shift in consumer behaviour could increase the overall revenue loss from £633m (with 5% loss of volumes) to 25% loss of volumes leads to a revenue loss of £955m. X

X

This analysis suggests that large shifts in customer behaviour could significantly reduce Royal Mail’s revenues. In such cases, the universal service change may be the genuine cause of this response or merely a catalyst, effecting an inevitable shift in customer behaviour. In either case, the possibility of a fundamental shift in customer behaviour is a relevant consideration.



Change in Volumes Royal Mail loses 5% of first class volumes; 95% switch to two day product

Royal Mail loses 25% of first class volumes; 75% switch to two day product

Change in Revenues

Total RM

-265m

-£633m

RM E2E

-446m

-£663m

1C Item

-4,067m

-£1,753m

2C Item

+3,779m

+£1,218m

1C Bulk

-923m

-£421m

2C Bulk

+764m

+£293m

Total RM

-1,251m

-£955m

RM E2E

-1,391m

-£978m

1C Item

-4,067m

-£1,753m

2C Item

+2,995m

+£965m

1C Bulk

-923m

-£421m

2C Bulk

+603m

+£232m

Table 39: First round effects for the single two day service scenario under alternative switching assumptions, 2006-07 Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)

SECOND ROUND (PRICE) EFFECTS The first round revenue changes estimated above, compared relative to any change in the costs incurred by Royal Mail from meeting the universal service specification, determine the first round Net Avoided Cost (NAC) within the model. In the second round of the model, we assume three further effects upon volumes and revenues: • price changes: a positive first round NAC is redistributed to consumers through lower prices (and the opposite is true with a negative NAC); in particular, cost changes in particular parts of the pipeline are passed through to products which use that part of the pipeline; • own- and cross-price demand effects: the change in prices leads to a demand response; and • market share effects: the change in prices leads to changing market shares as the mix of mail is altered.



These second round effects provide insight into several likely consequences of universal service modifications. First, we gain an indication of the magnitude of price changes achievable. Second, we can predict which products are likely to see larger price changes and which will see more limited (or no) changes in price. Third, we can estimate the extent of volume and revenue changes that result from any price changes. Fourth, we can predict the likely impact upon market share held by Royal Mail and alternative operators.

Methodology The second round effects estimated within our model are intended to provide indicative volume and revenue responses. We assume that, first, the first round NAC is redistributed as price changes. Second, these price changes lead to ownand cross-price demand effects. Third, market shares are affected as a result of the changing mix of mail. This section explains the approach we have used in estimating each of these effects.

Price changes Under each alternative universal service specification, the first round revenue effects reported above are compared relative to the estimated cost change achieved by Royal Mail. This defines a first round NAC. We assume a straightforward regulatory benchmark under which this NAC must be redistributed to consumers through a change in prices (thereby leaving Royal Mail unaffected, in terms of net costs, as a result of the modification). We assume a simple two stage process by which price changes are calculated: • first, the first round revenue change is reversed by altering prices (assuming fixed volumes); • second, the full cost saving associated with the universal service modification is passed through to customers by changing prices (again assuming fixed volumes). This two stage process reflects the fact that the NAC is composed of a revenue loss (regained in stage one) and a cost saving (redistributed in stage two). The first stage involves a straightforward calculation whereby the revenue associated with a particular product group before first round effects (i.e. the baseline revenue) is recovered. For the purposes of estimating price changes, we use seven product groups (first and second class item mail; first, second and third class bulk mail; Special Delivery; and access). Consider the following example for a particular product group: • initial revenues (in the 2006-07 base case) are £110m, with initial volumes of 550m items; • first round volume effects lead to a loss of 50m volumes and, for fixed prices, a loss of £10m in revenues; • first round volumes therefore fall to 500m, with revenue of £100m;



• in order to recover the original £110m revenue, assuming fixed volumes, we see an increase in price for this product route by 10%; and • with a 10% higher price, 500m items generate £110m in revenues. Having reversed the first round revenue change, we then redistribute the first round cost change to prices in the second stage. Cost savings are aggregated by broad pipeline component (collections, outward mail centres, air transport, other transport etc). We redistribute the costs saved at each part of the pipeline to those products which use that part of the pipeline. Therefore cost savings in delivery are passed through to prices across all products, while savings in outward mail centres are passed through only to item mail products, as indicated by Figure 14. X

RDCs £0.0m

Cost change 1C item mail 2C item mail

Collection £0.0m 1 1

1C bulk mail 2C bulk mail 3C bulk mail

X

MC - Outward £0.0m 1 1

1 1 1

Special Delivery

1

MC - Inward £0.0m

Air £0.0m

Delivery £0.0m

1

1 1

1 1

1 1

1 1 1

1

1

1 1 1

1 1 1

1

1

1

1

REVENUES TO SHARE BETWEEN

£2,034.6m

£3,255.3m

£2,908.2m

Other £0.0m

1 1

1

Access

Other trans. £0.0m

£5,616.9m

Additional air costs for SD

1 £2,175.9m

£3,678.4m

£5,616.9m

1 £5,616.9m

£0.0m

Figure 14: Redistribution of cost savings to products by broad pipeline component Source: Frontier Economics

Cost savings are divided between broad product categories according to the revenues associated with those product categories. Consider the following ‘two product, two pipeline component’ example which illustrates the way in which the cost change redistribution is carried out: • there are two pipeline components, ‘collection’ and ‘delivery’; • ‘Item mail’ is present in both pipeline components, and returns £100m in revenues; 34 TPF

FPT

• ‘Bulk mail’ is present only in the ‘delivery’ pipeline component, and returns £200m in revenues; • first round cost savings total £40m, comprising £10m in ‘collection’ and £30m in ‘delivery’; • the £10m cost saving in ‘collection’ is redistributed to ‘item mail’ alone, leading to a 10% reduction in prices; • the £30m cost saving in ‘delivery’ is shared between ‘item’ and ‘bulk’, in proportion to their revenues; therefore £10m is redistributed to ‘item’ and £20m to ‘bulk’ mail;

34 TP

PT

This is the original/baseline revenue associated with ‘item mail’, which is also the revenue after the first stage of redistributing the first round NAC has taken place.



• the £10m ‘item’ reduction leads to a 10% reduction in ‘item’ prices; • the £20m ‘bulk’ reduction leads to a 10% reduction in ‘bulk’ prices; • overall, ‘item’ prices fall by 20% (we simply sum the reductions from different pipeline components), with ‘item’ revenues falling from £100m to £80m; • ‘bulk’ prices fall by 10%, with revenues falling from £200m to £180m; and • total revenues decline by £40m, reflecting the £40m cost saving to be redistributed. This second stage thereby redistributes any first round cost changes into price changes.

Own- and cross-price demand effects One consequence of the price changes described above will be a demand response. Own-price effects describe demand changes to a given product when the price of that product changes. Cross-price effects describe demand changes to a given product when the price of a different, possibly substitute, product changes. The second round of our model captures both own-price effects and cross-price effects using estimated elasticities from Royal Mail’s ILTM.

Market share effects The second round of our model also accounts for market share effects. As a result of own- and cross-price demand effects, volumes of mail will move between product classes. These volumes will therefore move into product classes that are more or less contested by rival operators. Consequently, market shares will be affected. The price changes may also have a direct impact on market shares by altering the relative prices of access products relative to Royal Mail’s end to end products. This effect is likely to be relatively muted in most scenarios (including removing the requirement for Saturday collections and deliveries) but is potentially more significant in other scenarios – including reducing first class quality of service and, in particular, moving to a two day product. However, operators compete for mail on the basis of a small margin relative to the retail price of a product. In the absence of a detailed product costing exercise, it is therefore difficult to confidently predict the level of market shares following the second round price changes – in particular our price allocation rules do not necessarily maintain a clear headroom between access products and their retail equivalent. Nevertheless, some second round market share effects are clear – such as the fact that Royal Mail would be exposed to significant market share losses under a two day product scenario if it were not able to price at or below the second class price. The second round effects estimated within our model therefore provide indicative price changes that could be expected under a regulatory benchmark, and likely volume and revenue responses to these price changes.



Evidence In order to estimate the second round effects described above we required parameters to calculate the own- and cross-price effects. Consistent with the ‘pyramid approach’ discussed above, we used the available econometric evidence. The ILTM provides own- and cross-price elasticities for first class and second class item mail and for ‘other’ products, primarily comprising bulk mail products. • first class own-price elasticity = [excised]; • second class own-price elasticity = [excised]; • ‘other’ (i.e. bulk mail) own-price elasticity = -[excised]; • first class cross-price elasticity with respect to second class = [excised]; • second class cross-price elasticity with respect to first class = [excised]. We use this evidence directly in estimating the effect of the second round price changes on mail volumes. In addition, we assume that Special Delivery volumes exhibit similar sensitivity to that exhibited by first class (as the nearest substitute) and that the cross-price effects for bulk mail (not estimated in the ILTM) are not significant. Note that these ILTM elasticities suggest very low responsiveness of total mail demand to changes in price. For example, suppose all first and second class item prices fall uniformly by 10%. The first class own elasticity, [excised], suggests that first class volumes would increase by around [excised]. However, since second class prices have also fallen by 10%, the elasticity of first class with respect to second class, [excised], suggests that first class volumes will fall by around [excised]. Overall, first class volumes may rise by only around [excised]. There would be no change at all in second class volumes, as the own-price elasticity, [excised], is directly offset by the elasticity of second class with respect to first class, [excised]. These elasticities therefore suggest limited total mail demand responsiveness to price.

Results We first report the results for second round effects in the two day, ‘no Saturday’ and 85% first class quality of service scenarios, under the 2006-07 market scenario. We then present the second round effects under each of the 12 universal service changes. We also discuss the treatment of Special Delivery in the second round and compare the results under the alternative 2009-10 market scenarios. Consider first the estimated price changes for the three scenarios of particular interest, as given in Table 40. X

X



Two day

No Saturday

1C QoS: 85%

1C Item

n/a

-5.0%

-0.1%

2C Item

+7.3%

-4.3%

-4.1%

1C Bulk

n/a

-5.7%

-5.2%

2C Bulk

+1.4%

-4.7%

-0.1%

3C Bulk

-7.1%

-5.0%

-0.1%

RM Access

-15.3%

-4.7%

-0.3%

Table 40: Estimated price changes, 2006-07 Source: Frontier Economics

As described above, prices have been reduced to reflect estimated (net) cost savings achieved by Royal Mail in the first round. These savings have been attributed to broad pipeline components, with prices reduced only for those products present in that part of the pipeline. In the case of removing the requirement for Saturday collections and deliveries, a large proportion of the cost savings are achieved in delivery. Consequently, price changes are quite evenly spread across products. In the reduced first class quality of service scenario, price reductions to first class bulk reflect the savings achieved in the transport network (particular air services). A smaller reduction is estimated for first class item mail because although there is a significant cost saving, the net cost saving is rather small. Since there is a significant revenue loss from first class item mail in the first round, the net cost saving (i.e. NAC) to be redistributed to these products is far smaller than the total cost saving. Under the two day service scenario, the second class (i.e. two day product) price actually increases, as a result of the negative first round NAC estimated in this case. Essentially, since first round cost savings are insufficient to match first round revenue losses, the redistribution of the NAC requires prices to increase above the second class price in order to leave Royal Mail’s revenues unchanged as a result of the universal service change. X

These price changes lead to the following estimated demand effects, shown in Table 41. X



Two day

No Saturday

1C QoS: 85%

-90m

+336m

+35m

1C Item

n/a

+74m

-64m

2C Item

-227m

-12m

+72m

1C Bulk

n/a

+27m

+24m

2C Bulk

-29m

+76m

+2m

3C Bulk

+160m

+113m

+3m

+3m

+56m

+4m

Total RM

RM Access

Table 41: Second round volume changes, 2006-07 Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)

The reduction in prices identified in the ‘no Saturday’ scenario leads to an increase in volumes. However, this increase is relatively modest compared to the price changes given in Table 40, as a result of the relative inelasticity of total mail demand, discussed above. Moreover, second class item volumes actually fall, due to the uniformity with which prices are reduced across different product classes. More obvious switching effects are observed in the two day and reduced quality of service scenarios, under which the price changes are more variable across products. X

X

The resulting impact upon revenues is illustrated in Table 42. X

Two day

X

No Saturday

1C QoS: 85%

Total RM (Initial)

£5,270m

£5,270m

£5,270m

Total RM (First Round)

£5,226m

£5,541m

£5,346m

NAC Redistribution

+£44m

-£271m

-£76m

Price Effect

-£28m

+£103m

+£3m

£5,242m

£5,373m

£5,273m

Total RM (Second Round)

Table 42: Second round revenue changes, 2006-07 Source: Frontier Economics NB: excludes Special Delivery, international, door-to-door and other mail (e.g. redirections)



This indicates that the second round revenue changes, after the NAC achieved in the first round has been redistributed, is quite large in the scenario where the requirement for Saturday deliveries and collections was removed but rather smaller in the two day scenario and is insignificant in the reduced first class quality of service scenario. The estimated price changes for the 12 universal service modifications are given in Table 43. These price changes are largest for those modifications offering a larger first round NAC, therefore we see the most significant price reductions in the scenarios where the requirement for Saturday deliveries and collections was removed and under the single two day service. X

X

The second round volume changes estimated in response to these price changes are reported in Table 44. We see significant volume responses for the no Saturday and single two day service scenarios, as described above. Additionally, we observe a similar volume response in the case of earlier delivery times. These volume losses reflect the significant negative first round NAC estimated in these scenarios. These are recovered by price increases of 1.5-2.5%. These increases apply fairly uniformly across products as the costs incurred by Royal Mail in meeting this universal service specification occur in parts of the pipeline which carry most products. As in the case of removing the requirement for Saturday collections and deliveries, the uniform nature of the price increase means that volumes are lost across all products rather than simply recycled from one product class into another. X

X



Modification

1C Item

2C Item

1C Bulk

2C Bulk

3C Bulk

RM Access

Remove requirement for Saturday Del/Coll

-5.0%

-4.3%

-5.7%

-4.7%

-5.0%

-4.7%

1C QoS: 85%

-0.1%

-4.1%

-5.2%

-0.1%

-0.1%

-0.3%

1C QoS: 87%

-0.3%

-3.1%

-4.1%

-0.1%

-0.1%

-0.2%

1C QoS: 90%

-0.3%

-1.6%

-2.1%

+0.0%

0.0%

-0.1%


-0.6%

+0.5%

-1.4%

-0.2%

-0.2%

-0.2%


-0.2%

+0.3%

-0.6%

-0.1%

-0.1%

-0.1%


+1.4%

+1.4%

+1.8%

+1.8%

+1.8%

+1.8%


+1.6%

+1.6%

+2.4%

+2.4%

+2.4%

+2.4%


-0.5%

+0.8%

-1.5%

-0.3%

-0.3%

-0.2%


-0.1%

+0.4%

-0.6%

-0.2%

-0.2%

-0.1%


+1.2%

+1.1%

+1.3%

+1.3%

+1.3%

+1.2%


n/a

+7.3%

n/a

+1.4%

-7.1%

-15.3%

Table 43: Estimated price changes for 12 universal service modifications, 2006-07 Source: Frontier Economics



Modification Remove requirement for Saturday Del/Coll

Total RM

1C Item

2C Item

1C Bulk

2C Bulk

3C Bulk

RM Access

336m

74m

-12m

27m

76m

113m

56m

1C QoS: 85%

35m

-64m

72m

24m

2m

3m

4m

1C QoS: 87%

35m

-42m

49m

19m

1m

2m

3m

1C QoS: 90%

19m

-18m

22m

10m

1m

1m

1m


25m

27m

-20m

7m

4m

5m

2m


10m

9m

-7m

3m

2m

3m

1m


-118m

-18m

0m

-8m

-29m

-40m

-21m


-156m

-21m

0m

-11m

-40m

-55m

-29m


28m

26m

-21m

7m

5m

7m

3m


11m

9m

-8m

3m

3m

4m

2m


-85m

-15m

0m

-6m

-21m

-28m

-15m


-90m

n/a

-227m

n/a

-29m

160m

3m

Table 44: Second round volume changes for 12 universal service modifications, 2006-07 Source: Frontier Economics



Special Delivery The volume and revenue effects estimated in the second round, as in the first round, are sensitive to the assumptions regarding Special Delivery. Table 45 indicates the estimated price changes that would occur in response to three alternative universal service changes. This table also indicates the likely volume response to this price change and the resulting change in revenues. X

Two day

1C QoS: 85%

-5.6%

-4.2%

+9.9%

[excised]

[excised]

[excised]

-£9m

-£6m

+£11m

Price Change Volume Change

No Saturday

X

Revenue Change

Table 45: Second round effects for Special Delivery, 2006-07 Source: Frontier Economics

Table 45 indicates that net cost savings would be passed through to lower Special Delivery prices in the two day service scenario and the scenario where the requirement for Saturday deliveries and collections was removed. However, in the first class quality of service scenario the price of Special Delivery would increase by almost 10%. This reflects the cost of retaining a Special Delivery network in the absence of the air transport network, which would not otherwise be required under the reduced first class quality of service target. X

X

The revenue effects given in Table 45 suggest that the treatment of Special Delivery is significant in estimating the second round effects of universal service changes. However, compared to the volume and revenues changes anticipated in the first round (across all products), these revenue changes are unlikely to substantively affect overall conclusions. X

X

Alternative market scenarios Consistent with estimation of first round effects, we estimated second round effects under three alternative market scenarios. The results presented above are based on the 2006-07 market scenario. The following tables indicate estimate second round price changes and subsequent volume responses under the 2009-10 ‘access’ and 2009-10 ‘end to end entry’ market scenarios.



Two day

No Saturday

1C QoS: 85%

1C Item

n/a

-5.4%

-0.6%

2C Item

13.5%

-4.6%

-4.4%

1C Bulk

n/a

-6.0%

-5.7%

2C Bulk

+3.7%

-5.2%

-0.4%

3C Bulk

-8.1%

-5.3%

-0.1%

RM Access

-20.3%

-5.5%

-1.4%

Table 46: Estimated price changes, 2009-10 ‘access’ scenario Source: Frontier Economics

Two day

No Saturday

1C QoS: 85%

-257m

+377m

+60m

1C Item

n/a

+67m

-45m

2C Item

-310m

-10m

+50m

1C Bulk

n/a

+19m

+18m

2C Bulk

-46m

+51m

+4m

3C Bulk

+199m

+129m

+2m

RM Access

-100m

+121m

+31m

Total RM

Table 47: Second round volume changes, 2009-10 ‘access’ scenario Source: Frontier Economics



Two day

No Saturday

1C QoS: 85%

1C Item

n/a

-5.8%

-0.6%

2C Item

+10.6%

-5.0%

-4.4%

1C Bulk

n/a

-6.4%

-5.7%

2C Bulk

+5.2%

-5.6%

-0.4%

3C Bulk

-9.3%

-5.7%

-0.1%

RM Access

-19.4%

-5.5%

-1.1%

Table 48: Estimated price changes, 2009-10 ‘end to end entry’ scenario Source: Frontier Economics

Two day

No Saturday

1C QoS: 85%

-152m

+364m

+55m

1C Item

0m

+72m

-45m

2C Item

-241m

-11m

+52m

1C Bulk

0m

+22m

+19m

2C Bulk

-60m

+55m

+4m

3C Bulk

+242m

+142m

+2m

-93m

+85m

+23m

Total RM

RM Access

Table 49: Second round volume changes, 2009-10 ‘end to end entry’ scenario Source: Frontier Economics

The second round effects estimated under the alternative market scenarios are consistent with the first round effects presented above. The estimated price changes are similar across all market scenarios for the removing the requirement for Saturday deliveries and collections and reduced first class quality of service scenarios, leading to similar volume changes. In the case of the single two day service, we noted above that under 2009-10 market conditions Royal Mail would be likely to suffer larger revenue losses in the first round. This is due to the greater intensity of competition for second and third class volumes anticipated in 2009-10. Consequently, the NAC is a larger negative value under 2009-10 conditions. This is passed through to higher prices in the second round, leading to significant revenue losses.



ADDITIONAL CONSIDERATIONS In addition to the first and second round effects described above, our model takes account of the following consequence of modifying the universal service specification.

Profile effect of ceasing Saturday deliveries One particular issue that applies not just to total demand but the daily profile of mail volumes arises under the scenario that ceases Saturday deliveries. Under this scenario weekly posting profiles are likely to vary. First, items that were scheduled for delivery or collection on Saturday are most likely not to be sent. Second, customers may adjust their weekly posting profile to account for the additional delay over the weekend. We have estimated that 1.59% of total stamped volumes and 1.99% of total meter and PPI mail are lost in response to removing the requirement for Saturday deliveries and collections. For the purposes of our cost modelling, we assess how this affects the posting profile over the course of the week. We have assumed that these volumes are entirely composed of items that were scheduled to arrive on Saturday i.e. first class volumes posted on Friday and second class volumes posted on Thursday. This is around 10% of all mail that would otherwise have been posted on a Thursday (second class) or Friday (first class). We suppose that these volumes required Saturday delivery (which is no longer available) and could not be posted a day earlier. We assume a further volume response, whereby 5% of mail that would have been delayed by the absence of Saturday deliveries is now sent a day earlier. This applies to all volumes currently posted on Friday and also to second class volumes that are currently sent on Thursday.



Annexe 3: The cost module of the universal service model TRANSPORT The transport model assesses how air, road and ferry costs may vary under alternative universal service specifications. It is based on information provided by Royal Mail showing actual air and road services and other operational level information and is based on Royal Mail’s current mail centre network. 35 TPF

FPT

Mail centre network model Central to the transport model is a matrix linking each mail centre to every other mail centre (along with the Isle of Man and Channel Islands, distribution centres and a small number of other locations sending or receiving mail). This matrix is populated with: • actual mail volumes, with a split by product group (e.g. first class, second class, Special Delivery) and an estimated split between main and final despatch; 36 TPF

FPT

• road transport times, based on Royal Mail assumed travel times, including an allowance for changeover times at hubs; 37 and TPF

FPT

• the window for transport between despatch times at the outward mail centre (showing main and final despatch separately) and the latest arrival time at the inward mail centre. 38 TPF

FPT

With this information, we are able to assess where mail volumes are able to travel between mail centre pairs by road, and where they require air services. We do this by comparing the total road transport time with the available time window: • where transport time is less than the time window for the final despatch, all mail is able to travel by road; • where transport time is more than the time window for the final despatch, but less than the time window for the main despatch, we assume that a portion of mail travels by air, equal to the estimated average proportion of mail using the final despatch; and • where transport time is more than the time window for the main despatch, all mail must travel by air.

Source: Royal Mail.

35 TP

PT

Source: Royal Mail.

36 TP

PT

Source: Royal Mail.

37 TP

TP

38 PT

PT

Source: Royal Mail.

Annexe 3: The cost module of the universal service model


This gives us a basic matrix of volumes for mail centre to mail centre pairs showing the volumes of mail relying on air services.39 We assume that air services may carry first class mail, Special Delivery and all mail products for Northern Ireland, the Channel Islands and the Isle of Man. TPF

FPT

The next stage of the model aggregates this information to estimate mail flows on flights. We make the simplifying assumption that all flown mail from a mail centre travels from the same airport (in reality, some mail centres between two airports may use different airports for different services but this does not have a material impact on our results). Combined with the mail centre pairs, this generates a set of aircraft pairs between which mail must travel. Finally, this is combined with actual information about Royal Mail’s current flights. The volume of mail predicted to travel between airport pairs closely matches Royal Mail’s actual flight patterns, once connecting flights are taken into account. (For instance, mail from Edinburgh to Belfast travels via East Midlands airport.) With this basic model in place, we are able to test the impact of flexing: • the number of flights used; and • changes in flight requirements with changes in mail centre despatch or acceptance times. The first type of change is useful for understanding the potential regional impact on quality of service with changes in the size of the air network. The results of this assessment are presented in section 4. They take into account, for example, the need for connecting flights in order to achieve high quality of service on particular routes. X

X

The second type of change helps us understand how changes in collection or delivery times may affect transport costs and mail arrival patterns at mail centres. By increasing the time window, we can understand which mail centre pairs are able to use road services rather than air services. As the results show, extra time reduces the volume of mail needing to use air services. It therefore allows some reduction in air services. However, with increases of no more than two hours, there are only a small number of airport pairs where air services can be removed completely (such as Newcastle to Stansted). In most cases, the most distant mail centres using each airport still need air services in order to connect first class mail, and an extensive national network is therefore required. Similarly, the model demonstrates that it would difficult to shrink the time window below its current level, even allowing for extra air services. Many of the mail centre pairs that would fail are sufficiently close that introducing extra air connections would not save time, once travel time to airports and mail screening time are accounted for. We have therefore looked elsewhere in the network when seeking to bring forward delivery times.

39 TP

PT

Royal Mail has suggested that the available information may not give a reliable split of mail between the main and final despatch. Our results are not very sensitive to this split.



Estimating costs By using the mail centre network model, we can understand the operational implications of more or fewer air services, or greater or lesser time. We combine this with cost information to generate total network costs. The assessment of flight costs is relatively straightforward, and uses information form Royal Mail about current contract costs on a flight by flight basis. 40 We assume that if a flight is no longer required, Royal Mail will be able to save the entire contract costs associated with that aircraft (at least following a suitable break in the contract). In addition, we assume that screening costs are completely variable and saved in proportion to the volumes that are not flown, while 40% of hub costs vary in proportion to volumes using each hub. The remaining hub costs are only eliminated when no flights use EMA, EDI or STN. Overall costs associated with flights are estimated at £109m p.a. (excluding road feeder services). TPF

FPT

For the purposes of assessing changes in road costs, we have divided road services into nine groups based on a combination of service type (services to LHR/LGW; services to other airports; and other services) and timing (19:00 to 03:00; 03:00 to 12:00; and 12:00 to 19:00). This division provides an approximate indication of the current use of vehicles (e.g. vehicles leaving between 19:00 and 03:00, not travelling to airports are likely to be part of the standard first class network while those travelling between 12:00 and 19:00 are more likely to carry second class mail). It allows us to understand, in a relatively broad brush way, how factors like vehicle capacity, vehicle utilisation, and average costs vary across the Royal Mail’s current transport network, without developing a complex network model which is beyond the scope of this project. For instance, the average cost to transport each york one mile three times higher for services to airports than for standard services between 12:00 and 19:00, used primarily for second class mail. Changes in estimated road costs are then derived using these initial average road costs, estimates of the change in volumes using services, and cost elasticities. For instance, with two hours extra allowance in the transport network, around 28% of mail that currently travels by air would travel by road instead. This is equivalent to a 2.8% increase in volumes travelling by road. The BPM estimates that the cost elasticity in the mail centre network is 44%, so a 2.8% increase in volumes would typically translate into a 1.2% increase in costs. Given that mail that would otherwise travel by air is long distance mail, we make the conservative assumption that the cost increase is actually three times the typical increase. We then apply the final 3.7% cost increase to the total cost of all road services, excluding services to airports. In the same way, we estimate changes in road costs under a two day network, or with no Saturday deliveries based on volume changes and cost elasticities. For instance, we base our estimated cost savings with a two day network on the current difference in average costs per york per mile between services operating

TP

40 PT

Source: Royal Mail.



in the evening (predominantly first class) and those operating in the afternoon (predominantly second class). We assume that 75% of the cost difference is recoverable (the remainder may be due to other differences between services, and not the better utilisation made possible by a more relaxed timeframe) and also make allowances for 15% additional miles (since there is more direct running in the first class mail network). At the same time, no feeder services to airports would be required and the costs associated with these services are removed, to be replaced by additional road network costs and some feeders using larger vehicles between NDC and EMA for flights to Belfast.

DELIVERY OFFICES Delivery costs are estimated separately for indoor delivery (mail preparation) and outdoor delivery. The two models are linked so that indoor processing time reflects the number of outdoor walks required, while both models adapt to changes in volumes. Our estimates of indoor delivery costs are based on average processing times for different mail types taken from the SPM, and also take account of projected changes in walk sequencing and the proportion of mail walksorted at mail centres between now and 2009-10. These cost estimates are combined with an operational model of outdoor delivery costs, similar to Royal Mail’s Delivery Cost Model. The models are designed to estimate the cost impact of: • removing a delivery day; and • changing the variation in delivery profiles through the week. These effects are estimated together in a two stage process that uses the projected variation in delivery volumes shown in the tables in the annexe. The first stage estimates for each day of the week the cost base needed for delivery operations, based on average volumes for that day. The estimated cost base for Tuesday (12% of weekly delivery volumes) is therefore lower than for Thursday (with 19%). Higher delivery volumes on any given day require more vehicles, pouch drops and postmen to deliver to the same number of delivery points. The second stage is to work out the average delivery base needed. We assume that this is driven by the day with the highest delivery volumes but that, on other days, savings equivalent to 60% of the difference in cost can be made. 41 For indoor delivery, we assume that 80% of the difference in costs can be recovered, which may overstate the flexibility of Royal Mail’s workforce. TPF

FPT

Consequently, our estimates of delivery costs reflect both the total volumes of mail to be delivered, and the maximum volume of mail to be delivered on any day of the week. Our modelling suggests that Royal Mail would have used approximately 98,000 FTEs for indoor and outdoor delivery in 2006-07 based on

TP

41 PT

60% is a parameter that we can flex between 0% (cost base depends entirely on peak delivery days) and 100% (cost base is able to flex perfectly day to day). 60% was chosen as it means that outdoor delivery spans vary by up to half an hour, which we understand is the maximum variation currently accepted under union agreements.



the current 6 day network. With the same delivery volumes spread evenly over the week, our modelling suggests that Royal Mail could have required 2,000 fewer FTEs. This translates into a potential cost saving of £45m, just under 2% of costs. This variation in volumes is also taken into account when we consider moving to different delivery options. Part of the savings in delivery costs when moving to a five day service come from a smoother workflow throughout the week since the delivery week is more naturally aligned with a typical five day working week and hence mail posting profiles.

FEEDER SERVICES Our estimates of feeder service costs are designed to assess cost changes with: • different overall volumes and profile across the week; and • five or six collection days. The foundation of our model is information about the location of Royal Mail’s current DOs and their parent MCs. Using Mapinfo, a mapping programme, we have estimated the driving distance between each DO and MC. We also know the delivery volumes handled by each DO in 2006-07 (we assume the relative sizes of DOs remain constant in future years). Using the volume by day of week projections in the annexe, we can then estimate the volume of mail that has to be transported between each MC and each DO by day of the week. We have assumed that, on average, each vehicle travelling between a DO and its parent MC carries around 8,000 items. This excludes D2D mail which we assume is transported on any services with available capacity and which does not, therefore, drive costs. We then estimate the number of feeder services required by each DO based on this average vehicle fill. As a result, our estimate of total costs depends on: • total distance travelled, which is twice the number of services required (there and back) multiplied by the estimated travel distance; • total travel time, based on an average speed of 36.6kmh (SPM assumption); and • loading and unloading time, assumed to be 15 minutes at each end. As for deliveries, we make an adjustment for variation in volumes across the course of the week. We assume that 80% of any change in volume is reflected in changes in vehicle fill, rather than additional services, but that some additional services are required. With this assumption, our modelling suggests that the cost of feeder services could be up to 1.4% lower with current volumes if the delivery profile was even across the week. Based on these assumptions, we estimate that feeder services cost around £138m per year, with labour costs of £67m (around 3,000 FTEs) and fixed vehicle costs of £23m (4,800 vehicles) and variable vehicle costs of £48m (annual distance travelled 118m km).



The cost of feeder services varies with changes in mail volumes or the distribution of mail volumes over the course of the week. We have assumed that changes in volumes result partly in changes in the number of services required, and partly in changes in average vehicle fill. Specifically, we assume that a 10% change in volumes increases average vehicle fill by 4%, which consequently increases the number of services required by 5.7%. Feeders for collections are modelled in an identical way but based on the actual location of collection hubs, rather than all Delivery Offices.

COLLECTIONS Our assessment of collection costs uses information about the number of collection boxes, customers and PO Counters from which collections are made on weekdays and Saturdays. This is combined with an urban/rural split taken from the Strategic Planning Model, and information on total land area to estimate the average distance between collection points of different types. In a similar way to the delivery cost model, this allows us to estimate the average travel time required to visit all collection points, and hence the number of staff and vehicles needed in total. We assume that final collections have to take place within a two hour window in urban areas, but that five hours is available in rural areas. Overall, the model predicts that around 6,700 staff are required for final deliveries on weekdays (although many staff will combine collections with other duties or work part time) and 4,400 on Saturdays (who may combine collections with delivery rounds). In addition, other collections take place throughout the day. Our base case assumptions are that on average, each Box and PO counter is visited 2.5 times before the final collection in urban areas. In rural areas, PO counters are visited once for an earlier collection while one in five boxes also receives an additional pick up. No additional collections take place on Saturdays. Overall, we estimate around 6,500 FTEs are required for collections. In moving to a five day week, savings are only possible for Saturday collections. Fewer collection points are visited on Saturdays than on other days (most firms are closed and no relief collections are made) and no savings on fixed vehicle costs are possible, as vehicles are still required for other days. Consequently, total savings are around 6% of overall collection costs, or £11m. In addition, savings would be available with a single two day mail product and no first class service. With no first class, there is less need for relief collections throughout the day to provide mail centres with a head of work. Instead the main constraint is capacity at collection points. Consequently, we have assumed that only one relief collection per day is required at boxes in urban areas, and two for PO counters. This saves a substantial part of costs relating to relief collections – around £44m in total.



PIPELINE VOLUMES AND WORKPLANS This section contains our projections of: • volumes of mail handled by each part of the pipeline by day of the week; and • indicative workplans for mail centres by day of the week. These are shown in each of the major scenarios under consideration (i.e. removing a delivery day or moving to a two day network). The pipeline volumes show the week as a whole and also separately illustrate processing patterns for mail posted on a Friday. The projections are based on actual posting profiles throughout the week. Royal Mail has been able to provide very little information about the volumes of Mailsort 3 that are processed throughout the week. We have consequently assumed that equal volumes of mail are processed each day, with no Mailsort 3 deliveries on Saturday. In practice, a small number of delivery offices do undertake deliveries on a Saturday but we do not believe the changes materially alter our results.



Current six day service specification Current State:- Six Day Current State:- Six Day Delivery and Collection Service - Friday postings Mon

Tue

Wed

Thu

Fri

Posted 1C 2C 1C Bulk 2C Bulk 3C Bulk Access Collected 1C 2C 1C Bulk 2C Bulk MS3 Access Outward MC 1C 2C 1C Bulk 2C Bulk MS3 Access Inward MC 1C 2C 1C Bulk 2C Bulk MS3 Access Delivery 1C 2C 1C Bulk 2C Bulk MS3 Access

0.0%

0.0%

0.0%

0.0%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

Current State:- Six Day Delivery and Collection Service - All mail Sat

Total

Mon

Tue

Wed

Thu

Fri

Sat

Total

0.0%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

4.1% 4.2% 0.7% 3.2% 5.6% 2.5% 20.3%

4.1% 4.3% 0.8% 3.2% 4.1% 2.4% 19.0%

4.0% 4.4% 1.1% 3.3% 4.2% 2.5% 19.5%

3.9% 4.3% 1.1% 3.1% 4.2% 2.0% 18.6%

3.8% 4.4% 0.9% 3.3% 4.3% 2.1% 18.8%

1.1% 1.4% 0.1% 0.3% 0.1% 0.8% 3.9%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

4.1% 4.2% 0.7% 3.2% 4.5% 2.5% 19.2%

4.1% 4.3% 0.8% 3.2% 4.5% 2.4% 19.4%

4.0% 4.4% 1.1% 3.3% 4.5% 2.5% 19.8%

3.9% 4.3% 1.1% 3.1% 4.5% 2.0% 18.9%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

1.1% 1.4% 0.1% 0.3% 0.0% 0.8% 3.8%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

4.1% 1.4% 0.0% 0.0% 0.0% 0.0% 5.5%

4.1% 4.2% 0.0% 0.0% 0.0% 0.0% 8.3%

4.0% 4.3% 0.0% 0.0% 0.0% 0.0% 8.3%

3.9% 4.4% 0.0% 0.0% 0.0% 0.0% 8.3%

3.8% 4.3% 0.0% 0.0% 0.0% 0.0% 8.2%

1.1% 4.4% 0.0% 0.0% 0.0% 0.0% 5.5%

21.0% 23.0% 0.0% 0.0% 0.0% 0.0% 44.0%

1.1% 4.4% 0.1% 0.3% 4.5% 0.8% 11.2%

4.1% 1.4% 0.7% 3.2% 4.5% 2.5% 16.5%

4.1% 4.2% 0.8% 3.2% 4.5% 2.4% 19.2%

4.0% 4.3% 1.1% 3.3% 4.5% 2.5% 19.7%

3.9% 4.4% 1.1% 3.1% 4.5% 2.0% 19.0%

3.8% 4.3% 0.9% 3.3% 0.0% 2.1% 14.5%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

1.3% 4.4% 0.2% 3.3% 4.5% 2.1% 15.8%

3.9% 1.7% 0.7% 0.6% 4.5% 0.8% 12.2%

4.1% 3.9% 0.8% 2.9% 4.5% 2.5% 18.8%

4.0% 4.2% 1.1% 3.1% 4.5% 2.4% 19.4%

3.9% 4.3% 1.1% 3.3% 4.5% 2.5% 19.7%

3.8% 4.3% 0.9% 3.1% 0.0% 2.0% 14.1%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

2.1% 14.5%

0.0% 0.0%

2.1% 14.5%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

3.8% 0.0%

0.0% 4.4%

3.8% 4.4% 0.0% 0.0%

0.0%

0.0%

0.0%

0.0%

3.8%

4.4%

0.0% 8.2%

0.0% 4.4% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

3.8% 0.0% 0.9% 3.3%

3.8% 4.4% 0.9% 3.3%

0.0% 4.4%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

2.1% 10.2%

2.1% 14.5%

0.3% 3.9% 0.1% 3.0%

0.0% 0.4% 0.0% 0.3%

0.0% 0.1% 0.0% 0.1%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

3.6% 0.0% 0.8% 0.0%

3.8% 4.4% 0.9% 3.3%

2.1% 9.4%

0.0% 0.7%

0.0% 0.1%

0.0% 0.0%

0.0% 0.0%

0.0% 4.4%

2.1% 14.5%

Figure 15: Current service specification – six deliveries and collections

-Current State:- Six Day Delivery and Collection Service From 00:00 01:00 02:00 03:00 04:00 05:00 06:00 07:00 08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 20:00 21:00 22:00 23:00

To 01:00 02:00 03:00 04:00 05:00 06:00 07:00 08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 20:00 21:00 22:00 23:00 00:00

Network

Monday Inward Inward Inward Inward Inward Inward Outward 2C Outward 2C

Inward/Access Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Inward Inward

Tuesday Inward Inward Inward Inward Inward Inward Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Access Inward/Access Inward/Access Inward/Access Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Inward Inward

Wednesday Inward Inward Inward Inward Inward Inward Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Access Inward/Access Inward/Access Inward/Access Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Inward Inward

Thursday Inward Inward Inward Inward Inward Inward Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Access Inward/Access Inward/Access Inward/Access Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Inward Inward

Friday Inward Inward Inward Inward Inward Inward Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Access Inward/Access Inward/Access Inward/Access Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Inward Inward

As now: All 1C mail to IMC





Saturday Inward Inward Inward Inward Inward Inward Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Access Access Access Outward 1C Outward 1C Outward 1C

Sunday

Inward Inward

SAWN

Figure 16: Current service specification – six deliveries and collections



No Saturday deliveries or collections No Saturday collectionsNo Saturday collections or deliveries - Friday postings Mon

Tue

Wed

Collected 1C 2C 1C Bulk 2C Bulk MS3 Access Outward MC 1C 2C 1C Bulk 2C Bulk MS3 Access Inward MC 1C 2C 1C Bulk 2C Bulk MS3 Access Delivery 1C 2C 1C Bulk 2C Bulk MS3 Access

No Saturday collections or deliveries - All mail

Thu

Fri

Posted 1C 2C 1C Bulk 2C Bulk MS3 Access

Sat

Total

Mon

Tue

Wed

Thu

Fri

Sat

Total

4.1% 4.2% 0.7% 3.2% 4.5% 2.5% 19.2%

4.1% 4.3% 0.8% 3.2% 4.5% 2.4% 19.4%

4.0% 4.4% 1.1% 3.3% 4.5% 2.5% 19.8%

3.9% 4.3% 1.1% 3.1% 4.5% 2.0% 18.9%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

1.1% 1.4% 0.1% 0.3% 0.0% 0.8% 3.8%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

5.2% 5.6% 0.7% 3.2% 4.5% 2.5% 21.7%

4.1% 4.3% 0.8% 3.2% 4.5% 2.4% 19.4%

4.0% 4.4% 1.1% 3.3% 4.5% 2.5% 19.8%

3.9% 4.3% 1.1% 3.1% 4.5% 2.0% 18.9%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

0.0% 0.0% 0.1% 0.3% 0.0% 0.8% 1.2%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

5.2% 4.4% 0.0% 0.0% 0.0% 0.0% 9.6%

4.1% 5.6% 0.0% 0.0% 0.0% 0.0% 9.7%

4.0% 4.3% 0.0% 0.0% 0.0% 0.0% 8.3%

3.9% 4.4% 0.0% 0.0% 0.0% 0.0% 8.3%

3.8% 4.3% 0.0% 0.0% 0.0% 0.0% 8.2%

0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

21.0% 23.0% 0.0% 0.0% 0.0% 0.0% 44.0%

3.8% 4.3% 1.0% 3.3% 4.5% 2.9% 19.9%

5.2% 4.4% 0.7% 3.5% 4.5% 2.5% 20.8%

4.1% 5.6% 0.8% 3.2% 4.5% 2.4% 20.7%

4.0% 4.3% 1.1% 3.3% 4.5% 2.5% 19.7%

3.9% 4.4% 1.1% 3.1% 4.5% 2.0% 19.0%

0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

3.8% 4.4% 1.0% 3.1% 4.5% 2.0% 18.8%

5.1% 4.3% 0.8% 3.3% 4.5% 2.9% 20.9%

4.2% 5.5% 0.8% 3.5% 4.5% 2.5% 21.0%

4.0% 4.4% 1.1% 3.2% 4.5% 2.4% 19.6%

3.9% 4.4% 1.1% 3.3% 4.5% 2.5% 19.7%

0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

0.0%

0.0%

0.0%

0.0%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

0.0%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

2.1% 14.5%

0.0% 0.0%

2.1% 14.5%

0.0% 4.4%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

3.8% 0.0%

0.0%

3.8% 4.4% 0.0% 0.0%

4.4%

0.0%

0.0%

0.0%

3.8%

0.0%

3.8% 0.0% 0.9% 3.3%

0.0% 4.4% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

2.1% 10.2%

0.0% 4.4%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0%

2.1% 14.5%

3.6% 0.0% 0.8% 0.0%

0.3% 3.9% 0.1% 3.0%

0.0% 0.4% 0.0% 0.3%

0.0% 0.1% 0.0% 0.1%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

0.0% 4.4%

2.1% 9.4%

0.0% 0.7%

0.0% 0.1%

0.0% 0.0%

0.0% 0.0%

2.1% 14.5%

0.0%

0.0% 8.2% 3.8% 4.4% 0.9% 3.3%

Figure 17: No Saturday deliveries or collections

-No Saturday deliveries or collections From 00:00 01:00 02:00 03:00 04:00 05:00 06:00 07:00 08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 20:00 21:00 22:00 23:00

To 01:00 02:00 03:00 04:00 05:00 06:00 07:00 08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 20:00 21:00 22:00 23:00 00:00

Network

Monday Inward Inward Inward Inward Inward Inward Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Access Inward/Access Inward/Access Inward/Access Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Inward Inward


Tuesday Inward Inward Inward Inward Inward Inward Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Access Inward/Access Inward/Access Inward/Access Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Inward Inward


W ednesday Inward Inward Inward Inward Inward Inward Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Access Inward/Access Inward/Access Inward/Access Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Inward Inward


Thursday Inward Inward Inward Inward Inward Inward Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Access Inward/Access Inward/Access Inward/Access Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Inward Inward


Friday Inward Inward Inward Inward Inward Inward Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Outward 2C Inward/Access Inward/Access Inward/Access Inward/Access Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C Outward 1C

Saturday

Sunday

Inward Inward MC despatches as normal Friday night, road transport network runs as far as outward hub

Inter hub network

Feeders from inward hub to IMC with Friday's 1C mail, Thursday 2C mail

Figure 18: No Saturday deliveries or collections



Single two day product– six days Single two day networkSingle two day network - Friday postings Mon

Tue

Wed

Single two day network - All mail Thu

Fri

Posted 1C 2C 1C Bulk 2C Bulk MS3 Access Collected 1C 2C 1C Bulk 2C Bulk MS3 Access Outward MC 1C 2C 1C Bulk 2C Bulk MS3 Access Inward MC 1C 2C 1C Bulk 2C Bulk MS3 Access Delivery 1C 2C 1C Bulk 2C Bulk MS3 Access

Sat

Total

Mon

Tue

Wed

Thu

Fri

Sat

Total

4.1% 4.2% 0.7% 3.2% 4.5% 2.5% 19.2%

4.1% 4.3% 0.8% 3.2% 4.5% 2.4% 19.4%

4.0% 4.4% 1.1% 3.3% 4.5% 2.5% 19.8%

3.9% 4.3% 1.1% 3.1% 4.5% 2.0% 18.9%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

1.1% 1.4% 0.1% 0.3% 0.0% 0.8% 3.8%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

4.1% 4.2% 0.7% 3.2% 4.5% 2.5% 19.2%

4.1% 4.3% 0.8% 3.2% 4.5% 2.4% 19.4%

4.0% 4.4% 1.1% 3.3% 4.5% 2.5% 19.8%

3.9% 4.3% 1.1% 3.1% 4.5% 2.0% 18.9%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

1.1% 1.4% 0.1% 0.3% 0.0% 0.8% 3.8%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

4.1% 4.2% 0.0% 0.0% 0.0% 0.0% 8.2%

4.1% 4.3% 0.0% 0.0% 0.0% 0.0% 8.4%

4.0% 4.4% 0.0% 0.0% 0.0% 0.0% 8.3%

3.9% 4.3% 0.0% 0.0% 0.0% 0.0% 8.2%

3.8% 4.4% 0.0% 0.0% 0.0% 0.0% 8.2%

1.1% 1.4% 0.0% 0.0% 0.0% 0.0% 2.6%

21.0% 23.0% 0.0% 0.0% 0.0% 0.0% 44.0%

1.1% 1.4% 0.1% 0.3% 4.5% 0.8% 8.3%

4.1% 4.2% 0.7% 3.2% 4.5% 2.5% 19.2%

4.1% 4.3% 0.8% 3.2% 4.5% 2.4% 19.4%

4.0% 4.4% 1.1% 3.3% 4.5% 2.5% 19.8%

3.9% 4.3% 1.1% 3.1% 4.5% 2.0% 18.9%

3.8% 4.4% 0.9% 3.3% 0.0% 2.1% 14.5%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

1.3% 1.6% 0.1% 0.5% 4.5% 0.9% 8.8%

3.9% 4.0% 0.7% 3.0% 4.5% 2.4% 18.6%

4.1% 4.3% 0.8% 3.2% 4.5% 2.4% 19.3%

4.0% 4.4% 1.1% 3.3% 4.5% 2.5% 19.7%

3.9% 4.3% 1.1% 3.1% 0.0% 2.0% 14.5%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

0.0%

0.0%

0.0%

0.0%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

0.0%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

2.1% 14.5%

0.0% 0.0%

2.1% 14.5%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

3.8% 4.4%

0.0% 0.0%

3.8% 4.4% 0.0% 0.0%

0.0%

0.0%

0.0%

0.0%

8.2%

0.0%

0.0% 8.2%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

3.8% 4.4% 0.9% 3.3%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

2.1% 14.5%

2.1% 14.5%

3.6% 4.2% 0.8% 3.2%

0.2% 0.2% 0.0% 0.2%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

2.0% 13.8%

0.1% 0.7%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

2.1% 14.5%

Figure 19: Single two day product – six days

-Two day network From 00:00 01:00 02:00 03:00 04:00 05:00 06:00 07:00 08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 20:00 21:00 22:00 23:00

To 01:00 02:00 03:00 04:00 05:00 06:00 07:00 08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 20:00 21:00 22:00 23:00 00:00

Monday

All All All All All

inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access Outward - all Outward - all Outward - all Outward - all Outward - all

All All All All All All All All All All All

Tuesday Outward - all Outward - all Outward - all Outward/inward Inward - neigh Inward - neigh Inward - neigh Inward - neigh inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access Outward - all Outward - all Outward - all Outward - all Outward - all


W ednesday Outward - all Outward - all Outward - all Outward/inward Inward - neigh Inward - neigh Inward - neigh Inward - neigh inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access Outward - all Outward - all Outward - all Outward - all Outward - all


Thursday Outward - all Outward - all Outward - all Outward/inward Inward - neigh Inward - neigh Inward - neigh Inward - neigh inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access Outward - all Outward - all Outward - all Outward - all Outward - all


Friday Outward - all Outward - all Outward - all Outward/inward Inward - neigh Inward - neigh Inward - neigh Inward - neigh inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access Outward - all Outward - all Outward - all Outward - all Outward - all


Saturday Outward - all Outward - all Outward - all Outward/inward Inward - neigh Inward - neigh Inward - neigh Inward - neigh inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access Outward - all Outward - all Outward - all

Sunday

Network

Assumes nInward for Tue delivery

Inward for W ed delivery

Inward for Thur delivery

Inward for Fri delivyer Inward for Sat delivery

Inward for Mon delivery

Figure 20: Single two day product – six days



Single two day product – no Saturday service Single two day networkSingle two day network - no Saturday delivery or collections - Friday postings Mon

Tue

Wed

Thu

Fri

Posted 1C 2C 1C Bulk 2C Bulk MS3 Access Collected 1C 2C 1C Bulk 2C Bulk MS3 Access Outward MC 1C 2C 1C Bulk 2C Bulk MS3 Access Inward MC 1C 2C 1C Bulk 2C Bulk MS3 Access Delivery 1C 2C 1C Bulk 2C Bulk MS3 Access

Single two day network - no Saturday delivery or collections - All mail

Sat

Total

Mon

Tue

Wed

Thu

Fri

Sat

Total

4.1% 4.2% 0.7% 3.2% 4.5% 2.5% 19.2%

4.1% 4.3% 0.8% 3.2% 4.5% 2.4% 19.4%

4.0% 4.4% 1.1% 3.3% 4.5% 2.5% 19.8%

3.9% 4.3% 1.1% 3.1% 4.5% 2.0% 18.9%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

1.1% 1.4% 0.1% 0.3% 0.0% 0.8% 3.8%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

5.2% 5.6% 0.7% 3.2% 4.5% 2.5% 21.7%

4.1% 4.3% 0.8% 3.2% 4.5% 2.4% 19.4%

4.0% 4.4% 1.1% 3.3% 4.5% 2.5% 19.8%

3.9% 4.3% 1.1% 3.1% 4.5% 2.0% 18.9%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

0.0% 0.0% 0.0% 0.3% 0.0% 0.8% 1.1%

21.0% 23.0% 4.6% 16.4% 22.5% 12.4% 99.9%

5.2% 5.6% 0.0% 0.0% 0.0% 0.0% 10.8%

4.1% 4.3% 0.0% 0.0% 0.0% 0.0% 8.4%

4.0% 4.4% 0.0% 0.0% 0.0% 0.0% 8.3%

3.9% 4.3% 0.0% 0.0% 0.0% 0.0% 8.2%

3.8% 4.4% 0.0% 0.0% 0.0% 0.0% 8.2%

0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

21.0% 23.0% 0.0% 0.0% 0.0% 0.0% 44.0%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

5.2% 5.6% 0.8% 3.5% 4.5% 3.3% 22.9%

4.1% 4.3% 0.8% 3.2% 4.5% 2.4% 19.4%

4.0% 4.4% 1.1% 3.3% 4.5% 2.5% 19.8%

3.9% 4.3% 1.1% 3.1% 4.5% 2.0% 18.9%

0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

4.1% 4.5% 1.2% 3.2% 4.5% 2.1% 19.7%

3.6% 4.2% 0.8% 3.2% 4.5% 2.0% 18.3%

5.1% 5.5% 0.8% 3.5% 4.5% 3.3% 22.8%

4.2% 4.4% 0.8% 3.2% 4.5% 2.5% 19.5%

4.0% 4.4% 1.1% 3.3% 4.5% 2.5% 19.7%

0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

21.0% 23.0% 4.7% 16.4% 22.5% 12.4% 100.0%

0.0%

0.0%

0.0%

0.0%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

0.0%

3.8% 4.4% 0.9% 3.3% 4.5% 2.1% 19.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

2.1% 14.5%

0.0% 0.0%

2.1% 14.5%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

3.8% 4.4%

0.0% 0.0%

3.8% 4.4% 0.0% 0.0%

0.0%

0.0% 8.2%

0.0%

0.0%

0.0%

0.0%

8.2%

3.8% 4.4% 0.9% 3.3% 0.0% 2.1% 14.5%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

0.0%

2.1% 14.5%

0.0% 0.0% 0.0% 0.0%

3.6% 4.2% 0.8% 3.2%

0.2% 0.2% 0.0% 0.2%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

0.0% 0.0% 0.0% 0.0%

3.8% 4.4% 0.9% 3.3%

0.0% 0.0%

2.0% 13.8%

0.1% 0.7%

0.0% 0.0%

0.0% 0.0%

0.0% 0.0%

2.1% 14.5%

3.8% 4.4% 0.9% 3.3%

Figure 21: Single two day product – no Saturday service

-Two day network - no Saturday delivery or collection From 00:00 01:00 02:00 03:00 04:00 05:00 06:00 07:00 08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 20:00 21:00 22:00 23:00

To 01:00 02:00 03:00 04:00 05:00 06:00 07:00 08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 20:00 21:00 22:00 23:00 00:00

Monday


Inward - neigh Inward - neigh inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access Outward - all Outward - all Outward - all Outward - all Outward - all


Tuesday Outward - all Outward - all Outward - all Outward/inward Inward - neigh Inward - neigh Inward - neigh Inward - neigh inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access Outward - all Outward - all Outward - all Outward - all Outward - all


W ednesday Outward - all Outward - all Outward - all Outward/inward Inward - neigh Inward - neigh Inward - neigh Inward - neigh inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access Outward - all Outward - all Outward - all Outward - all Outward - all


Thursday Outward - all Outward - all Outward - all Outward/inward Inward - neigh Inward - neigh Inward - neigh Inward - neigh inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access Outward - all Outward - all Outward - all Outward - all Outward - all


Friday Outward - all Outward - all Outward - all Outward/inward Inward - neigh Inward - neigh Inward - neigh Inward - neigh inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access inward/MS/access Outward - all Outward - all Outward - all Outward - all Outward - all

Saturday Outward - all Outward - all Outward - all Outward/inward Inward - neigh Inward - neigh

Sunday

Network

Assumes nInward for Tues delivery

Inward for W ed delivery

Inward for Thur delivery

Inward for Mon delivery

Inward for Fri delivyer

Transport up to inward hub

Figure 22: Single two day product – no Saturday service



FIVE DAY COLLECTION AND DELIVERY SERVICE This section provides more information on the operational processes supporting a five day collection and delivery service with no operations on a Saturday.

Collections In theory, no collections will be made on Saturday so all collection and consolidation costs will be saved. However, post offices will still remain open on Saturday and will, presumably, still accept items across the counter (e.g. packets, parcels, Special Delivery). Whilst these could be held until Monday a.m., at Christmas a collection may be needed at around lunchtime as at present. Alternately, if some delivery presence is required on Saturdays, e.g. for Premium Special Delivery, then it may be that a collection could be made from PO Counters only in urban areas with the mail being held for processing on Monday. It may also be necessary to clear heavy boxes early on Monday to prevent overflow later in the day. The assumption is that no collections will be made on a Saturday with all mail posted on a Saturday being collected on Monday

Outward Processing No first class outward processing will occur on Saturday as there will be no mail collected. At present, outward processing for Friday’s 2nd class postings takes place on Saturday morning. There are three options here. Continue to do it on Saturday, do it overnight on Friday/Saturday or defer it until Monday a.m. The favoured approach is to defer processing until Monday morning (0600-1400) as this will enable mail centres to be closed down for the whole of Saturday saving on heating and lighting costs as well as providing a Monday-Friday working week for all staff. Delivery offices would close on a Saturday with consequent saving on heating, lighting costs, etc. P

P

Transport Network As there will be no Saturday delivery in theory there will be no need for a network to operate overnight on Friday/Saturday. However, Friday’s 1st class mail and Thursday’s 2nd class mail will need to be moved at some time. The 2nd class network could operate as normal or be combined with the 1st class network to save costs. The aim would be to move this mail to outward hubs on a Friday evening, returning with any intra-hub mail to the host mail centre. There would be no air services and a weekend road network would operate on Saturday/Sunday (exact timings would depend on the need to connect the more distant flows, e.g. Aberdeen-Plymouth and flows to/from Belfast, and whether there is as any benefit in operating a single weekend network which could incorporate Saturday international arrivals or any bulk postings made on Saturday). On Sunday evening, mail centres will collect their mail from their inward hub ready for inward processing. RDCs would also transfer Friday postings to the outward hubs to connect with the Weekend Network (Mailsort 1 to connect with Monday deliveries; Mailsort 2 to be inward processed on the Monday early shift and Mailsort 3 on the Monday/Tuesday early shifts). Access mail would not be accepted at mail centres on Saturday but would be deferred P

P

P

P

P

P

P


P


until Monday. It is assumed that Access customers will transport their Friday postings overnight on Friday/Saturday to arrive in their inward hubs on Saturday morning. This mail will then be held in those hubs and transferred to inward mail centres on Monday morning.

Inward Processing Inward processing would commence in mail centres at 2200 on Sunday to ensure all in time mail connects with the Monday delivery. This would include 1st class and Mailsort 1 postings from Friday, 2nd class mail posted on Thursday plus any other ‘in time’ mail, e.g. mail that has been delayed. Friday Mailsort 2 and 3 postings would not be inward processed overnight but would be held for processing after 0600 on the early processing shift. Friday Access mail postings would also be inward processed during the late a.m./early p.m. period. P

P

P

P

Delivery There would be no delivery on Saturday. Mail currently delivered on Saturday would be deferred until Monday which would include the proceeds of Friday 1st class postings (standard and bulk), Thursday 2nd class postings (standard and bulk), Mailsort 3 postings from Mon/Tue/Wed and Access postings from Thursday. Bulk and Access mail would have been inward sorted between 0600 and 1600 on the Friday. P

P

P


P


Summary of Net Savings Pipeline

Description

Included in model?

Saving

Collection

Saturday Collection and Consolidation costs cease (minor investment to clear heavy post offices and boxes on the Monday)

Based on the actual number of collections carried out on Saturdays

£14m

Outward processing

Saturday first class outward processing costs cease but largely offset elsewhere (small net saving in handling costs but most costs transferred to Monday)

Small cost saving based on lower volumes handled, no operational saving assumed

£7m

Transport

Friday night air network and associated costs cease, partly offset by road hub feeder services and hub costs (depends on whether some services can be combined with existing weekend network)

Most flights stopped but allowance for Belfast and offshore locations. Weekend road costs based on average unit costs on the SAWN network. Includes an offsetting allowance for heavier peak flows on Monday night

£25m

Inward processing

Neutral position for inward processing costs, although better scheduling may enable small saving

Small cost saving based on lower volumes handled, no operational saving assumed

£4m

Feeder runs to DOs

Saturday feeder runs from mail centres to delivery offices cease

Saturday savings, net of an allowance for increased costs on other days

£8m


Walk sorting and preparation cease at delivery offices on Saturday (although most costs will be transferred to Monday)

Saving of 6% of costs based on saving fixed time per walk (frame cleardown) on Saturday, and from smoother workflows through the week

£68m

Saturday deliveries cease

Saving of 12% of costs, after allowing for longer delivery runs on other days. Includes a benefit from smoother workflows through the week

£190m



£9m

Outdoor delivery

Other

Table 50: Summary of net savings with no Saturday collections or deliveries Source: Frontier Economics/PLCWW



SINGLE TWO DAY MAIL PRODUCT The aim of two day service option is to provide a single universal service product which would reflect a lower cost base than incurred by the current 1st class service. In determining the way the service would operate the transport network and the mail centre processing operation would see the largest changes. Under this proposal the mail centre will engage in two blocks of activity – inward sorting between 0300 and 1900 and outward sorting between 1900 and 0400. Mail centres could then connect outward postings with despatches at 0200hrs and 0400hrs. One option would be to provide a Day B service for local to local postings with a Day C service for the remainder of the inward traffic. However, this would limit the options for changing deliveries and moving to walk sequencing mail over night. P

P

Option 1 – Single Two Day Service over Six Days Collections Given that outward mail processing will not be required to commence until 1900 (and not completed until 0400), it would be feasible to perform just a single collection from collection points at the end of the day. There would be no requirement for relief collections to keep the afternoon processing period fed with work and to relief the evening processing peak which is geared to a current final despatch between 2100 and 2200 in most mail centres. The constraint is likely to be available capacity in boxes and post office counters which may mean that some additional collections are required during the day. It would also enable collection catchment areas to be spread more widely, potentially reducing the number of mail centres required (although this needs to be balanced against the need to service delivery offices in the same catchment area during the early morning). Assuming most collections are made between 1600 and 1800 then a steady arrival of work in mail centres between 1900 and, say, 2200 should be manageable. This also provides the opportunity for later collections, should they be required. In resourcing terms, collection hubs would probably be staffed with part timers or delivery staff on scheduled attendance, similar to the present arrangement. Similar to mail centres, there may also be an opportunity to rationalise collection hub given the later outward processing time. In mail centres, where collection staff tend to be full time, the option would be to engage collectors on a 14002200 shift, performing inward processing work from 1400-1600, collection work 1400-1900 (later if required) and outward processing 1900-2200.

Outward Processing Outward processing will take place between 1900 and 0400 (finish time will depend on volumes and capacity of individual mail centres). Given that no segregation and storage of 2nd class will be required then outward processing throughputs should be higher than under the current two-tier system. Saturday processing will be extended, potentially up to 2200, although this could be earlier depending on the completion time of the inward processing operation. P

P



The workplan shows a continuous intensive use of the mail centre from 1400 Monday – 2200 Saturday (0600 Monday-0600 Saturday under Option 2). The inward and outward blocks should each operate with a constant head of work with little interruption to change sorting plans or switch between each format. This should provide a high level of productivity by minimizing movement during the shift. Although there are only two elements to the operation it should still be feasible to operate a three shift system of earlies (0600-1400), lates (1400-2200) and nights (2200-0600) which should make scheduling easier.

Transport Network Given the longer time window, fewer air services would be required (some services will be needed to serve Northern Ireland, the Scottish Islands, the Channel Islands and the Isle of Man). In theory only a single transport wave is required which would potentially save the cost of the 2nd class network and the relief (main despatch) network. In practice some heavy neighbouring flows may require direct services (some of which may require two runs because of the volume) but the core network will be served via network hubs. At 0400 each mail centre will run to the outward hub, returning with any intra hub mail between 0700 and 0800. The inter hub network will then operate throughout the day with the mail centre collecting from the inward hub at optimum times until the final, most distant flows are received. P

P

The Bulk Network will operate at similar times to the present conveying Mailsort 2 and Mailsort 3 to arrive in mail centres at or later than 0600 the following day. There may be opportunities to combine the bulk and standard networks and hub operations which would provide further rationalise transport costs. Access mail would be despatched and received as at present, arriving in mail centres between 0800 and 1230. The weekend transport network would operate as at present with vehicles leaving outward mail centres for the outward hubs at about 2200 on Saturday, possibly returning with any intra hub mails. The inter-hub network then operates on Sunday/Monday (exact timings would depend where the most benefit could be achieved in terms of cost and scheduling). Mail centres would then pick up their mail from the inward hub on Monday morning at an appropriate time.

Inward Processing Inward processing would commence in mail centres at about 0300 (possibly overlapping with outward processing for the first hour) and be completed at about 1900. A full head of work should be in place at the start of the process from intra and intra-hub mail followed by distant arrivals at various times during the day, bulk arrivals between 0600 and 0800 and access mail between 0800 and 1230 forming a continuous flow throughout the day. This pattern will operate from Tuesday to Saturday. On Monday afternoon, between about 1400 and 1900, a short inward sorting slot will process mail which arrives on the Weekend network, and any access mail, e.g. TNT’s Premier Monday product.



Delivery There would not need to be any change to feeder services to delivery offices or to delivery arrangements. However, by completing inward processing by 19:00 the day before delivery, mail preparation could now be carried out overnight, especially given the investment in walk sequencing machines. Walk sequencing could be concentrated at a small number of large delivery offices and completed by early morning. This would allow earlier deliveries, if wanted, or the mail could be stored before transport to delivery offices for delivery at the same time as today. This pattern of working should assist in achieving the maximum benefit from walk sequencing technology. Walk sequencing can only operate effectively once all the mail due for delivery has been received. There are currently time constraints on this process. Under the two-day service all inward mail would have been walk sorted in the mail centre by 1900 on the evening before delivery is due in most mail centres. This effectively leaves a window of at least 11 hours for the remaining mail to be walk sequenced at the proposed preparation centres and subsequently conveyed to the delivery office. The increased time window between completion of inward sorting and the LAT at the delivery office may provide an opportunity to maximise the use of the walk sequencing machines planned for mail centres thus reducing the reliance on preparation centres. In theory, it should be feasible to sequence sort 100% of the mail at mail centres or at nearby locations providing sufficient machines could be sited there. This would probably extend the process and potential savings well beyond Royal Mail’s current projections.



Summary of Net Savings Pipeline

Description

Included in model?

Saving

Collection

Opportunity to reduce number of collection waves and reduce number of collection hubs

Only one relief collection per day for boxes and two per day for counters in urban areas, compared to three or four today. 20% better vehicle utilisation for feeder services to MCs

£56m

Outward processing

Longer processing time and no need to segregate mail


£65m

Transport

No night air network and associated costs, partly offset by road hub feeder services and hub costs – but opportunity to combine bulk and standard road networks

Small residual air network and improvement in road vehicle capacity to level achieved on second class network today. No services needed for airports, but higher volumes on road. No benefit assumed for combining bulk and standard networks

£99m

Inward processing

Two non-overlapping blocks of work – inward and outward – reduce costs by reducing changeover costs


£47m

Constant head of work improves processing productivity Feeder runs to DOs

Opportunity to reduce number of delivery waves and reduce number of delivery offices

20% better vehicle utilisation for feeder services to MCs

£30m


More time available for indoor processing


£10m

Outdoor delivery

More time available for outdoor delivery


£11m



£38m

Other




SINGLE TWO DAY SERVICE DELIVERIES OR COLLECTIONS

WITH

NO

SATURDAY

Collections Monday to Friday collections as for the six day mail service. Saturday collections would cease with all mail posted on Saturday collected on Monday. It may be necessary to provide a relief collection on Monday to clear out heavier boxes and post offices. Under this option therefore, the Monday late shift resourcing schedule would involve collectors performing collection duties from 1400 instead of 1600 as per the rest of the week.

Outward Processing Monday to Friday processing as for the six day mail service. There would be no Saturday outward processing. The volume of mail previously processed on Saturday would now be processed on Monday. This may require an increase in resource on Monday to ensure the additional volume is cleared to workplan

Transport Network Tuesday to Friday Network as for the six day mail service. On Saturday morning at 0400 the mail centres will forward their mail to the outward hub and return with any intra hub mail. All direct services will also operate as per usual. The inter-hub network will operate at the optimum time between Saturday a.m. and Monday a.m. to ensure pipeline costs are maintained at a minimum level consistent with the service requirement. On Monday morning a service will operate from the mail centre to the inward hub conveying the full proceeds of the distant network. This should aim to arrive in the mail centre at about 0800. The current weekend network would cease. Any bulk mail would be fed into the standard network. Access mail posted on Friday would be moved by the access customer overnight on Friday/Saturday and held at the access customer’s inward hub and forwarded to the inward mail centre on Monday morning.

Inward Processing Tuesday-Friday inward processing would be as for the six day mail service. A small amount of inward processing (intra and intra hub mail) would be undertaken between 0300 and 0600 on Saturday to complete the night shift. The mail centre would then close and re-open for processing at 0600 on Monday (in practice it will need to re-open at about 0400 to enable feeder runs to start operating to delivery offices). On Monday at 0600 inward processing would continue for all arrivals due to connect with Tuesday deliveries.

Delivery All feeder runs and deliveries would cease on Saturday. Inward mail processed on Friday will connect with the Monday delivery. Deliveries throughout the week would be based on a consistent workload. Savings on heating, lighting, etc. from Saturday closure of delivery units.



Summary of Net Savings (in addition to savings with a six day service) Pipeline

Description

Included in model?

Saving

Saturday Collection and Consolidation costs cease (minor investment to clear heavy post offices and boxes on Monday)

Savings based on number of collection points visited on Saturdays

£56m

Outward processing

Cessation of Saturday inward and outward processing costs after 0600, largely cost neutral but in practice should achieve higher productivity by combining with Monday workload

No additional savings assumed

£65m

Transport

Weekend transport network ceases

Offset by allowance made for additional services with peak flows on Monday

£99m

Inward processing

As outward processing


£47m

Feeder runs to DOs

Feeder runs from mail centres to delivery offices cease on Saturday (assuming no PO Box or callers’ service required)

Savings partially offset by higher volumes on other days

£30m


Walk sorting and preparation cease on Saturday

Savings of 4% related to fixed cost, including smooth workflow benefit

Saturday deliveries cease

Saving after allowing for longer delivery runs on other days. Includes a benefit from smoother workflows through the week

Collection

Outdoor delivery

Other



+£14m

+£4.5m

£10m +£45m £11m +£171m

£38m


CHANGES TO COLLECTION AND DELIVERY TIMES Two of the options that Postcomm want to examine as part of potential universal service changes are later collections and earlier deliveries. This section considers the costs of absorbing time changes in reduced processing times at mail



centres. Given limited available information, it is based on the changes that would be required at Milton Keynes Mail Centre, which is taken to represent a typical mail centre. In assessing the options for these it is assumed that the current 1st class network window will be preserved meaning that any changes must mainly be confined to mail centres. This is based on an assessment that no further air services could reliably allow further time reductions in the transport network, given the time taken to travel to airports and screen mail. P

P

Options Nine options were considered: 1. Two hour later collections with despatch time unaltered (2200) and delivery office arrival times unaltered (i.e. 0600/0645). This was not considered feasible because some collections would be arriving in the mail centre as the despatch was leaving the office meaning that it was not possible to connect the full collection proceeds. 2. Two hour later collections with despatch time also two hours later (2400) and delivery office arrival times unaltered (i.e. 0600/0645). This was not feasible without altering network times or failing mail, e.g. last 1st class arrival would arrive after feeder vehicles were due to leave inward mail centre for delivery offices. 3. One hour later collection with despatch time unaltered (2200) and delivery office arrival times unaltered (i.e. 0600/0645). 4. One hour later collection with despatch time also one hour later (2300) and delivery office arrival times unaltered (i.e. 0600/0645). 5. Two hour earlier delivery office arrival times (i.e. 0400/0445) with despatch time unaltered (2200). This was not feasible without changing the overnight network or failing some mail, e.g. last 1st class arrival at inward mail centre will arrive too late to connect with feeder services to delivery offices. 6. Two hour earlier delivery office arrival times (i.e. 0400/0445) with despatch time advanced by 2 hours (2000). This is not feasible without advancing collections or failing some mail, e.g. some collections will not arrive in mail centre until close to 2000 leaving insufficient processing time to connect with despatch. 7. One hour earlier delivery office arrival times (i.e. 0500/0545) with despatch time unaltered (2200). 8. One hour earlier delivery office arrival times (i.e. 0500/0545) with despatch time advanced by 1 hour (2100) (N.B. effectively the same as bullet point 3). P

P

P

P

9. One hour later collection with despatch time unaltered (2200) with one hour earlier delivery office arrival times (i.e. 0500/0545). As a result of this analysis the three highlighted options were considered for evaluation.



Later Collections The following factors are relevant in determining the implementation of later collections. | Most volume is received from firms and they tend to want collections in the

1700-1800 range which the majority of existing firms collections comply with. | Post offices also want a collection at close of business (1700-1730) but not

later, although in rural areas many collections are earlier in the afternoon (1500-1630). | Later collections are useful from main boxes and meter boxes, normally up to

1900, and it is these boxes that a late collection facility would benefit. | In planning a later collection it would be preferable to keep the existing

collections intact and introduce an additional later range of collections. This will involve extending each non-business collection run by at least one hour as well as introducing additional processing costs at the mail centre. It does however preserve the volume of mail on the Main Despatch and should only increase the Final Despatch by a small percentage. | The other option is to defer all collections by an hour throughout the day,

thereby maintaining the collection duty structure. Implications here are that additional costs will be incurred in mail centres with significant mail volume transferred from the Main to the Final Despatch. Later Collection Option – One hour later collection with despatch time unaltered (2200) and delivery office arrival times unaltered (i.e. 0600/0645) This is the option contained at bullet point 3 above. It contains the following assumptions: • assume existing collection pattern is deferred by one hour (1330-2000); • assume all 1st and 2nd class items are faced and stamped on late shift; P

P

P

P

• assume no 2nd class is processed on late shift peak period (1800-2140); • assume no change in despatch time (2140); • assume fixed machine capacity. The following calculations have been made based on the model week hours and work plan for Milton Keynes Mail Centre. 42 TPF

FPT

It is assumed that the last two hours of operation (2000-2200) form the peak time with all staff and machines working at full utilisation. Consequently, to continue to meet the same 2140 despatch either twice as much capacity is required between 2000 and 2100 (mech) and 2030-2130 (manual) or less urgent work is deferred, e.g. inward.

TP

42 PT

The information received from Royal Mail revealed a number of inconsistencies. It was also not able to build up the total picture for the mail centre because certain data was missing that would have provided a fuller picture, e.g. current staff and equipment utilisation on the late shift. Consequently, some broad assumptions have been made in completing this analysis



To continue to meet the 2140 despatch time all machining must be complete by 2100 to enable rejects to connect with the manual sorting and for all selections to be cleared down and trayed/bagged off. Currently 2 LSMs work on outward mail and 2 on inward mail at this time. By converting the 2 inward LSMs to outward and deferring the inward to the night shift should produce sufficient capacity. Spare capacity already exists on the V3 OCR machine to process the mail and extending the time of the CFCs is also feasible. These are assumed to be at no cost. Work previously performed at the inward peak will be transferred to nights for inward sorting. This will cost 6 night duties covering 2 LSMs during breaks (total 6 man hours). Remainder of night duties inward manual sorting transferred from Lates (7 hours per man x 6 = 42 hours) Currently 228 staff are required during the peak time (98 FT; 87 PT; 43 SA). In theory therefore 228 additional hours required at peak to sort double capacity in the peak hour. However, assume mech area OK by transferring inward to nights = 33 hours. From staff hour schedules, 6 FTs employed on late shift inward work can be transferred to nights (assume take up duties in para 6.2) = a further 6 peak hours. Peak hour therefore requires 228 – 39 hours = 189. Assume 102 night shift FTs (96 plus the additional 6 above) each attracts one hour SA at start of duty then a further 87 posts will be required at the peak hour. Assume sourcing the peak hour will require 87 AG/SA (at 4 hours each) which will mean that there will be ‘spare time’ of 261 hours. Offsetting costs will be transfer of all inward work from early to late shift. (200 hours) and by reducing AG/SA late attendances by one hour per person (130 hours).



Additional costs – hours Additional 6 Night Shift Duties

48

1 hour SA for night duties

102

Additional 87 AG/SA duties

348

Total Costs

498

Offsetting savings – hours Inward Work Transferred to Nights

48

1 hour reduction in AG/SA Lates

130

Inward Work transferred from Early

200

Net cost Net cost Annual cost Cost @ £17.43 per hour (PLCWW est.)

220 57,200 £996,996

Table 53: Additional costs with one hour later collection time Source: PLCWW, Frontier Economics

Earlier Deliveries Factors to consider here include the following. | Whilst early delivery would be favoured by a number of social customers

(getting the mail before leaving for work) duty start times before 0500 may not be popular with some employees (RM currently moved most start times back to 0600). | However, this may be increasingly feasible with the deployment of walk

sequencing machines (although the overnight network remains a constraining factor). | The other option is to open more delivery offices overnight (the reverse of

RM’s current policy). | Resourcing part timers on delivery is difficult with early starts.



Early Delivery Option – One hour earlier delivery office arrival times (i.e. 0500/0545) with despatch time unaltered (2200) This is the option contained at bullet point 7 in the list of options above. It contains the following assumptions: • assume no change to arrival patterns (last connection 0310); • assume Wave 1 feeder services depart at 0400 and Wave 2 at 0445; and • assume fixed machine capacity. The following calculations have been made based on the model week hours and work plan for Milton Keynes Mail Centre. The manual throughputs have been derived from the SMVs Royal Mail’s Strategic Planning Model. 43 TPF

FPT

The earlier DO arrival time reduces the inward processing window by 1 hour. To accommodate this it has been assumed that the processing of outward 2c on nights will be transferred to the early shift. The level of 2c has been derived from the Milton Keynes model week. To meet the earlier despatch to the DOs it has been assumed that an element of inward machineable mail will need to be transferred to manual. The level has been derived from the model week mech traffic and the current mech throughput i.e. mech letters divided by the current processing window. Offsetting the additional costs on the night and early shift there will be resource, i.e. 96 staff x 1hour, available at the “back end” of the night shift and it is assumed that this will be achieved by reducing the resource demand on the early shift.

TP

43 PT

“SPMv13.3 (PSC submission).xls”, sheet “MC SMVs”.



Additional costs – hours Additional 18 early shift duties to sort outward 2c transferred from night shift

144

Additional 32 night shift duties to manually sort transferred from mech

256

Total Costs

400

Offsetting savings – hours 98 duties @ 1 hour

98

Net cost Net cost

302

Annual cost

78,520

Cost @ £17.43 per hour (PLCWW est.)

£1,368,603

Table 54: Additional costs with one hour earlier delivery times Source: PLCWW, Frontier Economics

Combined Option – One hour later collection with despatch time unaltered (2200) with one hour earlier delivery office arrival times (i.e. 0500/0545) This is the option contained at bullet point 9 in the list of options above. It contains the following assumptions: • assume existing collection pattern is deferred by one hour (1330-2000); • assume all 1st and 2nd class items are faced and stamped on late shift; P

P

P

P

• assume no 2nd class is processed on late shift peak period (1800-22140); • assume no inward mail is processed during the late shift peak period (other than infill); • assume no change in despatch time (2140); • assume no change to arrival patterns (last connection 0310); • assume Wave 1 feeder services depart at 0400 and Wave 2 at 0445; and • assume fixed machine capacity. The following calculations are based on a combination of those in the two options above. Net costs are additive with the following exceptions.



| Additional 32 night shift duties will negate the need to transfer 6 duties from

the late shift to perform additional LSM work meaning 48 hours per day will not be required on nights. | The net additional 26 night duties means that 26 additional SAs can be

included on the late shift (+ 26 hours) reducing the need for 26 AG/SA posts on the late shift (26 x 4 hours each = 104 hours) producing a net reduction of 78 hours.

Additional costs – hours Net cost of later collections

220

Net cost of earlier deliveries

302

Total Costs

522

Offsetting savings – hours Net saving of 6 night shift duties

48

Net saving late shift SA/AGs

78

Total saving

126

Net cost Net cost Annual cost Cost @ £17.43 per hour (PLCWW est.)

396 102,960 £1,794,592

Table 55: Additional costs with one hour later collection time and one hour earlier delivery time Source: PLCWW, Frontier Economics

EVENING PACKET DELIVERY SERVICE Postcomm asked Frontier and PLCWW to assess the costs of introducing an evening packet delivery service once a week.

Customer Specification Customers are likely to value choice when receiving undelivered items. It is therefore assumed that an evening packet delivery service is in addition to existing collection facilities for undelivered items. It is assumed that customers select whether they wanted evening delivery or not and two options are open to customers – those selecting evening delivery on a ‘standing order’ basis and those selecting it as an ‘on demand’ service.



For customers requiring a Standing Order it is assumed that this will only be available on the day of the evening redelivery itself. This will enable the customer to receive the item the same day it is received at the delivery office (assuming this is the evening redelivery day) but also have the flexibility to decide throughout the rest of the week how best to access undeliverable items. For On Demand customers the process would involve the following: • Day 1: Postman cannot deliver item, posts ‘Sorry you were out’ card at customer’s address and returns undeliverable item to the delivery office; • Day 1: Customer receives card on return home (assume early evening) and selects evening redelivery via Royal Mail website; • Day 2: Undeliverable item prepared for redelivery from that evening (i.e. if Day 2 is the redelivery day then it will be delivered that night).

Delivery process The evening delivery would be performed from collection hubs broadly between the hours of 1800 and 2100 one evening each week (times may vary locally depending on completion time of collections, availability of staff and vehicles and distances to be covered). There would be three kinds of office involved. | Collection Hubs at delivery offices would perform evening delivery for its

own delivery area plus those areas covered by its Satellite delivery offices within its collection area. | Collection Hubs at mail centres that would perform evening deliveries for a

number of Satellite delivery offices within its collection area (a small number of mail centres also have their own delivery units on the same site). | Satellite delivery offices that will not perform evening deliveries but transfer

any items to the Collection Hub.

The Redelivery Process A description of the redelivery process is outlined below. This suggests that, in addition to the driver and vehicle performing the delivery most indoor costs are involved in the sorting items in the Returned Letter Enclosure and amending software systems to accommodate the new service.



Process for undelivered On Demand Items

Process for undelivered Standing Order Items

Potential Costs

Estimated cost

1. Delivery postman leaves ‘Sorry you were out’ card

1. Delivery postman identifies item at his preparation frame

No new costs

-

2. Returns to delivery office and hands item to postman in RLE

2. Hands item to postman in Returned Letter Enclosure (RLE)

No new costs

-

3. Customer requests evening delivery

3. No action

Process already exists. Will require software change only

-

4. Delivery Office informed of request

4. No action

New process but will happen automatically as part of 3. above

-

5. Items for redelivery recorded in RLE and transferred to ‘Evening Delivery’ bag(s)

5. Items recorded in RLE transferred to ‘Evening Delivery’ bag(s)

Will require some activity in RLE from postman. Assume same as sorting time

7.6

6. Addresses of items recorded with contents bill attached to each bag

Software change

-

7. For Satellite Offices: Bags transferred to vehicle conveying mail to collection hub (this vehicle service should already exist in all cases and normally runs early p.m.)

Cost of handling and transporting bag(s) (based on 1 minute per bag)

0.6

8. On arrival at Collection Hub, Evening Delivery bags transferred to the RLE and combined with Collection Hub’s own bags

Cost of handling bags within the collection hub and in the RLE (based on 1 minute per bag)

0.6

9. Addresses of all items automatically collated at Collection Hub and delivery routes developed

Routes developed using Paragon system. Probably already exists in most offices

-

10. Postman in Collection Hub RLE sorts items into selected routes during the afternoon period

Packet sort in RLE or on standard frames in the delivery office. Based on sort rate of 200 items ph

7.6

11. RLE postman hands over bags and delivery route to driver

Hand over costs (based on 1 minute per bag)

0.6

(pence per item)



12. Postman driver delivers items as per route schedule

Assume 3 hours per route per week plus vehicle costs

Average 76p

13. On return to office each driver confirms completion of delivery, returning any items still not delivered to be dealt with by the RLE the following day

-

14. Data at 13. conveyed automatically to RM redelivery website for retention and any follow up

-

Total

Based on average delivery costs

93p

Table 56: Costs of an evening packet delivery service, based on volumes of 19m items per year. Source: PLCWW/Frontier Economics



Annexe 4: Estimating quality of service changes This Annexe outlines the methodology used in assessing the impact on quality of service of changes to the Royal Mail network. In general, the methodology relies on two main sources of information: • actual Royal Mail quality of service performance; and • network structure obtained through operational modelling.

Quality of service Actual quality of service performance has been provided for each product by Royal Mail. 44 These provide total traffic from area to area and the corresponding percentage of mail delivered on time. The figures cover the period April 2006 to March 2007 excluding the pre-Christmas period. They therefore exclude any effects of the disruption due to industrial action which occurred later in 2007 and are the most representative basis for considering future operational changes. TPF

FPT

The traffic information does not appear to be totally consistent with the quality of service information provided. There are some traffic flows with no stated destination and some routes with recorded traffic but no quality of service samples. Moreover the weighted average quality of service over all routes does not agree exactly with the overall UK quality of service; for example, the overall quality of service of first class PPI is 93.05% but the weighted average over all routes is no more than 92.87%. It is assumed that the traffic and quality of service data come from different sources. Traffic with no stated destination has been ignored in the analyses described in this paper. For routes with no quality of service samples a level of quality of service has been inferred. A figure of 87.75% has been assumed for first class stamped and meter mail since this produces a set of figures consistent with the national performance of 94.04%; (a figure of 86.75% has been assumed for PPI mail). For first class PPI mail the route by route quality of service figures have a weighted average of 92.86% compared with the national performance of 93.05%. Royal Mail’s national quality of service measurement surveys do not cover the Channel Islands and the Isle of Man so operational changes to the service to these islands will have no effect on Royal Mail’s published quality of service.

Network structure Information on network structure comes from the operational models developed by Frontier and PLCWW for this project and described elsewhere in this report. Information is available for each mail centre to mail centre route and includes:

TP

44 PT

Responses to questions 3.5.1 a and 3.5.1 b of RFI, December 2007;

Annexe 4: Estimating quality of service changes


• the percentage of first class mail on main and final despatches; • the time required to transport mail by road from one mail centre to another; • the time of despatch and the latest acceptance time (LAT) at each mail centre; and • the availability (or otherwise) of scheduled outlets by air for the main and final despatches. Stamped and meter quality of service is measured from each postcode area of posting to postcode area of delivery. PPI quality of service is measured from each mail centre of posting to postcode area of delivery. Postcode areas have been allocated to mail centres using information supplied by Royal Mail. 45 Unless otherwise stated, it has been assumed that any operational changes will affect all postcode areas served by the same mail centre in the same way. TPF

FPT

Methodology The methodology is essentially straightforward. Each area to area route (postcode area to postcode area for stamped and meter mail and mail centre to postcode area for PPI mail) is considered in turn, and the quality of service achieved on that route is adjusted to take account of the planned operational change. The results are then aggregated using the traffic information supplied to give overall quality of service by postcode area, mail centre or nationally as required. This approach means that the quality of service analysis does not in general rely on network operations figures about the number of yorks etc.

Current Service Configuration. Actual quality of service performance in 2006-07 forms the baseline from which to judge the effect of any operational changes. The Mail Centre Network Model identifies the routes that can currently be served by road and allows the actual quality of service to be compared. It has been assumed that the percentage of mail sent on the main despatch is the same for PPI mail as for stamped and meter mail.

TP

45 PT

3.3.1 a of the RFI, December 2007;



Stamped/Meter

PPI

Traffic

Q of S

Traffic

Q of S -

Posted and delivered same postcode area

in

25.4

95.4

-

Posted and delivered same mail centre

in

4.5

95.1

9.1

95.4

Final despatch possible by road

59.9

93.9

72.6

93.1

Main despatch possible by road

4.6

92.0

7.8

91.4

Neither despatch possible by road

5.6

89.9

10.5

89.7

100.0

94.0

100.0

92.9

All Mail

Table 57: Achieved first class quality of service in 2006-07 Source: Royal Mail, PLCWW, Frontier Economics

Impact of no air services Under the existing network time window, some mail must be conveyed by air in order to arrive by the LAT and have scheduled next day service. If no air services are available (and there is no change to despatch times and LATs) this mail will have no scheduled outlet and all of it will fail service. The impact of having no air services is assessed by examining each area to area route in turn: • if mail is posted and delivered within the same mail centre, there is no effect on quality of service; • if the final despatch can be sent by road, there is again no effect on quality of service; • if the main despatch can be sent by road but the final despatch cannot, the quality of service is reduced in proportion to the percentage of mail on the main despatch (e.g., if the current QoS is 90.0 and 60% of mail travels on the main despatch, the QoS without air services would be 60% × 90.0 = 54.0); and • if neither the main nor the final despatch can be sent by road, the quality of service is set to zero. Quality of service is aggregated across the routes taking into account the traffic on each route. Estimates have been made of the quality of service for each postcode area (or mail centre) and for the UK as a whole.



The calculation in Table 57 above implicitly assumes that mail on the main and final despatches for the same route will have the same quality of service. In practice one might expect the main despatch to have better quality of service, but the effect is likely to be small. X

X

The calculation assumes that all postcode areas served by the same mail centre are affected in the same way, and therefore that local air services between Aberdeen and Shetland, Inverness and Orkney, and Glasgow and Western Isles continue to operate.

Impact of a smaller number of air services The impact of a smaller number of air services has been assessed in a similar way to the scenario of no air services. Details of the air network to be evaluated are provided by operational modelling as described elsewhere. The Mail Centre Network Model identifies the routes that cannot be served by road, and the Air Network Model describes the flights that make up the reduced air network and details the traffic that travels on each flight. Each mail centre to mail centre route is checked to identify whether a scheduled outlet is available. For example, if mail from Belfast to Edinburgh travels via East Midlands Airport, next day service is only possible if flights from Belfast to EMA and EMA to Edinburgh are both available. Each area to area route is then considered in turn: • if the final despatch can be sent by road or the mail is posted and delivered within the same mail centre, there is no effect on current quality of service; • if the final despatch can be sent by air using the smaller air network, there is again no effect on current quality of service; • if the final despatch cannot all be sent by air using the smaller air network - because of time or flight capacity constraints - but some mail can be sent by air (or road), the quality of service is reduced in proportion to the percentage of mail on the route that can receive scheduled next day service; and • if no scheduled air service is available, the quality of service is calculated as described above. The quality of service achieved on a route does not only depend on whether a network exists which connects with the next day’s delivery. It also depends on how well and how consistently the components of the mail pipeline perform. The calculation that has been used implies that, provided a scheduled outlet still exists, the reliability of the service provided by the smaller air network is the same as that provided by Skynet. This is an assumption. Skynet relies on a number of trunk road runs to provide connections to some flights. It is assumed that these will also be provided if required by the smaller air network.



Flights may be added to the air network one by one so that the effect of a limited air network and of adding more routes can all be evaluated. The effect on national quality of service, on different parts of the country, and on individual postcode areas or mail centres can all be calculated. The methodology assumes implicitly that local air services between Aberdeen and Shetland, Inverness and Orkney, and Glasgow and Western Isles continue to operate. Flights to and from Jersey, Guernsey and the Isle of Man have been considered as possible parts of the air network but they do not affect domestic quality of service.

Impact of a longer or shorter network time-window The impact of a change to the network time window has been modelled by assuming, in effect, that the main and final despatch times from the outward mail centres do not change and that the LATs move forward or backwards. The effect on quality of service if the LATs move backwards (a longer time-window) is considered as follows. | If mail is posted and delivered within the same mail centre, it will be available

for inward processing at the same time as it is now. There is unlikely to be any effect on quality of service. | If the final despatch can already be sent by road, there will be less risk of

missing the LAT through transport delays. There should also be more time for inward processing. Therefore there should be some improvement in quality of service. | If the main despatch can already be sent by road but the final despatch

cannot, the main despatch should benefit from the longer time-window in the same way as other road despatches. There should be some improvement in quality of service. | The later LAT will also allow some despatches to transfer from air to road.

Road transport is inherently more reliable than air transport, e.g. it is less liable to disruption through bad weather. However there could be counteracting effects if the road service arrives at the inward mail centre later than the air despatch. Some change in quality of service is possible. | The mail that still has to fly will be handled by a revised air network. There

could be a quality of service benefit if the mail arrives at the inward mail centre earlier compared with the LAT but the revised air network could result in later arrival times at the inward mail centre. It is possible to quantify the change in quality of service that might occur by examining how quality of service varies from route to route at present. A statistical model has been developed which considers the effect of the following factors. | The mode of transport: road, air or mixed (main despatch by road and final

despatch by air).The mode of transport is determined by whether the main and the final despatch can be sent by road in time to arrive before the LAT.



| The ‘slack’ time at the inward office. This is defined as the difference between

the time when the final despatch would arrive if sent by road and the LAT. (The slack time may therefore be negative if the final despatch is sent by air.) | The transport time between the mail centres by road. This is recorded for all

routes including those where the despatches are actually sent by air. The road transport time between the mail centres is a measure of how far apart the mail centres are and is included as a control factor. Data for the model was obtained from the Mail Centre Network Model. Mail posted and delivered in the same mail centre area and mail to and from Northern Ireland, Shetland, Orkney and the Western Isles were excluded when fitting the model. The model was fitted using multiple regression. Routes were aggregated into 80 groups with the same parameter values and a regression was performed on these 80 observations weighted by traffic and by service level. The parameter estimates for the model for first class stamped and meter mail are shown below.



Mode

Road

Slack

Value

6 hours or more

95.7%

5:00 to 5:59

95.3%

4:00 to 4:59

94.9%

3:00 to 3:59

94.7%

2:00 to 2:59

94.0%

1:00 to 1:59

93.4%

Less than 1 hour

93.6%

Negative slack of under 2 hours

93.9%

Negative slack of 2 hours or more

92.3%

Mixed

-

Air

94.0%

Road Transport Time

All Modes

Less than 4 hours

0.0%

4:00 to 7:59

-1.0%

8:00 to 11:59

-3.2%

12:00 to 13:59

-3.7%

14 hours or more

-17.2%

Table 58: Quality of service multiple regression parameters Source: PLCWW/Frontier Economics

Thus, for example, if the final and main despatch from one mail centre to another are both sent by road, the final despatch arrives 1 hour 10 minutes before the LAT and the road transport time is 5 hours, the predicted quality of service is 93.4% - 1.0% = 92.4%. Similarly, if the final and main despatch are both sent by air and the road transport time is 8 hours, the predicted quality of service is 94.0% - 3.2% = 90.8%.

QUALITY OF SERVICE WITH A TWO DAY PRODUCT This section considers the level of quality of service that could be achieved with a single Royal Mail two-day product. The analysis is based on actual Royal Mail quality of service performance in 2006-07 and on Royal Mail’s network structure.



Two Day Network At present Royal Mail offers both first class and second class products for personal customers and smaller businesses; the aim is to deliver first class mail by the next working day and second class mail within three working days. Under the alternative proposal, there would be only a single universal service product and the aim would be to deliver the mail within two working days. The main feature of a two-day network would be as follows: • first class and second class mail would be combined in a single stream. This would affect the fall-to-earth pattern of mail and the percentage that is local, short distance and long distance; • despatches would be sent by road and no use would be made of air services; • outward processing would take place over a longer time period and the number and timing of despatches would change; and • inward processing would take place over a wider period of time and many despatches would arrive a long time before the LAT. The estimates of quality of service depend on the precise operational changes that would be necessary with a two-day operation and on the times when various activities would take place. PLCWW has undertaken detailed modelling to develop a more detailed workplan for the two-day operation. This is described elsewhere in this report and is also summarised below.

Quality of Service of a Two Day Network The quality of service of a two-day network has been assessed by taking existing first class performance as a baseline and making a series of adjustments. The table below shows Royal Mail’s actual quality of service performance in 2006-07. Stamped/Meter

PPI

1st Class

2nd Class

1st Class

2nd Class

P

P

P

P

P

P

P

P

Delivered within working day

1

94.0

28.4

93.0

11.2

Delivered within working days

2

99.0

94.3

98.5

89.3

Delivered within working days

3

99.7

98.9

99.4

97.9

Table 59: Achieved first class Quality of Service in 2006-07 Source: Royal Mail, PLCWW, Frontier Economics



It should be noted that first class performance by day B (delivered within 1 working day) and second class performance by day C (delivered within 2 working days) are very similar. For stamped and meter mail the figures are practically identical - first class 94.0 and second class 94.3. This provides support for the approach of taking first class QoS as a basis of the analysis. It can also be seen that a high proportion of first class mail not delivered within 1 working day is delivered on the following day. A similar pattern holds for second class mail; for example, 82% of second class stamped and meter mail not delivered by day C is delivered on day D.

Fall to earth pattern Combining first class and second class mail into a single stream will change the fall-to-earth pattern of mail. The traffic distribution for stamped and meter mail is shown below. Second class mail travels less far than first class mail on average, there is more local mail and less mail on long distance routes. This in itself will increase overall quality of service to some extent. Stamped and Meter Mail

First Class

Second Class

All Mail

Posted and delivered in same postcode area

25.4%

33.3%

29.2%

Posted and delivered in same mail centre

4.5%

5.9%

5.2%

Final 1c despatch possible by road

59.9%

52.9%

56.6%

Main 1c despatch possible by road

4.6%

3.6%

4.1%

Neither 1c despatch possible by road

5.6%

4.3%

5.0%

100.0%

100.0%

100.0%

All Mail

Table 60: Achieved first class Quality of Service in 2006-07 Source: Royal Mail, PLCWW, Frontier Economics

Changes to workplan A statistical model has been developed to quantify how quality of service is affected by: • the mode of transport: road, air or mixed (main despatch by road and final despatch by air); • the transport time between the mail centres by road; and



• the ‘slack’ time at the inward office (this is defined as the difference between the time when the final despatch would arrive if sent by road and the Latest Acceptance Time at the inward office). In order to use this model for the single two-day product, it is necessary to know these three factors for each route. A two-day product will allow sufficient time for all despatches to be sent by road and it will not be necessary to use air services. Therefore the mode of transport will always be road. The road transport time is known for all routes. However the slack time depends on the workplan. The workplan that has been developed assumes that outward sorting will begin at mid/late afternoon and continue until 04:00 the following morning. There will be a main despatch at 02:00 and a final despatch at 04:00 from all mail centres. Inward sorting of local mail and possibly some other short-distance mail will begin on completion of outward sorting, i.e. at 04:00. Inward sorting of distant mail (and Mailsort) will take place through the day in order to connect with deliveries the following morning. The workplan does not itself specify the LAT since this will vary from mail centre to mail centre, The mail centre can be dedicated to inward processing during the day until outward sorting starts in the late afternoon. To reflect this situation, the statistical model has been fitted using ‘slack’ times which have been calculated using conservative assumptions as follows: • if the final despatch reaches the inward office before 14:00, the ‘slack’ time is calculated as the difference between 14:00 and the time when the final despatch arrives; and • if the final despatch reaches the inward office after 14:00, the ‘slack’ time is assumed to be less than one hour. The effect of using alternative calculation rules has been tested and not found to be significant.

Results – Stamped and meter mail It is estimated that it would be possible to achieve a quality of service for stamped and meter mail of 95.0% delivered within two working days. This compares with the current (2006-07) performance for first class stamped and meter mail of 94.0% delivered by the next working day. The table below shows how the quality of service estimate is developed: • the base assumption is that quality of service for the two-day product would be comparable to that for first class mail - 94.0%; • the changing fall-to-earth pattern increases overall average quality of service to 94.2%; • despatching all mail by road and allowing more time to process mail improves overall quality of service to 95.0%.



First Class

All Mail

New Work Plan

by day B

by day C

by day C

Posted and delivered in same PCA

95.4%

95.4%

95.4%


95.1%

95.1%

95.1%

Posted in one mail centre and delivered in another mail centre

93.5%

93.5%

94.8%

All mail

94.0%

94.2%

95.0%

Table 61: Quality of service with a two day network – stamped/meter mail Source: PLCWW, Frontier Economics

The scope for any further improvement in quality above the figure of 95.0% appears to be small since, for example, the quality of service of 94.8% for nonlocal mail is already very close to the day B quality of service for local mail. The main argument for a lower figure than 95.0% is that the two-day service may be less resilient to large day to day variations in traffic, particularly bulk mail. At present Mailsort 3 is used to provide some flexibility in processing and it is not clear whether this will be sufficient under a new network. Pending more detailed investigation, it might be unwise to assume any improvement in current Mailsort 2 quality of service. The comparisons in this report are based on Royal Mail’s actual performance in 2006-07 rather than universal service quality of service targets. First class retail quality of service in 2006-07 exceeded the universal service target for retail mail by 1.0%.

Results – PPI A similar analysis can be made for PPI mail. It is estimated that it would be possible to achieve a quality of service for PPI mail of 94.1% delivered within two working days. This compares with the current (2006-07) performance for first class PPI mail of 92.9% delivered by the next working day. The table below shows how the quality of service estimate is developed. First Class

All Mail

New Work Plan

by day B

by day C

by day C


95.4%

95.4%

95.4%

Posted in one mail centre and delivered in another mail centre

92.6%

92.7%

93.9%

All mail

92.9%

93.0%

94.1%

Table 62: Quality of service with a two day network – PPI Source: PLCWW, Frontier Economics


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