(advances in regulatory economics) michael a. crew, paul r. kleindorfer, james i., jr....

7/28/2019 (Advances in Regulatory Economics) Michael a. Crew, Paul R. Kleindorfer, James I., Jr. Campbell-Handbook of Wor

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Handbook of Worldwide Postal Reform


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ADVANCES IN REGULATORY ECONOMICS

Series Editors: Michael A. Crew, CRRI Professor of Regulatory Economics and Director, Center forResearch in Regulated Industries (CRRI), Rutgers, The State University of New Jersey, Newark,

USA andPaul R. Kleindorfer, Anheuser-Busch Professor Emeritus, The Wharton School, Universityof Pennsylvania, USA and INSEAD, Fontainebleau, France

Edited by Michael A. Crew and Paul R. Kleindorfer, this series aims to advance research in theory,practice and policy in the area of regulatory economics. While regulation is all-pervasive in themodern economy and touches almost every aspect of economic life, this series focuses on micro-economic issues in regulation rather than macro policies. Topics of interest include contributionsin the following areas: network industries, environmental, health and safety, risk and insurance,and financial services. Regulatory economics deals with both direct instruments affecting profitsand prices in these industries and governance structures in regulated industries, including self-regulation. Contributions may address specific instruments across industries as well as in-depthsector-specific studies.

Titles in the series include:

Liberalization of the Postal and Delivery SectorEdited by Michael A. Crew and Paul R. Kleindorfer

Competition and Regulation in the Postal and Delivery Sector

Edited by Michael A. Crew and Paul R. Kleindorfer

Handbook of Worldwide Postal ReformEdited by Michael A. Crew, Paul R. Kleindorfer and James I. Campbell Jr.


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Handbook of WorldwidePostal Reform

Edited by

Michael A. Crew

Center for Research in Regulated Industries (CRRI), Rutgers, The StateUniversity of New Jersey, Newark, USA

Paul R. KleindorferThe Wharton School, University of Pennsylvania, USA and INSEAD,France

and

James I. Campbell Jr.

George Mason University, USA

ADVANCES IN REGULATORY ECONOMICS

Edward ElgarCheltenham, UK Northampton, MA, USA


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Michael A. Crew, Paul R. Kleindorfer and James I. Campbell Jr. 2008

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system ortransmitted in any form or by any means, electronic, mechanical or photocopying, recording, orotherwise without the prior permission of the publisher.

Published byEdward Elgar Publishing LimitedThe Lypiatts15 Lansdown RoadCheltenhamGlos GL50 2JAUK

Edward Elgar Publishing, Inc.William Pratt House9 Dewey CourtNorthamptonMassachusetts 01060USA

A catalogue record for this bookis available from the British Library

Library of Congress Control Number: 2008934703

ISBN 978 1 84720 957 3Printed and bound in Great Britain by MPG Books Ltd, Bodmin, Cornwall


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Contents

List of contributors viiPreface and acknowledgements ix

1 Postal reform: introduction 1Michael A. Crew, Paul R. Kleindorfer and James I. Campbell Jr.

PART I ECONOMIC ANALYSIS OF REFORM

2 Interactions between regulatory and antitrust policies in a liberalized postalsector 15John C. Panzar

3 Pricing for postal access and worksharing 32Michael A. Crew and Paul R. Kleindorfer

4 An economic model of the regulatory structure created by the PostalAccountability and Enhancement Act of 2006 67Michael D. Bradley, JeffColvin and Mary K. Perkins

5 Economics of post office networks: strategic issues and the impact on mail

demand 80Martin Buser, Christian Jaag and Urs Trinkner6 Funding universal service obligations 98

John C. Panzar

7 Calculating the net cost of the USO: a practical example from Norway 110Kristin Bergum

PART II TRANSFORMATION AND INNOVATION

8 Reform of the United States Postal Service: an unfinished task 123

Michael A. Crew and Paul R. Kleindorfer9 Postal transformation: United States Postal Service builds a platform forfundamental future change 143Robert A.F. Reisner

10 Technological innovation and postal reform 160Jean-Philippe Ducasse, Luis Jimenez and Marc Morelli

11 Postal reform and product innovation 176Leon A. Pintsov and Andrei Obrea

PART III REGIONAL AND COUNTRY STUDIES

12 National postal policies in Europe on the eve of the Third Directive 195James I. Campbell Jr., Alex Kalevi Dieke and Antonia Niederprm

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13 Economic factors underlying postal reform in the European Union 216Michael A. Crew, Gonzales dAlcantara, Paul R. Kleindorfer, Philippe Claeys

and Bert Kuypers

14 EU law on postal services 245Richard Eccles

15 A brief history of the United States postal monopoly law 262James I. Campbell Jr.

16 Competition, wages and politics in the delivery sector: the case of postalminimum wages in Germany 282Alex Kalevi Dieke and Ralf Wojtek

17 Liberalization and market performance: towards higher efficiency in Sweden 298Peter Andersson

18 The French postal market in the wake of the Postal Law of 2005 316Catherine Gallet-Rybak, Ccile Moreno, Daniel Nadal and Jolle Toledano

19 United Kingdom postal services regulation 341Richard Eccles

20 The diverse characteristics of postal reforms in Asia: privatization,corporatization and liberalization 355Shoji Maruyama and Shinichi Sano

21 How much postal reform in Japanese postal privatization? 373James I. Campbell Jr. and Amelia Porges

22 Postal reform in Australia 388Chris Paterson

23 Postal reform in developing countries: challenges and choices 400Juan B. Ianni

24 India Post: an agenda for restructuring and commercialization 416V. Ranganathan

25 Postal reform in Israel 426Avi Azuz, Udi Nisan and Eli Sagi

Index 445

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Contributors

Peter Andersson, Associate Professor of Economics, Linkping University, Sweden.

Avi Azuz, Senior Coordinator, Regulation Economics and Budget Division, Ministry ofCommunication, Israel.

Kristin Bergum, Director of Governmental and International Affairs, Posten Norge, Oslo,Norway.

Michael D. Bradley, Professor of Economics and International Affairs, GeorgeWashington University, Washington, DC, USA.

Martin Buser, Swiss Post, Bern, Switzerland.

James I. Campbell Jr., Attorney and Adjunct Professor, School of Public Policy, GeorgeMason University, Fairfax, VA, USA.

Philippe Claeys, European Government Sector Advisor, PricewaterhouseCoopers,Brussels, Belgium.

JeffColvin, Manager Finance, United States Postal Service, Washington, DC, USA.

Michael A. Crew, CRRI Professor of Regulatory Economics and Director, Center forResearch in Regulated Industries (CRRI), Rutgers Business School, Rutgers University,New Brunswick, NJ, USA.

Gonzales dAlcantara, Senior Lecturer, University of Antwerp and Economic Expert,dAlcantara Economic Consulting, Belgium.

Alex Kalevi Dieke, Head of Department Postal Services and Logistics, WIKWissenschaftliches Institut fr Infrastruktur und Kommunikationsdienste, Bad Honnef,Germany.

Jean-Philippe Ducasse, Director, Postal Policy and Strategy, Pitney Bowes, Inc.,Stamford, CT, USA.

Richard Eccles, Partner, Bird & Bird, London, UK.

Catherine Gallet-Rybak, Head of Unit Authorizations and Universal Service, ARCEP(Autorit de Rgulation des Communications lectroniques et des Postes), Paris, France.

Juan B. Ianni, Postal Policy Expert, Nashville, USA.

Christian Jaag, Economist, Swiss Post and University of St. Gallen, Switzerland.

Luis Jimenez, Consultant, former Senior Vice President and Chief Industry Policy Officer,Pitney Bowes Inc., Stamford, CT, USA.

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Paul R. Kleindorfer, Professor Emeritus, The Wharton School, University ofPennsylvania, Philadelphia, PA, USA and Research Professor, INSEAD, Fontainebleau,France.

Bert Kuypers, Partner, PricewaterhouseCoopers, Brussels, Belgium.Shoji Maruyama, Senior Manager, Japan Post Service Co., Ltd, Tokyo, Japan.

Marc Morelli, former Director, Business Development, Pitney Bowes Inc., Stamford, CT,USA.

Ccile Moreno, ARCEP (Autorit de Rgulation des Communications lectroniques etdes Postes), Paris, France.

Daniel Nadal, ARCEP (Autorit de Rgulation des Communications lectroniques et desPostes), Paris, France.

Antonia Niederprm, Senior Economist, Department Postal Services and Logistics, WIKWissenschaftliches Institut fr Infrastruktur und Kommunikationsdienste, Bad Honnef,Germany.

Udi Nisan, Director General, Government Companies Authority, Ministry of Finance,Israel.

Andrei Obrea, Senior Fellow, Pitney Bowes, Inc., Shelton, CT, USA.

John C. Panzar, Professor of Economics, University of Auckland, New Zealand andLouis W. Menk Professor Emeritus, Northwestern University, USA.

Chris Paterson, Director, Diversified Specifics, Melbourne, Australia.

Mary K. Perkins, Associate Professor of Economics, Howard University, Washington,DC, USA.

Leon A. Pintsov, Pitney Bowes Fellow and Vice President, Pitney Bowes, Inc., Stamford,CT, USA.

Amelia Porges, Counsel, Sidley Austin LLP, Washington, DC and adjunct professor,Johns Hopkins School of Advanced International Studies, Baltimore, MD, USA.

V. Ranganathan, RBI Chair Professor, Indian Institute of Management, Bangalore, India.

Robert A.F. Reisner, President, Transformation Strategy Inc., Washington, DC, USA.

Eli Sagi, Emeritus Professor, Berglas School of Economics, Tel Aviv University, Israel.

Shinichi Sano, Manager, Japan Post Service Co., Ltd, Tokyo, Japan.

Jolle Toledano, Commissioner, ARCEP (Autorit de Rgulation des Communicationslectroniques et des Postes) and Professor of Economics (Supelec), Paris, France.

Urs Trinkner, Economist, Swiss Post and University of Zurich, Switzerland.

Ralf Wojtek, Attorney and Partner, Heuking Khn Ler Wojtek, Hamburg, Germany.

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Preface and acknowledgements

The origins of this book can be traced back to 1990, when the first Conference on Postaland Delivery Economics was held at Coton House, Rugby, England, July 2225, 1990, inhonor of the 150th anniversary of the Penny Post and the contributions of Sir RowlandHill. Since then there have been 15 conferences, three workshops, and now 14 editedvolumes as part of the CRRIs program on Postal and Delivery Economics. In 1990 it wasunclear whether the economics of the postal sector would prove a fruitful ground forresearch. Indeed, few participants then, including the sponsors, Royal Mail and theInternational Express Carriers Conference (now the Global Express Association), couldhave envisaged that research in the postal and delivery sector would take offto the extentthat it did, or anticipate the wave of postal reform that followed.

The present volume offers an overview of the multi-faceted international postal

reform movement that has been gathering definition and force for two decades (see

Chapter 1). The book aims to acquaint the reader with some of the background of

postal reform and to impart a basic understanding of the nature of the postal and deliv-

ery sector and why fundamental reform has been introduced despite strong opposition.

The book is also forward looking, offering insights into the future direction of reform

and identifying principles that will guide forthcoming policy and regulation of the

postal sector.

The editors have a long history of collaboration and an abiding interest in regulatory

reform. Michael Crew and Paul Kleindorfer have worked together since 1969. Their

work on the postal sector has been supported by the Postal Conferences, starting in

1990. Jim Campbell has been a regular presenter at these conferences over the years

and, as the representative of the express companies, was especially important in helping

to organize the first ones. His first experience with regulatory reform dates from the

mid-1970s when he was a young lawyer working for Senator Edward Kennedy in a

series of Senate hearings that ultimately led to deregulation of the US aviation system

in 1978.

The editors owe a debt of gratitude to sponsors of the Postal Conferences, which isacknowledged elsewhere in books resulting from the conferences. However, there are someindividuals without whom this book would not have been possible. First and foremost thebook would not have been possible without the cooperation of the authors of this volume.Second, the contribution of Paul Richards and Roger Tabor, formerly of Royal Mail, intaking the risk in sponsoring the first conference must not be underestimated. It markedthe beginning of the significant interest and research that have developed in the area.Others were of assistance along the road, including Marc Smith, of the United StatesPostal Service. Marc was instrumental in providing powerful encouragement to Crew andKleindorfer to work in the area of postal economics and coauthored two papers withthem.

Finally, we express our gratitude to the numerous participants in the Postal

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Conferences that have shaped our own thinking over the years on postal economics andwho have in the process given energy and direction to the postal reform efforts that arethe focus of this volume.

Michael A. Crew, Paul R. Kleindorfer and James I. Campbell Jr.

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1. Postal reform: introductionMichael A. Crew, Paul R. Kleindorfer and James I.Campbell Jr.

1. INTRODUCTION AND ORIGINS OF POSTAL REFORM

Although Herodotus wrote admiringly of Persian messengers undaunted by either snow,

or rain, or heat, or darkness of night, not the Persian Empire, or the Greek city states, orthe Chinese Emperors, or the Senate and People of Rome ever developed a service that iscomparable to what is today known as a postal service. None provided a universal col-lection and delivery service for documents and parcels. Persian messengers and their suc-cessors were, government couriers to whom the citizen had no access.

The concept of a public service for the transmission of documents developed graduallywith the development of Europe after the Middle Ages. In the twelfth century, inexpen-sive paper (as opposed to parchment) was introduced. Enterprising Venetian merchantsof the fourteenth century organized private courier systems to deliver commercial docu-ments, eventually extending their reach into the German hinterland. The Renaissance

saw, after centuries of repression, the reemergence of scholarly exchanges of ideas.Monasteries and universities, notably the University of Paris, began to organize messen-ger systems. In the fifteenth century, the invention of a printing press with moveable typeaccelerated the dissemination of ideas.

The fifteenth and sixteenth centuries saw the slow emergence of nation states in Franceand England. Royal governments sought to ban private messenger services, especiallyinternational services, as part of the process of consolidating their authority. Postal com-munications thus became a government monopoly. At the same time, to sustain and facil-itate commerce, government courier systems were opened to the public.

In the nineteenth century, the new technologies of the Industrial Revolution

prompted reconsideration of a broad range of social institutions including the nationalpost office. In 1840, Great Britain radically reduced and simplified postage rates and

introduced the practice of prepaying postage at a uniform rate irrespective of origin and

destination by means of adhesive stamps. It would be difficult to exaggerate the impact

of this change in the development of modern postal systems. The British reforms

were rapidly adopted in other countries. For the first time, the postal service became

affordable for ordinary communications by the common man. Mail volumes exploded,

paving the way for eventual development of the modern, affordable, universal postal

service of today.

1

Rutgers University. Wharton School and INSEAD. George Mason University.


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This book will examine a number of aspects of postal reform including the origins ofthe postal monopoly and universal postal service and the relationship between themonopoly (or the reserved area) and the legal obligation to maintain universal service (theuniversal service obligation or USO). Such considerations are at the heart of the postal

reform debate and will be a prominent and continuing theme in this book. This debatewill be apparent in many chapters that follow, including the studies of individual coun-tries or regions provided in the book. This chapter sets the scene for the book by provid-ing, in Section 2, a sketch of reform in a number of countries and, in Section 3, somehighlights of the chapters that follow.

2. POSTAL REFORM WORLDWIDE

Postal reform is taking a firm hold around the world. The driving force is undoubtedlythe changes that have been occasioned by increased competition, first by the emergenceof substantial private express companies in the 1980s and second, and more importantly,by the evolution of the Internet of other electronic services in the 1990s. Electronic com-petition, in particular, means that POs are facing declining demand for the letter mail thatnot only provides higher margins than, for example, newspapers and advertising mail, buthas traditionally been the raison of dtre of the government post. So POs are facingincreasing financial pressure through electronic competition. For most governments, anincreasingly competitive environment clearly implies the need to allow POs to operatemore efficiently and more like commercial companies as opposed to government bureau-cracies. This transformation requires not only operational changes but also the freedomto price in a more commercial manner. At the same time, governments are unwilling toallow POs to follow commercial logic to the point of cutting back on politically popularservices in areas of the country or for portions of the population.

Therefore, in granting commercial flexibility, governments have also found it necessaryto define with precision the standards of universal postal service which must be main-tained, that is, the USO. And governments, or their post offices, still have to finance theUSO as traditional postal markets are being eroded. Yet, at the same time, it is generallyagreed that the need to finance the USO or expand into new markets does not justify theextraction of monopoly rents from captured mailers or the use of predatory pricingagainst competitors. This three-way balancing among commercial flexibility, universalservice, and fair competition has been a continuing theme in the postal reform area andwill continue to be for the foreseeable future. We start with a brief overview of some ofthe major developments to highlight the approaches taken towards this issue and otherissues arising from competitive entry into traditional postal markets.

The Netherlands and New Zealand were among the first of the postal services to rec-ognize the importance of becoming more commercialized (Toime, 1991), followed closelythereafter by Sweden, which opened its markets to competition in 1993. The Netherlandsand Germany embraced privatization, while New Zealand Post and Sweden Post adopteda corporate structure and have remained wholly owned by the government.

Across Europe, a major restructuring of the postal sector across all 27 member statesof the EU is well underway. Shortly after the formal opening of the European internalmarket in 1992, the postal and logistics sector was recognized as a sector in need of

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reform. The Postal Directive of 1997, as amended in 2002 and 2008, is moving the EU toa full opening of the postal market to competition by January 1, 2011.2 Full marketopening means, among other things, no statutory monopoly privileges (that is, noreserved area) for any of the components of the postal value chain or for any postal

products. Thus, competitors will be free to collect, sort, and deliver all types of documentsand parcels whenever and wherever they wish. The impending market opening is trans-forming the European postal sector from a slow-moving government service, with alimited range of traditional products and excess employment, into a vibrant new indus-try. Crew and Kleindorfer (2006 and 2008) provide details of the ongoing transformationof European postal markets.

Some of the countries that are implementing wide-ranging postal reform have done sothrough changes in regulation and corporate structure directed at promoting commercial-ization of the national PO. A common approach has been to promote strong managementincentives for performance through executive profit targets as, for example, in Australia,Canada, Sweden and New Zealand, where the post offices are organized as corporations,with a for-profit, commercial culture, but with the government still the sole owner. Othercountriesare headedto full privatization. Today (February 2008), 69 percent of equity in thepostal service is privately owned in Germany and 100 percent in the Netherlands and Malta.

In addition, Post Danmark A/S recently transformed itself into a public limitedcompany (that is, a corporation), and then began a process of privatization; 25 percent ofits shares are now owned by a private investor. In 2005, Post Danmark and its investor, inturn, bought 50 percent of the Belgian Post Office (La Poste). The Austrian Post Office(sterreicherische Post AG) began the process of privatization with an IPO in 2006, inline with the changes that are occurring in Europe in communications markets as well asin parcel and express markets. The first tranche of shares in the Austrian Post Office,amounting to 49 percent of the business, were sold in an oversubscribed IPO, and sharesbegan trading on the Vienna Exchange on May 31, 2006. The Italian Post Office (PosteItaliane) has also announced the possibility of an IPO. Japan Post is a further interestingcase of privatization, which was the central issue in the Japanese parliamentary electionsin 2005 (see Campbell and Porges, Chapter 21, this volume).

The above represents some highlights of the fast-moving developments in the postalarena outside the United States. To give a sense of some of the important details that haveoccurred, we shall briefly summarize the experiences of four countries: New Zealand andSweden, which were early entrants to postal reform and have remained corporatized butnot privatized operators; and Germany and the Netherlands, the two largest privatizers.Sweden is examined in more detail in Chapter 17 by Andersson in this volume,and aspectsof the other three countries are also covered in the chapters that follow. This brief reviewof the experiences of these leaders in the postal reform area aims at setting out some ofthe main issues that are at stake in the postal reform movement.

2.1 Commercialization: New Zealand Post and Swedish Post

New Zealand Post and Sweden Post were early adopters of a commercializationapproach. New Zealand Post is chartered and organized as a corporate entity and isexpected to be run as a business: specifically, it is expected to give its primary shareholder,the government, a reasonable return on invested capital. It is also expected to maintain a

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specified minimum level of national postal services agreed with government; since April1998 it has done so with an open market without a reserved area. Executives faceperformance-based executive compensation systems, modeled after the private sectorwith which they compete for managerial talent. Shares in the corporation are owned by

the Ministry of Finance and the Ministry of State Owned Enterprises. There is virtuallyno sector-specific regulation of postal operators except a registration procedure andconsumer-protection measures administered by the Ministry of Economic Development.The combination of corporate structure, a charter that underlines the commercial natureof their activities, proper incentives for management, and light-handed regulation have allcombined to make New Zealand Post a successful business venture. Reflecting theefficiency improvements associated with commercialization, revenue per employee hasmore than doubled in nominal terms, while the real price of a single-piece stamp has fallenby almost a third during the 19872004 period.

In Sweden, the market was fully opened to competition in 1994, with Sweden Post(known as Sverige Posten AB) maintaining responsibility for the USO. The price of asingle-piece stamp was increased dramatically, by 38 percent between 1993 and 1997, butsubsequently moderated. In addition, Sweden Post took action to change the way it pro-vided universal service: the number of full-service postal counters was decreased dramat-ically after liberalization, with extensive franchising taking place. Similarly, in high-costrural areas, fixed counter services were replaced by rural postmen/women who deliveredthe mail and sold postal services. These and other activities by Sweden Post have led tosignificant cost savings and improved quality of service (measured by the percentage ofmail meeting its delivery requirements). Faced with competition in major urban areasbecause of the open market, Sweden Post has undertaken significant restructuring tobetter align the cost, value and prices of its services with customer demand. Althoughfully owned by the government, Sweden Posts status and culture as a for-profit corpora-tion and the competition it faces have made Sweden Post an oft-cited example to illustratethe benefits of corporatization and competition.

Posten turned out to be a formidable competitor, so formidable that it quickly facedantitrust action from its major competitor, CityMail, which complained of Postens dis-criminatory pricing and other practices. Ultimately a settlement was reached. Interestingly,CityMail has changed ownership a number of times. It has rarely reported profits, thoughit did so in 2005 and may now have finally reached a stage of profitability under the own-ership of Norway Post. The Swedish case raises interesting issues of the conflicts of inter-est created by public enterprise. Where a PO acts in a commercial manner and pricesaggressively, it may be subject to antitrust action. If the PO is publicly owned, the govern-ment has a conflict of interest in enforcing antitrust actions against a company it owns.

Commercialization without privatization thus introduces inevitable anomalies. Whilelegal institutions may provide adequate safeguards, at a minimum public ownershipmakes the application of competition law less straightforward than when two privatelyowned companies are parties to an antitrust dispute. A further difficulty with commer-cialization relative to privatization is that executive compensation is not related to anexogenous index of value like stock price and, thus, attempts to link compensation to per-formance are subject to additional problems of both measurement and legitimating.Perhaps most significantly, absence of private ownership means that public postal opera-tors are not subject to the scrutiny and discipline of capital markets.



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2.2 Privatization: The Netherlands and Germany

The Netherlands changed the structure of its post office in 1989 from a state enterprise toa private company whose stock was entirely owned by the government. As it turned out,this change was the first step towards full privatization. A close commercial relationshipbegan to develop between the Dutch post office and TNT, an international express carrierwith its origins in Australia. In 1994, the flotation of the Dutch Post as part of KPN (thecombined postal and telecommunications operator) took place on the Amsterdam StockExchange. In 1996, KPN acquired TNT. In 1998, KPN demerged into two companies,the new KPN, a telecommunications company, and TNT Post Group (TPG), a post andtransportation company. In 2005, the various strands of the relevant business wereregrouped and renamed as TNT. As Table 1.1 shows, TNT is now a large company witharound 128,000 employees and revenues of10.1 billion in 2005 from its postal businesses.Its success has arisen from a solid base of mail revenue upon which to build, but its morerecent activity is clearly global in scope, reaching out in both the express area and in letter-mail activities in various countries. TNT has used its privatized status, and its improvedknowledge of investor relations and markets, to gain an early-mover advantage in manyof the growing areas of business-to-business and business-to-consumer commerce. It isnow a force to be reckoned with in traditional mail, express and parcel markets, and sup-porting infrastructure, as well as in international trade.

The German privatization story begins with Postreform Iadopted in 1989. PostreformI created separate departments within the Ministry for Posts and Telecommunications for


Table 1.1 TNT: then and now, 1989 to 2005

1989 (PTT Post) 2005

Total employment (full-time 59,300 128,307equivalents, average for the year)

Employment in postal operations 59,300 77,447Employment in express and courier services NA 50,860Service quality D1 letter mail D1: 93% D1: 97%Single-piece letter mail price 0.34 0.39Total postal revenues from letter mail, parcels & express 1.9 10.1services 2

Revenues from mail2 NA 4.0Revenues from express services2 NA 6.1

Notes1. The employment figures here do not reflect the additional 35,007 employees who are part of the TNTLogistics Group. According to the TNT Annual Report 2005, the TNT Logistics Group is being divestedin order for TNT to focus entirely on its core delivery network businesses, for both mail and parcels.Employment and revenue figures for the Logistics Group are therefore excluded from this table. Similarly,telecommunications activities were included in KPN in 1989, and these figures have also been excluded inthe above table.

2. Revenues are in billions of euros. Excluded here are revenues from financial services and logistics servicesnot directly connected to TNTs delivery network businesses. Including such revenues for 2005 wouldyield total operating revenues for TNT of13.6 billion as reported in the 2005 TNT Annual Report.

Sources: PTT, Annual Report 1989 (PTT Post only); TNT, Annual Report 2005.


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postal services, postal banking, and telecommunications. The new Board of Directors ofthe postal agency, Deutsche Bundespost Postdienst (German Federal Postal Service),introduced a greater degree of private sector management and accounting practices.Further legislative and operational reforms followed, culminating in the sale of around athird of the equity in 2000 in an IPO. At the beginning of 2008, private investors own69 percent of what is now called Deutsche Post World Net (DPWN). In consort with thesechanges, the reserved area was completely eliminated as of 1 January 2008.

DPWN has become a force of change in the postal market worldwide; privatization hastransformed a once sleepy bureaucracy into a major multinational corporation. Maschke(2002) describes the transformation process of the German Post Office into the corporategiant DPWN over the course of the 1990s and early 2000s. The compensation structurewas transformed and managers imported from other industries, the mail and parcelsnetwork were modernized within Germany, and new products (such as hybrid mail ande-commerce) were developed. DPWN now has interests not only in the traditional mailand parcels businesses, but also in express mail, logistics, banking, and more. Indeed,DPWN has grown to a company with sales of44.6 billion in 2005 and total employmentof nearly 350,000, making it one of the worlds largest corporations.

The extent of the transformation is highlighted by comparing Deutsche Bundespost in1989 and DPWN in 2005 as illustrated in Table 1.2. Total employment in postal opera-tions was more than halved, and the 1989 figures in Table 1.2 do not even reflect the addi-tional 86,000 employees absorbed in 1990 from the former East German Post Office.Notwithstanding the employment reductions in postal operations, total employment in


Table 1.2 Deutsche Post: then and now, 1989 to 2005

1989 2005

Employment figures (full-time equivalents, 272,4911 347,607average of the year) Total employment

Employment in postal operations 232,985 129,200Employment in other operations 39,5061 218,407Service quality D1 and D2 letter mail D1: 76% D1: 95%

D2: 95% 2 D2: 99%Single-piece letter-mail price 0.51 3 0.55Revenue figures (bn) Total revenue 9.3 1 44.6Letter-mail revenues NA 12.9Postal revenues (letter mail, parcel and express services) 4 8.2 31.2Revenue from all other operations 1.11 13.4

Notes:1. Note: in 1989 Deutsche Post also provided telecommunications services. However, all figures given here

exclude telecommunications services. The figures for 1989 do not include the 86,000 employees thatDeutsche Post absorbed in 1990 from the former East German Post Office after reunification of East andWest Germany. Thus, the reduction in employment in postal operations is even more pronounced than isapparent from these comparisons for the years 1989 and 2005.

2. Figures for the year 1991 (no exact measurements before that year).3. 0.511.00 DM; price as of 1 April 1989.4. Excluding financial services and logistics.

Sources: Deutsche Bundespost, Annual Report 1989; DPWN, Annual Report 2005.


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the firm rose by around 25 percent over the 19892005 period. As traditional employmentopportunities declined, new opportunities were opened up in other growing businesses inthe overall enterprise. In addition, service quality improved, alleviating the concern thata profit-oriented business might skimp on quality relative to a public enterprise. The price

of a single-piece stamp also fell significantly in real terms, reflecting internal restructur-ing and improvements in operating efficiency.

2.3 The United States: Separating Market Dominant and Competitive Products

The 2006 Postal Accountability and Enhancement Act (PAEA) enacted a number ofsignificant changes to the Postal Reorganization Act (PRA) of 1970. Many of thesechanges relate to the modernization of the operational, financial, and management struc-tures of the USPS in the light of increased competition and USPSs continuing require-ment to meet its USO. In addition, the PAEA includes a number of provisions that requireseparate accounts and reports for USPSs competitive products, that is, those productsthat compete with similar products offered by commercial entities. Given the size andimportance of USPS for the postal industry, the history and structure of the postal reformmovement in the United States is described in several chapters in this volume, as we notein greater detail in the next section. These chapters contrast the approach taken in the USto that of the four countries above, which are clearly further along the postal reform paththan the US. While the developments envisaged in the US under the PAEA do not go asfar, they must still be seen in the context of major secular trends affecting postal service,particularly competition from electronic media, postal regulatory reform, and theopening up of postal markets worldwide to increased competition. USPS is clearly partof major changes that are affecting the postal sector worldwide and the PAEA is a partialreflection of this.

2.4 Commercialization as the Central Objective of International Postal Reform

Nations across the world are opening up their postal systems to commercialization andin a growing number of cases to privatization. They often had a unionized workforcebefore and after reform. In addition, workers in some countries enjoyed civil servantstatus. The combination of these two factors gave rise to wage and benefit terms that wereoften in excess of competitive levels, often exacerbated by the legacy costs of pensions orhealthcare commitments made to earlier generations of postal workers now or soon-to-be retired. Anyone designing and implementing changes in governance and regulation forPOs thus faces a number of major problems, in addition to the environmental changesencompassing electronic substitution. It is no surprise, therefore, that postal reform andcommercialization of POs remains a work in progress in many countries. Nonetheless, thedirection of change is clear, and there is growing evidence of the benefits from change.What is emerging from international efforts to date is that, when coupled with appropri-ate changes in regulation and commercial restructuring of the national PO, allowinggreater competition into the market for postal services can provide an important spur toefficiency and innovation for both corporatized and privatized post offices. This spur isneeded to allow POs and other stakeholders to adapt efficiently to the fundamentalchanges that continue to transform broader communications markets.



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3. THE WAY AHEAD

The book addresses three principal topics: Economic Analysis of Reform (Part I),Transformation and Innovation (Part II), and Regional and Country Studies (Part III).

The first provides some of the analytical foundations for the postal reform movement; thesecond examines how the postal sector is reinventing or transforming itself through orga-nizational change and technological innovation; and the third examines some of thesignificant developments taking place across specific countries and regions. The coverageis intended to be illustrative rather than provide comprehensive global coverage.

The analytical foundations of the postal reform movement rest on the deregulationmovement that began in the 1970s and is outlined in the survey of regulatory economicsby Crew and Kleindorfer (2002). A landmark event, if not the landmark event in thederegulation movement, was the divestiture by AT&T of its operating companies in1984.3 John Panzar recognizes the importance of the AT&T case as a principal motiva-tor of his chapter on antitrust policy and regulation (Chapter 2). The AT&T case brokenew ground by reducing the considerable immunity offered by regulation to prosecutionunder antitrust law, or competition law as it is usually known outside the US. Panzarargues, inter alia, that with an increasingly commercial orientation, POs are facing chal-lenges under antitrust law as well as under regulation. In addition, he indicates some areaswhere regulation and antitrust may be rivals. Indeed, as Richard Eccles notes in hischapter on legal developments in the EU, there may be instances where regulation takeson the role normally taken by antitrust. From reading Eccles and Panzar there should belittle doubt that antitrust will be a powerful force in the future of POs under full marketopening (FMO).

In Chapter 3, Crew and Kleindorfer address access, an area that is of serious concernto regulators and could concern competition authorities. Given the scale economies indelivery and the ubiquitous coverage by POs, specifying the terms under which the POshould provide access to its network by its competitors is currently an important issue andlikely to become more so. Access continues to be a major issue in other network indus-tries, notably, telecommunications. While Crew and Kleindorfer note the experience ofother industries, their chapter primarily surveys the issues of access in the postal sector,drawing on the developing literature on the topic. In Chapter 4, Michael Bradley, JeffColvin, and Mary K. Perkins examine a topic that figures prominently in Crew andKleindorfers chapter on access, namely, the role of price-cap regulation (PCR). In postalregulation, PCR has become the dominant form of regulation. One of the major changesin US postal law introduced by the PAEA is the adoption of PCR. Bradley et al. examinethe impact that PCR is likely to have on the future of USPS.

The USO has played a very prominent role in the postal reform debate. Funding andcosting of the USO are addressed by John Panzar (Chapter 6) and by Kristin Bergum(Chapter 7). Panzar provides some general background to the cost of the USO and anapproach to costing it. Bergum provides an interesting case study of how one country,Norway, has addressed in an innovative manner the issue of costing and funding the USO.Norways case describes the method that is used there to determine compensation from thegovernment for Posten Norge based upon estimates of the cost of the USO. In Chapter 5,Martin Buser, Christian Jaag and Urs Trinkner address another important aspect of theUSO, namely, the effect of density of post offices on mail demand. Their chapter contains



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a number of new wrinkles. Of especial interest is their comparison of the impact onfinancial viability and the extent of the network if banking and similar services are pro-vided at post offices. Their chapter throws new light on issues of economies of scope.

As transformation and innovation havefigured prominently in the postal reform move-

ment, it isfitting that the topic should be covered in this book. As a result of postal reform,POs have been required to reinvent or transform themselves. In addition, they have notbeen able to ignore the revolution that has taken place in microelectronics and fiber optics.The Internet continues to transform the way in which almost everyone does business, andPOs are not immune from its impact. Chapter 8 by Crew and Kleindorfer, and Chapter 9by Robert Reisner, examine how USPS is transforming itself. They evaluate progress andindicate where further change is needed. Crew and Kleindorfer criticize the PAEA for pro-viding little real reform. They argue that it may have provided too little too late for USPSto avoid much more serious disruption down the road. They examine not only shortcom-ings in the PAEA but also the possible role of privatization in the future of USPS. On theother hand Reisner, a former Vice President for Strategic Planning at USPS, argues thatUSPS has achieved a considerable degree of transformation within the constraintsit faces. The question is whether the transformation has been sufficient. Crew andKleindorfer argue that it has not. Reisner leaves the question open.

The role of technological innovation in the postal industry is examined in Chapter 10by Jean-Philippe Ducasse, Luis Jimenez and Marc Morelli and in Chapter 11 by Leon A.Pintsov and Andrei Obrea. Given their common employer, Pitney Bowes, it is not sur-prising that they all have a deep interest in the future of mail. Ducasse et al. examine theimpact of the microelectronic revolution and the Internet on the future of mail. They seeimportant consequences of the empowerment of mailers arising out of the technologicalrevolution. They examine ways to sustain the demand for mail, for example, through theuse of advances in database management. Pinstov and Obrea take the summary of pos-sible innovations in mail a step further and show how the electronic and the physical canbe brought together to provide many enhancements not present in traditional mail. Theyexamine the details of what customer empowerment means. They envisage a postal worldwhere customers themselves play a role in product design. For POs what they are propos-ing may be revolutionary, as it involves an entirely more proactive role by POs in workingwith their customers. The challenge they throw down is ostensibly daunting. However,capabilities that the electronic and Internet revolutions offer to meet the challenge appearvery promising. Not only must POs reinvent themselves, but the technology is here forthem to do so, in particular in the areas of improved marketing and innovative products.

While Part III, Regional and Country Studies, is inevitably the longest of the threeparts, it still has, of necessity, a number of omissions. An overview of regulatory and otherdevelopments of selected POs in Asia is provided by Shoji Maruyama and Shinichi Sano(Chapter 20). Jim Campbell and Amelia Porges (Chapter 21) analyze in more detail thenew postal privatization law in Japan. Chris Paterson (Chapter 22) contributes a study ofAustralia Post. Australia is a case where reform has been limited. Australia Post contin-ues to benefit from a reserved area, and there appear to be no plans for radical changealong the lines of the FMO in Europe. In some ways the Australian story makes a pow-erful case for gradual reform as opposed to radical reform. It is also a case for light-handed regulation. Australia Post is not regulated by a sector regulator but by theAustralia Competition and Consumer Commission.



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Postal reform in developing countries generally is the topic of Chapter 23, by Juan B.Ianni. Drawing on his experience as a postal policy analyst for the World Bank, Ianniquestions the benefits of the USO for emerging economies and looks to competition toprovide postal and delivery services where volumes are so low that scale and scope

economies are non-existent. This view should be weighed against the approach put forthby Ansn et al. (2006), whose studies have been influential at the Universal Postal Union.India, one of the most important developing countries, is examined by V. Ranganathan(Chapter 24). India Post faces major problems driven by a stifling bureaucracy, lostopportunities, and significant subsidization. Potential for reform in India is significant,but changes to date have barely scratched the surface. Israel provides another interestingcase study in a study by Avi Azuz, Udi Nisan and Eli Sagi (Chapter 25). The authors hadthe opportunity to influence the process of reform in Israel as all three served on the com-mittee that recommended the reforms.

In any treatise on postal reform the star has to be the European Union, which has madethe most significant changes in postal markets, including its plans for full market openingof all EU member states by 2013. The impact of the reforms in the EU has been consid-erable. Deutsche Post and TNT have transformed themselves from bureaucracies intomajor international corporations. Klaus Zumwinkel led the dramatic transformation ofDeutsche Post into a world leader in courier, logistics and parcel service, comparable inmany ways with the two leaders worldwide, UPS and FedEx. The transformation of theDutch PO into a leader in the sector tells a similar story, the main difference being the sizeof the two companies (so far). Reflecting the important place occupied by Germany in thepostal reform movement, Alex Kalevi Dieke and Ralf Wojtek (Chapter 16) provide a dis-cussion of the governments recent adoption of a minimum wage law which applies to thepostal sector only. While the relation between wages in the postal sector and those in thegeneral economy has been debated for many years (see, for example, Wachter and Perloff,1991), this chapter adds to this debate by examining the legal, political and economic con-siderations underlying the change in the German law.

Michael Crew, Gonzales dAlcantara, Paul R. Kleindorfer, Philippe Claeys and BertKuypers (Chapter 13) review the likely economic impact of FMO across member statesin the EU. Some are better prepared than others. Yet the legal and regulatory changesthat have already taken place are considerable, as shown in Chapter 12 by Jim Campbell,Alex Dieke and Antonia Niederprm in their review of the legal and regulatory landscapeon the eve of the Third Postal Directive. In Chapter 14, Richard Eccles examines theimplications of the Third Postal Directive and some of the legal principles underlying thepostal policy at the EU level. Jim Campbell (Chapter 15) also provides a brief historicaloverview of the United States postal monopoly law; his account suggests that the need tofund the USO was not the primary driver of the monopoly law in the United States.

No discussion of postal reform would be complete without some discussion of Sweden,France, and the UK. Sweden and the UK were both early adopters of FMO. Sweden waswell ahead of the rest of Europe with its repeal of postal monopoly in 1993. PeterAndersson (Chapter 17) reviews the results of the opening up of the Swedish market,including its effects on competition and consumers. France is notable in that it wasinitially opposed to FMO but was the leading protagonist among European POsof worksharing and access. Major changes are in store for France with FMO.Significant developments are already underway, as described in Chapter 18 by Catherine



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Gallet-Rybak, Ccile Moreno, Daniel Nadal and Jolle Toledano in their analysis of theFrench postal market in the wake of the Postal Law of 2005. Finally, there is the UK,where regulatory change has been considerable. The postal regulator, Postcomm, isregarded by many as the most active in the world. It brought about FMO in 2006, well

ahead of the rest of Europe. In Chapter 19, Richard Eccles reviews the regulations andpolicies of Postcomm and their impact on the postal market.

Postal reform is a continuing story, so this book cannot hope to offer the final word.For many, the proof of the pudding will be revealed by the outcome and aftermath ofthe liberalization in Europe, which begins for most of the EU on January 1, 2011. Otherswill have to wait longer, perhaps much longer, before they will be able to evaluate thebenefits and costs of postal reform. This book is at least intended to prepare the readerfor some of the possible outcomes that might unfold.

NOTES

1. Throughout the book the abbreviation, PO, will be used to mean national post office or postal operator.Where the term post office is used, it will be to describe a postal retail outlet.

2. Full market opening is delayed for some EU countries until January 1, 2013.3. William Kovacic, who is now Chairman of the United States Federal Trade Commission, evaluated this

case, United States v. AT&T Co, as probably the most important judicial decision in the field of economicregulation in the past 20 years (Kovacic, 2002, p. 25).

REFERENCES

Ansn, J., R. Cuadra, A. Lindares, G. Ronderos and J. Toledano (2006), First steps towards newpostal economics models for developing countries: learning from the Latin American experience,in M.A. Crew and P.R. Kleindorfer (eds), Liberalization of the Postal and Delivery Sector,Cheltenham, UK and Northampton, USA: Edward Elgar, pp. 21736.

Crew, Michael A. and Paul R. Kleindorfer (2002), Regulatory economics: twenty years ofprogress?, Journal of Regulatory Economics, 21 (1) January: 522.

Crew, Michael A. and Paul R. Kleindorfer (2006), Approaches to USO under entry, in Michael A.Crew and Paul R. Kleindorfer (eds), Liberalization of the Postal and Delivery Sector,Cheltenham, UK and Northampton, USA: Edward Elgar, pp. 118.

Crew, Michael A. and Paul R. Kleindorfer (2008), Regulation and the USO, in Michael A. Crewand Paul R. Kleindorfer (eds), Competition and Regulation in the Postal and Delivery Sector,Cheltenham, UK and Northampton, USA: Edward Elgar, pp. 322.

Kovacic, William E. (2002), Economic regulation and the courts 19822001: ten cases that made adifference, Journal of Regulatory Economics, 21 (1) January: 2334.

Maschke, Walter (2002), Transformation at Deutsche Post World Net using the example of sociallycompatible workprice adjustment, in Michael A. Crew and Paul R. Kleindorfer (eds), Postal andDelivery Services: Delivering on Competition, Boston, MA: Kluwer Academic, pp. 30320.

Toime, Elmar (1991), Competitive strategy for New Zealand Post, in Michael A. Crew and PaulR. Kleindorfer (eds), Competition and Innovation in Postal Services, Boston, MA: KluwerAcademic, pp. 27582.

Wachter, Michael L. and Jeffrey M. Perloff (1991), A comparative analysis of wage premiums andindustrial relations in the British Post Office and the United States Postal Service, in Michael A.Crew and Paul R. Kleindorfer (eds), Competition and Innovation in Postal Services, Boston, MA:Kluwer Academic, pp. 11538.



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PART I

Economic analysis of reform


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2. Interactions between regulatory andantitrust policies in a liberalized postalsectorJohn C. Panzar

1. INTRODUCTION AND SUMMARY

Liberalization has brought many changes to the postal sector. In the European Union(EU) and elsewhere, recent decades have seen the corporatization of postal operators.Posts have been transformed from ministries or government departments into more com-mercial enterprises. While privatization has been relatively rare, posts are typically subjectto economic regulation by an independent regulator. The full market opening of thepostal sector (scheduled for most countries in the EU for 2011) will likely bring with itadditional scrutiny from competition authorities. In the US, the Postal Accountabilityand Enhancement Act of 2006 (PAEA) subjects the United States Postal Service (USPS)to antitrust scrutiny for the first time in its history. The liberalization experience of other

vertically integrated network industries such as telecommunications and electric powerhave illustrated that the issues facing postal regulators and competition authorities arelikely to be closely linked.

Historically, the postal sector was largely insulated from both regulatory and antitrustcontrol. Not only was the post a state-owned enterprise (SOE), in most countries it wasalso an integral part of the government. For example, in the United States, the PostmasterGeneral was a cabinet-level position, while in many European countries the post was partof a government ministry: for example, the Ministry of Posts and Telecommunications.Under these circumstances, there was little if any room for regulatory or competitionpolicy to operate: postal policy was government policy.

This situation changed dramatically in the US with the Postal Reorganization Act of1970 (PRA). USPS was established as a government corporation whose operational deci-sions were removed from the political process. Importantly, the PRA mandated that thePostal Service operate essentially without direct government subsidy: that is, its operatingexpenses must be recovered through rates. The PRA also created the Postal RateCommission as a semi-independent regulatory body to approve the structure of postalrates. Thus a system of cost-plus, public-utility-style rate regulation was introduced intothe postal sector. However, as continued to be the case in other network industries suchas telecommunications and electric power, the USPS markets were not generally openedto competition under this new regime. In contrast, corporatization did not get seriously

15

Northwestern University and the University of Auckland.


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underway in Europe until the 1990s, following the issuance of the Green Paper by theEuropean Commission.

Traditionally, antitrust (or competition) policy is an ex post form of government inter-vention. That is, the antitrust authorities monitor the actions of market participants and

take corrective action after the fact if a violation is found as a result of a judicial pro-ceeding. In contrast, regulatory authorities act primarily on an ex ante basis. They for-mulate policies and procedures that usually are put in place before thefirm takes its marketactions.

In the United States, this distinction began to blur with the break-up of AT&T. A majorpremise of the Justice Departments antitrust case was that the Federal CommunicationsCommission (FCC) and state regulation of telecommunications was not adequate toprevent the Bell System from impeding the development of competition in the sector. Thesettlement of that case created a complex situation in which the telecommunicationssector was, in effect, administered by the federal courts as well as state and federal regu-lators.1 The Telecommunications Act of 1996 did not eliminate the potential for conflictbetween antitrust and regulatory authorities.2

It seems likely that competition and regulatory authorities will also have overlapping

concerns as postal liberalization continues. For the foreseeable future, incumbent posts

continue to have a dominant share in many postal markets that are also open to com-

petition. Thus, even though they are under the scrutiny of sector-specific regulatory

bodies, their market actions will naturally be of concern to competition authorities as

well. Under EU competition policy, the concern would be abuse of dominance, while

in the US, the terms used might be exclusionary and/or predatory behavior. The

purpose of this chapter is to discuss some of the economic issues that are likely to

be of concern to both regulatory and antitrust authorities and identify any potential

conflicts.

The structure of the postal sector differs greatly from country to country, even within

the EU. However, this chapter addresses general issues involving regulatory and com-

petition policy in the sector, rather than the details of such interactions within a partic-

ular country (Eccles, Ch. 14, this volume). Therefore, the interactions between

regulatory and competition policy will be examined in the context of a hypothetical,

typical postal sector with certain basic market and institutional characteristics,

namely:

1. The incumbent post is an SOE.2. The incumbent post is regulated by a sector-specific, postal regulator.3. The incumbent post is a dominant firm in at least the letters market.4. As a dominant firm, the incumbent will be subject to the competition authorities,

especially concerning charges of abuse of a dominant position.5. The incumbents overall rate level is controlled by some form of price-cap regulation,

at least for markets in which it is dominant.6. Despite its overall dominance the incumbent post faces actual or potential competi-

tion in at least some of its markets.7. Despite the inroads of competition, the incumbent post faces a universal service

obligation (USO).

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These characteristics reflect the modal situation in liberalized postal markets,

although (with the possible exception of the third), none holds universally. Taken

together, these characteristics naturally give rise to the policy issues that are the subject

of this chapter.

The remainder of the chapter is organized as follows. Section 2 analyzes issues that arisein regard to the market for downstream access to the incumbents delivery network. Thereare at least three policy interests there that may conflict. The first is that downstreamaccess creates the possibility of a competitive market for upstream services. But, alongwith that comes the possibility of exclusionary behavior in that market. A second role ofdownstream access is to facilitate competition in the end-to-end market. Finally, accessprices are part of the overall allocative efficiency of the postal rate structure. Given threepossible policy targets and only one policy instrument, it is not surprising that conflictsmay arise.

Section 3 revisits the long-standing question of the proper scope of operations forSOEs in competitive markets. Competitors have long argued that the only way to ensurea level playing field is to prohibit incumbent firms that enjoy either de facto or de juremonopoly power in one market from participating in related competitive markets.Regulators are typically reluctant to give up the benefits of substantial economies ofscope that this would require. The analysis supports the view that participation by theincumbent in related non-dominant markets is highly likely to be efficiency enhancing solong as the incumbent is motivated primarily by profit. However, if the incumbent SOEis more concerned with maximizing its sales, it may have an incentive to use its economiesof scope to foreclose more efficient competitors.

Section 4 discusses a similar issue caused by economies of scope between the USOproviders of basic letter and competitive services. Given the cross-subsidy embodied inthe uniform rate, rivals who have substantial market shares elsewhere have little interestin competing with the incumbent in high-cost areas. However, should the incumbent beginto receive USO payments to continue providing basic delivery service in such areas, com-petitors could rightfully claim that they were excluded by the subsidy.

Section 5 takes up another access problem that has vexed regulators and competition

authorities: the terms under which competitors can deliver mail to the incumbents PO

Box (PB) addresses. Incumbent posts tend to argue that placing letters into a sub-

scribers PB is just a very far downstream form of access and that something like the

efficient component pricing rule (ECPR) is the appropriate methodology to use.

Regulatory commissions tend to argue that the appropriate standard should be cost

based, arguing that the likely outcome in workably competitive postal and PB markets

should be operated on a cost-based access charge. There is also concern lest the incum-

bent post succeed in making use of its dominant position in the PB market to thwart

competition in markets for postal services. It turns out that this debate ignores an impor-

tant aspect of the market for PB services and postal markets generally: they are two-

sided markets. As the emerging literature on this topic has indicated, simple cost-based

rules rarely suffice to characterize either desirable or equilibrium characteristics of the

marketplace.

Section 6 concludes.

Interactions between regulatory and antitrust policies 17


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non-workshared products were treated symmetrically under the cap.5 The followingexample illustrates the possible exclusionary effects of this regulatory policy change.

Consider an incumbent that provides two market-dominant services: an end-to-endservice and a workshared (or access) service. In the case of the workshared service, com-

petitive consolidators provide upstream, sorting functions and the incumbent providesonly delivery. Assume that, initially, the incumbent was regulated to break even by cost ofservice regulation and the worksharing discount was set equal to the upstream unit costsof the incumbent, that is, according to the ECPR. Now suppose a price-cap regime isintroduced to control the prices of the incumbent and that, as is common, the priceweights are set equal to the actual market quantities in the previous period.

More formally, let D(p) denote the total demand for the end-to-end service as a func-tion of the stamp pricep and let S() denote the competitive supply of upstream servicesas a function of the worksharing discount . Thus, end-to-end and workshared volumescarried by the incumbent are given by D(p) S() and S(), respectively. Let t and c,respectively, denote the incumbents unit costs of upstream sorting and downstream deliv-ery and let Fdenote its fixed costs (from all stages). Finally, letp0 and 0, respectively,denote the stamp price and worksharing discount established by the regulator before themove to price-cap regulation. Then, the initial quantities of end-to-end and worksharedquantities are given by D(p0) S(0) and S(0), respectively.

Under these circumstances, the profits of the incumbent postal operator are given by:

(p, )(ptc)[D(p)S()](pc)S() F. (2.1)

The global price-cap regulation subjects the incumbents choice of stamp price and work-share discount to the following constraint:

p(D0S0)(p) S0 p0(D0S0)(p00)S0R0. (2.2)

This condition requires that, when evaluated at last periods volumes, the stamp price anddiscount chosen by the incumbent cannot be expected to yield more than last periods rev-enues. When the constraint is binding, it can be solved to yield an expression relating theallowed levels of the stamp price and worksharing discount, that is,

p*()(R0/D0)(R0/D0). (2.3)

Equation (2.3) has the intuitive interpretation that the price-cap constraint allows

the incumbent to increase its stamp price only if it also increases its worksharing

discount.

It is now possible to evaluate the incentives facing an incumbent which has been sub-jected to price-cap regulation in these circumstances. In order to examine the effects onincumbent profits of a small change in the worksharing discount, substitute equation (2.3)into equation (2.1) and differentiate with respect to to obtain:

(2.4)d[p*(), ]d

p dp*d

[ (p t c)D D]S0

D0 (t )S S.



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Evaluating this expression at 0t andpp*(t)p0 yields:

. (2.5)

Thus, the incumbent has a profit incentive to reduce the worksharing discount below itsinitial ECPR level.

Under ECPR (avoided cost) worksharing discounts,all upstream competitors that wereat least as efficient as the incumbent were active in the market. After the change in regu-latory policy, the incumbent would have a profit incentive (and regulatory permission)to exclude some of them. Presumably, this outcome would be of concern to the competi-tion authorities. That is, even if application of essential facility considerations does notdictate that there must be an upstream market for competition policy reasons, once sucha market has been created by regulatory fiat, competition policy criteria would apply.Usually, such potential conflicts can be avoided through adjustments in regulatory policy,for example, in the present example, one could change the form of the price cap and/orimpose the added constraint that worksharing discounts satisfy the ECPR. However, this

just reinforces the point that regulatory policies may sometimes conflict with competitionpolicy in this important area.

3. PREVENTING UNFAIR COMPETITION BY STATE-OWNEDENTERPRISES

Competitors continually claim that incumbent posts compete unfairly.6 Sometimes thesecomplaints have obvious merit, for example, the mail-box monopoly of the USPS which certainly has the effect of raising rivals costs. More commonly, charges of cross-subsidization are thinly disguised attempts to influence the regulatory process to sethigher rates for the incumbents products that are close substitutes for those of the com-plaining rival. This debate will intensify following liberalization, and it has the potentialto lead to conflicts between regulatory and competition policy objectives.

True, the end of the letter monopoly will also end critics most common complaint ofthis kind, that is, that the incumbent uses its protected monopoly to obtain the resourcesto finance unfair competition. Yet charges of cross-subsidization will undoubtedly con-tinue. Therefore, price-cap regimes are typically extended to include additional provisionsfor a price floor that prevent the incumbent from setting the price of any product belowits average incremental cost. It is here that the status of the incumbent as an SOE com-plicates matters.

A profit-maximizing firm that has an opportunity to earn at least some profits will notprice competitive products below their average incremental cost except as an attempt at pre-dation. It would increase its profits by abandoning that product line altogether. Predatorypricing by a profit-maximizing firm seems unlikely in the postal sector because of the rela-tive ease of entry into the market. This makes it very difficult for a predator to successfullyrecoup the losses resulting from the below-cost pricing required to drive the prey out of themarket. However, work by Sappington and Sidak (2003a and 2003b) has argued that SOEsmay have the incentive to engage in predatory behavior on a continuingbasis.

d[p*(t), t]

d

(p t c)D (p0)S(t)

D(p0

)

0



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This argument has serious implications for the coordination of regulatory and antitrustpolicies: the regulator may trust to conduct (pricing) restraints to limit cross-subsidization, while the antitrust authority may feel obliged to resort to structural mea-sures to prevent the incumbent from damaging competition. Sappington and Sidaks

analysis provides the rationale for these differing policy conclusions.From the regulatory point of view, there would seem to be little need for such price

floors as a tool to prevent predatory pricing. After all, the regulatory process would gen-erally make it impossible for the incumbent to recoup its investment in below-costpricing.7 However, as Sappington and Sidaks analysis explains, the situation changes dra-matically when the incumbent is an SOE whose goal is not profit maximization, but thepursuit of some other, more bureaucratic, objective. Sappington and Sidak suggestrevenue maximization as a way to summarize, or proxy, the goals of SOE managers whopursue careerist considerations in the absence of access to the stock option incentiveschemes available in privately owned companies. Profit considerations are reflectedthrough a (typically binding) constraint that the firm achieves at least a satisfactory levelof profits.8

Mathematically, this does not require a major change in the formulation of the usualconstrained optimization problem used to model the regulated firm. However, it leads tothe possibility of profound changes in the nature of the choices of the firm. Now, it isentirely possible for the firm to wish to adopt prices below marginal costs on a long-term,continuing basis, that is, not as a predatory device with an eye toward raising rates as soonas the prey has exited the market. For the reasons discussed below, regulatory cross-subsidy tests are ill-suited to deal with this situation.

There are potentially more serious problems as well. Because a revenue-maximizingSOE wishes to offer below-cost prices on a continuing basis, it may find it optimal to alterits strategic investment policies so as to distort the outcome of any incremental cost testto which its rates may be subject. There are many forms such distortion might take. As avery simple example, consider the following: an incumbent wishes to promote its X-Mailservice. However, instead of advertising that service explicitly, it decides upon an exten-sive corporate image-type advertising campaign. While not as cost effective as a targetedcampaign, such an advertising strategy has one obvious advantage: its costs are trulyjoint and common costs. If it had done an X-Mail ad campaign, its costs would beproduct-specific fixed costs, directly attributable to that product. As such, they wouldincrease the average incremental cost floor pertaining to X-Mail rates.

Competition authorities could be forgiven for looking for structural remedies in situa-tions in which the incentives for anticompetitive behavior are ongoing and the regulatorysafeguards in place to control it are subject to strategic manipulation. A typical proposedstructural remedy is to prevent the incumbent from offering services outside its dominantmarket. Structural separation remedies are frequently proposed in network industriessuch as telecommunications and electric power. In those cases, as in the postal case, thetradeoff is the potential loss of the economies of scope enjoyed by the operator offeringa wide range of products. The incumbent (and most regulators) see such economies ofscope as an important factor in keeping basic service rates low, while competitors see themas the key source of the incumbents (unfair) network advantage.

Take the following hypothetical situation. Suppose that, initially, the incumbent postalprovider (the incumbent) provides a set of mail services with the resulting revenues being



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at least sufficient to cover the incumbents cost of operation. Now suppose that a marketemerges for a new service, X-Mail. After observing the development of this market andthe level of the price being charged, the management of the incumbent concludes that itis desirable to enter this market. From the public interest point of view, what criteria

should be used to evaluate the desirability of the incumbents diversification?The answer is straightforward if it can be assumed that the incumbent maximizes its

profit and that the X-Mail market is competitive. Then the incumbent would make itsdiversification decision based upon whether the added revenues it could earn from selling avolume of X-Mail exceeded the added, or incremental, cost of producing that volume. Asis discussed more fully below, this incremental cost test is precisely the standard that a socialplanner would use in evaluating the general desirability of the incumbents diversificationinto competitive markets. The reason is quite intuitive. Ultimately, the key condition forsocial efficiency is whether or not the volume of service sold in the marketplace is producedat the lowest possible cost. When this volume is produced by two or more firms, productiveefficiency requires that the marginal costs of all active firms be equal. Competition ensuresthat this condition is satisfied for the incumbents rivals. Furthermore, the greatest profitsfor the incumbent in a competitive market would be obtained by operating at the quantityat which its marginal cost of X-Mail also equaled the market price. Then, as long as themarket price covers the average incremental costs of diversification, the participation of theincumbent in the market lowers the total costs of providing X-Mail service.

Thus, the entry of a profit-seeking incumbent into a competitive related marketimproves productive efficiency. More than likely, the market price will fall as a result ofthe additional supply of the incumbent, further benefiting the consumers of X-Mail.9

However, the other firms providing X-Mail will not benefit from the incumbents entry.Even if the X-Mail market were initially perfectly competitive, the largest firms wouldlikely earn significant economic rents, that is, profits. Not surprisingly, such competitorsare vehemently opposed to such market participation by incumbent postal providers.

The situation becomes even clearer if the X-Mail market is not perfectly competitive.Then, the strategic actions of a profit-seeking incumbent and/or its rivals will undoubt-edly result in a lower post-entry equilibrium price for X-Mail. First, consider the case inwhich the incumbent enters to dominate an existing competitive domestic X-Mail market.In order to obtain market share (and earn profits), the incumbent must lower the pre-existing market price. To do this, of course, it must be more efficient than the marginalcompetitive producers. Equally obvious is the fact that such entry would directly benefitconsumers and harm competitors. Things are more complicated if the X-Mail market isan oligopoly, simply because there is a large range of oligopoly models that might con-ceivably be used to analyze the situation. However, in the vast majority of cases, the endresults of strategic entry by a profit-seeking firm are lower market prices and lower com-petitor profits.10

The message should be clear: diversification by a profit-seeking or socially motivated,profit-constrained incumbent results in lower prices for consumers and lower profits forits competitors. Thus it is hardly surprising that competitors routinely and vociferouslyoppose such diversification by the incumbent and similarly situated monopolies.

Sappington and Sidak (2003a and 2003b) argue that the situation changes when theSOE is assumed to maximize revenues rather than profits or consumers surplus. The gistof their argument can be summarized as follows:



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1. the public firm (for example, the incumbent) is interested in maximizing revenuesubject to a break-even constraint;

2. pursuit of this objective may induce the public firm to enter competitive marketsdespite the unprofitability of such entry;

3. incremental cost tests may be ineffective in preventing such entry; because4. the public firm may, ex ante, choose to employ production technologies with high

common costs relative to product-specific fixed costs in order to be able to pass anyincremental cost test, ex post.

Theoretical arguments alone cannot resolve this debate. The choice between behavioraland structural approaches to the problem of the participation of state-owned incumbentsin competitive postal markets is highly dependent upon the hypothesized objectives forthese SOEs. Increased attention to executive compensation for SOE managers, togetherwith corporatization and commercialization, may result in a movement away frombureaucratic objectives to market-oriented profit objectives.11

4. UNIVERSAL SERVICE: A BURDENSOME OBLIGATION ORAN UNFAIR COMPETITIVE ADVANTAGE?

There is, as yet, no settled methodology for measuring the costs of an incumbent postsUSO.12 Indeed, there are some who argue that the ubiquity of the incumbents networkis a competitive advantage rather than a burdensome obligation. Liberalization willundoubtedly shed light on this question. However, regulatory policies designed to com-pensate the incumbent for its USO may well generate competition policy concerns. Asimple example will serve to illustrate this point.

Consider an incumbent serving a high-cost delivery area to which it delivers letter mail(in which it is market dominant) and X-Mail, a competitive product. Assume that thefixed costs of its delivery network are 6,000; the marginal cost of a letter is 1 and the mar-ginal cost of a unit of X-Mail is 2, given that its letter delivery network is in place.However, because of economies of scope, without its letter-mail network, the incumbentsunit cost of X-Mail would be 6. Assume also that there are 1,000 units of letter mail and1,000 units of X-Mail addressed to the area each period and that revenues minus upstreamcosts are 4 per unit for both letters and X-Mail.

To illustrate the potential competition issues involved, assume that there are two typesof competitors able to provide X-Mail delivery in the high-cost area. Newsco is the localnewspaper delivery provider. Due to economies of scope with its newspaper deliverynetwork, it is able to deliver X-Mail at a cost of 4 per unit. The other potential source ofX-Mail service are a number of competitive couriers, who are able to deliver X-Mailwithin the high-cost area at a cost of 5 per unit.

In the initial situation after liberalization, the incumbent continues to monopolize bothservices.13 However, the incumbent earns net revenues on its high-cost operation of 5,000:3,0001,000(41) from letters and 2,0001,000(42) from X-Mail. Since this falls shortof its fixed costs by 1,000, there would be a profit incentive to abandon providing deliv-ery to the high-cost area. The result of free exit from the high-cost area delivery by theincumbent would be that residents would have to pick up their mail at the Post Office and



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the profitable entry of Newsco into the local delivery of X-Mail. It would earn an incre-mental profit of 1,000 by (slightly) undercutting the competitive couriers unit cost of 5.

One would expect that residents would be upset at the prospect of loss of letter deliv-ery and would complain to the postal regulator. Suppose that a USO payment of 1,000

were offered to the incumbent in return for the continued delivery of letter mail.14 Whilethis would please the residents of the high-cost area, it would bring howls of protest fromNewsco. How would the antitrust authorities respond to the claim that but for the USOsubsidy, the incumbent could not successfully compete in the market for X-Mailaddressed to this area?

The regulator would have two responses to any suggestion that a USO-supportedincumbent be barred from delivering X-Mail: (i) It is socially efficient for the incumbentto provide X-Mail delivery to the area, given that it provides letter-mail delivery; and(ii) the USO payment would have to be raised to 3,000 if the incumbent were to be barredfrom X-Mail delivery.

A possible objection is that the example presumes that the incumbent will emerge as theUSO provider. However, it is easy to extend the example to demonstrate that the issuecannot necessarily be resolved by introducing competition for the market into the USOfunding process. Suppose that the 6,000 in fixed costs associated with the local deliverynetwork represents the incumbents true incremental fixed costs for serving the area giventhat it also serves several neighboring (profitable) areas. Suppose that if, instead, one cal-culated the incumbents stand-alone fixed costs for serving the area, the figure would be7,500. In addition, assume that Newsco could also achieve letter-mail unit costs of 1 byincurring additional network fixed costs of 7,000.

In the hypothesized situation, Newsco would be the efficient provider of letter andX-Mail delivery services for only the high-cost area. Yet, Newsco would not be expected tooutbid the incumbent in any competition for the USO. Why not? The incumbent wouldwin, not because of its absolute efficiency, but because of its economies of scope betweenthe high-cost area and other, profitable areas that it serves.

Thus, it is not surprising that competitors view economies of scope as a threat to com-petition, rather than a source of efficiency.15 However, it would appear that the onlyresolution to this problem would be to prohibit the incumbent from serving any non-dominant markets, regardless of the scope economies that would be forgone. As thisexample illustrates, there may well be a conflict from regulatory desires to exploiteconomies of scope in order to minimize USO payments and the desire to encourageentry.

5. PROBLEMS POSED BY TWO-SIDED MARKET ISSUES INTHE POSTAL SECTOR: PO BOXES

Both senders and receivers derive value from postal service. Potentially, this makes it a two-sided market. The two-sided nature of postal markets is not a major issue when servicesare provided by a vertically integrated monopolist. Rowland Hills sender pays innovationwas primarily an attempt to reduce the transaction costs of using the post and, thereby,more effectively exploit economies of scale. However, liberalization and unbundling giverise to many novel pricing opportunities, which may cause the unraveling of the Rowland



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Hill model. This promises to create serious conceptual difficulties for both regulators andcompetition authorities.16 Many such two-sided market issues are likely to arise in thefuture. Here, the focus is on the issues raised by the market for Post Office Boxes.17

As noted earlier, the role of essential facilities has been a controversial feature of the

process of liberalizing postal markets. Some have argued that the absence of substantialsunk costs means that there is no need for policies designed to deal with monopoly bot-tlenecks, such as those used in other network sectors such as telecommunications or elec-tricity.18 Others have argued that requiring incumbents to grant downstream access isessential for the

(advances in regulatory economics) michael a. crew, paul r. kleindorfer, james i., jr....

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