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BEFORE THE POSTAL REGULATORY COMMISSION WASHINGTON, D.C. 20268-0001 _____________________________________ : POSTAL RATE AND FEE CHANGES, 2006 : Docket No. R2006-1 _____________________________________ : INITIAL BRIEF OF THE UNITED STATES POSTAL SERVICE UNITED STATES POSTAL SERVICE By its attorneys: Daniel J. Foucheaux, Jr. Chief Counsel Frank R. Heselton Kenneth N. Hollies Eric P. Koetting Nan K. McKenzie Sheela A. Portonovo Elizabeth A. Reed Brian M. Reimer Scott L. Reiter David H. Rubin Michael T. Tidwell Keith E. Weidner 475 L'Enfant Plaza West, S.W. Washington, D.C. 20260-1137 (202) 268-2989 December 21, 2006 Postal Rate Commission Submitted 12/21/2006 3:54 pm Filing ID: 55476 Accepted 12/21/2006

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Page 1: BEFORE THE POSTAL REGULATORY COMMISSION WASHINGTON, D.C. 20268-0001 _____________________________________ : POSTAL RATE AND FEE CHANGES, 2006 : Docket No. R2006-1

BEFORE THE POSTAL REGULATORY COMMISSION

WASHINGTON, D.C. 20268-0001 _____________________________________ : POSTAL RATE AND FEE CHANGES, 2006 : Docket No. R2006-1 _____________________________________ :

INITIAL BRIEF OF THE UNITED STATES POSTAL SERVICE UNITED STATES POSTAL SERVICE By its attorneys: Daniel J. Foucheaux, Jr. Chief Counsel Frank R. Heselton Kenneth N. Hollies Eric P. Koetting Nan K. McKenzie Sheela A. Portonovo Elizabeth A. Reed Brian M. Reimer Scott L. Reiter David H. Rubin Michael T. Tidwell Keith E. Weidner 475 L'Enfant Plaza West, S.W. Washington, D.C. 20260-1137 (202) 268-2989 December 21, 2006

Postal Rate CommissionSubmitted 12/21/2006 3:54 pmFiling ID: 55476Accepted 12/21/2006

Page 2: BEFORE THE POSTAL REGULATORY COMMISSION WASHINGTON, D.C. 20268-0001 _____________________________________ : POSTAL RATE AND FEE CHANGES, 2006 : Docket No. R2006-1

TABLE OF CONTENTS

PROCEDURAL HISTORY .............................................................................................. 1 I. THE POSTAL SERVICE’S REVENUE REQUIREMENT IS SUPPORTED ON

THE RECORD, IS REASONABLE, AND SHOULD BE THE BASIS FOR THE COMMISSION’S RECOMMENDATIONS............................................................. 6

A. Witness Loutsch Provides Substantial Evidence that the Present and Projected Financial Condition of the Postal Service Supports the Requested Increase in Rates and Fees..................................................... 6

B. Substantial Record Evidence Supports Postal Management’s Judgment that a Provision for Contingencies of One Percent of Total Estimated Costs Should Be Included in the Revenue Requirement ........................... 8

C. Witness Buc’s Testimony Fails to Provide a Rational Basis for Reducing Any Aspect of the Revenue Requirement Estimates ............................... 10

1. Projected savings in supervisor costs resulting from cost reduction programs are already excluded from the revenue requirement..... 10

2. Witness Buc’s arguments for reducing the contingency provision to zero are based on misapprehensions and misjudgments. ............ 11

3. Witness Buc’s arguments have been mooted by subsequent record evidence........................................................................................ 13

II. POSTAL SERVICE DATA SYSTEMS PROVIDE AN APPROPRIATE AND

LONG-ACCEPTED FOUNDATION FOR THE ESTABLISHMENT OF RATES, CLASSIFICATIONS AND FEES......................................................................... 15

A. The In-Office Cost System (IOCS) Provides Reliable and More Accurate Estimates of Employee Work Time Devoted to Office Functions and Certain Mail Categories ........................................................................... 17

1. The redesigned IOCS data collection instrument is improved substantially. ................................................................................. 18

a. Best practices for surveys were used to redesign the data collection instrument........................................................... 18

b. The redesigned instrument was tested extensively............ 19 c. The redesign is explained by substantial documentation. .. 20

2. The only challenge to the redesigned IOCS was to its cost estimates for Within-County Periodicals........................................ 21

a. The claim that the Postal Service method does not determine whether within-county rates are paid is incorrect. ......................................................................... 21 b. Witness Heath’s interpretation of regulations applicable to

non-subscriber copies is incorrect. ..................................... 22 c. Other critiques by witnesses Heath and Siwek do not identify

substantial errors................................................................ 23 d. Witness Siwek’s pooling proposal is inappropriate and likely

to strongly bias within-county periodical costs.................... 25

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B. TRACS Provides A Reasonable And Sound Basis For Distributing Transportation Costs To Mail Categories................................................. 26

C. The Origin-Destination Information System and Revenue, Pieces and Weight (ODIS-RPW), the Bulk Mail Revenue, Pieces and Weight (BRPW) System, and the Revenue, Pieces and Weight Adjustment System (ARPW) Continue to Provide Reliable Data for the Postal Service Use and for the Ratemaking Process..................................................................... 28 1. Revenue, piece and weight estimates continue with low coefficients

of variation (high precision). .......................................................... 29 2. Within-county Periodicals RPW estimates remain sufficiently

precise for ratemaking purposes. .................................................. 30 D. The Carrier Cost Systems Provide A Reliable And Uncontested Means

For Distributing City And Rural Carrier Costs To Subclasses Of Mail...... 31 III. THE VOLUME FORECASTS INCLUDED WITH THE POSTAL SERVICE’S

FILING ARE PREDICATED ON THE WELL-ESTABLISHED FORECASTING METHODOLOGY EMPLOYED IN PREVIOUS CASES ..................................... 33

A. There Have Been Only Minimal Changes in the Postal Service’s Forecasting Methodology, and No Intervenors Propose Alternative Forecasts Based on Alternative Forecasting Methodologies ................... 35

B. GCA’s Witnesses Fail to Provide Any Basis to Alter the Forecasting Parameters Presented by the Postal Service .......................................... 37

1. Prof. Martin’s research approach is flawed, and his results do not support his conclusions................................................................. 38

a. The survey results fundamentally confirm the extremely minor role of postal rates in the greater scheme of electronic diversion. ............................................................................ 47

b. Prof. Martin’s results on the alleged triggering role of postal rates on electronic diversion are merely a function of his flawed research approach. ................................................. 48

c. Inherent deficiencies within the “trigger” questions invalidate their use to reach reliable conclusions. .............................. 50

2. Neither Dr. Clifton nor Prof. Kelejian offer any valid theoretical or empirical basis to rely on any estimates of own price elasticity other than those provided by witness Thress. ........................................ 56

a. The combination of serious flaws in economic theory and econometric practice has caused Dr. Clifton to produce an unusable model of the demand for single piece First-Class Mail..................................................................................... 56

b. The practical effects of the theoretical concerns raised by Prof. Kelejian are not material. ........................................... 59

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Page 4: BEFORE THE POSTAL REGULATORY COMMISSION WASHINGTON, D.C. 20268-0001 _____________________________________ : POSTAL RATE AND FEE CHANGES, 2006 : Docket No. R2006-1

IV. THE POSTAL SERVICE’S SUBCLASS COSTING PRESENTATION ENHANCES UNDERSTANDING OF THE BEHAVIOR OF POSTAL COSTS

AND PROVIDES AN APPROPRIATE FOUNDATION FOR RATEMAKING ...... 63 A. The Postal Service Cost Models Provide the Most Accurate Available

Estimates of Mail Processing Volume-Variable Costs and Should Be Accepted.................................................................................................. 68

1. The Postal Service mail processing methods are well-grounded in the operational reality of sorting operations. ................................. 70

a. The presence of non-volume-variable costs in sorting operations is consistent with the structure of operations. ... 71

b. The number of sorts—measured by total piece handlings (MODS TPF and TPH)—is the relevant “volume” for determining labor usage in sorting operations.................... 73

c. Substitution of manual for automated processing is rare and becoming rarer. .................................................................. 74

d. The operational analysis points directly to the main features of the Postal Service analysis............................................. 75

2. Postal Service methods correctly apply economic theory to the measurement of sorting operations’ costs..................................... 76 a. The Postal Service models are motivated from a standard

microeconomic production framework. ............................... 76 b. The Postal Service model correctly applies the distribution

key method, which is appropriate and necessary to measure subclass volume-variable costs.......................................... 77

i. The distribution key method has long been shown to be an appropriate, feasible method for calculating subclass costs. ........................................................ 77

ii. No intervenor proposal offers an alternative to the distribution key method............................................ 78

iii. Prof. Roberts mischaracterizes the “proportionality assumption” embodied in the distribution key

method, and does not find legitimate evidence of its failure....................................................................... 79

3. The Postal Service variability models use appropriate and reliable data and estimation methods............................................ 82 a. The MODS data are suitable for estimating mail processing variabilities.......................................................................... 82 i. MODS directly measures hours and workloads from actual operations on a continuous basis.......... 82 ii. MODS data issues are routine for operating data, and permit the construction of data sets sufficient for estimation purposes................................................. 83 iii. The Postal Service analysis make appropriate use of other data sources needed for the mail processing models. .................................................................... 84

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iv. Dr. Neels’s analysis of MODS data quality issues is error-plagued, misstates the true data quality issues, and should be rejected. ........................................... 85 b. There is no dispute in this proceeding that panel data methods are appropriate for mail processing variability estimation. .......................................................... 89 c. The Postal Service models produce robust results using consistently-applied methods.................................... 90 d. The Postal Service translog/GLS model is the superior option for automated operations. .......................... 91 i. The Postal Service models make appropriate use of machine-counted workloads. ................................... 91 ii. Cross-operation effects have been shown to be negligible. ................................................................ 92 iii. There is no evidence of “attenuation” of the automated operations’ elasticity estimates. ............. 93 e. Instrumental variables estimation is appropriate for operations where MODS workloads are subject to conversion error. ................................................................ 94 i. Measurement processes for manual piece handlings (and FHP in general) are distinct from automated operations’ machine TPF and TPH counts. ............. 94 ii. The appropriate response to conversion error in manual workloads is to use “robust” instrumental variable estimation techniques. ........... 95 iii. The simpler log-linear specification for the instrumental variable models are appropriate. ... 95 iv. The Postal Service models successfully eliminate measurement bias. .................................................. 96 4. The reliable evidence from intervenor analyses in this proceeding supports the Postal Service’s demonstration that mail processing costs are less than 100 percent volume-variable. ......................... 98 a. Prof. Roberts’s models, correctly updated, yield results largely consistent with the Postal Service models. ............. 98 i. While significantly flawed, Prof. Roberts’s models, if properly implemented, are superior to the alternative of maintaining the 100 percent variability assumption. ............................................................. 98 ii. Should the Commission adopt a model based on Prof. Roberts’s work, it should employ the updated version of Prof. Roberts’s model presented by Dr. Bozzo....................................................................... 99 iii. Prof. Roberts’s own update is rendered unusable by major technical flaws, unjustified model changes, and accordingly implausible results. ............................. 100

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iv. Prof. Roberts’s “additional outputs” models point to potential improvements to the OCA models, but the OCA-T-1 implementation is terminally flawed for its apparent purpose................................................... 103 v. There is no reliable evidence suggesting failure of the distribution key method’s “proportionality assumption.” .......................................................... 104 b. Dr. Neels’s alternative model, correctly implemented for “allied labor” and at the “plant level,” supports the use of reduced variabilities for allied labor and miscellaneous cost pools................................................................................. 106 i. Dr. Neels’s aggregate model is conceptually inferior to

the Postal Service and OCA models for sorting operations.............................................................. 106

ii. Dr. Neels’s model has some utility as a model of allied labor and other non-sorting operations. ................. 107

iii. Correctly employed as an allied labor or whole-plant model, Dr. Neels’s model supports the Postal

Service treatment of variabilities outside of sorting cost pools. ............................................................. 107

d. If the Commission declines to adopt an econometric variability model for sorting operations, it should modify its mail processing cost method to treat setup and take-down costs as non-volume-variable using the methods proposed by Dr. Elliott. ..................................................................... 108 i. The record supports treating setup and take-down

costs as non-volume-variable. ............................... 109 ii. Data from the redesigned IOCS instrument provides a

reasonable basis for estimating the setup and take-down costs............................................................. 110

5. The Commission should accept the Postal Service partition of administrative costs in Cost Segment 3, and recognize that the Postal Service treatment of mail processing “administrative” costs as part of Cost Segment 3.1 is correct. ....................................... 111 6. The Commission should continue to distribute volume-variable costs to subclass using IOCS-based distribution keys established at the cost pool level. ...................................................................... 112 a. Witness Van-Ty-Smith implements the long-accepted IOCS/MODS-based distribution key method. ................... 112 b. The accuracy of IOCS “direct tally” data used in the distribution keys has been improved by the recent IOCS redesign............................................................................ 113 c. The IOCS/MODS-based distribution keys calculated by cost pool remain the best method for distributing mail processing volume-variable costs to subclasses under alternative variability methods............................................................ 114

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Page 7: BEFORE THE POSTAL REGULATORY COMMISSION WASHINGTON, D.C. 20268-0001 _____________________________________ : POSTAL RATE AND FEE CHANGES, 2006 : Docket No. R2006-1

B. The Postal Service’s Updated Study for Window Service Costs Should Be Adopted ................................................................................................. 115

1. Witnesses Kelley and Bradley demonstrate that the 2005 transaction study utilized a sound sample design which resulted in a reliable database...................................................................... 116

2. Witness Bradley’s recommended window service model is superior to all proposed alternatives. ........................................................ 118

C. For Purposes of This Proceeding, the Commission Should Once Again Use the City Carrier Street Time Cost Results Introduced in the Previous Rate Case.............................................................................................. 119

1. OCA witness Smith fails to provide any suitable alternative to the previous variabilities.................................................................... 121

2. The concerns expressed by Valpak witnesses Haldi and Mitchell concerning capacity constraints and other city carrier costing issues are not warranted. ....................................................................... 124

D. The Postal Service Proposes Appropriate Treatment of the Costs of the Postal Transportation Networks............................................................. 128

V. THE RATE LEVELS PROPOSED BY THE POSTAL SERVICE FOR EACH

SUBCLASS OF MAIL REFLECT A REFINED APPLICATION OF THE RELEVANT STATUTORY CRITERIA .............................................................. 134

A. The Postal Service Has Appropriately Considered And Applied the Relevant Pricing Factors........................................................................ 134 B. The Cost Coverages Proposed By Postal Service Witness O’Hara Satisfy the Incremental Cost Test...................................................................... 136 C. The Postal Service’s Proposed Cost Coverages Reflect A Fair And Equitable Allocation Of Institutional Costs And Give Proper Consideration

To All Of The Applicable Ratemaking Criteria........................................ 139 1. First-Class Mail – Letters and Sealed Parcels ............................ 139 2. First-Class Mail – Cards.............................................................. 141 3. Priority Mail ................................................................................. 142 4. Express Mail ............................................................................... 143 5. Outside County Periodicals......................................................... 144 6. Within County Periodicals ........................................................... 144 7. Standard Mail .............................................................................. 145 a. Regular and Nonprofit ...................................................... 145 b. Enhanced Carrier Route and Nonprofit ............................ 147 8. Package Services Mail................................................................ 148 a. Parcel Post ....................................................................... 148 b. Bound Printed Matter ....................................................... 149 c. Media and Library Rate Mail............................................. 150 D. The Intervenor Cost Coverage Proposals Are Lacking.......................... 150 1. UPS witness Geddes’ Priority Mail proposals ignore the realities of

the marketplace........................................................................... 151 2. Amazon.com witness Haldi misapplies the pricing criteria in

proposing his Bound Printed Matter cost coverage..................... 156

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Page 8: BEFORE THE POSTAL REGULATORY COMMISSION WASHINGTON, D.C. 20268-0001 _____________________________________ : POSTAL RATE AND FEE CHANGES, 2006 : Docket No. R2006-1

3. Valpak’s nostalgic Standard Enhanced Carrier Route cost coverage proposal seeks to unfairly burden Standard Regular. ................. 157

4. The NAA post-discount approach to calculating the Within County Periodicals cost coverage should be rejected. ............................ 162

E. Conclusion ............................................................................................. 164 VI. THE RATE DESIGN PROPOSED BY THE POSTAL SERVICE WILL RECOVER

THE NECESSARY AMOUNT OF REVENUE FROM EACH SUBCLASS IN A MANNER WHICH COMPLIES WITH THE ACT............................................... 165

A. Several Important Principles Guide the Postal Service’s Overall Rate Design.................................................................................................... 165

1. There should be greater emphasis on shape in rate design. ...... 166 2. Overall rate design should reflect forward-looking operational

realities........................................................................................ 168 3. Efficient Component-Pricing should only be applied to worksharing

cost differences. .......................................................................... 169 a. Implications of the two approaches. ................................. 171 b. The broad view of the applicability of ECP is flawed and

should be rejected. ........................................................... 173 c. The strict interpretation of the applicability of ECP is

reasonable and should be adopted. ................................. 175 d. ECP is, at best, only a guide in setting pricing differentials. ...................................................................... 176 B. First-Class Mail ...................................................................................... 178 1. Postal Service proposals............................................................. 178 2. The Postal Service rate design is supported by more refined cost

analysis. ...................................................................................... 183 a. The mail processing cost methodology. ........................... 183 b. First-Class Mail delivery cost estimates............................ 185 c. BRM cost support. ............................................................ 187 3. Proposals for classification change. ............................................ 187 a. The Commission should recommend the shape-related

classification changes proposed by the Postal Service. ... 187 b. The Automation Carrier Route rate categories should be

eliminated. ........................................................................ 189 c. The Forever Stamp should be adopted. ........................... 190 d. The proposed classification changes satisfy the criteria of § 3623(c). ..................................................................... 192 4. The Commission should embrace the Postal Service’s “de-linking”

of Single Piece and Presort First-Class Mail rate design. ........... 195 5. The Commission should recommend the First-Class Mail rates

proposed by the Postal Service................................................... 201 a. The Postal Service’s initial ounce rates for single-piece

letters, flats and parcels merit approval. ........................... 201

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Page 9: BEFORE THE POSTAL REGULATORY COMMISSION WASHINGTON, D.C. 20268-0001 _____________________________________ : POSTAL RATE AND FEE CHANGES, 2006 : Docket No. R2006-1

b. The Postal Service rate proposals for the remaining First-Class Mail single-piece and nonautomation presort letter categories should be recommended. ............................... 203

i. Qualified Business Reply Mail letter rate. .............. 203 ii. Nonautomation presort rates for letters and flats. .. 204 iii. The proposed additional-ounce rate reductions are

appropriate. ........................................................... 205 iv. Elimination of the nonmachinable surcharge is

consistent with shape-based rate differentials. ...... 206 c. The Postal Service First-Class Mail rate design for bulk automation-based worksharing letter categories affirms the importance of automation. ................................................ 207 i. Automation Letter Rates ........................................ 209 ii. Automation Flats Rates ......................................... 212 iii. Business Parcels ................................................... 212 iv. Additional-Ounce ................................................... 214 v. Heavy-Piece Deduction ......................................... 214 vi. Nonmachinable Surcharge .................................... 214 d. The Cards subclass.......................................................... 215 i. Single-Piece Card Rate ......................................... 215 ii. Qualified Business Reply Mail Card Rate .............. 216 iii. Nonautomation Presort Card Rate......................... 216 iv. Automation Card Rate Categories ......................... 217 2. The Commission should reject the alternative intervenor First-Class Mail rate proposals...................................................................... 219 a. APWU’s 41-cent basic letter rate proposal does not reflect consideration of relevant factors....................................... 219 b. GCA’s alternative rate design proposals should be rejected........................................................................ 222 c. There is insufficient record support for Pitney Bowes’s postage evidencing discount ............................................ 225 d. MMA witness Bentley and TW witness Mitchell rely upon an overstated QBRM cost avoidance. ................................... 229 e. The OCA additional-ounce rate design should not be recommended. ................................................................. 232 f. Mr. Carlson’s Forever Stamp concerns are easily addressed. ............................................................. 236 g. The GCA square envelope test and essay on aesthetics provide no basis for rate design. ...................................... 243 i. The GCA square envelope test is fatally deficient. 244 ii. The USPS Engineering test is the low-aspect-ratio

gold standard. ........................................................ 247 iii. Witness Liss’ musings on the aesthetics of squares

vs. rectangles are not compelling. ......................... 248

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Page 10: BEFORE THE POSTAL REGULATORY COMMISSION WASHINGTON, D.C. 20268-0001 _____________________________________ : POSTAL RATE AND FEE CHANGES, 2006 : Docket No. R2006-1

h. Intervenors’ alternate approaches to First-Class Mail presort cost methodologies and cost estimates should be rejected............................................................................. 249 i. Intervenors’ mail processing cost estimates. ......... 249 ii. Delivery cost issues. .............................................. 254 C. The Commission Should Recommend the Postal Service’s Proposed

Priority Mail Classification and Rate Changes ....................................... 262 1. Proposed major classification changes include dim-weight pricing and a permanent classification for the Priority Mail flat-rate box. ................................................................................ 263 2. Other changes improve the Priority Mail rate structure. .............. 266 3. The Postal Service properly distributes certain Priority Mail

transportation costs on the basis of cube, not weight.................. 266 4. A new fee for on-call and scheduled pickup On-Demand® is

warranted. ................................................................................... 268 5. The Commission should not adopt the self-serving cost coverage

urged by UPS witness Geddes (UPS-T-3). ................................. 268 5. Conclusion. ................................................................................. 269 D. The Commission Should Recommend the Express Mail Rates Proposed

By the Postal Service............................................................................. 270 1. Witness Berkeley’s rate design is reasonable, supported by

substantial record evidence, and responsive to prior Commission concerns from R2005-1............................................................... 270

2. The Commission should maintain Same Day Airport service in the Classification Schedule. .............................................................. 272

3. The Commission should recommend the ungrouping of the combined one-and-two pound rate.............................................. 272

E. Standard Mail Rate and Classification Changes.................................... 273 1. Standard Mail Classification Proposals. ...................................... 274 a. Changes to subclass and rate category names................ 275 b. Standard Mail Regular/Nonprofit Regular......................... 276 i. Letters.................................................................... 276 ii. Flats....................................................................... 277 iii. Standard Regular Parcels...................................... 278 iv. Standard Regular Non Flat-Machinable Pieces (NFMs

or “Hybrid pieces”). ................................................ 279 v. Customized MarketMail (CMM). ............................ 281 c. ECR/Nonprofit ECR.......................................................... 281 i. ECR/NECR Letters. ............................................... 282 ii. ECR/NECR Flats. .................................................. 283 2. Intervenors’ classification proposals............................................ 284 a. PostCom’s proposals to raise the weight limit for Standard Mail automation letters from 3.5 to 4.0 ounces should be rejected............................................................................. 284

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b. Witness Horowitz’ proposal to expand the definition of Standard Mail to include advertising inserts beyond the 16 ounce limit fails to consider important issues with potentially harmful consequences and should be rejected. ............... 286 c. Witness Mitchell’s (VP-T-1) proposal to retain the automation basic rate category in ECR should be rejected................. 288 3. The Postal Service’s proposed Standard Mail classification changes meet the requirements of the Act and the Commission should recommend them............................................................. 290 4. The Postal Service’s rate proposals meet its revenue needs under the Act and appropriately reflect the policies and practical objectives embodied in its classification initiatives. ..................... 290 a. The Postal Service’s proposals meet its revenue needs by reasonably increasing rates in accordance with the Postal Reorganization Act (Act)................................................... 292 b. The proposed rates fairly and effectively balance multiple considerations. ................................................................. 293 c. The Standard Mail rates recognize important rate relationships. .................................................................... 294 d. Postal Service rate design recognizes appropriate cost distinctions........................................................................ 296 e. The rate design process fairly balances cost recognition and other considerations in light of the adverse effects of rate increases. ......................................................................... 297 f. The balancing of considerations present in the Postal Service’s rate design reasonably reflected worksharing efforts by mailers and send appropriate pricing signals................................................................... 299 g. The proposed rates effectively implement the Postal Service’s shape-based classification proposals. .............. 300 h. The Postal Service’s rate design promotes its automation programs and machinability of mail in general. ................ 302 i. The presort tree is not a necessary component of Standard Mail rate design or rate development methodology.......... 305 j. The Postal Service’s proposal for an alternative approach for charging for Standard Mail Forwarding is unopposed, and should be recommended. ................................................. 308 5. Intervenors’ Pricing Proposals..................................................... 309 a. The proposed parcel and NFM price increases are not unreasonably high, and the Commission should reject the opposition to, and alternatives for, the Postal Service’s Standard Mail shape-based rate proposals. ..................... 309 i. Witness Glick’s criticisms on behalf of PSA/PostCom do not withstand scrutiny. .............. 309

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ii. Witness Knight’s and witness Horowitz’ claims that the proposed parcel and NFM rates will have adverse impacts on their businesses are not necessarily disputed, but are an insufficient reason to reject needed price adjustments...................................... 315

iii. Witness Wilbur’s proposal that the rate changes for parcels should be implemented gradually fails to address the many issues that need to be considered before phased rates can be recommended and so should be rejected. ................................................ 319

iv. Witness Angelides’ testimony that the price elasticity of Standard Mail parcels may be different from the subclass average is insufficient to support an alternative rate proposal. ....................................... 320

b. ECR proposals. ................................................................ 321 i. NAA witness Ingraham’s criticism of the ECR rate

design is without merit. .......................................... 321 ii. Valpak’s argument that the ECR basic letter rate

should be decoupled from the Standard Mail Regular rates is without merit.............................................. 324

c. Drop-ship alternate rate design. ....................................... 328 i. Intervenor proposals to increase Standard Mail letter

and flat dropship passthroughs to 100 percent fail to address adjustments already made in the rate design for lightweight pieces. ............................................ 328

ii. De-averaging of Standard Mail presort flats entails rate shock considerations that preclude recommendation of Postcom’s proposal to set the passthrough for the new 5-digit automation flats discount, a new rate category, to 100 percent. ...... 331

F. The Postal Service’s Package Services Rate Proposals Should Be Recommended ...................................................................................... 333

1. Parcel Post.................................................................................. 333 a. The rates designed by witness Kiefer are reasonable and

supported by substantial record evidence. ....................... 333 b. UPS witness Luciani’s criticism of witness Kiefer’s rate

design methodology is unfounded.................................... 334 c. Witness Miller’s Parcel Post cost model is reliable and

should not be used to justify a lower passthrough for Parcel Select. .............................................................................. 335

i. Witness Luciani’s view that various cost inputs are materially “outdated” is unsubstantiated on the record and is proven incorrect by witness Miller. .............. 336

ii. The size of the CRA adjustment factor is not a meaningful indicator of the model’s reliability. ....... 337

iii. Witness Luciani’s selective delivery unit

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parcel sortation cost pool revision should be disregarded............................................................ 338

d. Witness Luciani’s proposed revision to the Parcel Select window service cost savings model is inappropriate. ....... 339

2. Bound Printed Matter .................................................................. 339 a. Amazon.com witness Haldi’s proposal to allow CDs and DVDs to be mailed as Bound Printed Matter is fatally flawed..................................................................... 340 3. Media Mail and Library Mail ........................................................ 341 a. PostCom witness Angelides provides no basis for disturbing

witness Yeh’s Media Mail rate structure. .......................... 342 G. The Periodicals Rates Proposed by the Postal Service Are More Balanced

than any Alternatives, and Should be Recommended ........................... 343 1. The Postal Service’s proposals for the Outside County subclass

should be adopted....................................................................... 343 a. The proposed container rate promotes efficiency and lower

costs. ................................................................................ 343 b. The piece-pound split should be adjusted as proposed. .. 344 c. The Postal Service’s proposals will promote more

dropshipping..................................................................... 344 d. The Postal Service’s proposals promote co-mailing and co-

palletization. ..................................................................... 345 e. The proposed presort discounts should be recommended. ................................................................. 345 2. The Postal Service opposes the alternative Periodicals Outside

County proposals by Time Warner, Inc., the Magazine Publishers of America and Alliance of Nonprofit Mailers, and by the National Newspaper Association............................................................... 346

a. The MPA/ANM and TW rate proposals fall short of the balance found in the Postal Service proposal................... 346

b. MPA/ANM’s proposal for a 5-digit pallet discount should be rejected............................................................................. 349

c. The Postal Service’s proposed Ride-Along rate follows established ratemaking practice, and is superior to MPA/ANM’s alternative proposal. ..................................... 350

d. The container rate should apply to all Periodicals mailings, including those entered in flats tubs and in unsacked bundles............................................................................. 351

i. The record does not support witness Heath’s assertion that the container rate would be a material disincentive for mailers to switch from sacks to flats tubs........................................................................ 352

ii. The record indicates that the container rate will likely play little to no role in the usage of unsacked

bundles. ................................................................. 354

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e. The Commission should adopt Postal Service witness Miller’s flats mail processing cost model over those proposed by MPA/ANM and TW. ..................................................... 356

i. Arbitrary incoming secondary factors should not be included in the model............................................. 357

ii. The flats model should use CRA flats costs rather than combined flats and parcels costs................... 358

iii. Proportional cost pool classifications should be based on whether the tasks are modeled......................... 358

iv. The proposed selective cost pool adjustments should be rejected............................................................. 359

v. Witness Stralberg’s bundle breakage revision should not be accepted. .................................................... 360

3. The Postal Service’s proposed rate design for Within County Periodicals is reasonable and should be recommended. ............ 360

a. Witness Tang’s rate design is reasonable and balanced........................................................................... 360 b. NNA’s proposed revisions result in an imbalanced rate design and should be rejected.......................................... 362 i. NNA’s proposed passthrough for Carrier Route Basic is inconsistent with prior Commission rate design and leads to inordinate increases for non-carrier route mailers. .................................................................. 363 ii. The Postal Service’s proposed piece/pound ratio for Within County leads to a balanced increase between the piece and pound sides, whereas NNA’s does not...................................................... 366 VII. THE PROPOSED FEES AND CLASSIFICATIONS FOR SPECIAL SERVICES

ARE FAIR AND EQUITABLE, COST-BASED, AND CONSISTENT WITH THE OTHER STATUTORY RATE AND CLASSIFICATION CRITERIA ................... 368

A. The Proposed Fee Redesign for Address Correction Service Should Be Recommended ...................................................................................... 372

B. The Proposed Business Reply Mail Fees Should Be Recommended ... 373 C. The Proposed Fee Changes for Collect-On-Delivery (C.O.D.) Should Be

Recommended ...................................................................................... 376 D. The Postal Service Proposal for Confirm Service is the Only One Likely to

Cover Attributable Costs ........................................................................ 379 1. The Postal Service’s proposal improves fairness and equity. ..... 381 2. Unit-based pricing facilitates adding other information-based

services under the Confirm umbrella........................................... 382 3. The existing fee structure has so many shortcomings that it would

still fail to cover Confirm costs, even if fees are increased.......... 383 4. The Postal Service proposal would not diminish the utility of

Confirm service for service performance assessment................. 386

-xiii-

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5. Witness Bentley’s proposal for a specific subscription just for workshared First-Class Mail may be worth examining, but it does not appear to be supported on the record. .................................. 386

E. The Enhancements to Insurance Service Allow Fee Reductions and Should Be Recommended ..................................................................... 387

F. The Proposed Classification Changes for Merchandise Return Should Be Recommended ...................................................................................... 389

G. The Proposal to Eliminate Meter Service Should Be Recommended .... 389 H. Registered Mail Fees Should be Based on Costs Estimated in Accordance

with the Postal Service’s Methodology................................................... 389 I. The Commission Should Recommend the Substantial Reduction in the

Electronic Return Receipt Fee Proposed by the Postal Service, But a Greater Reduction Is Not Justified ......................................................... 391

CONCLUSION

-xiv-

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PROCEDURAL HISTORY

On May 3, 2006, the United States Postal Service filed with the Postal Rate

Commission (hereinafter “Commission”) the Request of the United States Postal

Service for a Recommended Decision on Changes in Rates of Postage and Fees for

Postal Services (hereinafter “Request”). This Request was filed in accordance with 39

U.S.C. §§ 3622 and 3623 and the Commission’s Rules of Practice and Procedure. 39

C.F.R. §§ 3001.1 et seq.

The Request, based on a test year of Fiscal Year (FY) 2008, stated that, without

increases in rates and fees, the Postal Service would incur a substantial revenue

deficiency in the test year, in contravention of 39 U.S.C. § 3621. The Postal Service

estimated that at current rates, its test year revenues would approximate $73,532

million, and its total costs $79,406 million, creating a test year deficiency of some

$5,874 million. Included among the proposed rates was a rate of 42 cents for the first

ounce of First-Class Mail, and 20 cents for the additional-ounce rate.

In addition to requested rate changes, the Postal Service proposed: (1) a new

classification for a “Forever Stamp,” a stamp that would always be valid for the first

ounce of First-Class Mail letters, regardless of subsequent rate changes; (2) new

shape-based rate structures in First-Class Mail and Standard Mail; (3) new Priority Mail

dimensional weighting rate structures; (4) a new container rate, as well as extension of

dropship discounts to editorial pounds, for Periodicals; and (5) enhancements for

address correction service, Confirm® service, and insurance.

1

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The Request was accompanied by 47 pieces of direct testimony sponsored by 41

witnesses, with exhibits and workpapers related to these testimonies, as well as other

material responsive to Rule 54 of the Commission’s Rules of Practice. One additional

piece of direct testimony pertaining to the Postal Service’s “Forever Stamp” proposal,

USPS-T-48, was filed on July 14, 2006. The Commission granted the Postal Service’s

deferred filing of the “Forever Stamp” testimony in P.O. Ruling No. R2006-1/18 (July 18,

2006).

The Postal Service’s Request was set down for hearing by the Commission as

Docket No. R2006-1. By Order No. 1464, issued on May 5, 2006, the Commission

elected to sit en banc, and designated Shelley S. Dreifuss, Director of the Commission’s

Office of the Consumer Advocate (OCA), to represent the interests of the general public

in the proceeding. By separate order, Commission Chairman George A. Omas

designated himself to serve as Presiding Officer in the proceeding. Fifty-eight parties

filed notices of intervention.

The Commission scheduled an initial prehearing conference for June 16, 2006.

Following an opportunity to comment at the Prehearing Conference, the Presiding

Officer issued the procedural schedule in P.O. Ruling No. R2006-1/12. The Presiding

Officer set down special rules of practice for the proceeding in P.O. Ruling No. R2006-

1/11, as well as a special rule for materials submitted under protective conditions in

P.O. Ruling No. R2006-1/10.

During discovery, Postal Service witnesses and the Postal Service itself

responded to numerous written interrogatories, consisting of thousands of individual

questions. Most of these were filed during the regular discovery period on the

2

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witnesses’ testimonies, which ended on July 14, 2006. The discovery period on the

Postal Service’s “Forever Stamp” proposal extended until August 7, 2006. Responses

to discovery requests to the Postal Service and its witnesses were generally provided

within 14 days, as prescribed by the Commission’s rules. Evidentiary hearings on the

Postal Service’s case began on August 3, 2006, and continued through August 30,

2006.

Pursuant to the procedural schedule, the direct cases of participants other than

the Postal Service were filed on September 6, 2006. In accordance with the rules for

this proceeding, intervenors responded to interrogatories within 14 days. The period for

filing discovery on participants’ direct cases ended on October 4, 2006. Evidentiary

hearings on these cases began on October 24, 2006, and continued through November

8, 2006.

A number of significant issues arose during the course of the proceeding. One

such issue concerned the relationship between the theory of Efficient Component

Pricing (ECP) and the Postal Service’s rate design for First-Class Mail and Standard

Mail, and was reflected in Notices of Inquiry (NOI) Nos. 2 and 3 (issued July 21 and July

26, 2006, respectively).1 Several parties, including the Postal Service, filed comments

in response to NOI Nos. 2 and 3 on August 17, 2006. This issue continued to be raised

and debated throughout discovery on the Postal Service’s direct case, in intervenor

testimony, and will likely be argued on brief.

1 NOI No. 1, issued June 5, 2006, requested comments on the different methodologies for determining the markup for the Periodicals Within County subclass. The Postal Service provided its comments on June 16, 2006.

3

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The Presiding Officer issued a total of twenty-five Presiding Officer’s Information

Requests (POIR) directed at the Postal Service and selected intervenors. These POIRs

contained dozens of questions on a variety of issues. The Postal Service’s responses

to two POIRs, and the Presiding Officer’s designation of those responses for inclusion in

the evidentiary record, sparked a particularly contentious dispute. On October 16,

2006, the Presiding Officer designated the Postal Service’s responses to POIR No. 4,

Questions 4-12, and POIR No. 16, Questions 13-21 for inclusion in the record. One day

later, on October 17, 2006, eighteen intervenors jointly objected to the inclusion of the

responses in the record. The Presiding Officer certified the Joint Objection to the full

Commission for disposition.

The Postal Service’s POIR responses at issue concerned the Postal Service’s

City Carrier Street Time Study (CCSTS). In POIR No. 4, Questions 4-12, the Presiding

Officer asked the Postal Service to provide an updated version of the CCSTS with FY

2004 data and illustrate the effect the newer data would have on variability estimates.

The Postal Service provided its response on September 22, 2006. In POIR No. 16,

Questions 13-21, the Presiding Officer asked a series of follow-up questions to these

responses, and the Postal Service responded on October 12, 2006.

The Joint Objection filed on October 17, 2006, by eighteen intervenors, argued

that the responses provided by the Postal Service, if adopted, could require a

comprehensive revision of the Postal Service’s rate proposal. The Joint Objection

further contended that because of the complexity of the study, intervenors had

insufficient time to conduct discovery, cross-examine witnesses, or prepare rebuttal

evidence. In Order No. 1482, issued November 8, 2006, the Commission concurred

4

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with the arguments raised in the Joint Objection, and ruled that the responses would

only be included in the record for illustrative purposes, not for purposes of establishing

the truth of the matters asserted.

Rebuttal testimonies were filed by the parties and the Postal Service on

November 20, 2006. Hearings on rebuttal testimony began on November 29, 2006, and

continued through December 7, 2006. The Postal Service presented 18 pieces of

rebuttal testimony, and the other participants presented 17 rebuttal witnesses. The

complete evidentiary record currently consists of more than 13,000 transcribed pages

plus the direct case of the Postal Service. Also, voluminous materials, including over

200 Library References, were incorporated by reference.

The Record of the proceeding was closed on December 19, 2006, subject to the

decision of the full Commission on a Joint Objection filed by several parties on

December 18, 2006, regarding the receipt into evidence of the response to POIR No.

25. P.O. Ruling No. R2006-1/129 (December 19, 2006). The date for filing briefs was

set for December 21, 2006, with January 4, 2007, set for filing reply briefs. The

opportunity for oral argument is available upon request and, if requested, is scheduled

for January 10, 2007.

Pursuant to 39 U.S.C. § 3624(c)(1), the Commission’s Opinion and

Recommended Decision is due no later than March 3, 2007.

5

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I. THE POSTAL SERVICE’S REVENUE REQUIREMENT IS SUPPORTED ON THE RECORD, IS REASONABLE, AND SHOULD BE THE BASIS FOR THE COMMISSION’S RECOMMENDATIONS

The testimony of witness Richard G. Loutsch, USPS-T-6, together with

supplemental information on the record,1 provides the basis for the Postal Service’s

revenue requirement of $79.4 billion before rates in the test year (FY 2008). With

revenue at current rates estimated for the test year at $73.6 billion, that would leave a

revenue deficiency of $5.8 billion. The proposed rate and fee changes would produce

revenues of $77.6 billion to cover a total after-rates revenue requirement of $77.5

billion, resulting in a test year revenue surplus of $97 million.

A. Witness Loutsch Provides Substantial Evidence that the Present and Projected Financial Condition of the Postal Service Supports the Requested Increase in Rates and Fees

In addition to providing estimates of the Postal Service’s future needs that

underlie the overall moderate revenue increase requested in this case, Witness

Loutsch’s testimony describes the Postal Service’s current financial position and its

recent financial history. His testimony begins with a summary of the “uneven path” that

the Postal Service’s financial condition has followed over the last ten years. He

describes the first part of the ten-year period as one of “low, but increasing cost

inflation, combined with volume growth in both First-Class Mail and Standard Mail,

resulting in net incomes.” But the next few years were less bright: “Net income began

to decline in FY 1998 due to inflationary pressure on compensation and benefits costs,

1 Supplemental estimates and supporting documentation were provided in response to Presiding Officer’s Information Request No.16 and are contained in Postal Service Library Reference L-196. These estimates are updates to those provided in witness Loutsch’s revised testimony, including Exhibit USPS-6A (Statement of Revenue and Expense) and related documentation.

6

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particularly benefits costs, leading to a small net loss in FY 2000.” 2 Then, in addition to

the tragic events of September and October 2001, First-Class Mail volume began to

stagnate, resulting in net losses in FYs 2001 and 2002.

Positive financial results followed, however, from FY 2003 through FY 2005. Mail

volume growth in FY 2004 and FY 2005, the enactment of the Postal Civil Service

Retirement System Funding Reform Act of 2003 (Public Law 108-18) and cost

reductions related to the initiatives described in the Transformation Plan, April 2002

were the prime contributors to this improved financial performance. For FYs 2003

through 2005, Public Law 108-18 temporarily lowered Postal Service funding of its Civil

Service retirement obligations to prevent continued over-funding. These factors created

financial conditions that allowed for the full restoration of equity by the end of FY 2004,

and the elimination of debt by FY 2005.3

Positive financial results are not expected to continue, however. In addition to

continuing financial obligations imposed on the Postal Service by Public Law 108-184

and by the Postal Accountability and Enhancement Act of 2006,5 the Postal Service

faces a number of challenges to its financial health. These include: continuing

electronic diversion, challenges in capturing future cost reductions, continued

inflationary pressure on salaries and benefit costs for employees, continued increases

2 Id. at 11-26. 3 Id. at 12. 4 See id. at 11, 18-21. 5 It appears that, although the Act eliminates the escrow payment and certain retirement contribution obligations in the test year, the new requirement to pre-fund health benefits and the loss of escrow interest outweigh those savings, thereby having a significant negative effect on estimated test year net income.

7

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in retiree health benefit costs, as well as the need to maintain and expand the delivery

network to meet the universal service obligation.6

Witness Loutsch explained the projected financial consequences of these

obligations and circumstances:

Without a rate increase, the Postal Service is projected to incur combined net losses of $10.199 billion for the period FY 2006 through FY 2008. This will result in cumulative net loss of $7.860 billion and borrowing requirements that exceed the authorized annual debt limit in both FY 2007 and FY 2008.7

Witness Loutsch notes that “Incurring debt to finance current operations transfers the

funding of current year expenses to future years[,] … placing an unfair burden on future

ratepayers.”8 He concludes that, in light of increasing costs, which he discusses in

detail in his testimony,9 and his financial projections for the Test Year, “the only course

of action that will allow the Postal Service to fulfill its obligations under the Postal

Reorganization Act is to increase Postal Service revenues through a general increase in

rates.”10

B. Substantial Record Evidence Supports Postal Management’s Judgment that a Provision for Contingencies of One Percent of Total Estimated Costs Should Be Included in the Revenue Requirement

Witness Loutsch presents postal management’s financial policy decision to

include in the revenue requirement a provision for contingencies of one percent. In

management’s judgment, this amount is the minimum needed to provide a financial

6 Id. at 13. Witness Loutsch discusses the details of revenue and volume trends at pages 14-17, of productivity challenges at 21-22, and of compensation and benefit pressures at 22-24. 7 Id. at 14. 8 Id. at 26. 9 See id. at 27-61. 10 Id. at 26.

8

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cushion against events that are unforeseeable or whose financial impact is not currently

knowable. As Postal Service rebuttal witness W. Ashley Lyons testified, the

contingency provision “is designed to maintain stability in achieving the break-even

mandate [of 39 U.S.C. § 3621], in light of the largely unpredictable consequences of an

interplay among a complicated array of economic, social, and political forces, as well as

accidents and natural disasters.”11

Witness Loutsch explained the risks and uncertainties associated with various

factors, including: the escrow provision and related assumptions concerning interest

income on escrow balances, the challenges of obtaining cost reductions from planned

programs, the expiration of postal labor contracts, fuel and energy costs, and potential

changes in workers’ compensation liability estimates.12 The risk of disruptive events,

whether perpetrated by humans or nature, always remains, although the size of

potential losses is hard to gauge.13 The passage of postal reform legislation brings new

uncertainties in the context of a changed business and regulatory environment.

A contingency provision of one percent is the minimum acceptable level of

protection, in the judgment of postal management in this instance and significantly

below the reasonable expected range for contingencies intended by the Act. As witness

Lyons explained, “the ultimate decision to include a provision for contingencies is

logically and necessarily judgmental, and represents a major policy choice by the Board

11 USPS-RT-13, at 10. 12 Id. at 62-63. 13 Id. at 63.

9

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of Governors as to the level of risk with regard to unknown developments that the Postal

Service is willing to bear in the test year.”14

C. Witness Buc’s Testimony Fails to Provide a Rational Basis for Reducing Any Aspect of the Revenue Requirement Estimates

Witness Buc, on behalf of a group of mailers and mailer associations led by

DMA, argues that the Postal Service has underestimated cost reduction savings for

supervisors and that the one percent contingency is overstated. He also argues that the

proposed rates lead to an excessive surplus and that the revenue requirement should

be adjusted for actual results.15 The first two arguments are inconsistent with record

evidence, and the latter two arguments have been mooted by subsequent events and

information on the record.

1. Projected savings in supervisor costs resulting from cost reduction programs are already excluded from the revenue requirement.

Witness Buc argues that the revenue requirement should be reduced to reflect

reductions in supervisor costs in direct proportion to reductions in craft hours resulting

from cost reduction programs. He alleges that the Postal Service has failed to make

“any” reduction in supervisor costs. DMA-T-1, at 3. His facts, however, are wrong, and

his argument is contradicted by the record.

Witness Buc fails to demonstrate that supervisory costs, either in general or

specifically relative to cost reduction program implementation, are reduced in direct

proportion to craft labor costs; in fact, he admits that over certain time periods

supervisory costs do not decline in direct proportion to craft labor costs.16 No evidence

14 USPS-RT-13, at 10-11. 15 DMA-T-1. 16 Tr. 22/8044.

10

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has been presented that cost reduction programs generate supervisory savings

proportional to craft savings.17 Witness Buc disregarded witness Loutsch’s testimony

that the Postal Service “specifically examines” each program’s cost savings

opportunities for supervisors and that most programs do not result in changes in

supervisory functions that lead necessarily to a reduction in supervisor hours.18 Postal

Service rebuttal witness Chris Oronzio explained that supervisory reductions are

already reflected, either in specific program estimates, or in the estimates of savings

through Breakthrough Productivity and Local Management initiatives.19 In light of these

facts, witness Lyons testified that “[t]o make further reductions, as witness Buc

proposes, would be unjustified and would result in an overstatement of expected

savings.”20 The Commission should decline witness Buc’s invitation to make this error.

2. Witness Buc’s arguments for reducing the contingency provision to zero are based on misapprehensions and misjudgments.

Witness Buc maintains that no amount for contingencies should be included in

the revenue requirement. He bases his argument on his perception of “the Postal

Service’s strong financial position.”21 Unfortunately, his perception, at least in this

regard, lacks factual foundation, and is inconsistent with statutory intention. As the

Commission well knows, the Postal Reorganization Act22 anticipates that the revenue

requirement include a reasonable provision for contingencies and the legislative history

cites a range of 3 to 5 percent as reasonable. The Postal Service has included

17 See USPS-RT-3, at 4. 18 See id. at 4-5, quoting USPS-T-6, at 31. 19 USPS-RT-15, at 5-8. 20 Id. at 5. 21 DMA-T-1, at 11. 22 39 U.S.C. § 3621.

11

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contingency provisions ranging from 1 to 4 percent in its revenue requirement

estimates.23

In this case, witness Buc’s arguments do not support his proposed reduction of

the contingency provision to zero percent. First, his argument that the Postal Service

can cope with adverse events using its cash balance is based on a misreading of data

provided by witness Loutsch. Rather than a cash balance of $5.587 billion at the end of

the test year, as witness Buc presumes,24 witness Lyons explained that the Postal

Service will actually have a cash balance of only $1.0 billion, an amount “substantially

less than a single two week payroll disbursement.”25 As witness Lyons explained, this

amount is obtained through borrowing “in order to ensure that the payroll can be met”; it

“provides absolutely no cushion against adverse events.”26 The purpose of the

contingency is to prevent a net loss in the test year. Borrowed cash cannot prevent a

loss from occurring. If breaking even in the test year is the goal, a provision for

contingencies of at least one percent is essential.

Second, witness Buc’s argument that Postal Service’s equity is understated

because the appraised value of postal real estate may be higher than the value carried

on its books “ignores the legal and practical realities of postal operations.”27 As witness

Lyons explains, the Postal Service has a “universal service obligation and owns real

23 See USPS-RT-13, at 11. No contingency provision was added to the revenue requirement in Docket No. R2005-1. Unlike the instant case and all other omnibus rate cases, that case was narrowly designed to generate revenue to recover the known escrow requirement of Public Law 108-18, rather than to cover future estimated costs of postal operations, and the uncertainties associated therewith. 24 DMA-T-1, at 15. 25 USPS-RT-13, at 12. 26 Id. 27 id. at 13.

12

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estate for the purpose of supporting and operating a nationwide service network for the

long term to satisfy that obligation.” It cannot “dispose of its real estate at will in order to

realize its market value without ignoring the needs of current and future customers.”28

Indeed, witness Buc confirmed that real property is of “no use in dealing with an

adversity that would require additional cash unless the properties are sold or borrowed

against.”29 He also performed no analysis of the time required to transfer processing

operations, close, and sell a mail processing facility.30 Accordingly, his argument

regarding the book value of real estate is a red herring in the aquarium of an

appropriate contingency provision.31

3. Witness Buc’s arguments have been mooted by subsequent record evidence.

In support of his proposal to eliminate the contingency provision, witness Buc

also argued that the Postal Service has overstated its loss in FY 2006 and that

estimates for FY 2007 and the test year should be adjusted accordingly.32 Witness

Lyons’s testimony contains a detailed discussion demonstrating that “the record and

recent events demonstrate that the Postal Service’s 2006 revenue requirement estimate

was appropriate, but indicates that 2007 may be understated.”33 Thus, the record, as it

currently stands, contradicts witness Buc’s argument.

28 Id. 29 Tr. 22/8019. 30 Tr. 22/8018. 31 Moreover, witness Buc’s argument that the END program will result in higher-than-estimate real estate profit is speculative and misplaced in time, since any such gains, if they materialize, are unlikely to affect the test year to any substantial degree. USPS-T-13, at 13. 32 DMA-T-1, at 10-11.

13

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Witness Buc’s final argument was that a test-year after-rates surplus of $173

million, as estimated by the Postal Service at the time his testimony was prepared,

would be excessive.34 Subsequently, the estimate was revised to $97 million, as noted

by witness Lyons.35 Witness Buc agreed, during his cross-examination, that an amount

of this magnitude is consistent with the break-even requirement of the PRA.36

Substantial evidence on the record supports the Postal Service’s financial

estimates and judgments. For these reasons, the Postal Service’s revenue

requirement, as revised and updated, should be the basis for the Commission’s rate

and fee recommendations in this case.

33 USPS-T-13, at 9. 34 DMA-T-1, at 8. 35 USPS-RT-13, at 5-6. 36 Tr. 22/8047.

14

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15

II. POSTAL SERVICE DATA SYSTEMS PROVIDE AN APPROPRIATE AND LONG-ACCEPTED FOUNDATION FOR THE ESTABLISHMENT OF RATES, CLASSIFICATIONS AND FEES

The Postal Service and the Commission both rely upon long-established data

systems that inform business and ratemaking decisions. In this docket, the Postal

Service documents four such data systems both in direct testimony and via “library

references relating to . . . statistical cost and revenue reporting systems, and their

primary outputs,” also known as Category 1 library references. Rule 31(b)(2)(i). These

complex, multi-layered systems capture information regarding the Postal Service’s

nationwide flow of mail and costs to provide service. While they are continually

improved, in the main they are relatively stable over successive ratemaking cycles.

The four main data systems include the In-Office Cost System (IOCS), the

Transportation Cost System (TRACS), the Revenue, Pieces and Weight System

(RPW), and the Carrier Cost Systems (CCS).

In this docket, witness Czigler (USPS-T-1) sponsors the cost estimates from the

In-Office Cost System (IOCS). IOCS was improved at the beginning of FY 2005 by the

introduction of a revised data collection instrument that is administered using a laptop

computer. Dr. Czigler summarizes the impacts of the revised questionnaire upon cost

estimates for city carriers and supervisors (USPS-T-1 at 12-13). Witness Bozzo

(USPS-T-46) describes the design process for the revision in light of the purposes of

IOCS and necessary data elements. He also addresses major changes in the data

collection procedures, testing and evaluation conducted prior to implementation, and

major changes in IOCS-based cost estimates for clerks and mail handler labor believed

to result from the new survey instrument. Dr. Bozzo later provided rebuttal testimony

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16

(USPS-RT-1) that responded to criticisms of IOCS estimates for Within-County

publications lodged by National Newspaper Association witnesses Heath (NNA-T-1)

and Siwek (NNA-T-3).

Witness Hunter’s testimony (USPS-T-2) addresses the Transportation Cost

System (TRACS), a statistical information system used to distribute Base Year

purchased transportation costs to major mail categories. TRACS has four independent

subsystems, Highway, Freight Rail, Commercial Air and Network Air, each of which

entails a continuing, ongoing survey with its own design and estimation methodology.

Id. at 1. Witness Hunter presents estimates of transportation related costs by major

mail category, together with confidence intervals around major estimates.

The Origin-Destination Information System and Revenue, Pieces and Weight

(ODIS-RPW), the Bulk Mail Revenue, Pieces and Weight System (BRPW), and the

Revenue, Pieces and Weight Adjustment System (ARPW) are presented in the

testimony of witness Pafford (USPS-T-3). These systems are used to present unbiased

Base Year estimates of revenue, pieces and weight underlying the Postal Service

Request together with associated confidence intervals.

The Carrier Costing Systems (CCS) consist of the City Carrier Cost System

(CCCS), addressed in the testimony of witness Harahush (USPS-T-4), and the Rural

Carrier Cost System (RCCS), addressed in the testimony of witness Riddle (USPS-T-5).

Witness Harahush covers the general design of the CCCS, the types of estimates that

are produced, and tables showing the reliability of major estimates. Similarly, witness

Riddle covers the general design of RCCS, the types of estimates that are produced,

and tables showing the reliability of major estimates.

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17

No participant in this rate case has challenged any of the data systems or the

estimates they produce, with one limited exception: The National Newspaper

Association (NNA) argues that IOCS based estimates of costs for Within-County

Periodicals constitute assumptions. As explained in greater detail, below – and in the

rebuttal testimony of witness Bozzo (USPS-RT-1) – NNA is unable to challenge the

accuracy of a single IOCS tally. Accordingly, Postal Service data systems continue to

provide reliable estimates of Base Year volume, revenues and costs as the foundation

for the proposals embodied in the Request.

A. The In-Office Cost System (IOCS) Provides Reliable and More Accurate

Estimates of Employee Work Time Devoted to Office Functions and Certain Mail Categories

The In-Office Cost System (IOCS) is a work sampling system designed to

estimate proportions of time (and hence cost) for various activities for sampled crafts,1

including subclass and other characteristics of mail handled in clerk, mail handler, and

city carrier in-office activities. IOCS, and its redesigned data collection instrument

(unveiled in a rate case for the first time in Docket No. R2006-1) are presented in the

testimonies of witnesses Czigler (USPS-T-1) and Bozzo (USPS-T-46). Library

references2 USPS-LR-L-9 and USPS-LR-L-10 document the sample design, estimation

methodologies and computer systems, and provide base year data. Detailed

descriptions of data collection procedures are provided in library references USPS-LR-

L-21 and USPS-LR-L-23. USPS-LR-L-128, a Category 2 library reference sponsored

1 Clerks, mail handlers, city carriers, supervisors, and technical personnel. USPS-T-1 at 2.

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by Dr. Bozzo, supports his discussion of the redesign of the IOCS data collection

instrument and the impact of those changes.

1. The redesigned IOCS data collection instrument is improved

substantially.

a. Best practices for surveys were used to redesign the data collection instrument.

The redesigned IOCS data collection instrument deployed at the start of FY 2005

was the result of a lengthy development and testing process, incorporating advice from

the U.S. Census Bureau on best practices for survey questionnaire design. Among the

major improvements are (USPS-T-1 at 6-11):

• Data collectors “key what you see”, recording observable mailpiece

characteristics such as markings and barcodes;

• Use of ‘telescoping’, computer-directed branching, to focus questions on the

domain of interest;

• Fewer responses available for a given question, thereby reducing the chance of

selecting seemingly irrelevant, inconsistent, or rarely chosen options;

• Use of ‘first applicable option’, much reduced use of ‘all applicable options’;

• Context-dependent instructions, such as isolation and selection rules for

containers and mailpieces, displayed directly on-screen;

• Questions scripted for reading to telephone respondents;

2 Absent some over indication otherwise, library references identified in this IOCS section are Category 1 (reporting systems material).

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• Activity questions conform to the facility type, and are better aligned with

operations;

• Route information from the Address Management System is integrated so that

the data collector need only enter the ZIP Code and route number in lieu of

determining the route type;

• When appropriate, supervisor questions explicitly obtain the craft of employees

for which subordinate supervisors are responsible; and

• More extensive validation checks to warn of inconsistencies in responses.

b. The redesigned instrument was tested extensively.

Dr. Bozzo documents the testing of the redesigned data collection instrument in

USPS-T-46, section III, at 17-26.

The software was field-tested in six to nine districts over a 16-month period. This

long beta-testing period provided time for investigation of shifts in the data, and for

incorporation of incremental improvements into the software.

Simultaneously, the Postal Service conducted a "photocopy study" where copies

of mailpieces sampled at the beta test sites were sent to Dr. Bozzo’s employer, LRCA,3

and re-keyed by experienced staff members. The photocopy study results show a clear

reduction in class-level error rates – from 2.6 percent to 1.0 percent – as improvements

were made to the software. USPS-T-46 at 22-24.4

Finally a "keying study" provided a direct comparison of the old and new data

collection software using a common set of test pieces. This demonstrated that the

3 Laurits R. Christensen Associates, of Madison, Wisconsin.

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redesigned software had subclass-level error rates that were less than half of the old

version. USPS-T-46 at 25-26.

c. The redesign is explained by substantial documentation.

Extensive additional documentation concerning the redesigned data collection

instrument was provided in this docket, including:

• Descriptions of the instrument changes in USPS-T-1, section VI, at 5-11;

• For the first time, a detailed series of flowcharts displaying the logical flow of the

software and a data dictionary of the IOCS data fields in USPS-LR-L-9;

• A new Handbook F-45, “IOCS Field Operating Instructions” in USPS-LR-L-21

that provides screen-by-screen instructions to data collectors;

• Information on the motivation for the redesign and the process used to develop

the instrument, in USPS-T-46, sections I and II, at 2-16;

• Descriptions of the extensive software testing, in USPS-T-46, section III, at 17-

26, and in USPS-LR-L-128;

• Analysis of the impacts on In-Office City Carrier and Supervisor costs in USPS-T-

1, section VII, at 12-13; and

• Analysis of the impacts on Mail Processing costs, including effects on the

formation of cost pools for the mail processing model, at the mail class level in

USPS-T-46, section IV, at 12-13, and in USPS-LR-L-128.

4 Subclass-level error rates also declined markedly. See USPS-T-46 at 24.

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2. The only challenge to the redesigned IOCS was to its cost estimates for Within-County Periodicals.

The only challenge to IOCS methods came from the National Newspaper

Association (NNA) regarding cost estimates for Within-County Periodicals. NNA

witnesses Heath and Siwek (NNA-T-1 and NNA-T-3, respectively) question the

longstanding methodology for identifying Within-County Periodicals tallies, which

originated with the testimony of witness Degen in Docket No. R94-1 (USPS-ST-12, Tr.

2356 - 2395). Witnesses Heath and Siwek raise a number of situations in which tallies

for Periodicals pieces that may appear to be eligible for Within-County rates may,

nevertheless, have paid Outside-County rates. However, a broader NNA challenge was

limited to cases in which non-subscriber pieces may be required to pay Outside-County

rates. Tr. 29/9673; see also USPS-RT-1 at 6. Dr. Bozzo shows that the remaining NNA

critiques encompass too few pieces to warrant relief. Additionally, the NNA’s proposed

solution of pooling data from the "old" and "new" IOCS instruments lacks technical

merit.

a. The claim that the Postal Service method does not determine whether within-county rates are paid is incorrect.

NNA witness Siwek claims that the Postal Service does not know if the particular

copies sampled by IOCS paid Within-County rates or not, only whether they are eligible

or not. However, the vast majority of IOCS Within-County tallies are confirmed using

mailing statement data indicating that the mailer actually mails at Within-County rates,

as described in Dr. Bozzo’s rebuttal testimony. USPS-RT-1 at 3. Witnesses Heath and

Siwek suggested that mailers might gain or lose eligibility on an issue-by-issue basis

during the course of the year, and further suggested that mailers might nevertheless

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pay Outside-County rates even if eligible for Within-County rates. However, these

surmises are implausible, and no documentation of any such circumstances was

provided. Tr. 29/9594, 9673; see also USPS-RT-1 at 6. There is, otherwise, no dispute

that mailers would have a strong economic incentive to claim Within-County rates for

eligible subscriber and non-subscriber pieces.

b. Witness Heath’s interpretation of regulations applicable to

non-subscriber copies is incorrect.

NNA witness Heath claims that in several situations Within-County mailers must

pay Outside-County rates, including complimentary copies, expired subscription copies

and advertising copies. However, these are all circumstances where a piece becomes

a non-subscriber copy, and witness Heath has incorrectly leapt to the conclusion that

non-subscriber copies must pay Outside-County rates. In fact, these only pay the

higher Outside-County rate if the percentage of non-subscriber copies exceeds certain

thresholds, such as 10 percent of the total number of copies mailed at Within-County

rates. As Dr. Bozzo shows in USPS-RT-1, Table 1, at 10, the percentage of non-

subscriber copies that would be forced to pay higher Outside-County rates because of

exceeding the 10 percent threshold is only 0.1 percent. Thus, the likelihood of tally

misidentification is remote, and the impact on cost estimates is trivial. However, if

deemed necessary, it would be possible in the future to identify titles with large fractions

of non-subscriber copies and develop special procedures to reduce the possibility of

error.

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c. Other critiques by witnesses Heath and Siwek do not identify substantial errors.

Witness Heath suggests that routes may wander across county boundaries,

leading to misidentification of Periodical tallies. He concedes that the issue is likely to

be “small”. In fact, an analysis of 9-digit ZIP Codes, which contains routes that are

located strictly within one county, indicates that the potential error due to this issue

would be a maximum of 1.5 percent. It is likely that the actual error is even less than

this since the routes most likely to cross county boundaries are more likely to be outside

of or on the outskirts of towns, and thus less densely populated. USPS-RT-1 at 12.

The Postal Service intended to address this issue by modifying the IOCS data

collection instrument and recording the 9-digit ZIP Code for Periodicals. However, H.R.

6407 now calls into question the need for such action. Section 1003 of that bill, passed

by both the Senate and the House early on December 9, 2006, adds to title 39, United

States Code, section 3626(g) a new subsection (3) which states:

(3) For purposes of this section and former section 4358(a) through (c) of this title, those copies of an issue of a publication entered within the county in which it is published, but distributed outside such county on postal carrier routes originating in the county of publication, shall be treated as if they were distributed within the county of publication.

This subsection indicates that at least part of the issue has been addressed by making

Within-County rates apply to pieces that could be said to have “wandered” into a

neighboring county to the county of origin/publication. That appears to leave in question

only those pieces on routes that do not originate in the county of origin/publication but

which do “wander” into the county of origin for some deliveries. Since the Postal

Service has not studied this issue in any depth, it will need to do so before making a

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final decision on the merits of collecting addressees’ 9-digit ZIP Codes when Periodicals

pieces are sampled in IOCS.

Witness Siwek also contends that the directories of Periodicals, used to classify

tallies when PostalOne! data are not available, are outdated. However, the directories

are more timely than witness Siwek’s speculation suggests, as Dr. Bozzo shows in his

rebuttal testimony. USPS-RT-1 at 14. Furthermore there is little material change from

year to year in the data provided in the directories, USPS-RT-1, Table 2, at 15; Tr.

35/12337. This is as expected for the small, local publications (NNA members), who

are unlikely to experience wide swings in circulation.

Witness Siwek also suggested that two procedures used in IOCS to classify

tallies could lead to inaccuracies: i) the ‘local appeal’ criterion, and ii) the reuse of hand-

checked results from the previous two years. However, the few tallies that had been

classified with these procedures were re-checked by telephoning the local postmaster

and by using the most up-to-date information, and no tally changed its classification.

USPS-RT-1 at 16-18. This provides further evidence that IOCS procedures are, in fact,

accurate and reliable.

The failure of witnesses Heath and Siwek to document a single misclassified tally

(e.g., a tally of a Periodicals title that demonstrably did not employ Within-County rates),

together with Dr. Bozzo's demonstration that the NNA critiques apply to very few Within-

County pieces, confirm that the procedures used by the Postal Service to classify

Within-County Periodicals are reasonable and provide accurate estimates of costs.

USPS-RT-1 at 18.

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d. Witness Siwek’s pooling proposal is inappropriate and likely to strongly bias within-county periodical costs.

Witness Siwek proposes that the alleged IOCS errors can be ameliorated by

pooling FY2005 with FY2004 data. However, his own analysis shows that the

estimated costs for FY2005 are larger than for FY2004, at a statistically significant level,

an increase for which he does not find an explanation. He avoids the obvious

conclusion that the increase is due, in part, to the improved IOCS data collection

instrument and that Within-County rates were understated in previous years. USPS-

RT-1 at 20-21. Moreover, witness Siwek himself accepts that it is not appropriate to

pool data from two significantly different populations. Tr. 29/9685 (response to

USPS/NNA-T3-17). Furthermore he agrees that FY2005 cost estimates should ideally

be based on FY2005 data rather than pooled multi-year data. Response to USPS/NNA-

T3-17(b), Tr. 29/9685. Pooling data would inappropriately bias the FY2005 cost

estimates downward, albeit in the direction that would tend to lower the total postage

NNA members would expect to pay.

Witness Siwek also claims that his pooling methodology is an application of

‘sequential sampling’. However, it transparently is nothing of the sort as Dr. Bozzo has

demonstrated. USPS-RT-1 at 22.

In recommending multi-year pooling of cost data, witness Siwek is asking for

"relief from costing errors he has not demonstrated exist, from a costing system he has

not demonstrated is inaccurate." USPS-RT-1 at 24. Since the edit processes that

identify Within-County Periodicals have not changed, pooling the IOCS data does not

even specifically address the alleged problems, insignificant as they may be. Therefore,

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the Commission should continue to employ the accepted method for identifying Within-

County Periodicals costs in IOCS and reject NNA's proposal to pool costs from the FY

2004 and FY 2005 IOCS samples.

B. TRACS Provides A Reasonable And Sound Basis For Distributing Transportation Costs To Mail Categories

Transportation Cost System (TRACS) is a statistical sampling and data collection

system used to distribute Base Year (BY) purchased transportation costs to mail

categories. TRACS is composed of four independent subsystems: Commercial Air,

Network Air, Highway, and Freight Rail. These four subsystems are continuous

ongoing surveys, each with its own survey design and estimation methodology.

Postal Service witness Hunter’s testimony (USPS-T-2) and four of the Category 1

Library References he cites, USPS-LR-L-27, 29, 30, and 31, describe the sample

designs and estimation methodologies for these four subsystems. TRACS data

collection procedures can be found in Chapters 5, 6 and 8 of Handbook F-65, filed as

Library Reference USPS-LR-K-21/R2005-1. The data collection software, and

supplemental statistical programs policies and data collection instructions, are

documented in Category 1 library references USPS-LR-L-28 and USPS-LR-L-23,

respectively.

The Postal Service expanded TRACS sampling to include the FedEx Day Turn

network. TRACS now distributes those $1.1 billion volume variable transportation costs

to mail categories.

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The Postal Service improved the TRACS documentation several cases ago,

including updated mathematical formulas for the distribution keys of the Highway,

Commercial Air, Network Air, and Freight Rail subsystems and modes within, allowing

participants to review the TRACS estimation methods without having to parse

thousands of lines of SAS programming code. The updated documentation promotes a

full and complete understanding of the TRACS design and estimation methodologies.

The Postal Service has also improved TRACS’ overall sample design and

allocation on Highway, Commercial Air, and Network Air modes since the last litigated

case (Docket No. R2000-1). As a result, CVs for major mail categories have been

reduced substantially.

The success of the improved TRACS documentation is confirmed by the fact that

no discovery was directed to Witness Hunter and no participant questioned any of the

TRACS cost estimates or their distribution to major mail categories. TRACS produced

the following estimates (USPS-T-2 at 14-21):5

Table 1. BY05 Inter-BMC Highway Estimated Costs and Confidence Intervals Table 2. BY05 Intra-BMC Highway Estimated Costs and Confidence Intervals Table 3. BY05 Inter-SCF Highway Estimated Costs and Confidence Intervals Table 4. BY05 Intra-SCF Highway Estimated Costs and Confidence Intervals Table 5. BY05 Freight Rail Estimated Costs and Confidence Intervals Table 6. BY05 Commercial Air Estimated Costs and Confidence Intervals Table 7. BY05 Network Air Day Turn Estimated Costs and Confidence Intervals Table 8. BY05 Network Air Night Turn Estimated Costs and Confidence Intervals.

5 Indeed, the biggest change in TRACS since Docket No. R2005-1 is that costs for Passenger Rail (AMTRAK) need not be estimated. Compare, USPS-T-2/R2006-1 with USPS-T-3/R2005-1.

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The Commission should accordingly conclude that the TRACS estimators properly

reflect the selection probabilities and produce unbiased estimates for the costs

distributed in Tables 1-8.

C. The Origin-Destination Information System and Revenue, Pieces and Weight (ODIS-RPW), the Bulk Mail Revenue, Pieces and Weight (BRPW) System, and the Revenue, Pieces and Weight Adjustment System (ARPW) Continue to Provide Reliable Data for the Postal Service Use and for the Ratemaking Process.

ODIS-RPW is a data collection sampling system used to provide estimates of

revenue, pieces (volume) and weight for single-piece, for non-bulk entered mail

categories and development of associated unit costs. Data are collected by trained field

data collectors, entered in laptop computers and processed quarterly and yearly. From

the sample data, estimates of revenue, pieces and weight are used to distribute census

postage revenue to the measured categories of mail. BRPW provides estimates of

revenue, pieces and weight totals for bulk entered mail categories that have

corresponding postage revenues in the Postal Service’s accounting system. ARPW is

the system that combines ODIS-RPW and BRPW with other data to produce RPW

Report estimates that supply the revenues, volumes and weight for ratemaking

purposes.

Postal Service witness Pafford’s testimony (USPS-T-3) describes the ODIS-

RPW, BRPW and ARPW systems and describes the universe of related (Category 1)

RPW library references: USPS-LR-L-14, 15, 16, 17, 18, 19, 20, 23 and USPS-LR-K-

22/R2005-1. The RPW estimates produced from these systems are used throughout

the Postal Service’s Request.

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1. Revenue, piece and weight estimates continue with low coefficients of variation (High Precision).

In this and prior proceedings, and as required by Rule 31(k)(2)(ii), the Postal

Service produces estimates of sampling variability (coefficients of variation or CVs).

Compared to RPW estimates from Docket No. R2005-1, sample sizes remained

relatively constant in the ODIS-RPW sampling system (USPS-T-3 at 5), and BRPW

(USPS-LR-L-17, table 1 and USPS-LR-K-17/R2005-1, table at 2). Sample sizes are

one of the key inputs to sampling variability (equation (8) in USPS-LR-L-14). Through

continued use of large samples, and with the limited updates described by witness

Pafford (USPS-T-3 at 4-9), the Postal Service continues to maintain coefficients of

variation of less than 1 percent for most major mail categories (Tables 1, 2 and 3,

USPS-T-3 at 10-12). The use of census revenue, pieces and weight data, with its

concomitant absence of sampling variability from postage statements entered through

PostalOne! and the BRPW System, contribute to the high precision of the estimates and

low CVs.

The National Newspaper Association (NNA) made sure these facts were

documented in interrogatory responses. Witness Pafford, responding to NNA

interrogatories NNA/USPS-T3-12, and 20-21 (Tr. 9/2260, 2273-92, 2300-01),

specifically identified the worksheets showing the respective estimates of revenue,

pieces and weight from the ODIS-RPW sampling system (worksheet ‘drpw’) and the

primarily census-based BRPW system (worksheets ‘brpw’, ‘auto’ and ‘nonauto’). A

study of these worksheets shows, for example, that 100 percent of the Standard Mail

estimate comes from the primarily census-based BRPW system. The estimates of

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revenue, pieces and weight that support the ratemaking process accordingly maintain

their high levels of consistency and precision.

2. Within-County Periodicals RPW estimates remain sufficiently

precise for ratemaking purposes.

NNA consistently focuses in rate cases upon the RPW estimates for Within-

County Periodicals. In this docket, witness Pafford responded to 27 interrogatories from

NNA. In these responses, witness Pafford noted 1) the continued importance of the use

of census PostalOne! data (Tr. 9/2257 (response to NNA/USPS-T3-9)), 2) the large

office counts of automated offices used for census revenue, pieces and weight counts

(Tr. 9/2259 (response to NNA/USPS-T3-11)), 3) the controlling of revenue estimates to

census Periodical AIC revenue accounts (Tr. 9.2254 (response to NNA/USPS-T3-6)), 4)

the consistency of the non-automated panel office probability-based strata and sample

sizes from base year 1999 to Base Year 2005 (Tr. 9/2255, 2299 (responses to

NNA/USPS-T3-7,19), and 5) the growing contribution of the automated office panel to

the total Within-County estimates of revenue, pieces and weight. In base year 1999, 49

percent of Within-County Periodicals volume estimates were driven by the census

based automated office panel while in Base Year 2005 this percentage increased to

60.6 percent (Tr. 9/2306, 2256 (responses to NNA/USPS-T3-27 and NNA/USPS-T3-8,

respectively). The Postal Service remains committed to providing reliable and precise

estimates for ratemaking purposes, including Within-County mail.

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D. The Carrier Cost Systems Provide A Reliable And Uncontested Means For Distributing City And Rural Carrier Costs To Subclasses Of Mail.

The Carrier Cost Systems consist of the City Carrier Cost System (CCCS) and

Rural Carrier Cost System (RCCS), and are described in the testimonies of witnesses

Harahush (USPS-T-4) and Riddle (USPS-T-5), respectively. In turn, the sample design

and computer system processing are detailed in Category 1 library references USPS-

LR-L-11 and USPS-LR-L-12 for CCCS and RCCS. Handbook F-65, Chapters 3 and 4,

in Category 1 library reference USPS-LR-K-21/R2005 describe data collection

procedures. Supplemental data collection policies and instructions appear in Category

1 library reference USPS-LR-L-23, Supplemental Statistical Programs Policies & Data

Collection Instructions. CODES software is documented in Category 1 library reference

USPS-LR-L-13, CCCS-RCCS CODES Computer System Documentation and Source

Code.

The City Carrier Cost System is a probability sample of city carrier letter routes,

used to estimate the numbers of actual stops, potential stops, and the distribution of

mail by shape and subclass. The data are used to distribute attributable costs for city

carrier street time to subclasses of mail.

The Rural Carrier Cost System is a probability sample of rural carrier routes. For

each sampled route, all collected mail and a sample of all delivered mail are counted

and recorded. Mail characteristics collected on sampled, delivered mail include class,

subclass, and compensation category (shape or special service). The data are used to

distribute attributable costs for rural carriers to subclasses of mail.

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The quality of data from the Carrier Cost Systems has been uncontested in this

proceeding. Estimates for most categories are very precise, with coefficients of

variation (CVs) less than one percent for major categories. See USPS-T-4, Tables 1-5,

and USPS-T-5, Tables 1-4. The estimates of attributable costs for subclasses of mail

from these systems are highly reliable inputs to the Postal Service Request.

Witnesses Milanovic (USPS-T-9, base year costs) and Kelley (USPS-T-30,

delivery costs by rate category) are the primary users of output from the Carrier Cost

Systems. The Postal Service and the Postal Rate Commission have previously and

should again rely upon the Carrier Cost Systems in this docket.

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III. THE VOLUME FORECASTS INCLUDED WITH THE POSTAL SERVICE’S FILING ARE PREDICATED ON THE WELL-ESTABLISHED FORECASTING METHODOLOGY EMPLOYED IN PREVIOUS CASES To obtain its test year volume forecasts in this proceeding, the Postal Service

relies upon familiar expert witnesses employing familiar forecasting procedures. The

testimony of witness Thress appears as USPS-T-7, and the testimony of witness

Bernstein appears as USPS-T-8. Both of these witnesses have over a decade of

intensive experience working on postal demand research with their colleague, Prof.

George Tolley, and presenting rate case testimony on forecasting and forecasting-

related topics. As those witnesses explain, test year forecasts are based primarily on a

careful examination of the markets in which mail services are offered, the factors which

have explained mail volume changes historically, and the best available information as

to how those factors are expected to change going forward. Such a forecasting

procedure has in the past generally proven highly accurate in providing mail volume

forecasts over the typical rate case time horizon.

One feature of the Postal Service’s forecasting presentation in this case is a

continuing focus on the impact of technological diversion on the Postal Service. Both

witness Bernstein and witness Thress address trends in technological diversion, and

witness Thress explains current efforts to actually integrate the expected impact of such

technological diversion into the test year forecasts. Their testimonies in this case on

these issues clearly build on their previous testimonies to the Commission addressing

the same topics. For example, just in the last rate case, see the testimony of witness

Bernstein (Docket No. R2005-1, USPS-T-8) at pages 22-35 and 45-50, and the

testimony of witness Thress (Docket No. R2005-1, USPS-T-7) at pages 23-33, and 296-

33

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304. In Docket No. R2001-1, as in this case, the primary focus of the testimony of

witness Bernstein (Docket No. R2001-1, USPS-T-10) actually was on the impact of

technological diversion. The testimonies of witnesses Thress and Bernstein in this case

jointly show why technological diversion due to innovations such as the Internet is likely

to be a major concern for the foreseeable future.

While the forecasting witnesses provided hundreds of pages of context and

discussion, the actual volume forecasts are essentially summarized in Table 1 on pages

9-10 of the testimony of witness Thress. For each mail category, actual volume is

shown for FY 2002 and FY 2005, along with the average annual growth rate over that

period, and forecast volume is shown for the test year (FY 2008) assuming current rates

(denominated as TYBR), and for the test year assuming implementation on May 6, 2007

of the Postal Service’s proposed rates (denominated as TYAR), along with the implicit

annual growth rates associated with each forecast. Table 1 shows that, on a TYAR

basis, the Postal Service is expecting volume declines in First-Class Mail, Priority Mail,

Express Mail, and Periodicals, and volume growth in Standard Mail, Package Services,

and Special Services. Overall, the growing subclasses are expected to generate

slightly fewer additional pieces than the declining subclasses are expected to lose, with

a consequent forecast of total domestic mail pieces decreasing so slightly as to be

essentially flat (in the -0.1 annual percent range) between FY 2005 and FY 2008.

These figures show growth that cannot be considered robust in comparison with

historical averages over the decades of the 1980s and 1990s, and serve to highlight

significant evolutions in the postal environment in the last several years.

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A. There Have Been Only Minimal Changes in the Postal Service’s Forecasting Methodology, and No Intervenors Propose Alternative Forecasts Based on Alternative Forecasting Methodologies

As witness Thress indicated, there have been no major general methodological

changes relative to the presentation sponsored by him and relied upon by the

Commission in Docket No. R2005-1. USPS-T-7 at 13. Several new explanatory

variables, however, were introduced in one or more of the demand equations

presented. Id. In addition, for this case, separate demand equations were estimated for

single-piece and workshared First-Class cards and for Standard Nonprofit and Nonprofit

ECR mail volumes. Id. Lastly, several minor changes were made which could be

considered methodological in nature. These include a redefinition of the Internet

variable used to model the demands for First-Class single-piece letters and cards, and a

change to the methodology used to develop separate forecasts for First-Class and

Standard automated versus non-automated mail volumes. Overall, however, none of

these constitute major departures from the approach to demand analysis and

forecasting adopted by the Commission in previous cases.

Moreover, no direct testimony in this proceeding explicitly presents any

comprehensive alternative volume forecasts based on an alternative forecasting

methodology or demand analysis. APWU witness Kobe, for example, does present an

alternative volume forecast, but she merely uses witness Thress’ forecasting

methodology to illustrate anticipated volume and revenue consequences of her

alterative rate proposals for First-Class Mail. APWU-T-1 at 11-13. PostCom witness

Angelides, on the other hand, suggests that an elasticity other than the Standard

Regular subclass elasticity may be more appropriate for forecasting Standard Regular

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parcels. Postcom-T-4.1 Although he has an exercise which he presents as an

illustration of the potential effects of using a higher elasticity, he never claims that the

elasticity he uses in that example is correct. Moreover, his simplistic exercise bears

little resemblance to the actual methodology used by the Postal Service (which involves

both witnesses Thress and Kiefer) to derive volume forecasts at the level of

disaggregation of interest to Dr. Angelidies, and he certainly never purports to offer it as

a formal alternative forecast proposal. Id. at 9-10. Thus, while Dr. Angelides questions

the accuracy of the Postal Service’s forecast of Standard parcel volumes, he

acknowledges the lack of sufficient data to recommend any concrete improvements. Id.

at 8-9. Finally, even though Dr. Clifton and other GCA witnesses challenge two of the

1 The basic argument of Dr. Angelides is that, since parcels are such a small

part of the subclass, factors more relevant to categories other than parcels are likely to be driving the subclass elasticity, making that elasticity less likely to be applicable to parcels than the other more dominant parts of the subclass. Id. at 4-6, 7-8. It is difficult to argue with the logic of his suggestion that a specific elasticity for parcels might well be different from the aggregate subclass elasticity. His further argument, however, that the much more elastic estimate for Destination Entry Parcel Post might be considered a proxy for the unknown elasticity of Standard Regular parcels is not convincing. See id. at 6-7. For example, the point that Standard parcels are entered in bulk is a feature comparable to Destination Entry Parcel Post, but is likewise a comparable feature of the dominant parts of the Standard Regular subclass as well. Similarly, the fact that parcel shippers have non-postal alternatives does not distinguish Standard parcel mailers from the mailers of other types of Standard Mail, who also have non-postal alternatives for functions such as advertising. Dr. Angelides, however, has not studied other parts of Standard mail (Tr. 27/9368), and therefore cannot draw any conclusion that the availability of substitutes makes Standard parcels more price sensitive than other Standard Mail. Moreover, Dr. Angelides was not aware of any alternative carriers who specifically target Standard parcels by offering lower rates for parcels under one pound. Tr. 27/9368-69. This makes the availability of non-postal alternatives much less comparable than it would be, for example, with respect to the private carriers who vigorously compete directly in the same market as Destination Entry Parcel Post. Overall, Dr. Angelides may be correct that the price sensitivity of Standard parcels might deviate from that implied by the overall subclass elasticity, but he has not shown that it is necessarily higher.

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price elasticities estimated by witness Thress, Dr. Clifton presented no alternative

forecast based on different demand parameters in his direct testimony. GCA-T-1. His

focus in that testimony was clearly on the use of demand parameters for the purposes

of pricing and rate policy. Id. at 56-60. In any event, as discussed at length in the

following section, his testimony and analysis are seriously flawed.

Thus, to meet its need for before-rates and after-rates forecasts, the Commission

should once again rely on the comprehensive forecasts and forecasting methodology

sponsored by witness Thress. That workproduct, in conjunction with the testimony of

witness Bernstein, constitutes a thorough and comprehensive effort to address the

challenges of forecasting based on a rigorous and systematic analysis of historical data,

and balanced and well-reasoned judgments regarding the likely course of future

developments. It represents continuation of the forecasting approach mutually and

successfully relied upon by the Postal Service and the Commission over many cases.

To the extent that witnesses for GCA attempt to challenge specific components of the

demand analysis, as discussed next, their attempts fail and provide no basis to deviate

from the Postal Service’s proposed methodology for forecasting.

B. GCA’s Witnesses Fail to Provide Any Basis to Alter the Forecasting

Parameters Presented by the Postal Service GCA (ultimately) submitted the testimony of three witnesses to challenge the

forecasting presentation sponsored by the Postal Service – Clifton (GCA-T-1), Martin

(GCA-T-2), and Kelejian (GCA-T-5). The position that GCA is attempting to advocate

through these witnesses is that the demand for single-piece First-Class Mail is much

more price sensitive than reflected in the own price elasticity estimated in this case by

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Postal Service witness Thress. Importantly, the elasticity estimated by witness Thress

in this case is broadly consistent with the general level of the estimates jointly relied

upon by the Postal Service and the Commission over many cases, including as recently

as last year in Docket No. R2005-1. While there have been improvements in

methodology over those cases, and some resulting variation in the elasticity estimates,

the overall estimated level of price sensitivity has remained broadly consistent (in the

general neighborhood of -0.2) ) for many years.

The picture which the GCA witnesses attempt to paint (with the exception of Prof.

Kelejian, whose testimony is confined to technical econometric issues) is that, as

electronic alternatives have developed as substitutes for correspondence and

transaction previously carried as First-Class Mail, the natural result of these

technological and market changes must be that such mail has become more price

sensitive. While this argument may seem to have some superficial appeal, it withstands

neither critical scrutiny nor empirical analysis. Review of the testimonies of GCA

witnesses Martin and Clifton reveals the shortcomings which render this argument

hollow.

1. Prof. Martin’s research approach is flawed, and his results do not

support his conclusions. On behalf of GCA, Prof. Martin conducted research to examine emerging

competitive substitutes for First-Class letter mail. GCA-T-2 at 1. His work included both

survey research, and examining information and data from other sources. Id. His focus

was to examine the potential impact of postal rates on usage of such alternatives. Id. at

1-2. Prof. Martin, however, made a critical error in his approach to his research. He

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insists that, for purposes of assessing the impact of future postal rate changes on

electronic diversion, it is “not germane” to consider how much diversion would occur in

the absence of postal rate increases. Tr. 21/7523. In his view, attempting to explore

the amount of diversion that would occur without rate increases is “not the question

before the house,” and he therefore apparently believes it can reasonably be ignored.

Tr. 21/7616-17.

Prof. Martin is simply mistaken in this approach. It is impossible to identify the

“impact” of postal rate changes on the amount of electronic diversion in the absence of

a reasonable basis to understand the amount of diversion that would occur without rate

changes. It is for exactly this type of reason that Commission Rule 54(j)(5) requires

separate and distinct volume forecasts for a “before-rates” scenario and an “after-rates”

scenario, and that the Postal Service includes estimates of electronic diversion in both

its before-rates and after-rates forecasts. By failing to structure his research

accordingly, Prof. Martin has precluded an adequate foundation to support his alleged

conclusions.

Ironically, Prof. Martin’s own testimony begins with an acknowledgment that

previous researchers exploring the development of electronic alternatives have not

identified postal rate increases as playing any role in that process, much less a critical

role. GCA-T-2 at 1. Prof. Martin, however, refuses to draw the logical inference that

postal rates were not mentioned in the previous studies he examined because those

researchers did not identify postal rate changes to be a key factor in the emergence of

electronic alternatives. Tr. 21/7520, 7551-53. Rather than admit that previous

researchers might have omitted mention of postal rates simply because they found

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other factors as much more important in driving the adoption of electronic alternatives,

Prof. Martin expressed an inability to reach any such judgment. Tr. 21/7553.

Prof. Martin’s unwillingness to draw this logical inference, however, should not

impede others from doing so. Witness Bernstein, for example, explicitly made the point

that one reason why he believes that factors other than postal rates are dominant in

terms of explaining the growth in electronic alternatives is the numerous studies he has

examined on the topic that do not mention postal rates. Tr. 6/1443-44. Prof. Martin was

given ample opportunity to provide some other explanation for this significant

divergence between his work and that of previous studies, and his inability to do so

demolishes the credibility of his attempts to avoid admitting the obvious. Prof. Martin

refuses to concede the point because to do so would only highlight the fundamental flaw

in his research approach. If factors other than postal rates largely explain electronic

diversion, then there is little role left for the only factor in which he professes any

interest.

Contrary to Prof. Martin’s claim, however, that “no attention” was paid to the

potential role of postal rates in earlier studies (GCA-T-2 at 1), that potential role was

very explicitly examined and rejected over 12 years ago in testimony presented to the

Commission by Prof. Daniel Spulber. As discussed with Prof. Martin at Tr. 21/7553-55,

Prof. Spulber presented testimony in Docket No. R94-1 on behalf of various parties.

See Rebuttal Testimony of Daniel F. Spulber on Behalf of AMMA, MASAI, DMA, and

MOAA (AMMA et al.-RT-2), Sept. 7, 1994 (Docket No. R94-1, Tr. 19/9183-9239). Prof.

Spulber, with a background in regulated industries including telecommunications,

conducted “an economic analysis of the effectiveness of adjusting first-class (sic) postal

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rates as a competitive response to the diversion of some types of first-class mail (sic) to

electronic forms of transmission.” (AMMA-et al.-RT-2 at 2, Docket No. R94-1, Tr.

19/9185). Prof. Spulber’s conclusions in Docket No. R94-1 were plainly stated:

Technological and market changes are increasing the benefits and reducing the costs of electronic transmission. These factors are responsible for the rapid expansion of electronic transmission. These ongoing and fundamental changes are entirely independent of postal rates. They can no more be diverted or slowed by a change in postal rates than a reduction in the cost of feeding horses would have halted the development of the automobile.

(AMMA-et al.-RT-2 at 12, Docket No. R94-1, Tr. 19/9195). In this docket, another witness with substantial telecommunications expertise

appeared, Prof. Sidak, who actually has co-authored two books with Prof. Spulber. Tr.

32/10873. Although unaware of Prof. Spulber’s earlier testimony, Prof. Sidak endorsed

the thrust of the conclusions by Prof. Spulber quoted above. Tr. 32/10875-77. That it is

the increasing benefits and declining costs of electronic transmission which are

responsible for its rapid expansion seems to Prof. Sidak to be “pretty uncontroversial.”

Tr. 32/10876. He further states that he has no basis to disagree with Prof. Spulber’s

contention that these developments are independent of postal rates. Id.

One significance of Prof. Spulber’s earlier testimony is that, as noted above, it

directly refutes the claim by Prof. Martin that he is breaking new ground by attempting to

examine the relationship between postal rate changes and the growth in electronic

diversion. More importantly, though, the broader significance of the Spulber testimony,

and the similar testimony in this docket from Prof. Sidak, is that they underscore why

Prof. Martin’s research strategy is fundamentally flawed. By professing no interest in

the amount of electronic diversion that would occur independent of postal rate changes,

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witness Martin is intentionally ignoring what the other experts have determined to be its

critical drivers. Looking only in the wrong places, Prof. Martin is unavoidably going to

reach the wrong conclusions.

In his defense, Prof. Martin might argue that Prof. Sidak did not testify in this

case until the round after Prof. Martin’s testimony was prepared and presented, and that

he was unaware of Prof. Spulber’s earlier testimony. (Indeed, Prof. Martin declined to

comment on the limited portions of Prof. Spulber’s testimony presented to him during

hearings on the basis that he was unfamiliar with the totality of the work. Tr. 21/7554-

55.) But Prof. Martin already had available other earlier studies he cites, which likewise

identified factors other than postal rate as being the ones that would influence the pace

and intensity of electronic diversion. A clear example of this is the material prepared in

2003 by Greg Schmid for the President’s Commission on the United States Postal

Service. Prof. Martin cites Mr. Schmid in his conclusion in support of his claim that

postal rates are a triggering device for customers to examine electronic alternatives.

GCA-T-2 at 56.

As Prof. Martin agreed during cross-examination, however, Mr. Schmid did not

identify any role for postal rate changes, either in the quote presented by Prof. Martin on

page 56 of his direct testimony, or in Mr. Schmid’s discussion of various scenarios that

could result in greater or lesser diversion. Tr. 21/7599-7607. Mr. Schmid instead

identified other factors that he suggested would have an impact on diversion, and Prof.

Martin further agreed that such factors could to some extent play a role similar or

related to the “triggering device” role he is ascribing to postal rate changes. Tr.

21/7605-06. Yet in presenting neither the factors that could lead to a higher-diversion

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scenario, nor the factors that could lead to a lower-diversion scenario, does Mr. Schmid

even mention postal rates. Tr. 21/7607.

Thus, for Prof. Martin to quote Mr. Schmid in support of his assertion that postal

rates are a triggering device for electronic diversion is, at best, puzzling. It is even more

puzzling when one examines the substance of the quote from Mr. Schmid that appears

on page 56 of GCA-T-2. In that quote, (which actually appears on page 9 of Mr.

Schmid’s report, rather than page 29 as indicated in the footnote in Prof. Martin’s

testimony), Mr. Schmid highlights the extremely large inherent cost advantages in an

electronically-based payment system versus a paper-based system, quoting an order of

magnitude figure of three-to-one. Stating the obvious, Mr. Schmid then notes that it is

such inherent cost differentials that will fuel diversion, giving companies significant

incentives to induce their customers to embrace an electronically-based system. In

making such observations about the broader relative costs and benefits of an electronic

versus paper system for companies and consumers, Mr. Schmid is following exactly the

same tack taken earlier by witness Spulber. (See, e.g., Docket No. R94-1, Tr. 19/9210-

12, 9218-20.)

When questioned orally regarding how the quote from Mr. Schmid relates to the

portion of his testimony in which it was presented, Prof. Martin responded that what he

sought to draw from the quote was reflected in the three sentences in his testimony

immediately following the quote. Tr. 21/7600. Certainly there is no disagreement about

the first of those sentences. (“In other words, the diversions of either consumers or

businesses are interactive with and upon one another.”) What is startling appears in the

next two sentences (the concluding sentences of Prof. Martin’s direct testimony):

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And diversion is driven by inherent and important factors for both consumers and businesses that out weigh any offered by traditional mailing of payments and billing statements. The solution is obviously not found in raising First Class postage prices, which seems to trigger even more diversion.

GCA-T-2 at 56. Compare those two sentences from Prof. Martin’s testimony with two

sentences from the earlier testimony of Prof. Spulber:

The argument that electronic diversion is sensitive to first-class (sic) postal rates is fundamentally flawed since it is inconsistent with technological and market developments in computers and telecommunications. As a consequence of these developments, electronic transmission provides a number of advantages that override any effects of small changes in the price of first class mail (sic).

AMMA-et al.-RT-2 at 2, Docket No. R94-1, Tr. 19/9185.

Two things are quite striking about these quotes. First, both witnesses are in

absolute agreement that electronic transmissions offer benefits and advantages that

overwhelm (“out weigh” and “override”) the comparable features of paper-based

systems, and that these inherent benefits and advantages are the factors driving

diversion. Second, despite the complete congruence of their stated beliefs on those

facts, they draw diametrically opposite conclusions on the relationship between future

postal rate changes and diversion. Prof. Martin’s erroneous conclusion regarding postal

rate increases as triggering events clearly does not flow from anything he earlier draws

from Mr. Schmid, because it represents a clear departure from even his own

assessment (presented just one sentence earlier) of what is actually driving diversion,

an assessment which he shares not only with Mr. Schmid, but with Prof. Spulber and

Prof. Sidak as well (to say nothing of witnesses Bernstein and Thress).

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Prof. Martin, therefore, has only his survey research to fall back upon as a basis

for his assertions on the “triggering device” hypothesis. That hypothesis is proffered at

numerous points in the testimony, and articulated most fully as follows:

Postal rates seem to be a future trigger for diverting from mailed bill payments. That data suggest that, once motivated to switch from the mailed payments by the price (or changes in the price) of postage, major mailers then use other competitive attributes for the switching or diversion decision. . . . As with major mailers, postal rates seem to be a future trigger for minor mailers diverting from mailed bill payments. The data again suggests that minor mailers then use other competitive attributes for the switching or diversion decision.

GCA-T-2 at 23, 27 (Emphasis in original). Prof. Martin uses similar variations on the

“trigger” theme as the major thrust of the conclusions he purports to draw from his

survey research. Id. at 2, 21, 24, 25, 28, 51, 56.

The statements quoted above, however, present a gross distortion of Prof.

Martin’s survey. The notion that his survey respondents indicated to him that other

competitive attributes come into play only after postal rate changes have motivated a

switch is absurd. No such inquiry was put to them. The reality of his survey is quite

different, and underscores three points. First, every reported category of survey

respondents ranked postal rate changes as the least important factor when deciding

what method of bill payment to use. Second, even if the survey otherwise shed any

light on respondents’ actual reactions to potential postal rate changes, it cannot be

construed to identify the true “triggers” leading to diversion, because respondents were

offered no opportunity to indicate any “triggers” other than postal rate changes. Third,

poor wording of the survey’s “trigger” questions in fact precludes those questions from

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shedding any light even on how respondents might react to specific postal rate

changes.

Before addressing these points, however, it is perhaps necessary to summarize

the structure and flow Prof. Martin’s survey. For consumers, he first obtains information

about what portion (if any) of their bill are still paid by mail, and on the basis of their

responses he segments consumers into one of four categories (hard core mailer who

pay all bills by mail, major mailer who pay over half their bills by mail, minor mailers who

pay over half their bill electronically, and electronic mailers who pay all of their bills

electronically). GCA-T-2 at 19, E-2 – 3. Next, he asks consumers to rate 10 potential

factors that might affect the method they use to pay bills. Id. at E-4 – 6. The factors are

cost, convenience, timing, delivery assurance, due date receipt, provider preference,

security of payment, time involvement, tracking payment, and future postal rate

increases. Id. Only after eliciting these rankings of competitive attributes does the

survey ask consumers two subsequent questions about potential stamp prices at which

they would seriously consider switching to electronic payment, and about how likely

they would be to switch if they knew the Postal Service was planning regular (e.g.,

annual) increases in postal rates. Id. at E-7. (For ease of reference, these two

questions are referred to in this discussion as the “trigger” questions, as they were in

the cross-examination of Prof. Martin. Tr. 21/7608-09.) The structure and flow of the

business portion of the survey were similar, although business respondents were

grouped as either primarily business-to-business mailers or business-to-consumer

mailers, and one of the trigger questions preceded the competitive attribute question,

and one followed. Id. at 35-36, G-6 – 9.

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a. The survey results fundamentally confirm the extremely

minor role of postal rates in the greater scheme of electronic diversion.

Returning to point number one, the most noteworthy result of Prof. Martin’s

survey (indeed, the only noteworthy result of his survey in terms of this case) is the plain

fact that, for every consumer and business segment for which he reported results,

“future postal rate increases” ranked as the least important factor potentially affecting

choice of payment method. Id. at 22, 26, 30, 47. Given the opportunity to indicate how

postal rate changes compare to a variety of other factors, each respondent category

rated postal rate changes lower than every other possibility suggested – the tenth of

ten. To assess how damaging these findings are to the themes that Prof. Martin would

prefer to espouse, one need only consider how far Prof. Martin was willing to go to try to

avoid having to acknowledge them. See Tr. 21/7526, 7580-85, 7628, 7637.

Moreover, nothing in the manner in which these questions were posed provides

any basis whatsoever to support the assertion that switching based on a comparison of

these attributes occurs only after being triggered by a change in postal rates. Prof.

Martin makes that erroneous claim on pages 23 and 27 of his direct testimony (as

quoted above), and repeated it on the stand at Tr. 21/7606. Yet not only did both

consumer and business respondents rank the postal rate increase factor lower than all

others, but, as Prof. Martin later admitted, the order of the questions was such that

consumer respondents had not even been asked the trigger questions regarding postal

rates when asked to rate the competitive attributes. Tr. 21/7611. There simply is

nothing in the survey or its results which could possibly support any linkage between

how respondents’ switching decisions are influenced by the nine non-postal-rate factors

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in the list of competitive attributes, and the presence or absence of postal rate changes.

Id. Prof. Martin creates such a linkage out of whole cloth.

The absurdity of any claim to the contrary is readily confirmed by consideration of

the evolution of electronic diversion to date. For example, with great reluctance, Prof.

Martin eventually confirmed that the share of mailed bill payments declined by more

between 2003 and 2005, a period in which there were no (nominal) postal rate changes,

than it did between 2000 and 2003, a period in which the basic rate for First-Class Mail

went from 33 cents to 37 cents. Tr. 21/7535-36, 7594-99. Obviously, electronic

diversion has been ongoing, both in periods of postal rate changes and in periods of

nominal postal rate stability. Surely Prof. Martin would not suggest that electronic

diversion between 2000 and 2003 was driven by the effects of the competitive attributes

he was asking his respondents to rate, once consideration of such factors was

motivated by postal rate changes, but unaffected by such attributes between 2003 and

2005 in the absence of any postal rate changes. Or that there were some other set of

factors affecting electronic diversion between 2003 and 2005. Any suggestions along

these lines would be so clearly untenable as to merit no further discussion.

b. Prof. Martin’s results on the alleged triggering role of postal

rates on electronic diversion are merely a function of his flawed research approach.

In terms of point number two, Prof. Martin’s flawed research approach destroys

his ability to draw meaningful conclusions from his survey regarding the actual “triggers”

of electronic diversion. Having spent substantial amounts of effort both studying and

reporting in his testimony the myriad of factors that potentially relate to the pace and the

depth of electronic diversion in various applications and in various specific sectors of the

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economy (see, e.g., GCA-T-2 at 1-3, 9-15, 33-35, 37-41, 51-54), Prof. Martin looks as if

he actually would have been in a good position to conduct meaningful research on the

topic of future events that might alter the course of electronic diversion.2 For example,

the report presented by Mr. Schmid, and other materials cited by Prof. Martin,

suggested numerous types of technological and market developments that could act as

potential “triggers,” the likely reactions to which could have been explored with the

survey respondents. Tr. 21/7605-07, 7612-14. So he could have probed respondent’s

reaction to further shifts in the consumer cost of access to broadband, for example, or

major improvements in Internet security. Instead, Prof. Martin consciously chose to limit

his inquiry to changes in postal rates. Tr. 21/7615.

It was therefore a foregone (albeit an invalid) conclusion that postal rate changes

would be the only “trigger” emerging from the survey responses. In particular, there is

no possibility of comparing responses to questions about postal rate “triggers” with

responses regarding other potential non-rate “triggers.” Since such a comparison in the

context of the competitive attributes questions unambiguously reveals that other types

of factors totally dominate postal rates, the inability to do such a comparison with regard

to potential “triggers” immediately renders the postal rate “trigger” results suspect at

best and meaningless at worst.

In terms of research design and structure, one final point can be made regarding

why Prof. Martin’s emphasis on the “trigger” questions is so misplaced. Among

2 There is, however, the troubling issue of why Prof. Martin has such a high proportion of respondents without a high school diploma. Tr. 21/7521. Prof. Martin’s refusal to acknowledge any expectations regarding whether the percentage of bill payers without a high school diploma would be higher or lower than the adult population generally represents a transparent attempt to paper over what might be indicative of a potentially serious problem with the survey sample. Tr. 21/7549-50.

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consumers, Prof. Martin posed the “trigger” questions to respondents in the minor

mailer, major mailer, and hardcore mailer categories, but skipped the question for those

in the electronic payer category. GCA-T-2 at E-7, Tr. 21/7618. Consequently, Prof.

Martin has nothing in his survey which relates to the relationship between postal rate

changes and the decision to switch entirely to electronic payment by these former

mailers except for the competitive attribute question. Tr. 21/7618-21, 7625-27. Prof.

Martin tried to point (id. at 7618-19, 7625-26) to satisfaction level scores regarding

electronic payment service, but, unlike the “trigger” questions and the “future rate

changes” question in the attributes list, the level of satisfaction with electronic payment

service question plainly has nothing to with postal rate changes. Prof. Martin states his

expectation that electronic payers would provide a rich base for understanding their

selection of the electronic payment mechanism. GCA-T-2 at 29. But regarding postal

rate changes and this important respondent category, the only information we have is

that its respondents (like those in all other categories) rated changes in postal rates as

the least important factor affecting their switch (GCA-T-2 at 30), which runs totally

contrary Prof. Martin’s “trigger” hypothesis.

c. Inherent deficiencies within the “trigger” questions invalidate

their use to reach reliable conclusions. In terms of point number three, in addition to their other flaws, the “trigger”

questions are so inartfully drafted as to preclude any meaningful interpretation of the

results. The first “trigger” question discussed by Prof. Martin reads as follows:

If you had reason to believe or knew that the postal service was planning regular increases in the price of postage for paying your bills, such as every year, what effect would this have on you switching to electronic payment of your bills? Again, use a scale of one to seven to predict what

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you’d do. A seven indicates you would definitely switch to electronic payment and the other end of the scale, a one would indicate you would definitely continue using a pay by mail system.

GCA-T-2 at 21. The glaring problem with this question (other than its focus on a factor

which respondents already indicated was the least important of the 10 factors

suggested) is that it does not convey any indication to respondents of the magnitude of

the hypothesized “regular” increases. This deficiency was discussed with Prof. Martin

orally and in writing. Tr. 21/7522, 7555-61. In the absence of such information in the

question, a highly plausible interpretation would be that what is being hypothesized is a

rapid acceleration in the level of postal rates. Prof. Martin’s attitude seems to be that he

did not care how respondent interpreted the question. Tr. 21/7558-61. But, regardless

of whether Prof. Martin is willing to admit it or not, useful reliance on respondents’

answers must be conditioned on an understanding of how they interpreted the question.

For example, if respondents who indicated they would definitely switch had in mind

regular increases of 5 cents, and those who indicated they would definitely not switch

had in mind regular increases of 1 cent, the pattern of responses would merely be

indicative of the inherent ambiguity in the question. Prof. Martin’s failure to pose an

unambiguous question precludes any reliance on the results of this question to suggest

that, in practical terms, plausible postal rate strategies could serve as triggers for

material amounts of diversion.

The other “trigger” question is to some extent the flip side of the same coin. It

reads as follows:

Going back to your use of using the mail for your payment of bills. I’m going to read you some stamp prices for mailing those payments. Please stop me at a price where you would seriously consider switching to some form of electronic payment instead of using the mail.

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1 42¢ 2 45¢ 3 50¢ 4 60¢ 5 75¢ 6 $1.00 7 DK/Refused

GCA-T-2 at E-7. It represents the flip side because, in this instance, the question

specifies the magnitude of the hypothesized increases, but does not specify the time

frame involved. It is impossible to know whether respondents viewed this series of

hypothetical rate levels as ones that would be implemented immediately, or over some

unknown period of the future. Once again, the ambiguity was discussed with Prof.

Martin orally and in writing. Tr. 21/7525, 7576-80. Once again, his attitude towards

respondents and their understanding of his questions (or lack thereof) was that he did

not “crawl in their heads.” Tr. 21/7579. Yet he also appeared to suggest that, based on

their past experience, respondents could assume that “the 50¢ level could be reached

by 2010 or sooner.” Tr. 21/7526. Prof. Martin, though, while apparently willing to

attribute to his respondents an implicit understanding that a 50-cent rate could be reach

by 2010, was himself unaware that the most recent historical cumulative increase of as

much as 11 cents (the difference between the current rate of 39 cents and the

hypothetical rate of 50 cents) had occurred not in a period of less than 4 years, but in a

period of more than 15 years, going back prior to the Docket No. R90-1 implementation

of the 29-cent rate in February of 1991. Tr. 21/7578.

There are other difficulties with this question as well. For example, there is no

indication in the consumer questionnaire (pages E-1 – 8) that respondents were

reminded that the current stamp rate is 39 cents, as a benchmark by which to assess

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the hypothetical rate levels proposed. A respondent who was confused and might have

mistakenly thought that the current rate was, for example, still 37 cents, may have had

an unwarranted reaction to the 42-cent rate level. This becomes even more of a

problem for the business respondents, since they could currently be paying some type

of workshare rate which actually is less than 39 cents, and the prices hypothesized

could represent even higher increases relative to their current rate. Tr. 21/7567-7570.

Once again, Prof. Martin was oblivious to the problems this would create for a

meaningful interpretation of his results. Id.

Another significant issue relates to interpretation of the results of an inquiry which

ask respondents to identify a price at which they would “seriously consider switching to

some form of electronic payment instead of using the mail.” Would all of the

respondents who indicate merely that they would seriously consider switching actually

switch? On the one hand, Prof. Martin at one point suggests that the percentages he

reports as “seriously consider switching” can be directly applied to mail volumes to

generate, for example, a result that “forecasts a loss of more than 2 billion pieces of

billing mail from small business firms.” Tr. 21/7528. More typically, though, he

emphasizes that that a response indicating serious consideration of switching cannot be

equated with a statement that such respondents will switch. Tr. 21/7524, 7529, 7570-

72, 7575-76. He rejects the suggestion that researchers or respondents can know,

“with complete certitude,” respondents’ future behavior. Id. at 7570.3 Nevertheless, he

3 Taken at face value, Prof. Martin’s concern about respondents’ inability to know their future behavior “with complete certitude” is another factor that would clearly undermine confidence in the responses he received on the other “trigger” question regarding regular rate increases. As shown on page 21 of GCA-T-2 (and reproduced above), it contemplates self-identification of respondents who “would definitely switch to electronic

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apparently sees no contradiction with using a response that someone will seriously

consider switching as the basis for forecasting that the respondent will switch. As best

can be discerned, his reasoning seems to run something along the lines that a forecast

is just a statement of what probably will happen, rather than a guarantee of what will

happen. Tr. 21/7576. Ultimately, though, Prof. Martin had to concede that he is treating

a response that someone would seriously consider switching as a statement of intent to

switch. Tr. 21/7636-37.

Finally, one element of this question does not create a problem, per se, but puts

a major limitation on the usefulness of the results. In choosing his price points, Prof.

Martin moved immediately from the 42 cents proposed by the Postal Service in this

case to a hypothetical rate, 45 cents, that represents an increase (6 cents) that is

double that proposed (3 cents). Prof. Martin can therefore shed no light on whether his

respondents would have indicated a material difference in their rates of serious

consideration of switching at a rate merely 1 cent higher than the Postal Service’s

proposal (43 cents), or at a rate 1 cent lower (41 cents). He has not one iota of

evidence to offer relative to either of these two alternative rates, including the 41-cent

rate proposed by GCA witness Clifton, nor does he identify a rate change of any smaller

magnitude that would successfully avoid becoming what he calls a triggering device.

Obviously, as a matter of survey design, one can understand why it would be difficult to

expect respondents to differentiate between potential rates that differ by what would

appear to them to be such a trivial amount relative to the decision they are being asked

to evaluate. But that, of course, is exactly the point correctly made by Prof. Spulber

payment,” and respondents who “would definitely continue using a pay by mail system,” as well as those in between.

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twelve years ago – small changes on the margin of First-Class Mail rates are not going

to have a material impact on electronic diversion determinations.

To summarize the overall deficiencies in Prof. Martin’s testimony, the conclusions

he attempts to draw simply do not explain why electronic diversion occurs fairly steadily

during times of nominal postal rate stability and times of nominal postal rate increases.

Other experts have identified what is driving electronic diversion, and, essentially, it is

not postal rates. Given a fair opportunity to compare the importance of the effects of

postal rates with the importance of the effects of other factors, his respondent

categories rated postal rates as the least important factor with perfect consistency. On

the other hand, restricting their choice to only postal rates, and presenting questions

that could be interpreted to suggest potential postal rate changes that far surpass what

has been typical historically or has been proposed in this case, Prof. Martin shows that

it is possible that some respondents will express concern in the form of a willingness to

seriously consider switching to electronic bill payment. The Postal Service has never

doubted or denied that, on the margin, some mailers will consider changing their

behavior in response to rate changes, and a portion of those mailers will actually do so.

That is a far cry, however, from Prof. Martin’s spurious claims that postal rate changes

(of any magnitude, apparently) are a trigger for electronic diversion, and that other

vastly more influential competitive factors only come into play once triggered by postal

rate changes.

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2. Neither Dr. Clifton nor Prof. Kelejian offer any valid theoretical or empirical basis to rely on any estimates of own price elasticity other than those provided by witness Thress.

The testimonies of GCA witnesses Clifton and Kelejian are closely related, but

differ in scope. Prof. Kelejian’s testimony is narrowly limited to econometric theory,

providing criticisms of the econometric technique of witness Thress and identifying what

he believes are a few potential problems, but offering no quantification of potential

impact, or any alternative estimations. GCA-T-5. Dr. Clifton, on the other hand,

attempts to address what he believes to be trends in the market, what impact he

expects those trends should have on the own-price elasticity of single piece First-Class

Mail, and then attempts to offer his own estimates of the own price elasticities of single

piece First-Class Mail and Standard Regular. GCA-T-1. As shown in the rebuttal

testimony of witness Thress, however, neither of the two GCA witnesses ultimately

provides any basis to question reliance on the own price elasticities estimated and

employed by witness Thress. USPS-RT-2.

a. The combination of serious flaws in economic theory and

econometric practice has caused Dr. Clifton to produce an unusable model of the demand for single piece First-Class Mail.

Since Dr. Clifton has the testimony with the broader scope, it is necessary to

begin with him. Dr. Clifton spends a fair portion of his direct testimony discussing what

he believes to the relevant markets in which single piece First-Class Mail competes.

GCA-T-2 at 10-17. In Dr. Clifton’s view, one relevant market is the (non-cash)

payments market, rather than the bill payment market. Id. at 14; Tr. 29/10022. Witness

Thress explains the fallacy of this view. USPS-RT-2 at 3-8. The Postal Service does

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not compete in the payments market, but rather in the market for the delivery of bill

payments. Id. at 4. For payments made at the point of sale, which historically never

generated a bill or delivery of any payment by mail, there is minimal (if any) affect on

postal volumes if, for example, customers switch their payment method for groceries

from check to credit card. Id. at 4-5. Prof. Clifton, moreover, had to acknowledge that

under his definition of the relevant market, even a switch in grocery payments from cash

to credit card would be interpreted as a decline in the Postal Service’s market share.

Tr. 29/10010-11. This makes no sense.

As witness Thress explains, checks are not an adequate proxy for bill payments

by mail, and with 81 billion non-cash payments and only approximately 15 billion bill

payments, the payments market and the bill payments market are very distinct. USPS-

RT-2 at 6. The bottom line is that the only appropriate market to examine is the bill

payment market, the Postal Service has examined that market (see testimony of

witness Bernstein, USPS-T-8 at 51), and there is no disagreement that the Postal

Service’s market share is declining. USPS-RT-2 at 6-8. Dr. Clifton’s misguided attempt

to drag the broader payments market into the picture does nothing to enhance the

credibility of his arguments.

Another primary thrust of Dr. Clifton’s testimony is his repeated (but erroneous)

insistence that economic theory dictates that the introduction of more substitutes (such

as electronic payment alternative) into the market requires an increase in the own-price

elasticity. See GCA-T-1 at 37-49. As witness Thress indicated even prior to the

submission of Dr. Clifton’s testimony, all else equal, economic theory might tend to

support that suggestion, but all else is never held equal in the real world, and other

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factors must be taken into account. Tr. 6/1226. In his rebuttal testimony, witness

Thress cites a well-documented example of pharmaceuticals as another industry in

which the introduction of previously unavailable substitutes did not have the effect which

Dr. Clifton is postulating. USPS-RT-2 at 13-15. Moreover, directly with respect to the

First-Class Mail and the increasing availability of electronic alternatives, Prof. Sidak,

testifying on behalf of NAA, likewise agreed that the net effect of the emergence of such

alternatives could be constant or decreasing price sensitivity of the remaining postal

customers. Tr. 32/10879-80. Therefore, Dr. Clifton’s opinion that the own price

elasticity estimated by witness Thress cannot be reconciled with economic theory is

groundless. As witness Thress testified (USPS-RT-2 at 15), the interrelationships

between all of these market factors must be evaluated empirically, which is exactly what

witness Thress has done.

Dr. Clifton also attempted to construct an empirical model of the demand for

single piece First-Class Mail, but the model he presents is not useable. Witness Thress

highlights a number of reasons why this is so in USPS-RT-2 (at pages 37-50), but in

some sense, one need look no further than the first reason he discusses. As witness

Thress observes, Dr. Clifton’s recommendation in this case is to reduce the proposed

single piece (i.e., non-workshare) letter rate by one cent, and to leave the proposed

workshare rates unchanged. USPS-RT-2 at 42 (citing GCA-T-1 at 59). Yet Dr. Clifton

concedes that, using his demand model, the effect of implementing his proposal

(reducing the single piece rates by one cent, holding the workshare rates constant and

therefore also reducing the average worksharing discount by one cent), would be to

decrease single piece volume. Id. at 43 (citing Tr. 29/9932). Witness Thress draws the

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obvious conclusion: this result makes no sense, and the model must be fatally flawed.

Id. While witness Thress is able (id. at 37-42) to pinpoint the source of this

unacceptable result (Dr. Clifton’s misunderstanding of the function of the workshare

discount variable, and the economic logic which requires this variable to be negative in

the single piece equation), the more important point is that Dr. Clfiton’s model simply

cannot be used to forecast First-Class Mail volumes in this proceeding.

Witness Thress, however, also identifies a number of other flaws in the model.

First, by virtue of the testimony of GCA’s own expert econometrician, Prof. Kelejian, Dr.

Clifton’s autocorrelation correction procedure is not correct. USPS-RT-2 at 43-44.

Second, Dr. Clifton’s linear specification is not correct, based on the empirical test

recommended by Prof. Kelejian. Id. at 44-48. Third, other empirical tests indicate that

Dr. Clifton should have made some type of non-linear transformation of the internet

variable in his model. Id. at 48-50. The cumulative effect of these problems renders Dr.

Clifton’s model clearly inferior to that of witness Thress. Id.4

b. The practical effects of the theoretical concerns raised by

Prof. Kelejian are not material. On the other hand, with respect to Prof. Kelejian, witness Thress shows that the

potential theoretical issues identified by Prof. Kelejian raise no material concerns with

reliance on the estimates presented by witness Thress. Id. at 50-63. Prof. Kelejian

raised two concerns with the Box-Cox procedure. With respect to the simultaneous

estimation of lambda and the stochastic restriction, witness Thress re-estimated his

4 As witness Thress also testified, the same types of theoretical and econometric errors likewise undermine any reliability on Dr. Clifton’s Standard Regular model as well. USPS-T-2 at 44, 46-47, 48.

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model to incorporate this feature of Prof. Kelejian’s recommendation, and there was no

material affect on the estimates. Id. at 51-53.

With respect to the Box-Cox specification, witness Thress acknowledges the

difference in this case between the model he specified and a “correct” or conventional

Box-Cox specification. But he then presents the results of statistical test which show

that his modification of that conventional Box-Cox specification can be justified on

statistical grounds. Id. at 53-55., 59-60, 62-63. Yet to be as thorough as possible,

witness Thress presents the results (after making all applicable modifications based on

Prof. Kelejian’s criticisms) of both his version of the Box-Cox transformation, and the

conventional one. Once again, the differences in estimated own-price elasticity (relative

to witness Thress’ original estimate) are not material. Id. at 63. To the extent that Dr.

Clifton is suggesting (see, e.g., GCA-T-1 at 50) that anything questionable Mr. Thress

might have done with his Box-Cox transformation is explaining why the Postal Service’s

own price elasticity estimate is (at least in Dr. Clifton’s mind) so low, these results show

any such suggestion to be empirically wrong.

Prof. Kelejian also criticized the implementation by witness Thress of his imposed

symmetric condition. To address Prof. Kelejian’s theoretical concern, Mr. Thress

followed the professor’s recommendations and redid his own analysis. Once again, the

result was no material change in the estimated elasticity. USPS-RT-2 at 55-57. A

similar conclusion of no material effect follows when witness Thress changes his

autocorrelation correction procedure in response to Prof. Kelejian’s testimony. Id. at 57-

59.

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Prof. Kelejian’s criticism of the model selection procedure applied by witness

Thress stands on a different footing than his other criticisms. Boiled down to its

essence, Prof. Kelejian would prefer something that he would consider a more formal

statistical procedure. On the other hand, the Mean Square Error minimization criterion

certainly has the elements of a formal procedure as well. Tr. 38/13107-08, 13112-13.

But the primary point is, debate over model selection criteria only has relevance in

circumstances in which different model specifications are being advocated based on

different model selection criteria. In this case, while grousing about the criterion

employed by witness Thress to select his model, neither Dr. Clifton nor Prof. Kelejian

identify any other model as superior, based on any different criteria or the same

criterion. As witness Thress justifiably concludes, in this instance, the entire discussion

has no pragmatic relevance to any live controversy. Id. at 60-61.

Consistent with Prof. Kelejian’s recommendation, witness Thress employed the

same test that Dr. Clifton’s linear model failed in order to evaluate whether his own log-

linear model was empirically justified. The results show that the choice by witness

Thress to use the constant elasticity (log-linear) specification is correct. Id. at 61-62.5

Finally, to test empirically the hypothesis that the single piece own-price elasticity has

been increasing over time, witness Thress presents the results of a serious of

experiments he conducted to explore that hypothesis. The results of these experiments

provide no support for the supposition that there have been material increases in the

own-price elasticity caused by the factors suggested by Dr. Clifton. Id. at 63-67.

5 Of course, the Commission itself has long commented favorably on the log-log functional form for demand analysis. E.g., Docket R97-1, Op. & Rec.Dec., Vol. 2, App. H at page 31; Docket No. R90-1, Vol. 2, App. H at page 2; Docket No. R84-1, Vol. 2, App. H at page 2.

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Overall, witness Thress adjusted his model to incorporate as many of Prof.

Kelejian’s suggestions as he could translate into concrete alternative procedures, and

presented those results in his rebuttal testimony. All of the alternative single piece own-

price elasticities he estimates, however, fall in a very narrow band around his original

estimate of -0.184. A review of the rebuttal testimony shows that every one of the

estimated own-price elasticities is found in a range between -0.16 and -0.20. Id. at 53-

67. The conclusion of witness Thress, that correction of whatever valid problems Prof.

Kelejian has identified causes no material change in his results, is eminently justified.

The Commission can properly rely on the demand and forecasting models presented by

witness Thress in USPS-T-7.

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IV. THE POSTAL SERVICE’S SUBCLASS COSTING PRESENTATION ENHANCES UNDERSTANDING OF THE BEHAVIOR OF POSTAL COSTS AND PROVIDES AN APPROPRIATE FOUNDATION FOR RATEMAKING

The bedrock of postal ratemaking has been and remains the estimation of

subclass costs. Section 3622(b)(3) requires each subclass to cover the costs caused

by the provision of that service. Accurate subclass costing allows compliance with this

requirement of the Act, improves forecasts of accrued costs in future periods, and

creates a framework against which subclass revenues and the allocation of institutional

costs resulting from the pricing process can be evaluated. A significant part of the

Postal Service’s evidentiary presentation in this proceeding, consisting of the testimony

of numerous witnesses as well as extensive supporting documentation, is devoted to

the development and explanation of appropriate subclass costs. This body of material

constitutes a comprehensive foundation of cost information that, in conjunction with the

pricing analyses addressed subsequently in this brief, supports the rates proposed by

the Postal Service.

The Postal Service’s subclass costing presentation in this case closely parallels

similar costing presentations made in numerous previous rate cases. It begins with the

monumental amount of information collected and processed through the Postal

Service’s extensive data collection systems. That body of information is first used to

estimate the costs for each subclass in the base year. Base year subclass costs, in

turn, are then employed in the rollforward process to derive estimates of subclass costs

in the test year. The testimonies and other documentation relating to each of these

portions of the subclass costing process are described below.

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The base year for costing purposes employed in this proceeding was FY 2005,

the most recent year for which an audited Cost and Revenue Analysis (CRA) report is

available. In presenting its base year costs, the Postal Service seeks to address two

distinct levels of subclass cost causation -- the causation of costs at the margin, and the

incremental costs caused by provision of the entire volume of a particular subclass or

service. This formulation of the subclass costing inquiry follows the economic structure

presented by Prof. Panzar in his testimony (USPS-T-11) in Docket No. R97-1, and is

consistent with the structure used by the Postal Service in that case and ever since.

Such an explicit economic structure was most recently endorsed by the Governors of

the Postal Service in their first Decision in Docket No. R2000-1, dated December 4,

2001.

In this proceeding, the causation of costs at the margin is reflected in the volume

variable subclass costs estimates provided by witness Milanovich in USPS-T-9.

Incremental cost estimates, on the other hand, are presented by witness Pifer in USPS-

T-18.1 In their exhibits and workpapers, both of these witnesses provide subclass

1 No intervenor witness presents any alternative estimation of incremental cost, or quantifies any proposes adjustments to witness Pifer’s estimates. On behalf of Valpak, however, Dr. Haldi describes at some length theories according to which he claims that some non-volume-variable setup and take-down costs in sorting operations may constitute incremental costs for certain classes of mail and other product categories. VP-T-2 at 39-47. As established in Dr. Bozzo’s rebuttal testimony, Dr. Haldi’s argument fails for several interrelated reasons. USPS-RT-5 at 5-11. First, the setup costs clearly are not volume-variable (i.e., “attributable” as marginal costs). Id. at 6-8. Second, a significant portion of the setup costs Dr. Haldi discusses cannot be assigned to any class of mail as incremental cost, and even those costs that may be class-specific are not, in general, the incremental costs of any subclass. Id. at 8-9. Thus, methods intended to distribute pools of volume-variable cost to subclasses in order to represent marginal costs will have little application to these non-volume-variable costs. Id. Finally, it should be noted that the Postal Service incremental cost model includes “inframarginal” variable costs, so the possibility that setup costs may represent costs

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information for the cost segments and components into which postal costs are

disaggregated. Their overall subclass results, by virtue of the cumulative process by

which they are constructed, incorporate both the effects of the base year input data

generated by the relevant upstream data collection systems, and the conclusions

reached by a substantial body of current and past research into the behavior of specific

cost segments and components. As discussed next, in their testimonies in this

proceeding, several witnesses sponsored those new analyses that caused the relatively

modest changes in the Postal Service’s base year costing methodologies.

Cost attribution witnesses focused on the variability and/or the distribution of the

costs in specific cost segments. As in the last case, witnesses Van-Ty-Smith (USPS-T-

11) and Bozzo (USPS-T-12, USPS-RT-5) address issues pertaining to mail processing

costs (C/S 3), as does witness Smith (USPS-T-13), who also discusses facility costs

(C/S 15). Witnesses Bradley (USPS-T-14, USPS-RT-4), Stevens (USPS-T-15), and

Kelley (USPS-T-30) discuss aspects of carrier costing, which involves C/S 6, C/S 7, and

C/S 10. Transportation costing (C/S 14) issues are primarily addressed by witnesses

Kelley (USPS-T-15), Nash (USPS-T-16), and Bradley (USPS-T-14). Witnesses Bradley

(USPS-T-17, USPS-RT-4), Nieto (USPS-T-24), and Kelley (USPS-RT-6) present and

defend an updated study of Window Service (C/S 3.2) variability.

In this case, to further aid the understanding of the operational networks across

which postal costs are incurred, the Postal Service expanded further the panel of that may vary with volume in some respects, but not “on the margin,” is already incorporated in the incremental cost estimates. Id. at 8. Dr. Haldi’s testimony thus lacks either practical or theoretical significance, and Mr. Pifer’s incremental cost estimates are the only appropriate measures presented on this record for the purposes of cross-subsidy tests.

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witnesses sharing their operational expertise. Consequently, witnesses McCrery

(USPS-T-42, USPS-RT-14), Oronzio (USPS-RT-15) and Laws (USPS-RT-16) present

testimony on various aspects of operation of the mail processing network, while witness

Hintenach (USPS-T-43) explains relevant operational developments concerning the

retail network. Witness Coombs (USPS-T-44) performs that role regarding the delivery

network, as does witness Pajunas (USPS-T-45) with respect to operation of the

transportation networks.

In developing this case, as with previous cases, the Postal Service starts with

base year costs and uses the rollforward process to estimate for the test year both total

accrued costs and costs by subclass. Witness Waterbury is the rollforward witness, and

the total accrued and subclass volume variable cost estimates presented in her

testimony (USPS-T-10) are developed, using essentially the same new software

platform that she successfully introduced in the last case, in a process that follows the

very familiar pattern of previous pieces of rollforward testimony.2 That is to say, various

factors are applied to the base year costs in order to arrive at estimated test year costs.

Those factors, which have remained unchanged for many years, are cost levels, mail

volumes, nonvolume workload, additional workdays, cost reduction programs, and other

programs. Also incorporated into the analysis are Workyear Mix Adjustments and Final

2 In the instance of incremental costs, witness Pifer actually provides both base year and test year incremental costs. In providing his test year estimates, however, he relies extensively on the same inputs as those used by witness Waterbury.

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Adjustments.3 As is customary, witness Waterbury provided test year costs on both a

before-rates (TYBR) and an after-rates (TYAR) basis.

Thus, in its case as filed, the Postal Service presents fully-integrated subclass

costs estimates for the test year based on the best information available at the time of

case preparation. As is often the case, those estimates reflected a wide variety of

management plans and programs intended to improve the performance of the Postal

Service moving into the future. Moreover, in both the before-rates and after-rates

versions, the estimates were predicated, obviously, on the levels of mail volume

anticipated under the current and proposed rate regimes. Witness O’Hara, the rate

policy witness (USPS-T-31), then used the test year cost estimates provided by

witnesses Waterbury and Pifer, in conjunction with the pricing criteria of the Act, to

support the rate levels proposed by the Postal Service and presented in his testimony.

The sections that follow discuss subclass costing issues as they relate to various

new or updated costing presentations involving specific types of costs. The

Commission should adopt the subclass costs proposed by the Postal Service. Many

aspects of the Base Year cost presentation appear to be acceptable to all parties and

have not been challenged. But to the extent that intervenor witnesses challenge certain

methodologies or results of the Postal Service’s subclass costing analyses, as

discussed below, those challenges should be rejected.

3 The Final Adjustments used by witness Waterbury come from witness Page (USPS-T-23).

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A. The Postal Service Cost Models Provide the Most Accurate Available

Estimates of Mail Processing Volume-Variable Costs and Should Be Accepted

The Postal Service provides accurate estimates of mail processing volume

variable costs, showing that such costs are not one hundred percent variable with

volume. Witnesses McCrery (USPS-T-42) and Bozzo (USPS-T-12) describe the

operational basis for the presence of non-volume-variable costs in sorting operations,

and the results of witness Bozzo’s model indicate their presence. Dr. Bozzo’s results

are confirmed by the results of different models used by witnesses Roberts and Neels

which, when properly implemented, also indicate the presence of non-volume-variable

costs in mail processing. The major results are summarized in the table below.

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Model Weighted Average Variability Bozzo, Postal Service BY 2005, USPS-T-12 at 3

0.85

Roberts (March 2006 model, letter and flat-shape operations), updated in USPS-T-12 at 104

0.852

Neels (UPS-T-1 model), applied to LDC 17, USPS-RT-5 at 42

0.84

Neels (UPS-T-1 model), applied to "whole plant," USPS-RT-5 at 42, 44

0.82/0.903

Elliott (MPA et al.-RT-2 at 6, 13), IOCS-based method including setup and take-down

0.92/0.944

Bozzo, IOCS-based method including setup, take-down, and container handing; USPS-T-12 at 80

0.88/0.875

Dr. Bozzo develops his model as follows. He, witness McCrery, and witness

Oronzio (USPS-RT-15) show that MODS total piece handling measures are related to

sorting operations costs, and Dr. Bozzo applies relevant economic theory to measuring

sorting operations costs by applying a standard microeconomic production framework to

model the actual structure of Postal Service mailflows. See Section 2, below. He uses

MODS data from actual postal mail processing operations to measure the associated

hours and workloads. Since these data contain errors routinely found in operating data,

witness Bozzo screens them to mitigate the effect of errors, providing a data set

appropriate to estimating mail processing cost variability, and otherwise selects

appropriate estimation techniques given the characteristics of the data. Processing the 2 Letter and flat sorting only. 3 First figure is LDCs 11-14 and 17 (NWRS workhours); second is MODS "function 1" hours (LDCs 10-18), including supervisory workhours. 4 First figure is sorting cost pools analyzed in USPS-T-12; second is all other operations. 5 First figure is letter sorting cost pools; second is flat sorting cost pools.

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data through his econometric model yields accurate mail processing volume variable

costs that should be accepted by the Commission. See Sections 3-4, below. In

addition, the record in this case indicates that the Postal Service's treatment of

"administrative" costs in mail processing cost pools is correct and should be adopted by

the Commission. See Section 5, below.

The costs are distributed to subclass using long-standing distribution key

methods, which now benefit from more accurate subclass identification in tallies

recorded with the redesigned IOCS data collection instrument. See Section 6, below.

1. The Postal Service mail processing methods are well-grounded in

the operational reality of sorting operations. Dr. Bozzo depicts the major mailflows within letter- and flat-shape operations and

describes a partition of the activities in the MODS sorting cost pools. He explains in

detail the connection between each activity, MODS total piece handling measures, and

other factors that determine costs and the activities that comprise the associated sorting

cost pools. USPS-T-12 at 11-20, 26-32. Witness McCrery describes how, given

network effects and related factors, the expected consequences of volume changes are

"less than proportionate" changes in mail processing workhours. USPS-T-42 at 34-40.

Witness Oronzio describes how the Postal Service employs its sorting operations during

high-volume periods and indicates that first-handling pieces (MODS FHP) data are

considered by operations experts to be less reliable than machine-counted total piece

handlings as indicators of sorting workloads. USPS-RT-15 at 10-13. Together, the

Postal Service witnesses provide a solid operational foundation for the Postal Service

modeling approach and results.

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a. The presence of non-volume-variable costs in sorting operations is consistent with the structure of operations.

Dr. Bozzo describes a partition of sorting cost pools into several constituent

activities, which he calls runtime, "quasi-allied labor," setup and take-down, waiting for

mail, "overhead" activities (breaks and clocking in or out), and other activities not

involving handling of mail. USPS-T-12 at 26. Using FY 2005 IOCS data, Dr. Bozzo

identifies the proportions of time for each activity in each of the cost pools covered by

the Postal Service volume-variability analysis. Runtime, the time spent sorting mail or

operating running sorting machinery (including feeding mail and sweeping mail during

the run) is, unsurprisingly, the main activity in all of the cost pools, accounting for nearly

two-thirds of time in letter- and flat-sorting operations.6 Among non-overhead activities,

"Quasi-allied labor" (container handlings and other handling of mail outside of runtime)

and setup and take-down time are of similar magnitudes in letter and flat sorting;

cancellation, manual parcel, and manual Priority Mail sorting involve relatively high

fractions of container handlings. Waiting time and other not-handling activities are

generally small fractions of sorting operations. Overhead activities comprise up to a fifth

of the operations' total workhours. USPS-T-12 at 27-32.

Of these activity categories, only waiting time traditionally has been classified as

non-volume-variable. However, setup and take-down time is as large as, or even

larger, than waiting time in all of the operations studied in Dr. Bozzo's analysis. Id. at

27. Witness McCrery builds on witness Kingsley's description of the "schemes effect" in

6 The structure of the IOCS questionnaire for cancellation operations is such that "runtime" of cancellation equipment is categorized as "other handling."

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Docket No. R2001-1, indicating that relatively few schemes are run on multiple sorters

and that, in most cases, it is "neither necessary nor desirable" to do so. Most schemes

are set up and taken down once a day, regardless of volume, and the associated costs

are therefore non-volume-variable.7 Rather, network-related factors that are largely

independent of volume determine the setup and take-down costs. USPS-T-42 at 36.

Operational considerations also suggest that the degree of variability of container

handlings will tend to be less than 100 percent. Witness McCrery observes that many

destinations receive one container per processing cycle, regardless of volume, so the

costs of handling the containers will vary little with routine changes in the volumes going

to those destinations. USPS-T-42 at 38, lines 29-31; USPS-T-12 at 29, lines 18-20.

While container operations are a relatively small fraction of letter- and flat-sorting

operations, they are much more prominent in parcel, Priority, and cancellation

operations that the Postal Service analysis shows (and systematically has shown) to

have lower-than-average variabilities. USPS-T-12 at 27. Witness McCrery's

observations also apply to setups, take-downs, and container movements in LDC 17

allied labor cost pools; in particular, allied labor operations by definition involve

considerably larger proportions of container handling time than sorting operations.

Thus, variabilities greatly exceeding 100 percent are extremely difficult to square

with operational considerations. As Witness McCrery states, "[F]ixed costs are not just

a theory debated among economists; they are a reality that we live with every day in our

distribution operations." USPS-T-42 at 39. Dr. Bozzo further notes that, while certain

setup costs may in principle respond to some volume changes, they do not vary with 7 Note that sweeping processed mail during the course of a scheme run is part of the "runtime," not the setup and take-down time. Tr. 35/12530, lines 4-6.

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volume changes on the margin and should not be classified as volume-variable costs.

Rather, they are more properly treated as "inframarginal" costs in the incremental cost

model. USPS-RT-5 at 6-7; Tr. 35/12398-9.

b. The number of sorts—measured by total piece handlings

(MODS TPF and TPH)—is the relevant "volume" for determining labor usage in sorting operations.

Dr. Bozzo notes that the runtime and quasi-allied labor activities both explicitly

depend on the cost pools' total piece handlings (MODS TPF, or TPH for manual

operations). USPS-T-12 at 28-29. By definition, TPF and TPH count the number of

sorts carried out (or attempted) in the sorting operations, and there is by necessity a

direct engineering relationship between runtime and total piece handlings measures. Id.

at 28. In machine-paced (constant throughput) operations, Dr. Bozzo shows that

runtime is, in fact, 100 percent variable with TPF. Id., lines 8-10. Likewise, the relevant

volumes for determining "quasi-allied labor" are also total handlings, since each piece

must be brought to and taken from a sorting operation once per sort. Id. at 29, lines 14-

17. Dr. Bozzo's analysis of IOCS data shows runtime and quasi-allied labor activities to

constitute 70 percent of time in letter-sorting cost pools and 72 percent in flat-sorting

cost pools. USPS-T-12 at 27. This is the vast majority of non-overhead time in the

sorting cost pools. Consequently, there is little avenue for other cost pools' workloads

to affect labor requirements in the sorting cost pools.

Most of the remaining non-overhead time is in activities that have little relation to

volumes of any sort, including setup and take-down activities, waiting time, and small

fractions of time spent in other activities, such as incidental "administrative" work.

USPS-T-12 at 30-31.

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Insofar as sorting operations' direct labor consists of activities which either have

a strong engineering relationship with total piece handlings (by far the largest part) and

those which are driven by network and other non-volume factors, it follows that "within-

operation sorting volumes [TPF or TPH] should be the primary if not the exclusive

volume-related factors determining sorting operations' workhours." USPS-T-12 at 94,

lines 4-5. As is discussed further below, Dr. Bozzo did not merely assume the absence

of cross-effects from other cost pools' workloads, despite the strong prior case against

them, but also tested for cross-effects, and found no evidence of large or statistically

significant effects. Id. at 93-95.

c. Substitution of manual for automated processing is rare and

becoming rarer. The Postal Service's automated letter and flat sorting equipment can sort pieces

at much lower cost than manual operations, so "mail is directed to sorting operations on

the basis of physical characteristics, most significantly automation compatibility and [for

letters] barcode presence." USPS-T-12 at 14. Witness McCrery notes that manual

processing in plants is generally limited to physically nonmachinable pieces and

machine rejects. USPS-T-42 at 11-12, 19. Witness Oronzio further describes that

Postal Service operating procedures seek to minimize the need for manual processing

of machinable pieces, and notes that seasonal fluctuations in manual operations' usage

depends primarily on seasonal variations in mail characteristics rather than volume per

se. USPS-RT-15 at 12; Tr. 36/12294-12297.

As most letter- and flat-shape mail is automation compatible, the vast majority of

sorts are carried out on automation. In BY 2005, mail processing facilities carried out

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364.0 billion letter sorts (MODS TPH) on automation, versus 13.7 billion manual letter

sorts (96.4 percent automation); in flats, there were 32.9 billion automated sorts versus

6.9 billion manual sorts (82.7 percent automation). Tr. 10/2568, 2570, 2573. While

automated and manual processing technically may be substitutable to some extent,

manual and automated processing actually are not close economic substitutes. As

should be obvious, directing even small fractions of automatable mail to manual would

vastly increase the Postal Service's costs, and thus not constitute a good use of

managerial "discretion." Thus, "manual sorting is not… an economical substitute for

automated sorting when the latter is technically feasible." USPS-T-12 at 22.

d. The operational analysis points directly to the main features

of the Postal Service analysis. The major features of the Postal Service variability analysis are clear from the

operational analysis. First and foremost, the analysis clearly points to the existence of

non-volume-variable costs. The network-related factors that bring about the non-

volume-variable costs, as well as other cost-causing factors such as facility layouts, will

tend to be idiosyncratic to plants and therefore require that site-specific factors be taken

into account in the analysis, hence the fixed-effects econometric model. The

engineering relationship between sorting workhours and workloads indicates that total

piece handlings are the appropriate characterization of sorting operations' "output," and

imply limited roles for other operations' handlings in determining labor requirements.

Finally, the cost differentials between automated and manual sorting technologies is

such that intervenor theories that posit widespread substitution of manual for automated

processing as a justification of increased variabilities are not defensible.

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2. Postal Service methods correctly apply economic theory to the

measurement of sorting operations' costs.

a. The Postal Service models are motivated from a standard microeconomic production framework.

Dr. Bozzo's testimony describes in detail the links between his estimated labor

demand equations and the product transformation function from economic cost theory.8

In this model, mail processing plants produce sorts and other handlings (i.e., handlings

in cost pools not covered by Dr. Bozzo's models) which, under the Postal Service's

operating plan, are "intermediate" outputs used in the Postal Service's "final outputs,"

which are RPW-type end-to-end volumes (sometimes referred to by intervenors as

"delivered pieces"). USPS-T-12 at 48-49.

The most general form of Dr. Bozzo's product transformation function (Id. at 48,

equation 12) makes no specific assumptions on the structure of sorting operations, but

warrants imposing additional structure. In particular, certain labor and capital inputs

clearly produce some sorts, but not others. As Dr. Bozzo notes, committing labor to one

sorting operation implies the labor is unavailable to sort mail in other operations: for

example, the labor of a clerk "feeding mail at a BCS does not (indeed cannot)

simultaneously sort mail at a manual case." Id. at 49; see also USPS-T-12 at 21-23.

Thus, manual sorts properly are not considered outputs of automated operations, and

vice-versa. The cost pool-level production functions, specifying the sorts carried out in

the pools as "outputs," appropriately reflect the non-joint nature of the inputs and sorting

8 Product transformation functions are generalizations of production functions for production processes with multiple outputs.

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outputs. Using operation-level piece handlings as the explanatory variables in the

empirical labor demand functions follows from the operation-level production functions.

b. The Postal Service model correctly applies the distribution

key method, which is appropriate and necessary to measure subclass volume-variable costs.

i. The distribution key method has long been shown to be an appropriate, feasible method for calculating subclass costs.

The Postal Service method for calculating volume-variable costs by subclass is

an example of the "volume-variability/distribution key" cost method ("distribution key"

method for short). See USPS-LR-L-1, Appendix H. Witness Van-Ty-Smith determines

the total cost associated with each mail processing cost pool using a combination of pay

data, compensation amounts from the Postal Service's general ledger, MODS

workhours, and IOCS tally data. USPS-T-11 at 7. Dr. Bozzo estimates cost elasticities

for a group of sorting operations (and cancellation) and recommends application of the

sorting operation average to other cost pools. USPS-T-12 at 3. The products of the

total costs by cost pool and the associated volume-variability factors are the volume-

variable costs to be distributed. The costs are then distributed to subclass using IOCS-

based distribution keys calculated by witness Van-Ty-Smith. USPS-T-11 at 7; USPS-T-

12 at 33-35. This method yields volume-variable costs that, when unitized, approximate

the correct (but unobservable) marginal costs by subclass.9 USPS-T-12 at 34. The

9 The approximation is exact when the "cost driver" is a linear function of volumes. Dr. Bozzo shows that, given an "operating plan" of the Postal Service, this is approximately true. The "constructed marginal cost" method of estimating volume-variable costs directly using subclass volumes is infeasible. USPS-T-12 at 34.

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Commission's accepted cost method employs the 100 percent variability assumption10

in lieu of econometric variabilities and modifies witness Van-Ty-Smith's cost pool and

distribution key calculations, but conceptually is similar.

Because it constitutes a mathematical approximation to the correct marginal

costs, use of the distribution key method should not be controversial. Indeed, as Dr.

Bozzo notes, the distribution key method as a general approach to computing economic

costs was validated by the Data Quality Study (DQS),11 which concluded:

The Postal Service uses an economically sound approach grounded in activity based

concepts to determine its sub-class unit volume variable costs (UVVCs) on which Postal

Rates are based. The categories of data collected and analyzed are sufficiently

detailed and appropriate to arrive at the sub-class UVVCs. (USPS-RT-5 at 63, Tr.

35/12455, quoting Data Quality Study, Technical Report #1: Economic Analysis of Data

Quality Issues at 32.)

ii. No intervenor proposal offers an alternative to the distribution key method.

The most obvious sign of the emptiness of intervenor critiques of the distribution

key method is indicated by the critics themselves. Dr. Neels and Prof. Roberts actually

employ the distribution key method in the methods they advocate for calculating 10 In the "100 percent variability" method employed by the Commission, certain activities as indicated in IOCS are considered "fixed" costs. For the sorting cost pools under consideration, the implicit variabilities under the Commission method range from 95 percent to 99 percent. USPS-T-12 at 126. 11 The DQS did not address specific elasticity methods, though its authors did encourage replacing the 100 percent variability assumption with empirical elasticities. See, e.g., Summary Report, at 76; Technical Report #4, at 41-42. Dr. Bozzo discusses the Postal Service response to the Study's recommendations related to the IOCS-based mail processing distribution keys in USPS-T-46 at 4-10.

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subclass volume-variable costs. USPS-RT-5 at 62, Tr. 35/12454. Dr. Bozzo recounts

that in Docket No. R2000-1, Dr. Neels criticized the method even as he and UPS

witness Sellick advocated an implementation of the distribution key method using the

Postal Service's MODS and IOCS-based cost pools and distribution keys in conjunction

with the 100 percent variability assumption. USPS-RT-5 at 62. Prof. Roberts, likewise,

describes a distribution key method for computing subclass costs using his model,

complete with an untested "proportionality assumption" between FHP and RPW

volumes needed to equate the computed unit volume-variable cost with the

"constructed" marginal cost. Id. at 62-63; 69-70.

At such future time as an actual example of the "constructed marginal cost"

method for estimating subclass volume-variable costs is proffered, it would be

appropriate for the Commission to consider the practical merits and demerits of that

approach against the distribution key method. Presently, all of the competing volume-

variable cost methods, including the Commission's accepted method, are examples of

the distribution key method. Criticisms of the distribution key method, both as per se

inappropriate, and as failing specific assumptions, are misguided at best. Subject to

appropriate methodological choices in the details, the distribution key method should be

recognized as a valid approach to approximating the correct marginal costs.

iii. Prof. Roberts mischaracterizes the "proportionality

assumption" embodied in the distribution key method, and does not find legitimate evidence of its failure.

Prof. Roberts introduces his analysis purporting to show failure of the

"proportionality assumption" by asserting that the Postal Service models assume "that

the aggregate output in each operation, TPF, is used in a fixed proportion to the volume

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of mail in the plant." OCA-T-1 at 9, emphasis added. Prof. Roberts's claim is

fundamentally erroneous in that he specifies the wrong volume concept: the

"proportionality assumption" is made explicitly with respect to subclass RPW volumes

(i.e., the "final outputs" of the Postal Service), not the "volume of mail in the plant."

USPS-T-12 at 105-106, 33-34.

The "proportionality assumption" controversy arose from Dr. Neels's critiques in

Docket No. R97-1 that the Postal Service methods failed to determine the relationship

between costs and delivered volumes. See, e.g., Docket No. R2000-1, UPS-T-1 at 31;

USPS-RT-6 at 12-13. As a theoretical matter, Dr. Neels's criticism was inappropriate,

as the express purpose of the distribution key method is to provide a valid

approximation to marginal (unit volume-variable) costs when it is not possible to

estimate marginal costs directly from subclass volumes. USPS-LR-L-1, App. H., at H-3.

The approximation (the "assumption") is exact when the cost drivers are linear functions

of subclass volumes. Id. at H-5; see also USPS-T-12 at 107. (That this approximation

method is unobjectionable is key to the DQS assessment of the approach, quoted

above.) While the key results were published in 1993,12 Prof. Roberts goes so far as to

deny that the "proportionality" in the distribution key method is with respect to RPW

volumes. Tr. 23/8293.

Prof. Roberts's views on the relationship between MODS workloads and RPW

volumes are not reliable. Prof. Roberts claimed that equations in USPS-T-12

(equations 8 and 9, at pages 45-46), separately specifying relationships between TPF 12 Michael D. Bradley, Jeff Colvin, and Marc A. Smith, "Measuring Product Costs for Ratemaking: The United States Postal Service," in Regulation and the Evolving Nature of Postal and Delivery Services, ed. M.A. Crew and P.R. Kleindorfer (Kluwer Academic Publishers, 1993).

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and RPW volumes and between FHP and RPW volumes, were "not correct" because

Prof. Roberts does "not use piece handlings." Tr. 23/8293. Prof. Roberts subsequently

agreed that, to calculate volume-variable costs as he proposed, an assumed

relationship between FHP and RPW volumes was, in fact, required. Tr. 23/8429-8432.

Asked to contrast the FHP and RPW volume concepts, Prof. Roberts manages to both

incorrectly define FHP (which he calls the "volume of mail in each processing plant"

rather than the correct "number of pieces sorted in each processing plant") and also to

fail to note that ODIS-RPW destinating volumes may include mail that bypasses the

plant. Response to USPS/OCA-T1-4(b), Tr. 23/8293. Later, asked to provide his own

views on the relationship between FHP and RPW volumes (to determine whether they

actually differed from Dr. Bozzo's equation), Prof. Roberts disclaimed sufficient

knowledge of RPW volume methodology, even to state a relationship between volumes

and FHP, except for the trivial case of volumes that totally bypass mail processing. Tr.

23/8340-8341. Being unable to make reliable basic definitional statements regarding

the volume and workload concepts under discussion, Prof. Roberts is unable to

disagree authoritatively with Dr. Bozzo on the relationship between MODS workloads

and mail volumes.

Nor is Prof. Roberts's critique valid even as a redefinition of the "proportionality

assumption." In Docket No. R2000-1, Dr. Neels purported to show a failure of

"proportionality" based on estimates of the relationships between total piece handlings

and first handling pieces. In addition to demonstrating econometric flaws in Dr. Neels's

analysis, Dr. Bozzo demonstrated that a TPF-FHP "proportionality" adjustment was

irrelevant. Based on that analysis, Dr. Bozzo shows mathematically that any TPF-FHP

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disproportionality must be cancelled out (to a first approximation) by an offsetting FHP-

volume effect. USPS-T-12 at 107-108. The latter effect is unmeasured by Prof.

Roberts. Tr. 23/8325-8327, 8331. As such, Prof. Roberts's analysis is simply a rehash

of Dr. Neels's discredited analysis.

Finally, Prof. Roberts's econometric analysis of the relationship is deficient.

USPS-RT-5 at 63-68. This subject is discussed further in section 4(a)(v), below.

3. The Postal Service variability models use appropriate and reliable

data and estimation methods.

a. The MODS data are suitable for estimating mail processing variabilities.

i. MODS directly measures hours and workloads from

actual operations on a continuous basis. MODS is an operating data system that partitions plant operations and records

workhours and, where possible, workloads for those operations. For sorting operations,

the workload measures are counts of pieces receiving a first sort in the plant ("first

handling pieces," or FHP), counts of the number of successful sorts ("total piece

handlings," or TPH), and the number of attempted sorts ("total pieces fed," or TPF,

recorded for automated and mechanized operations only). See USPS-T-12 at 23-25.

These data have the advantage of being collected directly from operations every day,

around the clock, at hundreds of mail processing facilities. MODS data, therefore,

provide a rich data set covering many more sites over much longer time periods than

would be available from special studies of operations. The "cost" is that as MODS is a

tool designed for local management use, care must be taken in developing econometric

analysis based on MODS data. Given appropriate choice of econometric techniques,

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there is no fundamental obstacle to employing the MODS data to model mail

processing, and indeed Dr. Bozzo and – in a milestone for the mail processing analysis

– Prof. Roberts both are able to recommend econometric results based on the MODS

data. OCA-T-1 at 2; Tr. 23/8300-8301. Even Dr. Neels advances (but does not exactly

recommend) an analysis of MODS data as constituting "new evidence" on mail

processing variability, despite his criticisms13 of MODS data quality. UPS-T-1 at 49-54.

ii. MODS data issues are routine for operating data, and

permit the construction of data sets sufficient for estimation purposes.

MODS, like any data system, is not perfect. MODS data are subject to several

well-known error processes, including measurement error in the FHP conversion

process (and the associated manual TPH), errors in the 3-digit operations to which data

are recorded, and data transmission and aggregation errors. These have been

acknowledged since the Postal Service began presenting econometric analysis of

MODS data in Docket No. R97-1. See, e.g., Docket No. R97-1, USPS-T-14 at 27-33.

Many of the analytically relevant errors can be corrected or eliminated in the

process of constructing the estimation data sets. Combining 3-digit MODS operations

into analytically relevant cost pools, for instance, corrects situations where data are

recorded to operation A instead of to operation B within the same cost pool. Response

to USPS/UPS-T1-11(e) Tr. 23/8484-8485. Indeed, Dr. Bozzo reports a specific

anomaly in certain data for BCS operations that is corrected by pooling. USPS-T-12 at

50; USPS-RT-5 at 24-26, Tr. 36/12416-12418. Clearly erroneous observations not

corrected by pooling can be, and should be, eliminated by appropriately chosen 13 Which, as will be discussed below, are greatly overstated.

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screens. USPS-T-12 at 63; OCA-T-1 at 18. Finally, errors that are inherent in the data,

such as conversion error in FHP and manual TPH data, should be addressed by

appropriate estimation techniques. USPS-T-12 at 51.

Dr. Bozzo, synthesizing past intervenor and Commission critiques, concludes

that a reasonable screening philosophy is to eliminate obvious errors from the

estimating data sets while treading lightly on data that are merely anomalous. USPS-

RT-5 at 21, Tr. 36/12413. Indeed, he directly addressed the tensions in regression

sample selection in describing the screening approach in the Postal Service models,

which uses operational information to identify clearly invalid observations, while seeking

to avoid inconsistency due to sample truncation. USPS-T-12 at 63-64.

iii. The Postal Service analysis makes appropriate use of

other data sources needed for the mail processing models.

Fully specifying labor demand equations for mail processing operations requires

data from sources other than MODS. The Postal Service models incorporate data from

a number of data systems to construct variables representing delivery network

characteristics, capital input, and hourly labor rates. Additionally, variables not used

directly in the model, but used as instrumental variables, are included in the data sets.

USPS-T-12 at 55-63. Dr. Neels and Prof. Roberts also employ certain of these data in

their models.14

The main controversy regarding the data from sources other than MODS

concerns the equipment inventory data used to construct capital input variables. In his

14 Dr. Neels omits capital variables from his model; Prof. Roberts does not include delivery network variables.

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March 2006 paper, Prof. Roberts noted apparent lags between the commencement of

operations as indicated by the MODS data and the appearance of related equipment in

the inventory data. This particularly affects the AFSM 100 operation, which involved the

major equipment deployment over the period under study. Prior to the filing of this rate

case, Dr. Bozzo initiated an investigation of the timing issue, and found that there was

some lag between equipment installation and reporting to the relevant databases, but

that the timing issue could be mitigated to a significant extent by increasing the

frequency with which the inventory data are checked for new equipment. USPS-T-12 at

100. While Prof. Roberts seemed to find this solution unsatisfactory, even though his

method omits observations from operations' start-up and wind-down periods from the

regression samples for other reasons (Tr. 23/8370-8372), Dr. Bozzo notes that a

comprehensive solution may be obtained (at some one-time processing cost) by

employing equipment deployment schedules to determine the actual installation timing.

USPS-RT-5 at 56, Tr. 36/12448.

iv. Dr. Neels's analysis of MODS data quality issues is error-plagued, misstates the true data quality issues, and should be rejected.

Dr. Neels presents a variety of analyses in which he claims to demonstrate the

presence of serious errors in the MODS data. This includes a comparison of IOCS

activity data with the MODS operations recorded on IOCS tallies, tables listing

observations from the MODS data set exhibiting "data errors," and tabulations indicating

effects of various claimed errors on sample sizes by operation. UPS-T-1 at 12-23.

However, a variety of failings lead Dr. Neels's analysis to greatly overstate the extent

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and seriousness of MODS data issues. More than a little ironically—given Dr. Neels's

original criticisms of Prof. Bradley for applying "excessive" screens in Docket No. R97-1,

coupled with his accompanying contention that anomalous data may contain the most

information of greatest interest (Docket No. R97-1, UPS-T-1 at 27)—Dr. Neels's

analysis fails by its absence of any signs of efforts to distinguish analytically significant

errors in the estimating data sets from mere anomalies that may either be quantitatively

insignificant or even correctable by proper data handling. A variety of other definitional

errors also serve to inflate the appearance of errors in Dr. Neels's account. USPS-RT-5

at 12-28. Accordingly, the Commission should accept the recommendation of Prof.

Greene from Docket No. R2000-1 that researchers should focus on extracting useful

information out of MODS, rather than simply seeking to discredit the data. Docket No.

R2000-1, USPS-RT-7 at 5-6. In this proceeding, while Prof. Roberts does not go so far

as to endorse Prof. Greene's recommendation (Tr. 23/8375), Prof. Roberts evidently

does not view MODS data issues as fundamental obstacles to recommending MODS-

based econometric results to the Commission.

Dr. Neels's analysis purporting to show serious misclocking problems in MODS

sorting operations suffers from major conceptual and technical errors, which when

resolved show MODS and IOCS activities to be substantially in agreement. Dr. Neels's

intent was to match IOCS activities with the MODS operation groups defined for Dr.

Bozzo's econometric analysis, but Dr. Neels inappropriately omitted several significant

operations15 such that they were misclassified as potential clocking errors when the

15 Mail processing barcode sorter (MPBCS) operations in the D/BCS operation groups; linear integrated package sorter (LIPS) operations in the SPBS operation groups, and cancellation "allied labor" operations. Tr. 23/8470-8471.

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IOCS and MODS operations actually were consistent. USPS-RT-5 at 12-13, Tr.

36/12404-12405. Dr. Neels also presented the results of his data so as to

inappropriately imply that certain overheads and other activities that are part of sorting

operations were indicative of misclocking. Id. at 13. Incorporating the technical

corrections mentioned above, Dr. Bozzo shows that, for the sorting cost pools, the IOCS

and MODS activities are fully consistent for 93 percent of weighted tallies, and a

majority of the remaining tallies are in related sorting activities. Id. at 14. Given that

any inaccuracies in either system would contribute to the relatively small proportion of

anomalous observations, the correct conclusion is that the systems are substantially

consistent. Id. at 15.

Dr. Neels's analysis of the MODS data set fares little better than his IOCS

analysis. Taken at face value, Dr. Neels's analysis would suggest that the MODS data

for manual sorting data are better than that for automated operations. UPS-T-1 at 22-

23; USPS-RT-5 at 20. As witness Oronzio testifies, that is contrary to the experience of

Postal Service operations experts and field managers, who regard FHP and other

volumes subject to conversions as less reliable than machine counted data. USPS-RT-

15 at 12-13. Dr. Neels achieves the result in large part by identifying as "anomalous"

observations in which FHP exceeds TPH and/or TPF, which he claims should not occur

by definition. However, as Dr. Bozzo and Prof. Roberts both note, the combination of

independent measurement methods for FHP and automated TPF (and TPH) and

measurement error in FHP means that the definitional relationship Dr. Neels imposes

need not hold in practice. USPS-RT-5 at 22; Tr. 23/8326. Comparing automated FHP

to TPF cannot, in itself, discern whether there is any error in either variable other than

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the conversion error, and Dr. Neels performed no analysis to determine whether the

"anomalies" actually represented errors. USPS-RT-5 at 22-23; Tr. 23/8473-8474. And,

perversely, this criterion would tend to identify more errors in cases where FHP and

TPF (or TPH) were close in principle, and hence where the FHP-TPF anomaly could

result from relatively small FHP measurement errors. USPS-RT-5 at 23. The

independent measurement methods for FHP and automated operations' TPF and TPH

imply that the magnitudes of FHP errors are irrelevant to evaluating the quality of the

machine-counted piece handling data used in the Postal Service models. Id. Indeed,

the relevance of FHP errors generally is questionable given that the instrumental

variable procedures are specifically intended to be robust to the FHP measurement

process. Id. at 27-28.

Dr. Neels identifies additional MODS data anomalies without due regard to

whether the issues in question are relevant for estimation purposes. Dr. Neels screens

for errors below the cost pool level defeating, at least to some extent, the purpose of

pooling MODS operations. In some such cases, Dr. Bozzo had indicated specifically

that investigation of the anomalies in question had revealed that the errors were

amenable to correction by pooling (i.e., the data were booked to operaton A instead of

operation B in the same pool). USPS-RT-5 at 24-26. Dr. Neels included the effects of

screens for any errors in the weekly data in his assessment of the quarterly

observations in the MODS data set, even though the weekly observations are small

relative to the quarterly data (about 1/13th, on average), and theory indicates that

relatively small measurement errors are less likely to have material consequences for

estimation. Id. at 26-27. He also employed screening procedures designed to identify

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anomalies in cost pool-level TPF and TPH (via TPF/TPH productivity screens) in his

alternative "plant-level" model even though his explanatory variables were shape-level

FHP. UPS-T-1 at 51-52. Given the aforementioned differences in measurement

methods and volume concepts, Dr. Neels's screening procedures stand in sharp

contrast to Prof. Roberts's approach, which actually sought to identify actual errors in

the FHP and workhour data entering Prof. Roberts's labor demand models. Tr.

23/8370-8372.16

The general impression of Dr. Neels's review of the MODS data is that he was

driven to identify any and all anomalies without regard to whether they posed any

analytically significant problems. The criteria Dr. Neels employed to assess MODS data

quality in this proceeding are, indeed, excessive and inappropriate by the terms Dr.

Neels himself established in Docket No. R97-1.

b. There is no dispute in this proceeding that panel data

methods are appropriate for mail processing variability estimation.

Another milestone reached in this proceeding is that there is no significant

dispute among the Postal Service and intervenor experts over the use of the panel

data/fixed effects econometric model, a major source of controversy in the R97-1 and

R2000-1 rate cases. Prof. Bradley and Dr. Bozzo have consistently maintained that the

panel data/fixed effects approach is appropriate; standard statistical test results have

just as consistently supported their positions. See, e.g., USPS-T-12 at 73-74.

In Docket No. R2000-1, the noted econometrician Prof. William Greene testified: 16 It would be helpful to other researchers, however, if Prof. Roberts systematized his screening procedures; it is difficult to discern exactly what Prof. Roberts found to be wrong about the data he eliminates in some cases.

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The Commission should have taken a much more favorable view [of the fixed effects

model] in 1997, and should at this time consider the panel data, fixed effects form of

econometric analysis an appropriate platform for continuing work on developing a model

for mail processing costs. (Docket No. R2000-1, USPS-RT-7 at 5, quoted at Tr.

23/8376.)

Prof. Roberts, who has also consistently employed panel data/fixed effects

models within his framework, expressly agrees with Prof. Greene. Tr. 23/8376. Dr.

Neels's alternative model also employs the panel data/fixed effects estimation method.

UPS-T-1 at 52. Given the absence of dispute regarding the appropriate estimation

framework, the Commission should, at a minimum, adopt Prof. Green's

recommendation that future analysis of mail processing costs employ the panel data

methods that have been consistently supported by econometric theory and specification

test results.

c. The Postal Service models produce robust results using

consistently-applied methods. The Postal Service's mail processing models have employed consistent methods

for BY 2004 and BY 2005, and as Dr. Neels observes, have consequently produced

results that are "substantially the same" for the two years. UPS-T-1 at 9; USPS-RT-5 at

28, Tr. 35/12420. While Dr. Neels may not intend a compliment, consistent results from

consistent methodology – well-grounded operationally and econometrically – implies

robustness of the results, and that normally is desirable.

Dr. Neels cannot be accused of consistency in his approaches to mail processing

modeling. While in this proceeding Dr. Neels has not tried to buck standard

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econometric practice and employed a panel data econometric method (albeit one that is

badly flawed as he implements it), he attempts the feat of trying to prop up his previous,

incommensurable, and demonstrably inappropriate modeling approaches from the R97-

1 and R2000-1 rate cases. Tr. 23/8502-8503.

Prof. Roberts's major model changes, for the most part, have represented

evolutionary changes within a consistent framework. Nevertheless, were Prof. Roberts

trying to show that his models are unstable and unreliable, the double-digit changes

between his March 2006 results and the OCA-T-1 recommendations would accomplish

the goal in impressive fashion. However, as discussed below, Prof. Roberts's update

incorporated a major specification error, among other unjustified changes; subject to the

well-justified updates carried out by Dr. Bozzo, Prof. Roberts's two-output models yield

relatively stable results. USPS-RT-5 at 48-59, Tr. 36/12440-12451.

d. The Postal Service translog/GLS model is the superior

option for automated operations.

i. The Postal Service models make appropriate use of machine-counted workloads.

Total piece handlings (MODS TPF and TPH) in automated operations are directly

measured from machine counts of pieces. USPS-T-12 at 23-26. Thus, in contrast with

FHP and manual TPH variables, automated total piece handlings are not subject to the

process of converting weight to pieces or to the resulting measurement error. As a

result, it is not necessary to employ instrumental variables methods to address errors-

in-variables issues with the automated TPF. Id. at 87-88. Nor, as discussed in Section

1 (above), is there a prior operational reason to believe that total piece handlings are

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"endogenous" because plant managers use their "discretion" to decide the processing

paths for pieces in any significant way. Thus, the Postal Service models can use the

flexible translog functional form while providing estimates that are efficient relative to

instrumental variables estimates using simpler log-linear specifications.

ii. Cross-operation effects have been shown to be

negligible. The operational structure of sorting operations provides little reason to expect

significant cross-operation effects—i.e., where costs one operation are affected by

sorting workload in another operation—as discussed above. Nevertheless, Dr. Bozzo

checked for the presence of cross-effects in automated letter and flat-sorting operations.

USPS-T-12 at 93-95. The estimated cross-effects uniformly are small and statistically

are insignificant in seven out of the eight cases, supporting the operational analysis that

within-operation TPF are the relevant explanatory variables for sorting operations'

workhours. Id.

Dr. Bozzo also investigated the presence of cross-operation and cross-shape

effects in the context of the alternative models advanced by Dr. Neels and Prof.

Roberts. Dr. Neels claims that there may be, contrary to the Postal Service operational

analysis, substantial cross-operation and even cross-shape effects in sorting operations'

workhours. UPS-T-1 at 49-50. Dr. Neels had, further, attempted to describe

mechanisms by which such effects might arise. Tr. 23/8457-8460. However, the cross-

effects he describes are minor in principle and, more significantly, are absent from the

data. USPS-T-12 at 93-95; USPS-RT-5 at 37-40, Tr. 36/12429-32.

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That cross-operation effects are negligible within shapes had already been

addressed by Dr. Bozzo, as described above, and Dr. Neels conspicuously failed to

investigate model specifications that might have explicitly demonstrated such effects.

USPS-RT-5 at 39, Tr. 36/12431. Dr. Bozzo estimated a letter-shape version of Dr.

Neels's model showing no effect of non-letter FHP on letter-shape sorting operations'

workhours, contrary to Dr. Neels's claimed suspicions. Id at 40, Tr. 36/12432. The

empirical result is consistent with the treatment of the shape-based mailstreams as

analytically separate in the Postal Service and OCA models.

Similarly, Dr. Bozzo's investigation of Prof. Roberts's models with additional FHP

"outputs" shows the expected result that manual volumes – which do not flow to

automated processing – have no statistically significant effect on automated operation

workhours, though at a considerable efficiency cost relative to the translog/GLS models

using machine-counted piece handlings. Id. at 60-61, Tr. 35/12452-3. Both operational

considerations and the empirical results support the long-held Postal Service position

that within-operation total piece handlings (MODS TPF) are the correct output variables

for automated operations.

iii. There is no evidence of "attenuation" of the

automated operations' elasticity estimates. Dr. Bozzo likewise investigated instrumental variables formulations of the labor

demand models for automated operations, rather than simply assuming an absence of

bias in the translog models. USPS-T-12 at 87-89. The results show no systematic

direction to the differences between the results at the cost pool level, while the weighted

average elasticities are barely different – 0.88 for the translog method, 0.89 for

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instrumental variables.17 However, the individual instrumental variables elasticities have

considerably larger standard errors. Id. at 88. Dr. Bozzo notes that it is undesirable to

choose a statistically inefficient estimation method such as instrumental variables based

on differences in the details that may largely relate to increased sampling variability.

Moreover, he notes that extremes – low as well as high – of the cost pool-level

instrumental variables elasticities are difficult to square with operational considerations.

Id. Thus, the more statistically efficient and more plausible translog results are

preferable. Id. at 89.

e. Instrumental variables estimation is appropriate for

operations where MODS workloads are subject to conversion error.

i. Measurement processes for manual piece handlings

(and FHP in general) are distinct from automated operations' machine TPF and TPH counts.

In contrast to automated operations' machine counts of sorted pieces for total

piece handlings (TPF and TPH), manual TPH—and FHP in all operations—employ

conversion methods rather than exact piece counts. For letter- and flat-shape

operations, mail is weighed and the weight of mail is converted to pieces according to

national conversion factors that vary by the mail's "source/type" code. Parcel and

Priority Mail operations involve conversions of container counts to pieces. Tr. 10/2559-

17 Prof. Roberts estimates an alternative set of instrumental variables models using TPF, which while labeled "USPS Model" is actually a separate implementation devised by Prof. Roberts, and finds qualitatively similar results. OCA-T-1 at 13 (Table 1, column "USPS Model"); Tr. 23/8302-8304.

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2561; MODS Handbook M-32, section 2-2.2.1 (filed as USPS-LR-L-150). Witness

Oronzio reports that the Postal Service is "experimenting with methods to eliminate

weighing in the computation of FHP" (USPS-RT-15 at 13). However, in general,

analysis of manual TPH data and all FHP data must allow for the presence of

conversion error in the data.

ii. The appropriate response to conversion error in

manual workloads is to use "robust" instrumental variable estimation techniques.

Since all manual piece handling (FHP and TPH) data will depend to some extent

on conversions of weight or (for parcels) containers to piece counts, it is not possible—

in contrast to automated operations—to eliminate the analytically relevant errors in

manual piece handlings by screening out specific observations with errors.

Consequently, the Postal Service models for manual operations employ instrumental

variable estimators to obtain statistically consistent elasticity estimates in the presence

of measurement error. USPS-T-12 at 51; see also Docket No. R2005-1, USPS-T-12 at

26-27. Dr. Neels and Prof. Roberts both employ related instrumental variable

estimation methods to deal with the presence of measurement error in the FHP

variables used as "outputs" in their respective models. OCA-T-1 at 3; UPS-T-1 at 52.

Thus, there is no significant disagreement over the use of instrumental variable

methods where needed to address measurement error issues.

iii. The simpler log-linear specifications for the

instrumental variable models are appropriate. The instrumental variable models estimated by Dr. Bozzo, Dr. Neels, and Prof.

Roberts all employ estimating equations that are log-linear in hours and "outputs."

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USPS-T-12 at 51; Tr. 23/8467 (Neels); Tr. 23/8328 (Roberts). While the models differ in

many details, the functional form of the equations in this broader regard is justifiable and

has not been (and should not be) a matter of significant controversy. Dr. Bozzo noted in

Docket No. R2005-1, "Selection of instrumental variables for higher-order and

interaction terms of output is not a trivial matter… loss of the translog form's improved

approximation properties is likely to be less important than obtaining variabilities that are

robust to the measurement error problem." Docket No. R2005-1, USPS-T-12 at 30,

cited at Docket No. R2006-1, USPS-T-12 at 51.

iv. The Postal Service models successfully eliminate

measurement error bias. Comparing his recommended instrumental variable models to alternative GLS

models, Dr. Bozzo concludes that the instrumental variable procedure is warranted for

manual operations, and that the procedure is successful in addressing attenuation of

the elasticities due to measurement error. USPS-T-12 at 86-87.

Dr. Neels presented a table in which he purported to show that "weak

instruments" issues with the Postal Service models may result in significant bias despite

the use of instrumental variables methods. UPS-T-1 at 30. Dr. Neels's "analysis" is

unfounded and must be rejected. While Dr. Neels had cited a well-known paper on the

"weak instruments" problem in his testimony, he admitted that his conclusion that the

Postal Service models could be biased was not based on any formal statistical test. Tr.

23/8486. Accordingly, as Dr. Bozzo states, "it is impossible to evaluate whether the

criteria Dr. Neels employed are valid." USPS-RT-5 at 33-34. Nor, as Dr. Bozzo

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observes, is there any evidence that Dr. Neels took into account significant findings

from the paper Dr. Neels himself cited. Id. at 34.

Nor does Dr. Neels's judgment appear to have been reliable. A recent paper

provides an explicit formula with which the possibility of bias may be assessed from the

information Dr. Neels had at hand. The bias of two-stage least squares, relative to

ordinary least squares, is )~

/( 2Rnl , where l is the number of instruments, n is the sample

size, and 2~

R is the partial R-squared reported by Dr. Neels. 18 As shown in the table

below, the Postal Service IV models for manual operations eliminate 89-98% of the OLS

models' bias. Dr. Neels's judgment regarding the Postal Service instrumental variable

models is not reliable.

Line Cost Pool Manual

Letter Manual Flat

Manual Parcel

Manual Priority

Source

1 Partial R2 0.0103 0.0106 0.0056 0.0101 UPS-T-1 at 30

2 # inst (l) 2 2 3 3 USPS-LR-L-56 at 9 (footnote 6)

3 N 7180 8451 4846 5520 USPS-T-12 at 73

4 Rel. Bias )

~/( 2Rnl

2% 3% 11% 5% L2/(L1 x L3)

5 % of OLS Bias eliminated

98% 97% 89% 95% 1-L4

18 Michael P. Murray, "Avoiding Invalid Instruments and Coping with Weak Instruments," Journal of Economic Perspectives Vol. 20, No. 4 (Fall 2006), at 124.

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4. The reliable evidence from intervenor analyses in this proceeding supports the Postal Service’s demonstration that mail processing costs are less than 100 percent volume-variable.

a. Prof. Roberts's models, correctly updated, yield results

largely consistent with the Postal Service models.

i. While significantly flawed, Prof. Roberts's models, if properly implemented, are superior to the alternative of maintaining the 100 percent variability assumption.

In March 2006, Prof. Roberts presented a major extension and update of the mail

processing model he developed for the OCA in 2002. Dr. Bozzo commends Prof.

Roberts for having "greatly improved his models by incorporating a refined

characterization of sorting output that partly accounts for the amount of sorting

improvement in addition to the number of unique pieces sorted." USPS-T-12 at 7.

However, Prof. Roberts's continued use of MODS FHP to measure sorting

operations' output remains problematic. Prof. Roberts's theoretical model considers

measuring costs for a large number of products distinguished by required sort depth,

other cost-causing characteristics, and rate categories, which is conceptually valid but

infeasible Id. at 8 (esp. footnote 8). Dr. Bozzo observes that both FHP and total piece

handlings (TPF and TPH) differ from Prof. Roberts's theoretical output characterization

in some ways, though total piece handlings by definition track differences in net sort

depth not captured by FHP, and therefore not reflected in Prof. Roberts's empirical

models. Id. at 7-8. Dr. Bozzo compares the FHP and total handling measures in detail,

and notes that the measures can provide "reasonably consistent" characterizations of

sorting output. Id. at 8, 35-43. Consequently, it is not surprising that Prof. Roberts's

March 2006 results generally resemble those of the Postal Service models in BY 2004

and BY 2005. Id. at 8.

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While the Postal Service models are "most consistent with the structure of

operations and… most demonstrably robust," Dr. Bozzo regards Prof. Roberts's March

2006 models, updated for BY 2005 in USPS-T-12, as an "acceptable alternative."

USPS-RT-5 at 75; Tr. 35/12467; see also USPS-T-12 at 101-104.

ii. Should the Commission adopt a model based on Prof.

Roberts's work, it should employ the updated version of Prof. Roberts's model presented by Dr. Bozzo.

As part of the Postal Service's direct case, Dr. Bozzo estimated an updated

version of Prof. Roberts's March 2006 two-output model. Dr. Bozzo added FY 2005

data, adjusted the BCS cost pool structure, and implemented improved capital variables

to address data issues raised by Prof. Roberts. USPS-T-12 at 101. The results of the

update, including back-casting of the updated model to the FY 1999-FY 2004 period

analyzed by Prof. Roberts for the March 2006 paper, were elasitcities for combined

letter and flat operations in the narrow range of 0.85-0.90. Those results are generally

consistent with the corresponding results from the Postal Service models, and well

within the margin of sampling error for Prof. Roberts's March 2006 results, which

showed an overall elasticity of 0.89 with a standard error of 0.06. Id. at 104.

Dr. Bozzo noted that his modifications eliminated some anomalous BCS results

from Prof. Roberts's March 2006 paper on the letter side, and appropriately adjusted the

relative influence of the elasticities for the AFSM 100 and now-defunct FSM 881

operations on the flat side, resulting in some convergence of the results from the

Roberts and Postal Service models. The results were "reasonably stable" from FY

2004 to FY 2005, which would normally be considered a positive result for a new and

relatively untested model. Id. at 102-103.

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Insofar as Prof. Roberts made no mention of Dr. Bozzo's update of Prof.

Roberts's model in OCA-T-1, somewhat to the surprise of the Postal Service, Prof.

Roberts was asked whether he had considered it, and if so, why he rejected it. Tr.

23/8606-8. Prof. Roberts's explanation was even more surprising. As Dr. Bozzo notes,

the factors Prof. Roberts cites did "not support rejection of the Postal Service updates,

as the factors… [were] not actually defects of the USPS-T-12 update." USPS-RT-5 at

55, Tr. 35/12447. The factors Prof. Roberts cited included signs of the stability of his

model, the aforementioned improvements to the capital data, elasticity weighting

changes that Prof. Roberts actually adopted for his recommended results from OCA-T-

1, and the BCS cost pool change (regarding which, Prof. Roberts does not actually

claim that Dr. Bozzo's approach was incorrect, and Dr. Bozzo notes that he had

provided results using Prof. Roberts's methodology, which do not substantially alter the

results). Id. at 56-57, Tr. 35/12448-9.

iii. Prof. Roberts's own update is rendered unusable by

major technical flaws, unjustified model changes, and accordingly implausible results.

Prof. Roberts provides his own update of the March 2006 two-output models in

OCA-T-1, incorporating a number of changes which form the basis for his

recommended results. OCA-T-1 at 5-8. Prof. Roberts's update introduces a significant

error into his econometric implementation, unjustifiably changes other previous

modeling decisions, and in some cases palpably reduces the quality of his results, and

therefore should be rejected.

The outright error, partly acknowledged by Prof. Roberts, was including quarterly

dummy variables as "excluded" instruments to help identify his labor demand models.

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OCA-T-1 at 5. In effect, Prof. Roberts did half the job of determining whether the

quarterly dummies were good candidates to serve as instruments. Instruments should

be correlated with the variable subject to measurement error (which, as Prof. Roberts

explains, is satisfied) but also should be properly excluded from the model. Indeed,

omitted variables can be problematic in instrumental variables estimation even in

circumstances where they are not troublesome in least squares estimation, so

"researchers [should] be doubly vigilant about omitted variables when doing

instrumental variable estimation."19

Prof. Roberts had justified his omission of the quarterly dummies on the grounds

that Postal Service operations experts had not mentioned them. USPS-RT-5 at 51,

citing Roberts 2006 at 59. In this, Prof. Roberts was insufficiently vigilant, since Postal

Service operations witness Moden had discussed seasonal factors affecting both

workloads and workhours in Docket No. R97-1. USPS-RT-5 at 51-52. Indeed, Prof.

Roberts himself had included quarterly dummy variables in his 2002 analysis based on

an argument similar to witness Moden's (Id. at 52), though he incorrectly (and

unfathomably) claims not to have previously included those variables. Tr. 23/8412.

Regardless of the reasons for the retrogression of Prof. Roberts's methods, though, he

correctly admits that the failure of over identifying restrictions tests for models using the

quarterly dummy variables as excluded instruments implies that those models are not

appropriate. Tr. 23/8312-8313.

Prof. Roberts's other major change was to significantly shorten the sample period

employed in his models, from seven years of quarterly observations in Roberts 2002

19 Murray, op. cit., at 118.

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and six years of quarterly observations in Roberts 2006, to four years in the OCA-T-1

models. Tr. 23/8419. The main stated justification is to separate the pre- and post-

AFSM 100 periods in flats processing, though Prof. Roberts applies the same sample

period to letter-shape and other labor cost pools where changes to operations have

been relatively minor. OCA-T-1 at 6; USPS-RT-5 at 49-51.

The changes implemented for OCA-T-1 appear particularly arbitrary as Prof.

Roberts had, in his 2002 paper, taken some pains specifically to justify the use of a

longer sample in the face of considerable changes to letter-sorting operations owing to

implementation of the letter automation plan, concluding that incorporation of control

variables for sorting technologies was an appropriate solution. Roberts 2002 at 19-21;

USPS-RT-5 at 50-51. Particularly insofar as the technology controls remain a feature of

Prof. Roberts's models, the drastic reductions in sample size are not justified by Prof.

Roberts's own logic.

Prof. Roberts's changes also are not justified by clear improvements in results.

Prof. Roberts explains the much higher manual letters elasticity, compared to his earlier

results, as a possible consequence of diverting automatable pieces to higher-cost

manual processing. Tr. 23/8300, 8445-8447. However, as witness Oronzio explains,

automated letter-sorting operations have sufficient capacity that the need to send

automation-compatible pieces to manual is extremely limited. USPS-RT-15 at 10-12;

Tr. 36/12278-12280.

In flat operations, the volatility of results that prevents Prof. Roberts form

recommending elasticities from his flat-shape models is confined largely to the FSM

1000 cost pool, where as Dr. Bozzo notes the elasticities are very imprecisely

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estimated, such that it is far from clear that there is a difference in the correct elasticities

based on the shorter sample period. USPS-RT-5 at 50. Moreover, the updated flats

elasticities show a far stronger effect of outgoing flats FHP on workhours, compared to

Prof. Roberts's March 2006 results, despite flats workhours and workloads being highly

concentrated in incoming operations. The OCA-T-1 results are inconsistent with Prof.

Roberts's explanation for his March 2006 results, in which Prof. Roberts had reasonably

observed the small contribution of outgoing flats volumes to flat operations' total

workloads. Roberts 2006 at 49; USPS-RT-5 at 58.

Prof. Roberts's econometric errors and faulty model selection logic render his

results from OCA-T-1 unusable. Dr. Bozzo's update, showing robust results relative to

Prof. Roberts's March 2006 paper without anomalous results, is clearly preferable

among the models derived from Prof. Roberts's research.

iv. Prof. Roberts's "additional outputs" models point to

potential improvements to the OCA models, but the OCA-T-1 implementation is terminally flawed for its apparent purpose.

A fundamental shortcoming of Prof. Roberts's models has been the failure of the

FHP measures he specifies to reflect systematic differences in work content associated

with many types of mail, since MODS FHP provides limited information on the

processing modes and amount of sorting that is performed. While he has not gone to

the logical conclusion of employing MODS variables that reflect the amount of sorting

(i.e., total piece handlings), Prof. Roberts has at least recognized the importance of

representing systematic differences in work content (and hence cost) cost differences

between various categories of mail in his labor demand models. OCA-T-1 at 20-24.

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Such considerations motivate his models with "additional outputs" reflecting what he

characterizes as automation and non-automation volumes. Tr. 23/8287-8288.

While conceptually a step in the right direction, Prof. Roberts's implementation is

rendered useless by a gross technical flaw: he fails to distinguish automation from non-

automation volumes. USPS-RT-5 at 59. Specifically, Prof. Roberts's "nonautomation"

volume combines manual mail with non-prebarcoded volumes that would be handled in

the automation mailstream and thus have costs consistent with automation rather than

manual mail. Tr. 23/8381-8383, 8404.

Indeed, as Dr. Bozzo notes, automation-compatible volumes are a majority of

Prof. Roberts's "non-automation" category. Accordingly, it is not surprising that Prof.

Roberts would have had difficulty reliably distinguishing the cost effects of the

respective categories. The correct approach to identifying the categories as Prof.

Roberts labeled them would have been to separate manual from automation-compatible

FHP, to obtain mail categories with more properly distinguished cost characteristics.

USPS-RT-5 at 60.

v. There is no reliable evidence suggesting failure of the

distribution key method's "proportionality assumption." In addition to being conceptually faulty in considering the wrong "volume"

measures, Prof. Roberts's analysis purporting to show failure of the "proportionality

assumption" also incorporates two major econometric errors.

First, Prof. Roberts's erroneous use of quarterly dummy variables in the OCA-T-1

instrumental variable analysis extends to the models of piece handlings with which he

purports to test the assumption. USPS-RT-5 at 63-64. Dr. Bozzo shows that the

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"overidentifying restrictions" tests that Prof. Roberts's initially-recommended labor

demand models fail, are also conclusively failed by the piece handlings models. Id. at

64; USPS-LR-L-192, file USPSmod_threestep.log. Thus, Prof. Roberts's piece handling

models are invalidated by the same considerations that weigh against the use of the

quarterly dummy variables as instruments in the labor demand models. See Tr.

23/8312-8313. Prof. Roberts's error also invalidates the analysis (OCA-T-1 at 8-17) in

which he purports to reconcile TPF- and FHP-based models using the TPF-FHP

elasticities, as the results upon which it is based are econometrically inappropriate.

Prof. Roberts does not provide alternative piece handling results unaffected by

the instrument selection error, though such models would not, themselves, be adequate

to model the relationship between TPF and FHP. Prof. Roberts's piece handling models

are clearly misspecified, assuming a common effect of all shape-level FHP on cost pool-

level TPF, when the true specification must allow for differing amounts of subsequent

handlings both by FHP source and by site. For example, Prof. Roberts agrees that

manual FHP will not cause subsequent handlings in automated operations (Tr.

23/8299), which implies that manual FHP are not an explanatory variable for automated

TPF (USPS-RT-5 at 66), but he does not specify his automated handling models

accordingly. Indeed, Prof. Roberts asserts that he does not have to account for

mailflows in his piece handling models (Tr. 23/8325-8326), effectively claiming that he

can freely impose false restrictions into his models without biasing his results. While, as

Dr. Bozzo notes, there are some special cases in which Prof. Roberts's model is

sufficient—i.e., the manual/automation mix is constant over time—data provided by

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Prof. Roberts actually shows declining manual shares in FHP in both letter and flat

operations. Tr. 23/8382-8383; USPS-RT-5 at 66-67.

In order to avoid the problem of accounting for the complexities of mailflows in

the piece handling models, it is possible to employ shape-level aggregates, which Dr.

Bozzo did in response to Dr. Neels's analysis in Docket No. R2000-1. Prof. Roberts did

not estimate such models, but Dr. Bozzo did so using Prof. Roberts's original instrument

specification and an alternative specification, and finds no evidence of statistically

significant violations of TPF-FHP "proportionality." USPS-RT-5 at 67-68.

b. Dr. Neels's alternative model, correctly implemented for "allied labor" and at the "plant level," supports the use of reduced variabilities for allied labor and miscellaneous cost pools.

i. Dr. Neels's aggregate model is conceptually inferior to

the Postal Service and OCA models for sorting operations.

Dr. Neels presents a model of sorting operations aggregated over shapes that he

styles a "plant-level" variability model. UPS-T-1 at 49-54. As a model of sorting

operations, Dr. Neels's model is inappropriately specified. Dr. Neels's model abandons

the shape-based structure common to the Postal Service and OCA models based on

vague suspicions of cross-shape effects with operational foundations that are tenuous

at best and which, more significantly, are not borne out by the data as noted above in

Section 3. Meanwhile, by only considering shape-level FHP aggregates as sorting

"outputs," Dr. Neels's model is unable to reflect a variety of patterns of cost causation—

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e.g., cost differences between automation and non-automation pieces—that he agrees

are characteristics of the operations, and which Prof. Roberts at least agrees could be

desirable to reflect in properly-specified labor demand models. USPS-RT-5 at 36-40;

see also Section 4(a)(iv), above.

ii. Dr. Neels's model has some utility as a model of allied

labor and other non-sorting operations. While Dr. Neels's model is inadequate for sorting operations, it does have

potential applicability to allied labor operations and, potentially, as a means of

characterizing overall variability for plant operations. In that context, Dr. Neels's model

is a relative of Dr. Bradley's allied labor models from Docket No. R97-1, which

incorporated multiple cost drivers representing shape and machinability characteristics.

USPS-RT-5 at 41, Tr. 35/12433. Employing multiple cost drivers is necessary in this

case because the allied labor operations generally support all of the shape-based

mailstreams. See also USPS-T-12 at 84, lines 5-9. Dr. Neels's choice of functional

form is reasonable in this application, and despite data handling errors such as using

TPH productivity screens while specifying the model with FHP, Dr. Bozzo concludes

that "the broad outlines of the model are acceptable." USPS-RT-5 at 41, line 19; Tr.

35/12433.

iii. Correctly employed as an allied labor or whole-plant

model, Dr. Neels's model supports the Postal Service treatment of variabilities outside of sorting cost pools.

Dr. Neels believed himself unable to estimate his model for allied labor

operations. UPS-T-1 at 49. However, as Dr. Bozzo notes, Dr. Neels was incorrect, and

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NWRS workhour data for the allied labor Labor Distribution Code (LDC 17) had been

available from the beginning in USPS-LR-L-56. USPS-RT-5 at 42, Tr. 35/12434.

Dr. Bozzo estimated Dr. Neels's model using the LDC 17 allied labor workhours,

and the resulting 0.84 elasticity differs minimally from the 0.85 sorting operation average

employed in the Postal Service mail processing models. Id. Dr. Bozzo also estimated

Dr. Neels's model using two definitions of plant-level workhours, one from NWRS

incorporating LDC 13 and 17 workhours not covered in Dr. Neels's implementation, and

another using a broader set of MODS workhours incorporating all "Function 1"

operations plus supervisory workhours. USPS-RT-5 at 42-44, Tr. 35/12434-12436.

The range of the resulting elasticities, 0.82-0.90, brackets the 0.85 sorting operation

average employed by the Postal Service and does not differ significantly from the

sorting operation average; the elasticities from Dr. Neels's model applied at the plant

level are lower than 100 percent by statistically significant amounts. Id. Consequently,

Dr. Neels's model, correctly applied to allied labor or the entire plant level, actually

supports the variability levels employed in the Postal Service mail processing model.

d. If the Commission declines to adopt an econometric

variability model for sorting operations, it should modify its mail processing cost method to treat setup and take-down costs as non-volume-variable using the methods proposed by Dr. Elliott.

The record amply supports adoption of the Postal Service variability models or, in

the alternative, Prof. Roberts's models as updated by Dr. Bozzo, for the reasons stated

above. If the Commission, nevertheless, does not accept econometric variability

models at this time, it should modify its existing method, based on the partition of

activities identified in IOCS into 100 percent variable and non-volume-variable

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categories, to reflect activities that the record shows to be non-volume-variable as

recommended by Dr. Bozzo and Dr. Elliott. USPS-RT-5 at 75-76; MPA et al.-RT-2 at 3-

5.

i. The record supports treating setup and take-down

costs as non-volume-variable. As discussed above, witness McCrery explains that setup and take-down costs

for sorting schemes are substantially non-volume-variable, instead depending primarily

on network-related factors. Witness McCrery notes that relatively few schemes are run

on multiple machines, and the great majority of schemes (especially incoming

secondary schemes) are very rarely, if ever, run on multiple machines for technical or

other practical concerns, e.g., the lack of technology to collate the output of identical

delivery point sequencing schemes run in parallel. As a result, it is patently incorrect to

conclude that the number of schemes run, and hence setup and take-down times,

would vary directly with volumes. USPS-T-42 at 36. Witness McCrery provided results

from a nationwide query of End-of-Run System data that confirm his account. Tr.

11/2895-97; see also MPA et al.-RT-2 at 3, USPS-RT-5 at 6-7.

While Dr. Haldi raises situations in which setup and take-down costs may vary

with volume in some respects, he admits that it would generally take a large increment

of volume to lead to a change in the number of schemes. Tr. 23/8613. Small changes

in volume on the margin are not sufficient to vary the number of schemes. USPS-RT-5

at 7. Thus, to the extent that a portion of setup and take-down costs may be variable

with volume in some sense, it is in the sense of "inframarginal" costs, which are a

component of incremental costs that the Postal Service incremental cost model

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accounts for. The costs in schemes that are necessarily run on a single sorter are

"fixed" with respect to the entire volume of mail, and thus not properly considered

variable or volume-variable at all. Id. at 7-8. Dr. Haldi, too, states that it is important not

to confuse marginal (volume-variable) costs with incremental costs. Tr. 23/8614-8615.

Accordingly, the treatment of the setup and take-down costs as non-volume-variable is

conceptually correct, possible incremental cost issues notwithstanding.

ii. Data from the redesigned IOCS instrument provides a

reasonable basis for estimating the setup and take-down costs.

In prior proceedings, it had been difficult to comprehensively quantify the amount

of time spent in setup and take-down activities, and hence the magnitude of the

"schemes effect." When Postal Service witness Kingsley sought to quantify the effect in

Docket No. R2001-1, in the absence of systemwide data she used data on automated

sorting operations for two plants. USPS-T-42 at 35-36. In BY 2005, the redesigned

IOCS data collection instrument includes response categories that permit the

quantification of setup and take-down time.20 USPS-T-42 at 35-36; USPS-T-12 at 27.

While the IOCS processing does not currently assign an activity code to

specifically identify setup and take-down time, it is conceptually straightforward to

identify the tallies directly from the IOCS question 18 responses. Dr. Elliott's testimony

provides the results of such calculations for the cost pools covered by the econometric

analysis (MPA et al.-RT-2 at 6), and Dr. Bozzo additionally provides results applicable

to the remaining mail processing cost pools. MPA et al.-RT-2 at 7; Tr. 10/2545-6. 20 Moreover, the setup and take-down time is identified separately from sweeping mail from machines or cases during the run, which is considered part of the (volume-variable) runtime in Dr. Bozzo's activity partition. Tr. 36/12530, lines 4-6.

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5. The Commission should accept the Postal Service partition of

administrative costs in Cost Segment 3, and recognize that the Postal Service treatment of mail processing "administrative" costs as part of Cost Segment 3.1 is correct.

In the course of his analysis purporting to show the existence of significant

clocking errors in MODS, Dr. Neels cited past controversy over the existence of a

considerable number of IOCS tallies that are assigned to mail processing cost pools

despite bearing IOCS "administrative" operation codes, and suggested that the

Commission might again need to shift those tallies to the administrative clerks cost

segment (cost segment 3.3). UPS-T-1 at 14. The record supports treating the

"administrative" tallies as part of the mail processing cost pools to which they are

assigned by witness Van-Ty-Smith.

Dr. Neels admits that it is not unexpected to encounter certain IOCS

"administrative" activities in mail processing operations. Tr. 23/8510, 8548-8551. In

sorting operations, most of the administrative tallies simply represent workers clocking

in or out of the operations; such tallies, Dr. Bozzo notes, are always assigned

administrative operation codes in IOCS tally processing. USPS-RT-5 at 16. The

remaining administrative tallies constitute less than one percent of sorting operation,

well within the range of what can be expected for incidental activities within the sorting

cost pools. Id. at 16-17. Dr. Neels agrees that small fraction of administrative tallies

would not be analytically significant either way. Tr. 23/8552.

In fact, Dr. Bozzo shows that the vast majority of the "administrative" tallies in

mail processing cost pools – 73 percent – appear in just 17 three-digit operations that

are clearly defined for administrative and miscellaneous activities in mail processing.

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He also notes that there are significant administrative tallies in additional operations with

record-keeping or clerical activities (e.g., mail acceptance operations). Last, the

definitions of the cost pools are such that all of the tallies in question are recorded at

finance numbers corresponding to mail processing facilities. USPS-RT-5 at 18-19.

Since the evidence indicates that these administrative tallies are correctly included in

Cost Segment 3.1, the Commission should accept the Postal Service's assignment of

those tallies as recommended by Dr. Bozzo.

6. The Commission should continue to distribute volume-variable

costs to subclass using IOCS-based distribution keys established at the cost pool level.

a. Witness Van-Ty-Smith implements the long-accepted

IOCS/MODS-based distribution key method. Witness Van-Ty-Smith describes the calculations that implement the calculations

of volume-variable costs by subclass using the IOCS/MODS-based method employed

by the Postal Service since BY 1996 of Docket No. R97-1, and also adopted by the

Commission (with modifications) in that proceeding. USPS-T-11 at 2-20. Witness Van-

Ty-Smith implements a number of changes to the details of the calculations, to ensure

that the cost pool definitions are consistent with the current structure of operations and

to incorporate current input data. Id. at 4-6; 8. Witness Van-Ty-Smith's general

methods for computing costs and distribution keys are substantially unchanged in this

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proceeding, and accordingly there are no significant methodological issues before the

Commission related to the distribution key calculations.

b. The accuracy of IOCS "direct tally" data used in the

distribution keys has been improved by the recent IOCS redesign.

For BY 2005, the IOCS-based distribution keys use, for the first time, data from

the redesigned IOCS instrument. Dr. Bozzo explains that IOCS "measures the

concepts of interest for the cost distribution methodology." IOCS "handling mail" tallies

provide information on the proportions of time for employees handling pieces and

containers of mail in all mail processing operations, and IOCS sampling methods further

ensure that appropriate mailpiece data are collected from automated operations in

which employees may not physically touch the mail while working. USPS-T-46 at 5-10.

Using the IOCS data collection instrument to reinforce IOCS sampling rules increased

"direct" tallies with subclass information from 43 to 48 percent of mail processing

observations, with an accompanying reduction in "not-handling" tallies. USPS-T-46 at

27-28. Also significantly, testing of the redesigned IOCS question 23 (which collects

class and subclass data) shows that the redesigned instrument improves accuracy of

the subclass-level data relative to "old" IOCS. Id. at 25-26. The sampling variability of

the IOCS-based volume-variable costs by subclass also improve somewhat in excess of

what would be expected from returning IOCS test sites to the production samples. Id. at

42.

The Postal Service expects to research additional improvements to the IOCS

distribution key data in line with the Data Quality Study's recommendations, most

notably development of sub-sampling methods for mixed-mail containers to reduce the

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need for mixed-mail subclass distribution assumptions in the distribution key

methodology. USPS-T-46 at 4.

c. The IOCS/MODS-based distribution keys calculated by cost

pool remain the best method for distributing mail processing volume-variable costs to subclasses under alternative variability methods.

Prof. Roberts outlined an alternative method for computing volume-variable costs

by subclass based on his sorting operation models that would use volume-based

distribution keys to assign costs to subclass. Tr. 23/8337-8740; USPS-RT-5 at 69.

Should the Commission adopt sorting operation variabilities based on Prof. Roberts's

models, it should continue to use the accepted cost distribution method. USPS-RT-5 at

76. Even Prof. Roberts's FHP-based two-output mdoels for sorting operations clearly

do not account for all variations in work content of pieces (due to, e.g., varying presort

level and/or finalization level) that would be relevant for accurate subclass distribution.

Thus, it would be appropriate to use a distribution key source such as IOCS that does

reflect those cost differences. Id. at 70-71. As Dr. Bozzo observes, Prof. Roberts's

method can be computed using existing cost pool totals, with appropriate IOCS-based

distribution keys reflecting the incoming-vs.-outgoing operations that underlie the

estimated elasticities. USPS-RT-5 at 73-74. Beyond the incoming/outgoing

disaggregation for sorting distribution keys, no wholesale changes to cost pool

formation and/or distribution key methods would be necessary or, indeed, desirable.

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B. The Postal Service’s Updated Study for Window Service Costs Should Be Adopted

The Postal Service is presenting an updated set of supply side variabilities for

window service transactions. In order to provide this update, the Postal Service was

required to sponsor a new field study of transaction times and to re-estimate the

established econometric equation. In addition, a review of the established methodology

for calculating variabilities revealed that the computational formula used is not correct.

The correct formula was derived and applied.

The established methodology is based upon the testimonies of Postal Service

witnesss LaMorte (in Docket No. R90-1) and Brehm (in Docket No. R97-1.)21 Starting in

1997, The Postal Service began a rollout of a new point-of-sale system. Direct

Testimony of Michael D. Bradley on Behalf of the United States Postal Service, Docket

No. R2006-1, USPS-T-17 at 3. Known as POS (Point of Service) ONE, it was designed

to replace integrated retail terminals with commercial off-the-shelf hardware and

software, along with support services and training. Id. at 4. With the deployment of

POS ONE, the Postal Service was able to capture detailed transaction data and

transmit that information to support sales and marketing efforts, as well as improve

operations. Direct Testimony of Frederick J. Hintenach, III, on Behalf of the United

States Postal Service, Docket No. R2006-1, USPS-T-43 at 2.

The introduction of the POS ONE system raised the possibility that the “supply

side” nature of window service transactions had changed. Specifically, with a new

21 See, Direct Testimony of Michelle LaMorte on Behalf of the United States Postal Service, Docket No. R90-1, USPS-T-6 and Direct Testimony of Christopher Brehm on Behalf of the United States Postal Service, Docket No. R97-1, USPS-T-21.

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technology used for processing transactions, it is possible that the relationship between

transactions and transaction time was modified. If so, the transaction supply side

variabilities will have changed. This provides an important reason for updating the

established econometric equation.

In addition, the existence of a new, more comprehensive data set relating to

window service transactions raises the possibility that a more detailed, perhaps more

accurate, product costing analysis could be performed. Transactional data captured

through the POS ONE system has far more extensive data about window transactions

and could be a potentially valuable data source. See USPS-T-43 at 2. For these

reasons, the Postal Service decided to initiate an update and possible refinement of the

established methodology.

The update and refinement of the established variabilities required the Postal

Service to field a new transaction time study which would take advantage of the recent

technological advances to provide accurate data that would meet the Commission’s

requirements for rate case studies. That study is sponsored by witness Nieto. Direct

Testimony of Norma B. Nieto on Behalf of the United States Postal Service, Docket No.

R2006-1, USPS-T-24. It follows the study methodology as the approved study from

Docket No. R97-1, but applies more recent technology to produce more accurate

transaction times.

1. Witnesses Kelley and Bradley demonstrate that the 2005 transaction study utilized a sound sample design which resulted in a reliable database.

Only one party raised concerns about the Postal Service’s window service costs

study, and that party was the Office of the Consumer Advocate, through its witness, J.

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Edward Smith. Direct Testimony of J. Edward Smith on Behalf of the Office of the

Consumer Advocate, Docket No. R2006-1, OCA-T-2. Witness Smith raised five

concerns about the transaction time study conducted by witness Nieto. See id. In their

rebuttal testimonies, witnesses Kelley and Bradley addressed and soundly dismissed

each of these concerns. Rebuttal Testimony of John P. Kelley on Behalf of the United

States Postal Service, Docket No. R2006-1, USPS-RT-6; Rebuttal Testimony of Michael

D. Bradley on Behalf of the United States Postal Service, Docket No. R2006-1, USPS-

RT-4 at 28-44.

After thoroughly reviewing the sample design and data quality issues for The

2005 Transaction Time Study, witness Kelley concludes that a sound and defensible

process was used for each in developing the final database of 7,915 transactions.

USPS-RT-6 at 18-19.

According to witness Kelley, first, the preparation for the study involved a

thorough investigation of the coverage and scope of the frame (POS-ONE offices). The

frame used to select offices provided ample coverage of the universe (ninety percent of

revenue) and contained a diverse mixture of transaction types which were necessary for

the construction of a defensible econometric model. Id.

Second, the sample design utilized by the 2005 Transaction Study can easily be

justified, and it was implemented the way it was designed. A common sample design,

stratified random, was used, and revenue per office and geographic area were

employed as stratification variables. The result was a design that ensured that both

large and small revenue offices across all geographic areas were included in the final

sample of twenty-seven post offices. Id.

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Third, the use of Palm Pilots to collect the data was instrumental in collecting

accurate information from the study. They provided the data collectors with a simple

method for recording important instances during a transaction with the touch of a button.

They also allowed data collectors to easily inspect the information record so that many

inconsistencies or errors could be fixed by the data collector. Id.

Lastly, the ability to match and validate collected data with the POS-ONE

transaction database was critical to the success of the study. Each piece of information

recorded by the data collectors was matched with the POS-ONE database. Information

that could not be matched with POS-ONE was dropped from the final dataset. As a

result, the final dataset of 7,915 transactions is highly likely to be accurate. Id.

Witness Bradley reviews the concerns that witness Smith voices with the new

transaction time study database as they relate to calculation of variabilities, and finds

that his concerns about the updated data set are speculative and not substantive, and

do not have the effects on the variabilities that he asserts. USPS-RT-4 at 29-41. Dr.

Bradley’s rebuttal testimony thoroughly describes how witness Smith’s speculations

about possible problems in the transactions time study database for calculating

variabilities are wide of the mark, why walk time is not part of transaction time and

should not be included in the estimated equation (and indeed shows how witness

Smith’s own estimation demonstrates this point), and how witness Smith’s outlier

analyses are mechanistic, ineffective, excessive, and should not be used. Id.

2. Witness Bradley’s recommended window service model is superior to all proposed alternatives.

Witness Bradley’s review of witness Smith’s alternative econometric analyses

identifies important deficiencies, and shows that none of witness Smith’s alternatives

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are preferred to Dr. Bradley’s recommended model. Of the five variants presented by

witness Smith, three of those variants should be rejected because they include walk

time. Four of those variants should be rejected because they apply mechanistic and

unevaluated outlier screens. As a result of these deficiencies, none of witness Smith’s

alternatives are preferred to the recommended window service model. USPS-RT-4 at

28-44.

C. For Purposes of This Proceeding, the Commission Should Once Again Use the City Carrier Street Time Cost Results Introduced in the Previous Rate Case

In Docket No. R2005-1, the Postal Service presented a new and extensive study

of city carrier street time which provided significant improvements over the old series of

special studies. Despite the limited nature of that case, the city carriers street time

study (CCSTS) was vigorously tested on the record and the Commission was able to

provide a complete, thorough, multi-section review and analysis of the Postal Service

study. While expressing some concerns with the data collection effort and econometric

model, the Commission tentatively accepted the study and its results.

Docket No. R2006-1 was filed immediately on the heels of Docket No. R2005-1.

Prof. Bradley explained in his direct testimony the extreme time constraint which

precluded the Postal Service from even attempting any methodological improvements

between issuance of the Commission’s Opinion in Docket No. R2005-1 and the date by

which variabilities had to be locked in for the Docket No. R2006-1 base year

presentation. USPS-T-14 at 10. Consequently, the Postal Service proposes to rely on

the established model, as indicated by the Commission in Docket No. R2005-1.

Nevertheless, all parties had an opportunity to again examine and review the Postal

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Services' R2005-1 CCSTS study through written discovery, cross examination of Prof.

Bradley, and presentation of their own testimony. In essence, Docket No. R2006-1

gave all parties a second bite at the apple.

Only one party, the OCA, provides any testimony presenting criticisms of or

alternatives to the Postal Service study. The OCA’s testimony was presented by Dr. J.

Edward Smith (OCA-T-3). As discussed in detail in the following section, rebuttal

testimonies by witnesses Bradley and Crowder show that Dr. Smith’s testimony is

riddled with major mistakes, and his proposed alternatives are fatally flawed. Dr. Smith

simply provides no basis to depart from the CCSTS variabilities accepted in the last

case.

Also during this proceeding, however, the Postal Service provided two large

databases on city carrier street time. The first was an extensive extract taken directly

from the DOIS database that was requested by the OCA, provided as USPS-LR-L-160,

and analyzed by Dr. Smith. The second was a 2004 data collection effort that was

requested by the Presiding Officer and preliminarily analyzed by Prof. Bradley. See

Response of Postal Service Witness Bradley to Item 11 of POIR No. 4; USPS-LR-L-179

and L-180. Neither of the efforts using these two other databases, however, provide

results superior to those adopted by the Commission in Docket No. R2005-1.22 In sum,

while there is need for ongoing research in this area, and, time permitting, the Postal

Service plans to analyze the comments provide by the Commission in Docket No.

R2005-1, there is nothing on the record in this case which provides a feasible

22 Moreover, in Order No. 1482 (Nov. 8, 2006), the Commission limited use of the POIR responses and the 2004 data to illustrative purposes in this proceeding.

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alternative to the established model. The Commission should continue to rely upon it to

estimate costs and recommend rates in this proceeding.

1. OCA witness Smith fails to provide any suitable alternatives to the previous variabilities.

The only witness in this case actually proposing any deviation from the

variabilities used in the last case is OCA witness Smith (OCA-T-3). Dr. Smith, however,

presents his recommendations with no great enthusiasm. Some of his reservations

about current work, and his agreement with the consensus regarding the need for future

work, are reproduced in the rebuttal testimony of witness Crowder. MPA et al.-RT-1 at

11-12. In fact, Dr Smith recommends two different sets of variabilities, and yet appears

to offer no guidance as to which of the two is preferred. See id. at 1. This in and of

itself might be problematic, if Prof. Bradley and witness Crowder had not already

demonstrated that none of Dr. Smith’s alternative variabilities compare favorably with

the variabilities used in the last case.

Dr. Smith’s testimony presents the results of two distinct research efforts. The

first utilizes the same database (CCSTS) as that used by Prof. Bradley in the last case

to estimate the existing variabilities. OCA-T-3 at 3-15. The second utilizes DOIS data

provided in USPS-LR-L-60 in response to OCA/USPS-T14-8. Id. at 16-22. Unlike the

CCSTS data, the DOIS data are operating data, not specifically collected for cost study

purposes. Dr. Smith presents the results of a variety of different model specifications

and functional forms using each database, and then recommends one equation from

each set as his choice from within that set. As noted above, Dr. Smith makes no

pretense of having definitive results, as he advocates that the Commission view the

appropriate variabilities as an open question. Id. at 23.

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Two witnesses rebut Dr. Smith’s testimony, Prof. Bradley on behalf of the Postal

Service (USPS-RT-4), and witness Crowder on behalf a consortium of mailers (MPA et

al.-RT-1). Their criticisms overlap to some degree. For example, witness Crowder

shows that Dr. Smith’s analysis of the density variable flies in the face of operational

reality. RT-1 at 8-10. Dr. Bradley makes the same point, and further demonstrates that

Dr. Smith’s opinions on density also run contrary to the practices successfully employed

by leading researchers in the field. RT-4 at 1-9. Prof. Bradley has a detailed discussion

of why Dr. Smith’s attempts to re-estimate the CCSTS model contain errors in both

theoretical specifications and econometric practice. RT-4 at 13-20. Likewise, witness

Crowder faults Dr. Smith on his failure to conduct more review of the CCSTS database,

his lack of an appropriate conceptual structure, and various econometric problems. RT-

1 at 5-8.

With respect to the DOIS models, the problems are even more fundamental.

Prof. Bradley cites criteria previously articulated by the Commission for purposes of

evaluating the adequacy of operational data, and shows in substantial detail how Dr.

Smith has patently failed to address, much less meet, these criteria. RT-4 at 21-25.

Witness Crowder reaches the same conclusion. RT-1 at 14-17. It is not, moreover, as

if the OCA has had no time to explore the properties of DOIS. The Postal Service, both

formally and informally, generated very substantial amounts of background information

about DOIS at the OCA’s request in Docket No. R2005-1. See, e.g., Responses of

Postal Service Witness Lewis to OCA Interrogatories (OCA/USPS-T30-1 – 7) (May 18,

2005). Moreover, the Postal Service provided a sizeable extract of DOIS data in that

case, also at the OCA’s request. USPS-LR-K-152 (Sept. 22, 2005). Follow-up

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questions that arose from examination of that material between 2005 and 2006 could

have been posed in the ample discovery period in this case, during which the OCA was

pursuing (and obtaining) the DOIS data base against which Dr. Smith ran his equations.

And while the Postal Service is by no means attempting here to understate the amount

of effort that would be required to obtain sufficient working knowledge of how DOIS is

put together to understand what reported DOIS data represent, or otherwise to fault the

diligence of the OCA, if proposals are made to base cost variabilities on operating data,

certain questions have to be addressed and resolved before such a proposal can

reasonably be entertained by the Commission. That simply has not been done in this

instance. Replacing the variabilities relied upon in the last case with any of Dr. Smith’s

variabilities based on his preliminary research with DOIS is not a viable option in this

case.

Dr. Bradley and witness Crowder identify other serious problems with the DOIS

models. Data on key variables are missing, and this causes major conceptual and

econometric problems. RT-4 at 25-26, RT-1 at 15-16. Also, Dr. Smith does not provide

the cost pools and distribution keys to which his variabilities, even if acceptable (which

they are not), could be applied. Id. Finally, Prof. Bradley demonstrates why Dr. Smith’s

allegations regarding mail collection by carriers are totally off the mark. RT-4 at 26-27.

Thus, both Prof. Bradley and witness Crowder properly conclude that none of the

results presented by Dr. Smith could remotely be considered suitable replacements for

the existing variabilities. All witnesses, even Dr. Smith, agree that more work needs to

be done. Until opportunities for further research are realized, based on the record in

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this proceeding, the only prudent course is to maintain reliance on the same variabilities

used by the Commission in Docket No. R2005-1.

2. The concerns expressed by Valpak witnesses Haldi And Mitchell concerning capacity constraints and other city carrier costing issues are not warranted.

In this case, Dr. Haldi resurrects the same type of capacity constraint arguments

that he attempted to raise in the last case. VP-T-2 at 56-73. Dr. Haldi proposes no

specific adjustments to any costs, however, and his concerns therefore remain largely

theoretical. Perhaps more importantly, however, they are unfounded.

Dr. Haldi insists that capacity constraints which limit the ability of city carriers to

take all saturation ECR directly to the street as an extra bundle are an issue of great

importance to the proper costing of saturation ECR mail. Id. at 56. In the real world,

though, the issue lacks the importance that Dr. Haldi wishes to attach to it. At the top of

page 69, he states that “No information is available on how often the Postal Service is

faced with conflicts of the type discussed here.” In fact, based on her experience,

witness Coombs, the Postal Service’s delivery operations expert, describes such

conflicts as “highly unlikely,” “not common,” and “rare.” Tr. 13/3710, 3717, 3718, 3721.

On page 67, Dr. Haldi suggests that “Based on the testimony of witness Lewis (USPS-

RT-2) in Docket No. R2005-1 and witness Coombs in this docket, it would appear that

collation is the preferred alternative, but casing may be required where it cannot be

determined that the two mailings are being sent to identical lists of addresses.” Earlier

in the same paragraph, though, Dr. Haldi acknowledges that it may be possible for both

mailings to be taken directly to the street by using the same tray for both mailings. And

in response to VP/USPS-T44-17.b (Tr. 13/3717), witness Coombs indicated that, rather

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than collate, “On a purely curbline route, and in the rare circumstances where both sets

of saturation flats had to be delivered on the same day, the carrier would most likely

take both sets of flats directly to the street.” Thus, Dr. Haldi’s statement regarding

collation as the apparent preferred alternative would not apply (and, in fairness to him,

perhaps was not intended to apply) to purely curbline routes, where neither collation nor

casing is the preferred alternative.

Saturation Mailers Coalition and Advo witness Crowder has an entire section of

her rebuttal testimony explaining the flaws in Dr. Haldi’s capacity constraint contentions.

SMC-RT-1 at 33-40. She identifies the evidence of record in this case and the last case

showing that any capacity constraints are not as binding on carrier operations as Dr.

Haldi suggests. Id. at 36-38. Moreover, she testifies that the presence or absence of

saturation flats is not what is causing saturation letters to be handled in the DPS

operation. Id. at 38-39. Witness Crowder even questions Dr. Haldi’s assertion that

more DPS processing would increase saturation letter costs. Id. at 39-40. Overall, she

demonstrates that Dr. Haldi has exaggerated the importance of the matter.

Witness Crowder also challenges the “fairness” argument raised by Valpak

witness Mitchell in VP-T-3, which relates closely to Dr. Haldi’s allegations on capacity

constraints. Even Mr. Mitchell concedes that, for example, if saturation flats are not the

cause of the higher DPS costs for letters hypothesized by Dr. Haldi, then Mr. Mitchell’s

fairness concerns do not arise. Tr. 22/8078. As described above, witness Crowder

shows why Dr. Haldi’s hypothesis on that chain of causation is erroneous. Moreover,

she identifies other flaws in Mr. Mitchell’s presentation. SMC-T-1 at 41-45. Mr.

Mitchell’s testimony professes only to pose questions, and not answer them. VP-T-3 at

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12. Witness Crowder’s testimony shows why Mr. Mitchell fails to achieve even this

much more modest objective in any meaningful fashion.

Before leaving the Valpak witnesses and city carrier costing issues, one more

topic merits mention. On page 70 of his direct testimony (VP-T-2), Dr. Haldi suggests

that “[w]ith respect to city carrier street costs (Cost Segment 7), Postal Service witness

John P. Kelley (USPS-T-30) states that his Segment 7 unit costs constitute valid base-

year marginal costs only at the subclass level,” and next quotes an interrogatory

response from witness Kelley supposedly in support of that statement. Dr. Haldi then

continues with a lament that “pricing decisions need to reflect marginal costs,” thus

implying that the Cost Segment 7 information provided by the Postal Service below the

subclass level is inadequate for ratemaking. This suggestion is not correct.

The interrogatory response quoted by Dr. Haldi was a portion of the response of

witness Kelley to VP/USPS-T30-26(e). VP/USPS-T30-26 was a follow-up question to

VP/USPS-T30-10, and part (e) of question 26 was specifically seeking an interpretation

of the unit costs provided in response to VP/USPS-T30-10. The unit costs provided in

response to VP/USPS-T30-10 (and reproduced in the response to question 26) were

the ratio of volume variable city street time costs to the volume delivered on city routes,

or the unit cost per delivered piece, as opposed to the unit costs shown in USPS-T-30,

which are per originating (or RPW) piece. In his response to question 10, witness

Kelley emphasized that distinction as follows:

For the purpose of answering this question, I make three assumptions: 1) street costs refer to volume variable street costs with piggybacks included; 2) the scope of your questions refers to ECR; and 3) the unit costs requested are per CCCS piece.

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The last assumption requires a bit more discussion. USPS-LR-L-67 includes data that allows unit costs per CCCS piece to be computed. However this is not the purpose of the delivery cost model. The purpose is to derive delivery costs per originating piece. USPS-LR-L-67 disaggregates the delivery costs from the CRA from the subclass level to the rate category level. Unit cost analysis within the CRA is done per originating piece and that is repeated in USPS-LR-L-67. Since the objective of USPS-LR-L-67 is not to derive unit delivery costs as you define them, I do not endorse the unit delivery costs provided in the table below.

Tr. 12/3450. Therefore, when witness Kelley stated in response to VP/USPS-T30-26(e)

that he could not determine “if these disaggregated costs are valid estimates of the

marginal street costs” (as quoted on page 70 of Dr. Haldi’s testimony), the specific

disaggregated costs to which he was referring were unit delivery costs per delivered

piece.

In contrast, in his answer to VP/USPS-T30-11(a), in response to Valpak’s inquiry

as to where in this case the marginal street time costs of letters is provided, witness

Kelley stated that “a thorough explanation of the manner in which the total volume

variable street time marginal costs are attributed to rate categories appears in USPS-

LR-L-67.doc starting on page 16. For a specific rate category the base-year street time

costs can be found by adding the costs in columns H and I for the desired rate category

(which are in the rows) in workbook UDCModel.USPS.xls worksheet ‘11SummaryBY’.”

Tr. 12/3453-54. This response, therefore, confirms the explicit statement by witness

Kelley in his direct testimony that the test year unit costs by rate category “listed in

Table 1 [reproduced on the next page of this testimony] represent marginal costs.”

USPS-T-30 at 3.

Thus, the concern Dr. Haldi raises on page 70 of his testimony regarding the

unavailability of marginal street time (Cost Segment 7) delivery costs below the

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subclass level applies only to the marginal cost per delivered piece, but not to marginal

cost per originating piece. As correctly stated by witness Kelley in his direct testimony

and in response to Valpak question 11(a), the relevant marginal costs, those per

originating piece, are broken out at the rate category level within his library reference.

D. The Postal Service Proposes Appropriate Treatment of the Costs of the Postal Transportation Networks

Transportation costing (C/S 14) issues were primarily addressed by witnesses

Kelley (USPS-T-15), Nash (USPS-T-16), and Bradley (USPS-T-14), and the outputs

were provided to witness Milanovic (USPS-T-9). For this cost segment, the Postal

Service followed established methodologies, with an exception for non-fuel transport

costs on the Fed-Ex Day-turn operation.

The Postal Service's treatment of costs on the Fed-Ex Day-turn, as described

below, recognizes the variability that exists in non-fuel transport costs, the marginal

costs for flying classes of mail on the day-turn, and assures that Priority Mail and First-

Class Mail cover their incremental costs. As explained below, the Commission should

adopt the Postal Service's treatment of these costs, and not the treatment urged by

UPS witness Neels (UPS-T-1).

As background information, witness Pajunas (USPS-T-45) testified that the

FedEx day-turn operation was originally sized to carry Priority and First Class Mail.

USPS-T-45 at 1. About 75 percent of the capacity was allocated for Priority and about

25 percent of the space was allocated for First Class Mail. Id. The day-turn network

has a minimum capacity guarantee. Id. This means that the Postal Service is obligated

to pay for a prescribed amount of cubic capacity whether it uses the capacity or not. Id.

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The Postal Service currently exceeds the original minimum guarantee by about

70% on a daily basis and has been doing so since the beginning of the contract. Id.

The Postal Service contracts for capacity above the minimums approximately every 12

to 18 months in the form of contract addendums. Id. The Postal Service also exceeds

the increased capacity reflected in those minimums by approximately 10 percent to 20

percent on a schedule period basis. Id. at 1-2. The contract minimums are well below

the volume of Priority and First Class Mail that must fly on the FedEx network in order to

meet their service obligations. Id. at 2. The Postal Service has been able to acquire

capacity above the original contract minimums at a reduced rate per cubic foot. Id.

There are several tiers of discounted rates available that are dependant on the amount

of volume tendered. Id.

Because of the discount tier rate structure witness Pajunas testified that he was

unaware of any less costly alternatives that were available during 2005 that would have

met the Postal Service's service requirements for mail products that flew on the FedEx

Network. Id. Additional volume can be added to the day turn network without taking

other volume off. Id. As a result of the lack of the reliability and availability of much of

the commercial passenger airline service, the use of the FedEx day and night turn

networks is required to meet Postal Service product service commitments. Id. Even if

Priority Mail was eliminated as a product offering the Postal Service would still have a

need for a network such as the FedEx Network to meet its First Class Mail service

obligations. Id.

Witness Bradley (USPS-T-14) testified about the bases for costing the FedEx

Day-turn. He noted that the existence of a declining block rate structure in an air

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transportation network will lead to a volume variability of less than 100 percent. USPS-

T-14 at 4. He also discussed circumstances under which an air network constructed

using dedicated equipment could generate a premium cost. Id. at 4-6. He noted that

there are two essential requirements for a premium cost to arise. Id. at 5. First, the

minimum size network must be larger than the capacity required to carry the mail for

which the network was designed. Id. Second, the cost of transporting that mail must be

more expensive on the air transportation network than on the alternative. Id.

As witness Pajunas testified, however, there is no extra capacity on either the

FedEx day turn or the FedEx night turn, as both are contracted networks that do not

require dedicated aircraft. USPS-T-45 at 1-2. Witness Bradley testified that this

situation means that they are not subject to the classic minimum efficient size network

constraint. USPS-T-14 at 5. As witness Pajunas further testified, the minimum on the

FedEx day-turn is well below the amount of Priority Mail and First Class Mail that must

fly on it for service and security reasons. USPS-T-45 at 1-2. While Professor Bradley

testified that a premium could still arise in a contracted network if the contract specified

a minimum amount of capacity that the Postal Service would have to purchase and that

capacity was routinely greater than the capacity needed to move the mail that had to fly

on the network for service and security reasons, USPS-T-14 at 5-6, this condition does

not arise. Accordingly, he concluded that there is no premium cost to be attributed for

either of the FedEx networks. USPS-T-14 at 6.

Professor Bradley then explained the proper cost attribution for the situation that

arises on the day-turn, where the air transportation network was created essentially for

the transportation of a group of products: First-Class Mail and Priority Mail. When a

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network is created for a group of products, the volume variable costs for all products

would be computed in the traditional way. USPS-T-14 at 7. The non-volume variable

cost for that network should be included in the incremental cost for that group of

products. Id.

Witness Kelley (USPS-T-15) calculated the variability factor for the FedEx Day-

turn non-fuel transport costs. He noted that, under the FedEx contract, the Postal

Service incurs expenses relating to a variety of activities provided by FedEx, falling into

three categories: handling; fuel; and non- fuel transport. USPS-T-15 at 2. Handling

charges are incurred for each item handled and scanned at FedEx hubs, and are

treated as fully variable with volume because the expenses increase proportionately

with the number of scans. Id. Similarly, a fuel charge is assessed for each cubic foot of

capacity purchased, and because increases in mail volume result in proportionate

increases in cubic feet of capacity required to handle the volume, fuel charges are also

treated as fully variable with volume. Id. Witness Kelley testified that as the contract

was originally written, non-fuel transport charges were incurred at a fixed rate per cubic

foot of capacity purchased, and were treated as fully volume variable. USPS-T-15 at 2.

In the fall of 2001, however, the Postal Service complied with a directive issued

by the Transportation Security Agency to remove all mail in excess of a certain weight

that had not been subjected to a pre-boarding security screening, resulting in a

substantial increase in the cubic volume of mail flown on the FedEx Day Turn network.

USPS-T-15 at 2. As a result, there have been addenda to the contract, which feature a

declining block rate structure -- after a certain cubic capacity threshold is reached, the

non-fuel transport charge for additional capacity decreases by a fixed amount to a lower

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rate per cubic foot, and as more capacity is added and higher thresholds are reached

the rate steps down. Id. This rate structure results in a marginal cost that declines with

increases in capacity purchased, and, in the higher tiers, the marginal cost is less than

the average cost. Id. at 2-3.

Witness Kelley then explained that volume variability is defined as the cost

elasticity with respect to volume. When there is a single cost driver, the variability can

be shown to equal the ratio of marginal cost (MC) to average cost (AC). Said otherwise,

when MC < AC then the variability MC/AC is less than one. Id. at 3.

Witness Bradley in Docket No. R2005-1 (USPS-T-31, Section II) presented the

analytical method for calculating a variability when costs are characterized by declining

block rates. On the basis of this theoretical construct, witness Kelley described the

development and application of the variability using FedEx operational and contractual

data. USPS-T-15 at 3.

Using actual invoicing data, witness Kelley calculated the average daily cubic

volume of mail by FedEx schedule block, and then flowed the schedule block average

daily volumes through the rate tiers to determine the marginal cost (simply the last tier

rate). USPS-T-15 at 3. To find the variability, the marginal cost was multiplied by the

average daily volume and then divided by the total cost for transporting the entire

average daily volume based on the declining rate structure. Id.

Aggregating across quarters, he calculated the quarterly marginal and average

costs, resulting in quarterly variabilities of 0.7409, 0.7356, 0.7229, and 0.7583 for

quarters one through four, respectively. USPS-T-15 at 4. He applied these factors to

the accrued costs for non-fuel transport charges in Cost Segment 14. Id.

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Witness Kelley testified that, as the variability is less than one, there will be some

non-volume variable costs incurred in the provision of the network. USPS-T-15 at 4.

Relying on witness Bradley (USPS-T-14), he explained that these non-volume variable

costs should be included in the incremental costs of the group of products that caused

the FedEx Day Turn network to arise -- First Class Mail and Priority Mail. Id.

The only non-postal witness to address this costing issue was UPS witness

Neels (UPS-T-1), who did not challenge the Postal Service's calculation of volume

variability. UPS-T-1 at 60. He argued, however, that the costs which the Postal Service

treats as non-volume variable should be included in the baseline attributable costs of

Priority Mail and First-Class Mail, UPS-T-1 at 61, or that the costs of the Day-turn

network should be shared among all classes of mail in proportion to their respective

capacity usage. UPS-T-1 at 63.

Witness Neels has not, however, argued that costs which the Postal Service

treats as non-volume variable are marginal to either Priority Mail or First-Class Mail.

Because they are not marginal in relation to any class of mail, the Postal Service

respectfully submits that its treatment of them as incremental to the group of products

comprised of First-Class Mail and Priority is appropriate and should be adopted by the

Commission.

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V. THE RATE LEVELS PROPOSED BY THE POSTAL SERVICE FOR EACH SUBCLASS OF MAIL REFLECT A REFINED APPLICATION OF THE RELEVANT STATUTORY CRITERIA

A. The Postal Service Has Appropriately Considered And Applied The Relevant Pricing Factors In the two-tier postal ratemaking process established by Congress, pricing

follows costing as the second tier. The cornerstone of pricing is the application of the

policies in 39 U.S.C. ' 3622(b) to determine how much revenue to seek from each

subclass, in excess of the incremental costs identified as having been caused by that

subclass during the costing process. Allocation of institutional cost burden among the

various subclasses and special services is designed so that the Postal Service can

achieve financial breakeven.1

The pricing exercise is accomplished by a consideration and application of the

nine enumerated postal ratemaking criteria in 39 U.S.C. § 3622(b):

(1) the establishment and maintenance of a fair and equitable schedule; (2) the value of the mail service actually provided each class or type of mail service to both the sender and the recipient including, but not limited to the collection, mode of transportation, and priority of delivery; (3) the requirement that each class of mail bear the direct and indirect postal costs attributed to that class plus that portion of all other costs of the Postal Service reasonably assignable to such class or type; (4) the effect of rate increases upon the general public, business mail users, and enterprises in the private sector of the economy engaged in the delivery of mail matter other than letters;

1 After rate policy issues are resolved and a target revenue has been set for each subclass, rate design is the subsequent pricing task necessary to determine how to split that revenue burden among the various rate categories and rate elements of the subclass.

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(5) the available alternative means of sending and receiving letters and other mail matter at reasonable costs; (6) the degree of preparation of mail for delivery into the postal system and its effect upon reducing costs to the Postal Service; (7) simplicity of structure for the entire schedule and simple, identifiable relationships between the rates or fees charged the various classes of mail for the postal services; (8) the educational, cultural, scientific and informational value to the recipient of mail matter; and (9) such other factors as the Commission may deem appropriate. The Postal Reorganization Act mandates that each subclass must objectively satisfy the

requirement in Criterion 3 that its revenue target meet or exceed the sum of its direct

and indirect attributable costs. All of the other criteria are judgmentally applied.

National Association of Greeting Card Publishers v. United States Postal Service, 462

U.S. 810, 820 (1983).

In this case, as in previous cases, the Postal Service has provided a rate policy

witness to explain why the rate levels proposed for each subclass and service are in

accord with the statutory factors that guide the pricing process. The rate policy witness

in the instant case was witness Donald O’Hara.2

Careful review of Dr. O’Hara’s testimony will reveal that his rate level proposals

rest on evaluations of the statutory factors that are consistent with previous applications

of the criteria by his predecessors. Like the analyses of his predecessors, witness

2 Docket No. R2006-1, Direct Testimony of Donald J. O’Hara On Behalf of United States Postal Service, USPS-T-31.

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O’Hara’s testimony reflects similar concerns and a similar considered weighing of the

various statutory criteria that have been the hallmarks of the analyses relied upon in the

past by both the Postal Service in developing its rate proposals, and the Commission in

recommending rates to the Governors.

The Postal Service has provided an additional analysis with its filing in this case,

designed to enhance the Commission's ability to fulfill its statutory mission. Postal

Service witness Dion Pifer (USPS-T-18) produces a comprehensive set of incremental

subclass cost estimates for consideration. Taking account of witness Pifer’s analysis,

witness O’Hara has proposed rate levels that meet all of the relevant statutory criteria in

a reasonable and rational fashion. His allocation of institutional costs also ensures that

each subclass covers its incremental costs.

On the other hand, intervenor witnesses who make alternative proposals or

suggest alternative pricing procedures rely upon analyses with substantial

shortcomings. In this section of its Brief, the Postal Service will review the proper

economic and statutory framework for pricing, will demonstrate why the rate levels

proposed by witness O’Hara best fit within that framework, and will show why the

proposals of opposing intervenors should be rejected.

B. The Cost Coverages Proposed By Postal Service Witness O’Hara Satisfy The Incremental Cost Test

Relying on the same methodology as was presented in Docket No. R2005-1, the

Docket No. R2006-1 testimony of witness Pifer (USPS-T-18) fulfills the Commission's

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directive3 that the Postal Service develop incremental cost estimates that would allow

the Commission to perform a cross-subsidy analysis on that basis. On behalf of the

Postal Service, witness O’Hara (USPS-T-31) explains that “incremental cost is the cost

savings that would result from completely eliminating a subclass (holding volume in

other subclasses constant).” USPS-T-31 at 11-12. He testifies:

In general, incremental cost for a given volume of mail will be greater than the corresponding volume-variable cost, and thus this test is more stringent than comparing revenue to volume-variable cost. If a subclass’s revenue equals or exceeds its incremental cost, that subclass imposes no burden on other subclasses (i.e., it is not cross-subsided by other subclasses), and the more its revenue exceeds incremental cost, the more it reduces the amount of institutional cost that must be covered by other subclasses. Id. By ensuring that, for each subclass, the proposed rates lead to revenues in excess

of the incremental costs for that subclass, Dr. O’Hara ensures that the requirements of '

3622(b)(3) are satisfied.

3 See, PRC Op. R94-1, Appendix F, at 24, &170.

The Postal Service has presented significant refinements to its In-Office Cost

System, and improved its volume-variable window service and mail processing cost

analysis. See the direct testimonies of witnesses Bozzo (USPS-T-12 and USPS-T-46),

Bradley (USPS-T-17), and Nieto (USPS-T-24), which are discussed above in Section V

of this Brief. These improvements are important to the application of the ' 3622(b)(3)

requirement that each class of mail or type of service bear the direct and indirect postal

costs attributable to that class.

The proposed cost coverage of each subclass is a summary index of the many

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considerations in ' 3622(b) that are weighed to determine the proper share of

institutional cost allocated to that subclass. A discussion of why the specific cost

coverages put forth by Dr. O’Hara warrant approval by the Commission will be

facilitated by first describing the methodology used to arrive at the proposed cost

coverages, and why such an approach is appropriate.

As the Postal Service's witness on rate policy, Dr. O’Hara determines how

institutional costs should be allocated among the classes and subclasses of mail such

that total revenues equal total cost. His approach to that task is spelled out in his direct

testimony, USPS-T-31.

Dr. O’Hara’s proposed rate levels are the product of a comprehensive process,

covering all aspects of the various postal subclasses. He applies his expertise in a

manner prescribed by the specific pricing criteria established by Congress, and the

evolution of the interpretation of the Act through the Commission's recommended

opinions, decisions of the Governors and judicial precedent. Dr. O’Hara makes no

pretense that his was anything other than an iterative, judgmental approach to pricing.

His methodology is consistent with the Postal Reorganization Act and Commission

precedent. See PRC Op. R87-1 at 378-89, ¶4063. Judicial review of this approach

confirms its validity. See Direct Marketing Association v. United States Postal Service,

778 F. 2d at 102.

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C. The Postal Service’s Proposed Cost Coverages Reflect A Fair And Equitable Allocation Of Institutional Costs And Give Proper Consideration To All Of The Applicable Ratemaking Criteria

In the preceding subsection, the Postal Service described the basic approach

taken by witness O’Hara and has demonstrated why it is the most appropriate method

on record in this proceeding for fairly and equitably allocating institutional costs. Below,

subclass-by-subclass, the Postal Service will explain how Dr. O’Hara’s proposed cost

coverages reflect the proper application of that methodology. Dr. O’Hara ensures that

each subclass meets the requirement of ' 3622(b)(3). He applies his judgment to

allocate institutional costs, based upon his consideration of the remaining ' 3622(b)

criteria. A summary of his analysis is presented below.

1. First-Class Mail – Letters and Sealed Parcels

The Postal Service's proposed rates for First-Class Mail (letters and sealed

parcels) reflect a cost coverage of 229 percent and an average 7.1 percent rate

increase, well below the 8.5 system average and the smallest percentage increase

proposed for any subclass. USPS-T-31, at 17. For single-piece letters, the increase is

7.7 percent, taking into consideration the proposal of a three-cent increase in the basic

rate and reduction of the additional-ounce rate, as well as the proposed shape-based

rate design. Although the average rate increase proposed by Postal Service witness

Altaf Taufique (USPS-T-32) for single-piece letters is 7.7 percent compared to a 6.4

percent average for presort letters (USPS-T-32 at 3), this difference is largely a result of

the higher proportion of flats and parcels in single-piece. USPS-T-32 at 17. The value

of service of First-Class Mail, by any standard, is high. With the exception of Express

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Mail and Priority Mail, First-Class Mail receives the most expeditious transportation and

delivery of all the mail classes. The existing collection network provides a major

convenience to many First-Class Mail users. First-Class Mail is forwarded without

additional cost. The contents of First-Class Mail pieces are normally free from any

postal inspection, thereby providing privacy of communication. Id. at 17-18. These

factors clearly enhance its value from the perspective of senders and recipients.

Although Dr. O’Hara testifies that the First-Class Mail letters subclass is also

characterized by a relatively low price-elasticity, he emphasizes that its elasticity may be

influenced by the application of the Private Express Statutes (18 U.S.C. '' 1693-1699;

39 U.S.C. '' 601-606). Id. at 18.

The proposed rates ensure that the class continues to recover its volume-

variable and incremental costs, and that it makes a substantial contribution to

institutional costs. At the same time, in accordance with 39 U.S.C. '3622(b)(5), the

proposed coverage was influenced by the restrictions upon available alternatives which

result from the application of the Private Express Statutes, as well as the increased

availability of electronic alternatives to First-Class Mail. Id. at 18-19.

In accordance with ' 3622(b)(6), Dr. O’Hara appropriately considers the degree

of pre-mailing preparation and the impact of his rate proposals on the mail preparation

industry in formulating the rates for various First-Class Mail presort and automation-

related rate categories. USPS-T-31 at 19. His analysis reflects consideration of the

impact of the proposed shape-based rate redesign on mailers of flats and parcels. Id. at

18. He also gives consideration to the Commission’s past evaluations of the

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educational, cultural, scientific and informational (ECSI) value of First-Class Mail. Id. at

19.

The Postal Service's proposed First-Class Mail letter rate structure is fair and

equitable. It satisfies all applicable '3622(b) criteria and merits the approval of the

Commission.

2. First-Class Mail – Cards

The Postal Service's proposed rates for First-Class Mail cards reflect a cost

coverage of 176 percent. Dr. O’Hara analyzes cards in comparison to letters as part of

determining the appropriate cost coverage for cards. Id. at 19.

After some analysis, witness O’Hara concludes that the intrinsic value of service

for cards is less than it is for letters. Id. at 19-20. The Postal Service's proposed card

rates will also ensure that the tradition of a lower per-piece institutional cost contribution

for cards is maintained, reflecting the lower value of cards compared to letters.

Reviewing the impact of the proposed increase on mailers and competitors, Dr.

O’Hara testifies that the proposed percentage rate increase for cards (10.5 percent) is

relatively higher than that for letters and for the system average. Dr. O’Hara took

account of the broader availability of alternatives for cards, in relation to letters. Id. at

20. The degree of presortation within the rate structure for cards is nearly parallel to the

structure for letters, leading him to conclude that degree of preparation performed by

the card mailers and the complexity of the schedule are at a similar, acceptable level as

well, and consistent with ' 3622(b)(6) and (b)(7). Id.

Dr. O’Hara carefully considered the relevant pricing criteria of '3622(b). His

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First-Class Mail post card cost coverage deserves the concurrence of the Commission.

3. Priority Mail

Dr. O’Hara proposes a 13.6 percent rate increase for Priority Mail, which reflects

a 163 percent cost coverage. Id. at 21. At over 13 percent, the proposed Priority Mail

rate increase is well above the proposed system average increase of 8.5 percent.

As the name of the service implies, Priority Mail receives preference in handling

and dispatch. It enjoys a higher priority in processing and dispatch than First-Class Mail,

and receives even greater use of air transportation. Compared to First-Class Mail,

Priority Mail enjoys expanded two-day service commitment zones and the availability of

Delivery Confirmation on all piece shapes. Id. at 21. On the other hand, its price

elasticity is considerably higher than that of First-Class Mail, indicating a lower

economic value of service. Id. Priority Mail does not have as much access to the postal

collection system as does First-Class Mail. Id. And it faces an increase in retail

customer access to competing services. Id. The proposed sharp increase in Priority

Mail rates is driven largely by the steep increase in volume-variable costs. Priority Mail

will experience a percentage rate increase which is considerably higher than the

system-wide average. The proposed cost coverage clearly ensures that Priority Mail

covers its attributable costs and makes a significant contribution to institutional costs.

This cost coverage also ensures that proposed rates are not designed to harm

competition. Id. at 22.

Current Priority Mail rates are based upon the weight of a package and (except

where the rates are unzoned) the distance it will travel. In this regard, the rates are

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relatively simple for the public to use. As Dr. O’Hara observes, Postal Service witness

Scherer (USPS-T-33) proposes the introduction of dim-weight pricing to certain

segments of Priority Mail as a supplement to the current weight-distance structure, in

order to more properly align the rates for bulky, lightweight packages with their costs.

Id. at 22. The Postal Service's Priority Mail cost coverage proposal should be

recommended by the Commission.

4. Express Mail

Dr. O’Hara proposes an Express Mail cost coverage of 191 percent, resulting in a

12.5 percent average rate increase for the subclass. He testifies that Express Mail's

value of service is very high, when intrinsic factors are considered. Express Mail

receives the highest delivery priority, extensive air transportation, and a significant

collection system, though not as extensive as the general collection system for First-

Class Mail. USPS-T-31 at 23. Express Mail also benefits from a service guarantee and

tracking capability. On the other hand, its price-elasticity indicates an extremely low

economic value of service. Id. The proposed increase will clearly have an effect on

mailers. In view of Express Mail's relatively small market share and modest recent

growth, the increase should not have an unfair effect on competition. Id. Witness

O’Hara noted that a number of private sector alternatives, with relatively attractive

service features, are available to Express Mail users.4 He also testifies that the deposit

or pickup of pieces at post offices reduces postal costs and constitutes a form of mailer

4 For individuals and small volume business users, these alternatives may only be available at a higher price, with additional features. USPS-T-31 at 23-24.

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preparation recognized by separate rate schedules. Id. at 24. His application of the

statutory criteria should be approved.

5. Outside County Periodicals

Dr. O’Hara proposes a cost coverage of 106 percent for Outside County

Periodicals, which results in an average rate increase of 11.7 percent. These figures

incorporate the impact of applying the five percent rate discount from the editorial pound

rate for qualified Nonprofit and Classroom Periodicals. USPS-T-31 at 24.

Witness O’Hara considers the value of service of Periodicals, taking into account

intrinsic characteristics, as well as comparisons to other mail classes. He observes that

the own-price elasticity translates into a high value of service. Id. at 25. He accounts

for the educational, cultural, scientific and informational (ECSI) value of Outside County

Periodicals in the cost coverage. Id. Another factor he analyzes is the availability of

alternatives. However, he notes that the degree to which they exist for different

publications varies. Id.

Because it reflects the means by which Periodicals mailers reduce postal costs

through various forms of mail preparation, the Periodicals rate schedule reflects

consideration of ' 3622(b)(6). Although witness O’Hara observes that the Periodicals

rate structure is relatively complex, he notes that Postal Service witness Tang (USPS-

T-24) is proposing some rate design initiatives intended to eliminate some complex

requirements associated with co-palletization. Id. at 25-26. The results of Dr. O’Hara’s

analysis should be embraced by the Commission.

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6. Within County Periodicals

Section 3626(a)(3) requires that the markup for the Within County Periodicals

subclass shall be equivalent to half the markup of for the Outside County subclass.

This has been calculated before the application of the five percent Nonprofit and

Classroom discount. In its response to NOI 1, the Postal Service explained why this is

appropriate.

Thus, . . . using preferred rate revenue before the discounts, is appropriate if one is willing to assume that the mere fact that a Periodicals publication is classified as regular rate, nonprofit, or classroom does not have any intrinsic effect on its costs. Periodicals mail pieces with identical characteristics should have the same costs, regardless of how they are classified. This approach is consistent with the legislative intent of the current version of section 3626, to reflect a rate preference (e.g., a reduced share of institutional costs), rather than any intrinsic cost differences between regular-rate and preferred rate pieces. Senate Report No. 106-468 confirms that the intent of the nonprofit and classroom discounts is to continue rate preferences previously established through other procedures. Moreover, the “50 percent markup” rule is similarly

intended to reflect rate preferences for Within County periodicals. Assuming similar cost characteristics, if the discounts for nonprofit and classroom are not added back to the revenues before calculating the “50 percent” markup, then the net result would be an excessive Within County rate preference, caused by layering the Within County preference on top of the nonprofit and classroom rate preference. Thus, the first option, the before-discount approach, makes sense and is consistent with the legislative intent.

USPS Response to NOI 1 at 3-4 (June 16, 2006). That undiscounted cost coverage is

approximately 107 percent, which leads Dr. O’Hara to propose a cost coverage of 103.5

percent for Within County Periodicals. The result is an average rate increase for the

subclass of 24.2 percent. USPS-T-31 at 26. But, as Dr. O’Hara observes, the formula

leaves no room for mitigation. Id. The result is in accord with the policies of the Act.

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7. Standard Mail

a. Regular and Nonprofit

Dr. O’Hara proposes a cost coverage of 176 percent for the Regular subclass

(including Nonprofit), which results in an average increase of 9.6 percent for the

subclass. USPS-T-31 at 27. He considers the value of service for Standard Regular

subclass mail, taking into account such factors as delivery generally being subject to

deferral, the use of ground transportation, and lack of access to the collection system.

Id. He observes that Postal Service attempts to satisfy mailer-specific delivery windows

typically require advance coordination by mailers. Id. Dr. O’Hara evaluates the price

elasticity for Standard Mail Regular as falling between that of First-Class Mail and

Enhanced Carrier Route, suggesting an intermediate economic value of service. Id. at

27.

The proposed 9.6 percent average rate increase for Standard Regular is above

the systemwide average increase and has a tolerable impact on users. Id. at 27-28.

Importantly, witness O’Hara notes that the proposed percentage increase, combined

with the proposed cost coverage, establish that competitors also are not being unfairly

targeted. Id.

Dr. O’Hara discusses the availability of alternatives, particularly other

demographically targeted communications media. He also compares the Regular

subclass to Enhanced Carrier Route (ECR), which has more of a geographic focus. He

testifies that the Regular subclass has a substantial degree of mailer preparation, but

less than ECR. Id. at 28. Because the Standard Regular rate schedule is designed to

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offer a range of rates to accommodate the varying ways in which mailers may choose to

perform worksharing in accordance with ' 3622(b)(6), it is relatively complex.

Nevertheless, it maintains reasonable and identifiable rate relationships, as required by

' 3622(b)(7) and is not overly complex for the sophisticated mailers who use it.

The Postal Service’s Standard Regular cost coverage analysis should be

affirmed by the Commission.

b. Enhanced Carrier Route and Nonprofit

Dr. O’Hara advocates a cost coverage of 214 percent for the Enhanced Carrier

Route (ECR) subclass, which results in a 8.9 percent average rate increase for the

subclass, just over the 8.5 percent systemwide average. USPS-T-31 at 29.

ECR mail has a relatively high degree of preparation, as much of it must be

tendered in either line-of-travel or walk-sequence. The geographic density of ECR mail

creates opportunities for alternative delivery firms and newspaper inserts to serve as

viable competitive options for advertisers. Id. at 30. The proposed cost coverage

reflects Dr. O’Hara consideration of the intrinsic value of service for ECR, which is

relatively low, since it lacks access to the collection system, receives ground

transportation, and is subject to delivery deferral. Id. He testifies that, although the

Postal Service is sometimes able to accommodate mailer requests for delivery within a

specified window, this requires mailer preparation, coordination, and planning.5 The

price-elasticity of ECR is much higher than for First-Class Mail, Periodicals, and

5 For high-density and saturation mailings, this is also facilitated by the regularity with which many of these mailings occur. USPS-T-31 at 39.

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Standard Regular, indicating a relatively low economic value of service as well. Id.

Given the near-average percentage rate increase and the proposed cost

coverage over 200 percent, Dr. O’Hara concludes that the proposed increase cannot be

said to unfairly compete with private sector enterprises in the business of delivering

geographically targeted solicitations. Id. at 29-30.

Witness O’Hara testifies that consideration of many of the pricing factors might,

at first blush, lead one to rush to the judgment that a lower cost coverage than he has

proposed is warranted. However, he emphasizes that ECR must make a reasonable

contribution to institutional costs, notwithstanding the high degree of preparation that

drives down its unit volume-variable costs, compared to Standard Regular mail. Thus,

he has proposed a cost coverage for ECR -- 214 percent -- which results in it making a

similar unit contribution to institutional cost as Standard Regular, for which, as noted

above, he proposes a 176 percent cost coverage. Taking all of the factors into

consideration, Dr. O’Hara’s approach is fair and equitable, and should be endorsed by

the Commission.

8. Package Services Mail

a. Parcel Post

Dr. O’Hara proposes a Parcel Post cost coverage of 115 percent, which

corresponds to an average rate increase of 13.2 percent for the subclass. USPS-T-31

at 31. Parcel Post exhibits a low intrinsic value of service, low priority of delivery, and

generally relies upon surface transportation. Because of security concerns, stamped

Parcel Post no longer has access to the collection system. It does not have many of the

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standard features of competitors’ services, like free insurance, tracking and pickup.6

Parcel Post’s own-price elasticity indicates a low economic value of service. Id.

Alternatives abound for large-volume business mailers, and the accessibility to these

alternatives for household mailers and small businesses has been significantly

expanded by the growing number of UPS Stores and FedEx/Kinko’s centers. Id. at 32.

Commercial package sending agencies, where accessible at the retail level, often

charge a premium over competitors' rates for use of Parcel Post. For many mailers in

remote areas, alternatives to Parcel Post may be relatively inaccessible and/or

expensive. Id. at 32.

The relatively high percentage rate increase implied by Dr. O’Hara’s proposed

Parcel Post cost coverage is driven by the need to ensue that the subclass covers its

increasing costs. While this may have some adverse impact on Parcel Post users, it

cannot be judged as having an adverse or unfair impact on competitors. Id. at 31-32.

The results of witness O’Hara’s analysis should be affirmed.

b. Bound Printed Matter

The proposed cost coverage for this subclass is 125 percent, resulting in an

average rate increase of 11.9 percent. USPS-T-31 at 32. As with Parcel Post, the

intrinsic value of Bound Printed Matter is relatively low. Conversely, its own-price

elasticity suggests a moderately high economic value of service. Id.

The proposed nearly 12 percent rate increase will obviously affect users of

6 The availability of Delivery Confirmation for Parcel Post may increase its value for some customers. However, unlike with Priority Mail, single-piece Parcel Post customers must pay extra for this added feature.

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Bound Printed Matter negatively. Witness O’Hara has applied the statutory criteria in a

manner designed to mitigate the impact of the Bound Printed Matter cost increases

which have occurred since Docket No. R97-1. The above-average proposed rate

increase and the proposed 125 percent cost coverage establish conclusively that the

Postal Service is not attempting to unfairly target competitors. Id. at 33.

Dr. O’Hara considers the alternatives available to Bound Printed Matter users.

For book mailers, the Media Mail subclass is an alternative. He also examines the

limited availability of alternative delivery for catalogs and telephone directories. Id. at

33. His cost coverage proposal reflects consideration of the relevant pricing criteria and

merits the Commission's approval.

c. Media and Library Rate Mail

The proposed cost coverage for this subclass is 109 percent. The result is an

average rate increase of 18 percent for Media Mail and an 18.2 percent increase for

Library Rate. USPS-T-31 at 34. As with other Package Services subclasses, the

intrinsic value of the Media Mail subclass is relatively low. Its price elasticity suggests a

low value of service. Id. Bound Printed Matter is available as an alternative for

business mailers. For individuals, alternatives are more limited and more costly. Id.

Nevertheless, the relatively steep percentage rate increases proposed for Media and

Library Rate mail mirror the substantial volume-variable cost increases; and the

resulting revenue provides only a small margin above those costs. Id. Materials such

as books, films, and sound recordings give the Media Mail subclass a high ECSI value

in Dr. O’Hara’s judgment, and he reflects this in his proposed cost coverage. Id.

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Witness O’Hara’s application of the pricing criteria for the Media and Library Rate

subclass should be approved.

D. The Intervenor Cost Coverage Proposals Are Lacking

1. UPS witness Geddes’ Priority Mail proposals ignore the realities of Priority Mail’s place in the package delivery market. On behalf of United Parcel Service, witness Richard Geddes presents a rate and

cost coverage proposal for Priority Mail that would result in a 23.6 percent increase in

Priority Mail rates. UPS-T-3 at 12, line 9. To justify this rate proposal, Dr. Geddes

asserts:

This is the same markup that the Postal Service recommends. It is also close to the markup of 62 percent recommended by the Commission in Docket No. R2000-1, the last fully litigated rate case. UPS-T-3 at 12 (footnotes omitted). Dr. Geddes also discusses the Priority Mail

marketplace at length to justify UPS’s self-serving rate proposals. However, as Postal

Service rebuttal witness Maura Robinson notes, his discussion “fails to provide the

market and rate context needed to inform the Commission’s recommended decision.”

USPS-RT-10 at 16.

The Postal Service agrees that, in some respects, Docket Nos. R2001-1 and

R2005-1 were not typical postal rate cases. But, in many ways, every omnibus rate

docket, those two included, provides the Postal Service and the Commission with

unique circumstances that each agency must consider in developing pricing and rate

design proposals that must meet the criteria of § 3622 and other pertinent policies of

the Act. The Postal Service strongly disagrees with witness Geddes’ assertion that the

Docket No. R2001-1 and R2005-1:

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rate cases did not provide an opportunity for the Commission to receive testimony and hear debate from all of the large number of interested parties who normally participate in an omnibus rate case.

UPS-T-3 at 7. The procedural history in each docket refutes the assertion that any of

the score s of parties who intervened were denied the opportunity to raise any issue for

consideration by the Commission.7 It is not the number of pages or the number of lines

on a page devoted to a topic that defines substantial record evidence; it is the quality of

evidence that influences the Commission’s determinations. Dr. Geddes’ summary

dismissal of the outcomes in Docket Nos. R2001-1 and R2005-1 devalues the

Commission’s careful deliberations and its clear determination to fully evaluate the

merits of all positions advocated by parties in those cases, especially those parties who

disagreed that settlement of issues in those cases was appropriate.

Moreover, Dr. Geddes characterization of Docket No. R2001-1 seems to be at

odds with UPS’ contemporaneous description of that case:

In light of this clear fact [that the discounts APWU criticizes do not exceed properly measured avoided costs] the Commission should not venture into the thicket of deciding fundamental ratemaking principles of the type raised by APWU when, as here, that is not necessary to reaching a proper decision. That is especially so since, given the all but unanimous support for the Settlement rates, other parties have not addressed those issues fully.

Docket No. R2001-1, UPS Reply Brief at 3. (Emphasis added.) UPS clearly believed

that the Commission could reach a proper decision that was consistent with the Act,

7 What parties choose to do with their opportunities is something different altogether. In every rate docket, each intervenor makes judgments about the degree to which it disagrees with the Postal Service’s request and the degree to which it will seek to challenge it and/or offer alternatives. Docket Nos. R2001-1 and R2005-1 were not exceptional in this regard.

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absent an exhaustive debate among the parties on every conceivable issue, and also

clearly understood that parties such as APWU (and presumably UPS itself) had the

opportunity to advocate for their preferred outcomes. Simply asserting in Docket No.

R2006-1, as Dr. Geddes does (UPS-T-3 at 7), that the rate relationships adopted in the

last “fully litigated” rate case (Docket No. R2001-1) are “presumptively reasonable,”

ignores the value of the Commission’s deliberations during the intervening two dockets.

The Commission, however, cannot ignore history and the evolution of rates and rate

relationships over the past six years. In presenting its Docket No. R2006-1 rate

proposals, the Postal Service has carefully examined all relevant variables and

presented rate proposals that are fair and equitable, and that balance all of the § 3622

pricing criteria. Admittedly, UPS witness Geddes, on the surface, has presented a

similar analysis. However, his proposals must be viewed through the lens of UPS’s

self-interest. As Postal Service rebuttal witness Robinson explains, “witness Geddes

fails to provide the market and rate context needed to inform the Commission’s

recommended decision.” USPS-RT-10 at 16. Specifically, he proposes a Priority Mail

cost coverage that he justifies as appropriate, based on an assertion that (1) it is close

to that recommended by the Commission in Docket No. R2000-1; and (2) it is that

proposed by the Postal Service in this docket. UPS-T-3 at 12. When questioned

further, Dr. Geddes claims that “the best recommended cost coverage is not dependent

on the cost basis utilized.” Tr. 26/9122.

Clearly, this has not been the Commission’s viewpoint. For example, in

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discussing the principles embodied in the pricing criteria and its application of these

criteria, the Commission clearly considers whether costing methodologies differ:

Once the Commission has completed the process of analyzing the extent that Postal Service costs can be directly or indirectly attributed to classes of mail and services consistent with the appropriate interpretation of [§ 3622](b)(3), the attribution level for each class is reviewed. Particular attention is focused on understanding differences in attribution between cases. If the attribution level for certain classes has changed significantly, the impact of that change on rates should be understood. If changes in attribution level are likely to affect inter- class rate relationships, this possibility also should be recognized.

PRC Op. R87-1 at 371, ¶4041. Ignoring these factors (and analogously ignoring

differences between the Postal Service’s proposed costing methodology and that used

by the Commission in previous dockets) as UPS witness Geddes does, can only lead to

simplistic and fatally defective proposals for the allocation of institutional costs.

Taking a broader perspective, Postal Service rebuttal witness Robinson

demonstrates that Dr. Geddes’ proposed cost coverages would result in a rate increase

that is excessive in light of the history of Priority Mail rate increases over the past

decade. USPS-RT-10 at 16; Tr. 32/10715. Admittedly, greater-than-average rate

increases are often necessary, for example, due to cost pressures and the need to meet

the mandate in § 3622(b)(3). In fact, the Postal Service’s proposed Priority Mail rate

increase is greater than average by a substantial amount and is driven, in part, by

Priority Mail cost trends. In weighing the effect on customers of a larger Priority Mail

rate increase in this docket, Postal Service rate levels witness O’Hara (USPS-T-31)

determines that it would not be appropriate. On behalf of UPS, Dr. Geddes second-

guesses this conclusion based, in part, on an overly optimistic assessment of the

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marketplace. Apparently a relatively short-term improvement in Priority Mail volume, in

Dr. Geddes’ view (UPS-T-3 at 17, Table 1) offsets a 27 percent reduction in Priority Mail

volume from FY 2000 to FY 2005. As Postal Service witness Robinson explains, such

an analysis is inconsistent with sound ratemaking and the Commission’s stated

principles regarding consideration of the effect on customers of a proposed rate change.

Dr. Geddes also asserts that the Priority Mail cost coverage should not be lowered in

order to protect the Postal Service’s market share. UPS-T-3 at 9. Again, the

Commission has made a clear determination that moderating cost coverage to protect

customers and to avoid harm to the Postal Service’s market position is appropriate,

despite UPS’ arguments to the contrary. See, PRC Op. R2000-1 at 313, ¶5317. It has

been observed that:

As to §3622(b)(5), the Commission has consistently, and reasonably, held that it authorizes a reduction in rates to maintain the position of the Postal Service as a competitor in the mail delivery industry.

United Parcel Service v. United States Postal Service, 184. F.3d 827,845 (D.C. Cir.

1999).

Despite all of Dr. Geddes’ posturing to the contrary, Postal Service witness

Scherer’s description of the competitive position of the Priority Mail in the marketplace

has not been refuted. Priority Mail’s market share has dropped substantially and its

volume has fallen (USPS-T-33 at 8), while that of UPS has grown. See designated

institutional response of UPS to interrogatory USPS/UPS-T3-7. The -1.02 own-price

elasticity measured for Priority Mail by witness Thress (USPS-T-7) is also significantly

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higher than the levels found in Dockets Nos. R2000-1 and R2001-1. Like the decline in

market share, this suggests a deterioration of Priority Mail’s competitive position. The

Commission should weight these facts accordingly and dismiss UPS witness Geddes’

self-serving pricing proposals.

2. Amazon.com witness Haldi misapplies the pricing criteria in proposing his Bound Printed Matter cost coverage.

On behalf of Amazon, witness John Haldi (AMZ-T-1) suggests that the

Commission reduce the cost coverage for Bound Printed Matter from the level proposed

by the Postal Service (125 percent) to about 114 percent, based on his view that Postal

Service witness O’Hara (USPS-T-31) has not appropriately applied the pricing criteria to

Bound Printed Matter.8 AMZ-T-1 at 28-34. Dr. Haldi points to pricing Criterion 8 (the

educational, cultural, scientific, and informational value of the mail, ECSI) to argue that,

in part, because the Bound Printed Matter subclass includes books, it should be

assigned a higher ECSI value than Parcel Post. Consequently, Dr. Haldi views the

appropriate ordering of cost coverages for the commercial Package Services

subclasses to be one that results in a lower coverage for Media Mail than for Bound

Printed Matter which, in turn should be less than that of Parcel Post. He further

proposes this ordering be achieved by reducing the cost coverage for Bound Printed

Matter to about 114 percent.

8 Amazon witness Haldi (AMZ-T-1) also proposes a classification change which would remove certain content restrictions on mail set as Bound Printed Matter. Postal Service rebuttal witness James Kiefer (USPS-RT-11) explains why this proposal should not be recommended.

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Amazon witness Haldi’s proposal fails to recognize the full circumstances

surrounding the relative pricing and cost coverage proposals for Bound Printed Matter.

Postal Service witness O’Hara (USPS-T-31) proposes an 11.7 percent rate increase for

Bound Printed Matter, lower than the proposed 13.2 percent rate increase for Parcel

Post. Dr. O’Hara’s proposal is consistent with the application of all of the pricing criteria,

including recognition that Bound Printed Matter has been given “some ECSI

consideration in setting rate levels.” USPS-T-31 at 33. What Dr. Haldi fails to consider

is that factors other than relative ECSI value are incorporated in the Postal Service’s

proposal. Specifically, Postal Service witness O’Hara indicated that the Postal Service’s

Parcel Post rate proposal has been influenced by consideration of the potential adverse

effect on customers of a greater increase, balanced against the increasing costs of

providing Parcel Post service. USPS-T-31 at 31.

Consideration of the cost coverage for Bound Printed Matter is not an exercise in

“ranking” the criteria based solely on ECSI or any other single consideration. Rather,

the Commission must consider the full range of factors affecting all subclasses, and

balance all factors within the context of a comprehensive pricing recommendation. As

the Commission has often noted, evaluating the appropriate cost coverage for all

subclasses, including Bound Printed Matter, does not result in a ordinal ranking of

coverages along a single dimension such as ECSI.

3. Valpak’s nostalgic Standard Enhanced Carrier Route cost coverage proposal seeks to unfairly burden Standard Regular. Reminiscent of the swallows upon their return to Mission San Juan Capistrano,

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Valpak witness Mitchell (VP-T-1) returns to another Postal Rate Commission docket to

testify that that Enhanced Carrier Route (ECR) subclass cost coverage proposed by the

Postal Service is too high and should be lowered to levels idealized in Docket No.

MC95-1. The Postal Service commends the Commission to contrast witness Mitchell’s

longing for the rate level relationships of yester-year with the rebuttal testimony of

Newspaper Association of America witness Gregory Sidak (NAA-RT-1; Tr. 32/10819 et

seq.) which, at least, argues that institutional cost allocations in this docket should be

based on current and anticipated mail volume trends and market realities, as opposed

to hopes expressed in the mid-1990’s.

The recurring refrain in witness Mitchell’s testimony is that the Commission

should moderate the proposed Enhanced Carrier Route subclass cost coverage. He

proposes that Standard Mail ECR rates should decrease by nearly 8.5 percent, while

Standard Regular rates increase by over 17.5 percent. VP-T-1 at 97. In contrast, under

Dr. O’Hara’s proposal on behalf of the Postal Service, Standard Regular rates would

increase 9.6 percent, compared to 8.9 percent for Standard ECR. Exhibit USPS-31D.

And both subclasses would make equivalent unit contributions to institutional cost.

USPS-T-31 at 30; Tr. 17/5125.

It is noteworthy that, except in the circumstances relating to its across-the-board

proposal for meeting its unusual Docket No. R2005-1 escrow revenue requirement, the

Postal Service has generally proposed price increases for Standard ECR that were

below the system average, and below the proposed increases for Standard Mail

Regular. The Postal Service’s Docket No. R2006-1 application of the § 3622(b) criteria,

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again, continues this trend. Witness O’Hara (USPS-T-31) applies the criteria to allocate

institutional costs in such a way that the average percentage rate increase for the

Standard ECR subclass is below the average percentage increase for Standard Mail

Regular. Exhibit USPS-31D. Over time, the cost coverage for Standard ECR, relative

to the systemwide average coverage, has been declining. Tr. 17/5122-24.

Even if one were to accept Valpak witness Mitchell’s claim that ECR cost

coverage is “too high,” his “solution” is to place all the burden of his “correction” on the

Standard Mail Regular subclass. In contrast, a fair and equitable adjustment in

institutional costs and relative rates of this magnitude should involve a complete

reconsideration and potential recalibration of the cost coverages of all subclasses.

Standard ECR, while a separate subclass, bears many of the characteristics of a

worksharing category. For example, Standard Regular mail that has 10 pieces per

carrier route can become eligible for ECR solely by the application of additional mailer

worksharing. As is well known, all else being equal, the cost coverage on workshared

mail is higher than that of comparable non-workshared mail because the unit cost of

workshare mail is lower. Thus, it cannot be said that the Standard ECR cost coverage

bears an aberrational relationship with that of Standard Regular.

Nevertheless, witness Mitchell doggedly asserts that, somehow, the goals of

Docket No. MC95-1 have not been achieved, because the cost coverage for Standard

Mail ECR has not been reduced below that of Standard Mail Regular. He cites the

Commission’s paraphrasing of Postal Service witness Moeller’s Docket No. MC95-1

suggestion that ECR cost coverage should be lower (see, e.g., VP-T-1 at 29); however,

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witness Mitchell does not provide any direct evidence that the Commission has

established a long-term policy aimed at reducing Standard Mail ECR cost coverages to

the levels he suggests.

In fact, in its first opportunity to adjust Standard Mail ECR cost coverages

following Docket No. MC95-1:

[t]he Commission . . . [agreed] with the Service that even though several of the statutory factors might indicate a low ECR cost coverage, on balance the record supports an ECR cost coverage that is well above average.

PRC Op. R97-1 at 447, ¶5550. In its Docket No. R97-1 recommended decision, and in

each subsequent recommended decision, the Commission has balanced the often

conflicting factors embodied in the pricing criteria and reached the conclusion that a

greater-than-average Standard Mail ECR cost coverage is consistent with the policies of

the Act. In its current proposal, the Postal Service has carefully weighed the statutory

pricing criteria and provided substantial evidence supporting the conclusion that a

greater-than-average Standard Mail ECR cost coverage is justified. This proposal

should be accepted.

Eventually, witness Mitchell is able to let go of the past to discuss postal reform

legislation that was pending at the time of his testimony. At pages 96-97 of VP-T-1, he

asserts that since the legislation, if enacted, would be expected to change the way that

postal prices are set, any pricing inequalities that exist today must be eliminated now,

before the new pricing regime is instituted, otherwise inequities might be permanently

baked in.

The Postal Service submits that the Commission has repeatedly recommended

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above-average cost coverages for ECR, seeming to suggest that whatever

misalignment that might exist between its recommended coverage and some unknown

ideal, the “discrepancy” was not so great that it required immediate correction. Mr.

Mitchell’s assertion that ECR is entitled to some form of pre-reform correction should be

summarily dismissed. In this regard, Standard ECR has no special status and is

entitled to no more of a pre-reform “nip/tuck” before the Postal Accountability and

Enhancement Act is in full effect than any other subclass. Adoption of his proposal

would be highly disruptive and would lead to unreasonably high increases for some

categories of Standard Mail Regular. There is no compelling basis, rooted in the

upcoming legislative change or elsewhere, for raising their prices so severely and

heedless of the impacts on mailers.

Moreover, witness Mitchell’s belief that statutory changes to the ratemaking

process may preclude further adjustment of ECR’s cost coverage before the ratemaking

process changes turns out to have been a miscalculation. New section 3622(f) in the

Postal Accountability and Enhancement Act contains a provision that permits the Postal

Service to file a rate case under the Commission’s existing rules during the one-year

period that begins on the date of its enactment:

Transition Rule. -- For the 1-year period beginning on the date of enactment of this section, rates and classes for market-dominant products shall remain subject to modification in accordance with the provisions of this chapter and section 407, as such provisions were last in effect before the date of enactment of this section. Proceedings initiated to consider a request for a recommended decision filed by the Postal Service during that 1-year period shall be completed in accordance with subchapter II of chapter 36 of this title and implementing regulations, as in effect before the date of enactment of this section.

Moreover under new §3622(a), the Commission has up to 18 months to establish the

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implementing regulations governing the pricing of market dominant products, which

includes Standard Mail:

(a) AUTHORITY GENERALLY. -- The Postal Regulatory Commission shall, within 18 months after the date of enactment of this section, by regulation establish (and may from time to time thereafter by regulation revise) a modern system for regulating rates and classes for market-dominant products.

Thus, it is not beyond the realm of possibility that an opportunity to revisit all of these

issues again could arise before the Commission’s new rules are implemented.

4. The NAA post-discount approach to calculating the Within County Periodicals cost coverage should be rejected.

The proposed cost coverage for Within County Periodicals is half that of the

Outside County cost coverage, calculated using total Outside County revenue (that is,

Regular Rate revenue plus Nonprofit and Classroom revenue before the application of

the 5 percent discount applicable to those preferred rate categories). The Postal

Service, in its June 16, 2006, response to Notice of Inquiry (NOI) No. 1, explains why

using this Outside County pre-discount cost coverage is the appropriate way to

determine the markup for Within County for purposes of the “half markup rule” of

§ 3626. NNA, on the other hand, argues for a post-discount approach. See Response

of the National Newspaper Association to the Commission Notice of Inquiry No. 1 (June

16, 2006).

The recent enactment of the H.R. 6407, the Postal Accountability and

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Enhancement Act (PAEA) raises a question as to the continued applicability of the “half

markup rule.” The PAEA revises § 3626 to eliminate the statutorily hard-wired “half

markup rule” and replaces it with discretionary language that states that Within County

rates should simply reflect the subclass’ “preferred status as compared to the rates for

the most closely corresponding regular-rate category mailing.” See PAEA, § 1003. An

open question is whether this revision to § 3626 is effective immediately, or whether the

“half markup” rule still governs rate modifications for another year under the transition

provision found at § 201 of the PAEA. The Postal Service believes that there is no need

to answer this question now. Instead, for purposes of this proceeding the Commission

should simply utilize the Postal Service’s pre-discount approach, which satisfies both

the “half markup rule” and is within the Commission’s discretion under the new standard

of the PAEA.

Whether the “half markup rule” is still statutorily mandated or is adopted by the

Commission for purposes of satisfying, for this proceeding, the PAEA’s new “preferred

status” language, the Postal Service’s response to NOI No. 1 demonstrates why the

pre-discount approach used by witnesses Tang and O’Hara is preferable to the post-

discount approach urged by the NNA. As the Postal Service notes, using a pre-

discount Outside County cost coverage appropriately assumes that the unit costs for

similar regular and preferred rate pieces are the same. Response of Postal Service to

NOI No. 1, at 3-4. The post-discount approach, on the other hand, implicitly assumes

the opposite. Since there is no reason to believe that the Nonprofit and Classroom

discounts are set in order to offset intrinsic cost differences between similar preferred

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and regular rate periodicals, a pre-discount approach is a better estimate of the regular-

rate markup. Id. at 4-5.

E. Conclusion

The cost coverages proposed by the Postal Service represent a fair and

equitable allocation of institutional costs. Dr. O’Hara’s approach is the only balanced

and comprehensive application of the various statutory criteria to each subclass of mail.

He takes into account the relevant statutory criteria while analyzing each specific

subclass and ensured that the institutional cost contributions of the various subclasses

are fair and equitable in comparison to each other. The result of his analysis is an

allocation of institutional costs which treats mailers and competitors fairly, takes into

account the unique characteristics of each subclass, and best allows the Postal Service

to meet the needs of the mailing public. Some intervenor witnesses offered cost

coverages proposals for only one or a few subclasses of mail. These proposals, made

in isolation with self-serving intent, are not comprehensive and did not provide the

means by which to balance the revenue burden so as to achieve financial breakeven.

Accordingly, the Postal Service urges the Commission to give full support to the

proposals advanced by Dr. O’Hara.

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VI. THE RATE DESIGN PROPOSED BY THE POSTAL SERVICE WILL RECOVER THE NECESSARY AMOUNT OF REVENUE FROM EACH SUBCLASS IN A MANNER WHICH COMPLIES WITH THE ACT

A. Several Important Principles Guide the Postal Service’s Overall Rate Design After the Postal Service determines the appropriate cost coverage for each

subclass of mail, it must design rates for each subclass which generate sufficient

revenue to ensure that the ratio of per-piece revenue to per-piece volume-variable cost

equals the prescribed cost coverage. The revenue burden for each mail subclass or

service must be spread across each rate category of that subclass or distinct element of

that service offering in a fair and equitable manner. As is evident from the preceding

chapter of this Brief, Postal Service witness O’Hara (USPS-T-31) accords each

subclass an independent application and weighting of the appropriate statutory policy

considerations. Only a comprehensive subclass-by-subclass approach, such as his, will

ensure that all of the relevant costing and pricing criteria have been reasonably

considered and fairly applied.

The Postal Service has presented substantial record evidence which reflects a

strict adherence to the fundamental principles of postal ratemaking. The product of this

effort is a comprehensive, integrated and harmonious rate schedule. The Postal

Service's proposed rates for each subclass are discussed below and are contrasted

with the pricing proposals of the intervenors. The record in this proceeding

demonstrates that the Postal Service's rate proposals ensure that the Postal Service's

revenue requirement will be met in a manner which is fair and equitable to mailers and

competition. The rates proposed by the Postal Service are consistent with the public

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interest and should be preferred by the Commission to those suggested by the various

intervenors.

Before embarking on a class-by-class discussion of rate design matters, it may

be helpful to review some general principles that guided the Postal Service in its

broader approach to rate design in this docket. The Postal Service urges the

Commission to consider them as it develops its rate recommendations.

1. There should be greater emphasis on shape in rate design.

The Postal Service seeks a rate and classification schedule that reflects greater

recognition of mailpiece shape. The objective of this policy is to encourage more

efficient preparation of mail and to help assure that distinct categories make a

contribution to the institutional cost burden borne by their respective subclasses.

To the extent that it is possible to choose among shape formats for sending

letters, merchandise or other items, the pricing proposals submitted here for review

encourage efficient choices. Of course, some articles that are mailed require a

particular shape format. For example, a sleeve of golf balls cannot be configured into a

letter or flat mailpiece. However, an unfolded document currently mailed in a flat-

shaped envelope could possibly be folded and sent in a letter-shaped envelope. It is

this latter example that shows how a price difference could lead to production of mail

that can be handled at a lower cost. To the extent any net additional cost of producing

a letter instead of a flat (e.g., the additional cost of folding and inserting) is lower than

the price difference, the mailer may consider choosing the letter format. Ultimately, that

decision will also incorporate any value gained by having the recipient receive an

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unfolded document, and in a larger mailpiece that might garner more attention. In any

event, by having a price difference, there is heightened consideration to the selection of

the shape format. Likewise, if the rate for mailing a package is based only on weight

and distance, then there is little reason to be mindful of the size of the box that may be

used. By incorporating a price element that acknowledges the “fullness” or the density

of a package, the Postal Service encourages mailers to use mailing boxes that, all else

considered, are not larger than necessary. A conscious decision to use a smaller box

can lead to a lower price, and will help make the postal system more efficient overall.

To the extent that it is not possible to choose among shape formats for sending

messages or other mailable articles, the proposals are advantageous in that they result

in a more equitable distribution of the institutional cost burden within a subclass. As

noted above, the physical nature of what is being sent may make it incompatible with

the standards for a more efficiently-processed shape. Also, even if it were possible to

reconfigure an item into another mailing shape, doing so might harm the content, or

otherwise make the mailpiece less beneficial to the sender and recipient. In such

instances, the mailer will be expected to decide to retain the more effective mailpiece

shape, even though the applicable postal rate is higher. In the end, though, that higher

rate helps that rate category cover its costs, and helps the subclass meet its individual

revenue target.

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2. Overall rate design should reflect forward-looking operational realities. Ideally, the Postal Service can avoid requiring mailers to do more mail

preparation work than is necessary by offering prices that induce the appropriate level

of preparation. All parties have an interest in making the postal system more efficient.

A rate schedule with prices that require mailers to do more work than necessary is

counter to that objective. For instance, if the postal processing of a certain type of mail

is initially conducted at a mail processing plant, then mailers should not be encouraged

to undertake expensive activities designed to result in entry of that mail deeper into the

system, at a delivery unit. Likewise, if the initial postal processing is on a machine with

a sortation scheme that does not require a fine level of presort, it is counter-productive

to have a mailer presort that mail to a level beyond that which is necessary for entry into

the mailstream for postal processing. The Postal Service’s rate design proposals

embody this sensible acknowledgment of the operational environment, and result in a

more efficient overall mail production, processing, and delivery system.

It is appropriate for rate design and prices to acknowledge changes in the postal

mail processing environment. As in past postal rate cases, the proposed rates and

classifications reflect a cognizance of recent operational changes and their ongoing

development. The testimonies of Postal Service operations experts Marc McCrery

(USPS-T-42) and Joyce Coombs (USPS-T-44) describe the mail processing and

delivery environments. The proposed Domestic Mail Classification Schedule includes

many new rate categories designed to better align prices with these operational realities

and plans. And the prices proposed for these new categories, as well as the existing

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categories, are mindful of the efficiency that can be gained when the prices signal the

most advantageous mail preparation.

3. Efficient Component-Pricing should only be applied to worksharing cost differences.

During this docket, the Commission requested views of the parties on the

applicability of efficient component-pricing (ECP) to price differences in costs between

different categories of mail within the same subclass. NOI No. 2 at 7 (July 21, 2006)

and NOI No. 3 at 6-7 (July 26, 2006). Many participants responded to one or both of the

NOIs, giving their views on how ECP was applicable in pricing intra-subclass rate

categories.1 In addition, several witnesses addressed ECP, either explicitly or implicitly

in their testimonies. See, e.g., PB-T-1 (Panzar), NAA-T-1 (Sidak), SMC-RT-1(Crowder),

(USPS-RT-10) Robinson , USPS-RT-11 (Kiefer), VP-RT-1(Mitchell), PSA/PostCom-T-1

(Glick) and ABA-RT-1 (Kent).

The Commission’s NOI Nos. 2 and 3 provide the same general description of the

ECP concept:

Consider that Baumol and Sidak define the efficient component price as the input’s direct per-unit incremental cost plus the opportunity cost to the input supplier of the sale of a unit of output.

NOI No. 2 at 7; NOI No. 3 at 6. Another definition that sets ECP within its appropriate

context is given in the response of Association for Mail Electronic Enhancement et. al.

to NOI No. 3:

The Efficient Component Pricing Rule, a specialized rule for productive efficiency in the pricing of individual components of vertically integrated

1 Some participants responded to the NOIs but did not specifically address the question of the applicability of ECP to pricing intra-subclass cost differences.

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goods or services offered by a regulated monopolist, requires that the components available from competing suppliers be priced at their marginal (or average incremental) cost.

Response of Association for Mail Electronic Enhancement et al. (AMEE) to NOI No. 3 at

14. This definition supplies useful context: the producer subject to the ECP rule is, first

of all, a regulated monopoly, it is vertically integrated, and it competes with outside

suppliers for the supply of some components of its final product.

NOI Nos. 2 and 3 invited respondents to address the question of how ECP

applies to pricing cost differences between categories within a subclass. NOI No. 2 at

7; NOI No. 3 at 6-7. The respondents who addressed this question (either responding

directly to either or both NOIs, or in testimony) generally fall into two groups. The first

group (which includes the Parcel Shippers Association, the Association for Mail

Electronic Enhancement, the Association for Postal Commerce, Pitney Bowes, and the

Saturation Mailers Coalition) holds that the ECP pricing rule should be applied broadly.

See Responses of PSA to NOI No. 2 and AMEE et. al. to NOI No. 3; PSA/POSTCOM-

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T-1, PB-T-1, SMC-RT-1).2 These commenters do not limit ECP only to pricing

worksharing activities.3

The second group of respondents argues for a more strict interpretation of ECP.

They assert that ECP is appropriately applied for costs that can be avoided directly by

mailer activities, that is, by worksharing as traditionally defined. This second group

includes the Postal Service, Newspaper Association of America, Time Warner, United

Parcel Service, and Valpak. (See Response of Time Warner to NOI Nos. 2 and 3 at 3-4,

including footnote 4; Response of UPS to NOI Nos. 2 and 3, Response of the Postal

Service to NOI No. 2 and Response of the Postal Service to NOI No. 3, Response of

Valpak to NOI Nos. 2 and 3; NAA-T-1).

a. Implications of the two approaches.

In general, application of ECP in the top-down approach that the Commission

customarily uses for pricing worksharing cost differences “would entail a 100 percent

2 Saturation Mailers Coalition witness Antoinette Crowder’s rebuttal testimony clearly asserts a broad view of ECP (SMC-RT-1 at 6-8, 21-23) and she reiterated that stance upon cross examination (Tr.35/11815, line 23 to 11816, line 6). Yet witness Crowder also clearly qualified her advocacy of a broad applicability for ECP. Cases where there are known, but not necessarily quantifiable, differences in value within a subclass, “it is useful, very useful, to depart from ECP….” Tr. 35/11807; see also at 11808, line 17 to 11809, line 6. And witness Crowder does not agree that only cost differences should be used to price below the subclass level, stating “I do agree that if you don’t have any other information on price sensitivity, that ECP is the best that you’re going to be able to get to, unless you’re making some judgments about those 3622(b) factors….” Tr. 35/11830 (emphasis added). 3 Witness Panzar (PB-T-1) achieves this broadening, at least in part, by broadening the definition of worksharing. See PB-T-1 at 7. Association for Mail Electronic Enhancement, et. al. do not explicitly claim that ECP should be used for non-worksharing avoided costs, but argue that the Postal Service’s calculation of avoided costs is too narrow and should be more broad. Response of AMEE et. al. to NOI No. 3 at 4-5.

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passthrough of avoided cost for all cost-causing characteristics.” NOI No. 2 at 7, n. 6.

The broad interpretation of ECP applicability implies that all cost differences must be

recognized at 100 percent, which is equivalent to stating that all pieces within a

subclass should have the same unit contributions (regardless of shape and other non-

worksharing differences). See Tr. 35/11820 (Crowder); USPS-RT-11 at 8-9.

The strict interpretation of ECP applicability recognizes that 100 percent of

worksharing cost differences should be passed through into rates, but that ECP “is not

an appropriate concept to use in calculating shape-based rates in the same manner that

would be used to determine worksharing discounts.” NAA-T-1 at 11; see also NAA-T-1

at 10, lines 3-4; Postal Service Response to NOI No. 2 at 3-5; and Valpak Response to

NOI Nos. 2 and 3 at 13. Therefore, pieces within a subclass that differ by shape, zone

or weight need not make equal unit contributions. USPS-RT-11 at 9, 18-19; Tr.

33/11161-62; Valpak Response to NOI Nos. 2 and 3 at 14-16.

Related to this discussion is the notion of price discrimination. NOI No. 2 posits a

definition of price discrimination from Professor Stigler’s textbook that suggests price

discrimination is present when the price minus the marginal cost is not the same for two

products. This is mathematically equivalent to a 100 percent recognition (or

passthrough) of cost differences. NOI No. 2 at 5-6. Professor Stigler also offers

another, preferred, definition of price discrimination, where discrimination occurs where

two similar products have differing ratios of price to marginal cost. Postal Service

Response to NOI No. 2 at 6-8. Professor Stigler’s preferred definition “does not equate

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price discrimination with deviations from 100 percent passthroughs of costs.” Postal

Service Response to NOI No. 2 at 7 (emphasis in original).

An important qualification in Professor Stigler’s definition is that the two products

being compared be “similar.” Postal Service Response to NOI No. 2 at 7. No

participant in this docket has provided concrete evidence sufficient to determine that

shape differences among postal classifications are similar enough to trigger either of

Professor Stigler’s definitions of price discrimination.

b. The broad view of the applicability of ECP is flawed and should be rejected.

NAA witness Sidak clearly testifies that ECP cannot be applied to shape based

differences in the same way it is applicable to worksharing differences. NAA-T-1 at 11.

Dr. Ingrahm, another NAA witness, agrees. Tr. 24/8720. This is because mail shapes

do not generate avoidable costs for the Postal Service similar to worksharing. Although

mailers may have a choice of mail shape to use, “it is not a choice between the mailer

or the Postal Service performing a particular function in the type of scenario to which

ECP is intended to apply.” NAA-T-1 at 11-12. With differences based on mail piece

characteristics, like shape, that are not worksharing, there is no transformative service

performed by the Postal Service that a “more efficient” mailer can avoid. Postal Service

Response to NOI No. 2 at 4.

Witness Panzar supports broad applicability for ECP. Part of the justification for

this broad applicability is an expanded definition for worksharing. PB-T-1 at 7. Witness

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Panzar’s expanded definition is unreasonable.4 It potentially could include under the

worksharing umbrella changing any mail piece characteristic that can be affected by

mailers that can affect postal costs, whether or not any work or costs are avoided by the

Postal Service. Moreover, witness Panzar’s broad applicability for ECP can potentially

produce problematic results and lead to undesirable real-world consequences. See

USPS-RT-11, Chapter V, especially at 18-19.5

No other party has provided any theoretical underpinning to support the broad

view of ECP applicability. SMC witness Crowder appeals to Pitney Bowes witness

Panzar for her theoretical support, but even her own testimony reveals that her view of

the applicability of ECP outside of worksharing is significantly qualified.6 PSA/PostCom

4 It likewise does not appear to be consistent with the definition of worksharing included in the reform legislation recently passed by Congress. See Postal Accountability and Enhancement Act, 39 U.S.C. § 3622(e). 5 For example, in response to USPS/PB-T1-5, Prof. Panzar himself identifies a very practical limitation on his testimony when he acknowledges that it “sets forth the arguments in favor of instituting a system of cost-based discounts at the subclass level,” but that it “does not specifically address the issue of how one makes changes from an existing system of discounts that are less than avoided costs.” Tr. 26/9159. Postal Service rebuttal witness Robinson cites this as an example of why mechanistic application of theoretical rules that fail to take account of the myriad factors of the Act must be approached with caution. USPS-RT-10 at 6. 6 SMC witness Crowder claims that NAA witness Sidak also supports broader applicability for ECP. SMC-RT-1 at 6. But her interpretation of witness Sidak’s responses to two ADVO interrogatories (ADVO/NAA-T1-4 and -5) goes well beyond the rather limited nature of witness Sidak’s responses. Moreover, witness Crowder has provided no evidence that the qualifying situation mentioned in witness Sidak’s two responses—where two products have the same “value”—actually holds in practical circumstances where a rate maker must set rates between products having different shapes. Witness Crowder also goes beyond witness Sidak’s testimony when she asserts that he agrees with the extension of ECP to weight and shape based on assuming products have the same value. A fairer interpretation of witness Sidak’s testimony would be that extension of ECP might be warranted if products’ values were measured and found to be the same. Regardless, witness Crowder has provided no

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witness Glick also implicitly supports application of ECP to shape-based cost

differences. PSA/POSTCOM-T-1 at 3-4. But neither witness Glick, nor PSA’s response

to NOI No. 2 provide any evidence (other than mere assumption) to support the

applicability of ECP to shape-based costs. See USPS-RT-11 at 10.

Furthermore, applying the ECP rule to non-worksharing cost differences might

limit the ability of the Postal Service and the Commission to use reasonable judgment to

reflect information (such as shape-based demand and impact information) in setting

rates below the subclass level. USPS-RT-11 at 19. Even where products are similar,

applying ECP to non-worksharing cost differences does not guarantee that price

discrimination is being avoided. Using Professor Stigler’s definition for price

discrimination, applying ECP to shape-based cost differences to achieve 100 percent

recognition of cost differences would not ensure against price discrimination. Response

of the Postal Service to NOI No. 2 at 7.

c. The strict interpretation of the applicability of ECP is reasonable and should be adopted.

The strict interpretation is consistent with NAA witness Sidak’s testimony

regarding the applicability of ECP to worksharing and to shape-based differences in

costs. NAA-T-1 at 8-12. In addition, it does not treat cost differences arising from

different shapes and mail processing paths as transformative changes. Postal Service

Response to NOI No. 2 at 4. Mailers do not regard shape as a characteristic that can

evidence to support even the assumption that the same “value” between different mail shapes is reasonable. See USPS-RT-11 at 17, line 18, to 18, line 5.

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be easily changed in response to price changes. USPS-RT-11 at 15-16; see especially

n. 6.

The strict interpretation recognizes that subclasses are not homogeneous. Postal

Service Response to NOI No. 3, Chapter II; USPS-RT-11 at 16-18. With heterogeneity

within subclasses, the strict view of ECP applicability allows the recognition of additional

information (both cost and non-cost) that might reasonably be incorporated into pricing.

Postal Service Response to NOI No. 3 at 3, 8; USPS-RT-11 at 19.7

The strict interpretation of ECP applicability does not raise price discrimination

concerns. Price discrimination between products requires products to be similar. USPS

Response to NOI No. 2 at 7. Mail shapes are at least prima facie dissimilar products,

and no participant in this docket has provided evidence sufficient to demonstrate that

dissimilar-shaped mail categories are “similar” enough to trigger the likelihood of price

discrimination. There is no solid basis on the record to claim that different shape-based

mail categories exhibit price discrimination solely because certain rate differentials do

not equate to the corresponding cost differentials. Postal Service Response to NOI No.

2 at 8.

d. ECP is, at best, only a guide in setting pricing differentials.

Even for pricing worksharing, ECP is only a guide in pricing. Postal Service

Response to NOI No. 2 at 2, 3. The Commission has recognized that justifications often

exist for deviating from pure productive economic efficiency, which is the sole focus of

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ECP. NOI No. 2 at 2, Postal Service Response to NOI No. 2 at 16-17. Efficiency

considerations must be balanced by non-economic policy factors to reach an

appropriate pricing recommendation. The use of ECP, and other theoretical rules, to

postal pricing must be tempered by considering a variety of non-economic factors and

public policy goals. Postal Service Response to NOI No. 3 at 3.

The Postal Service does not operate in a purely theoretical world where narrow

application of any single theoretical economic model, like the ECP rule, is sufficient for

pricing. The Postal Service recognizes the need to send appropriate efficiency signals

in its pricing. In this, ECP can offer guidance. But more than ECP must be considered.

The pricing criteria and other policies of the Act require consideration of a wide range of

non-economic policy factors. The Postal Service’s current pricing proposals have

carefully weighed the often contradictory policy objectives embodied in the statutory

pricing criteria. The Postal Service’s pricing proposals look at the totality of the situation

and appropriately balance economic efficiency and other policy factors. Postal Service

Response to NOI No. 3 at 11-12.

Even proponents of the broader applicability of ECP recognize that it has

limitations. 8 SMC witness Crowder believes that factors other than ECP must be

considered when pricing. Tr. 35/11830, lines 4-7; see also 11830, line 25 to 11831, line

4. She says it is sometimes very useful to depart from applying ECP in pricing. Tr.

7 SMC witness Crowder, although she supports a more expansive application of ECP, clearly has some misgivings about going too far. See Tr. 35/11830, lines 4-7 and 11809, lines 3-6. 8 Prof. Panzar himself continues to recognize justifications for deviations from ECP. See Tr. 26/9154-57.

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35/11806, line 25 to 11807, line 6. One cannot apply ECP as a hard and fast rule.

Each circumstance will tell how ECP (or other theories) may be applied. Tr. 35/11809.

Thus, in summary, ECP is a pricing theory promoting economic efficiency that

should only be applied to worksharing cost differences, not to shape-based cost

differences. Theories like ECP must be applied by looking at the totality of the situation,

which the Postal Service has done. The Postal Service has given appropriate

consideration to economic efficiency, including theories like ECP in its pricing. NAA-T-1

at 8-11; Postal Service Response to NOI No. 3 at 11-12. The merits of the Postal

Service’s rate design are explained in detail below.

B. First-Class Mail

1. Postal Service Proposals

The Postal Service’s First-Class Mail rate and classification proposals are

depicted in the Docket No. R2006-1 Request of the United States Postal Service For A

Recommended Decision On Changes In Rates Of Postage And Fees For Postal

Services, at Attachments A (pages 4-7) and B (pages 1-3 and 5) (May 3, 2006). The

justification for these proposals is explained in the two direct testimonies of Postal

Service witness Altaf Taufique, USPS-T-32 and USPS-T-48.9

9 Docket No. R2006-1, Direct Testimony of Altaf H. Taufique On Behalf Of United States Postal Service, USPS-T-32 and USPS-T-48.

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First-Class Mail is generally divided into three subclasses, witness Taufique

proposes prices for the Letters and Sealed Parcels, and Cards subclasses. Witness

Thomas Scherer (USPS-T-33) proposes Priority Mail. For the Letters and Sealed

Parcels subclass, the proposed rate design by witness Taufique reflects an average

rate increase of 7.1 percent and a cost coverage of 228 percent. USPS-T-32 at 3. For

the Cards subclass, he proposes an average rate increase of 10.5 percent and a cost

coverage of 176 percent. For First-Class Mail as a whole, the proposed cost coverage

is 226 percent and the average rate increase is 7.2 percent. USPS-T-32 at 3; Exhibit

USPS-32A.

A significant feature of witness Taufique’s First-Class Mail rate design is his

proposed change in the foundation for the design of workshare discounts. He

advocates an approach based upon “de-linking” of the rate design for the various

workshare rate categories from the rate design for the single-piece rate categories.

USPS-T-32 at 12. Witness Taufique also proposes the establishment of new rate

categories within the Letters and Sealed Parcels subclass on the basis of shape -- for

letters, flats and parcels. USPS-T-32 at 17-18.10 Witness Taufique also proposes that

the Automation Carrier Route rate categories within the Letters and Sealed Parcels and

Cards subclasses of First-Class Mail be eliminated. Last but not least, he proposes the

establishment of a “Forever Stamp” classification. USPS-T-32 at 26-27; USPS-T-48.

10 In conjunction with this shape-based redesign, witness Taufique advocates two related classification changes. The first is the elimination of the heavy piece discount for presorted and automation mail. Secondly, in lieu of the current nonmachinable surcharges applicable to certain one-ounce First-Class Mail letters, witness Taufique

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Under this concept, mailers would be authorized to use a specially designed stamp

(purchased at a value equivalent to the initial-ounce letter rate) and use it as valid

payment of postage on any one-ounce First-Class Mail letter, even after the applicable

rate for that letter is later increased to a point above the purchase of the stamp.11 All of

witness Taufique’s specific rate design proposals, including these proposed

classification changes, are summarized and discussed below.

For the Single-Piece and Nonautomation Presort categories of First-Class Mail,

witness Taufique proposes the following rate and classification changes:

The current rate for the first ounce of a basic First-Class Mail letter should be

increased from 39 cents to 42 cents. In line with his proposal to reclassify First-Class

Mail on the basis of shape, witness Taufique proposes that rates of 62 cents and $1.00

be established for one-ounce single-piece flats and parcels, respectively. In conjunction

with shape-based rate de-averaging, witness Taufique advocates that the 24-cent

additional-ounce rate currently applicable to single-piece First-Class Mail (letters, flats

and parcels) be decreased to 20 cents. He proposes that the current 3.2-cent discount

for the first ounce of a Qualified Business Reply Mail (QBRM) piece be reduced to 2.5

cents, resulting in the QBRM initial-ounce letter rate increasing from 35.8 to 39.5 cents.

In lieu of a stand-alone surcharge for nonmachinable single-piece letters, witness

proposes that such pieces simply pay the higher rate proposed for corresponding one-ounce flats. USPS-T-32 at 19. 11 Although the stamp is intended for use on one-ounce letters, its use on other mail pieces, at a value equivalent to the First-Class Mail one-ounce letter rate prevailing at the time of use, also will be tolerated.

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Taufique proposes that such letters pay the proposed rate for one-ounce single-piece

flats -- 62 cents. USPS-T-32 at 6, 19.

Witness Taufique proposes that the current 37.1-cent initial-ounce rate for

nonautomation Presort letters be increased to 40.0 cents, and that the corresponding

rate for flats be increased from 42.912 to 51.9 cents. With the creation of the First-Class

Mail Business Parcels rate category, Nonautomation Presort mail is proposed to include

only letter- and flat-shaped pieces. And, as mentioned earlier in conjunction with

shape-based rate de-averaging, witness Taufique advocates that the 23.7-cent

additional-ounce rate currently applicable to such letters and flats also be decreased to

20 cents. USPS-T-32 at 8.

For Automation Letters, witness Taufique proposes the following initial-ounce

rate changes: the Mixed AADC rate should be increased from 32.6 to 34.6 cents. The

AADC rate should be increased from 31.7 to 33.5 cents. The current 3-digit and 5-digit

rates, 30.8 and 29.3 cents respectively, should be increased to 33.1 and 31.2 cents,

respectively. Witness Taufique advocates that the 23.7-cent additional-ounce rate

currently applicable to such letters be decreased to 15.5 cents. USPS-T-32 at 6.

Witness Taufique proposes the following changes for Automation Flats initial-

ounce rates:13 the Mixed ADC rate should be increased from 41.7 to 46.5 cents. The

12 The current non-automation presort first ounce rate applicable to flats is discussed here in terms of the sum of the currently applicable initial ounce rate and the 5.8-cent nonmachinable surcharge. 13 The current Automation Flats initial ounce rates are discussed here in terms of the sum of the currently applicable initial ounce rate for each category and the 5.8-cent nonmachinable surcharge.

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ADC rate should be increased from 40.9 to 43.3 cents. The current 3-digit and 5-digit

rates, 39.7 and 37.6 cents respectively, should be increased to 42.3 and 39.8 cents,

respectively. Witness Taufique advocates that the 23.7-cent additional-ounce rate

currently applicable to such flats be decreased to 20.0 cents. USPS-T-32 at 7.

Assuming the establishment of the new Business Parcels rate categories,

witness Taufique proposes that the following initial-ounce rates be adopted:14 the ADC

rate should be increased from 42.9 to 72.7 cents. The current rate of 42.9 cents

applicable to 3- and 5-Digit presorted parcels should be increased to 71.7 cents for

parcels sorted to 3-Digit and 64.3 cents for parcels sorted to 5-digit. Witness Taufique

advocates that the 23.7-cent additional-ounce rate currently applicable to such parcels

also be decreased to 20.0 cents. USPS-T-32 at 7. Under his rate design, Business

Parcels that do not meet specified automation requirements would be subjected to a 5-

cent surcharge.15

Within the Cards subclass, witness Taufique proposes that the single-piece

rate be increased from 24 to 27 cents and that the rate for QBRM cards be increased

from 21.1 cents to 24.5 cents. Under his design, the rate for Nonautomation Presort

cards would be increased from 22.3 to 24.1 cents. For the various Automation rate card

categories, witness Taufique proposes that the Mixed AADC rate be increased from

20.4 cents to 22.2 cents, that the AADC rate be changed from 19.7 cents to 21.5 cents,

14 The rates currently applicable to pieces that would qualify for the proposed presorted Business Parcels categories are expressed in terms of the sum of the currently applicable initial ounce rate for each category and the 5.8-cent nonmachinable surcharge.

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that the current 19.3-cent 3-digit rate be increased to 21.1 cents, and that the 5-digit

rate be changed from 18.6 cents to 20.4 cents.

2. The Postal Service’s rate design is supported by more refined cost analysis.

a. The mail processing cost methodology

To estimate mail processing costs First-Class Mail letters, Witness Abdirahman

(USPS-T-22) utilizes a cost methodology similar, in many respects, to the one the

Commission employed in past dockets. He uses a “hybrid” cost methodology that relies

on both CRA mail processing unit costs and model-based mail processing unit costs to

develop mail processing unit cost estimates by rate category. He analyzes shape-

specific CRA mail processing unit cost estimates developed from the Presort Letters

and Sealed Parcels CRA category. The CRA mail processing unit costs for the First-

Class Mail Presort Letters are each subdivided into 63 cost pools. Each cost pool

represents a specific mail processing task performed at Bulk Mail Centers (BMC),

Management Operating Data System (MODS) plants, or non-MODS plants. The costs

are “mapped” to each cost pool, as described in USPS-LR-L-55.

Consistent with past methodology, witness Abdirahman then models the costs in

order to de-average the CRA mail processing unit costs for “First-Class Mail Presort

Letters” into cost estimates by rate category. Each of these cost models consists of two

spreadsheets: a mail flow spreadsheet and a cost spreadsheet. A weighted model cost

for all the rate categories being de-averaged is then computed using base year mail

volumes and is tied back to the CRA using the adjustment factor. The sum of the CRA

15 With the exception of parcels sorted to the 5-digit level. USPS-T-32 at 37.

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proportional cost pools is then divided by this weighted model cost in order to calculate

the CRA proportional adjustment factor. This factor is then applied to the model costs in

order to estimate the total mail processing unit costs by rate category. The costs for the

remaining cost pools (i.e. the fixed cost pools) are summed and used as fixed

adjustments.

Witness Abdirahman’s cost models have a number of methodological changes.

The models combine the automation and nonautomation cost because of the issues

discussed in the response to in Docket No. R2005-1 to POIR No.1, Question 1(a) (May

9, 2005). See also Docket No. R2006-1, USPS-T22 at 5-6. The models no longer use

Bulk Metered Mail unit costs in the First-Class Mail letters mail processing cost analysis.

Id. at 6. In the past, the mail processing cost models have used two CRA adjustment

factors and three cost pool classifications: proportional, worksharing related fixed, and

nonworksharing related fixed. With the de-linking pricing approach, only one CRA

factor is needed. Moreover, the distinction between worksharing-related and

nonworksharing-related cost pools is eliminated because, as witness Abdirahman

explains:

All analyses of workshare-related activities are constrained within the self- contained CRA set of costs associated with Presort letters.

USPS-T-22 at 6. In the cost models in this case, witness Abdirahman uses two cost

pool classifications: proportional and fixed. Id. at 6. Nevertheless, the Postal Service’s

approach to cost pool classifications in this docket is consistent with the approaches

adopted by the Commission in previous dockets. Each cost pool is classified as being

proportional or fixed. The “proportional” cost pools contain the costs for tasks that are

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actually modeled. The bar code sorter (“/BCS”) cost pool is an example of a proportional

cost pool. The “fixed” cost pools represent tasks that have not been modeled. The

Express Mail (“EXPRESS”) cost pool is an example of a fixed cost pool. A cost pool is

classified as proportional only when the associated mail processing activities identified

within that cost pool are understood to vary in known ways by presort level, i.e., the

more finely presorted a piece is, the less the cost of processing in a given cost pool.

USPS-RT-7 at 10-11. Tr. 35/11957-58.

b. First-Class Mail delivery cost estimates

In the instant proceeding, the Postal Service revises the way in which it produces

rate category delivery unit cost estimates. The revision is based upon a re-evaluation of

the factors that impact delivery and what about these factors is known and unknown.

The re-evaluation reveals that machinability is the one characteristic of a mail-piece that

has a quantifiable impact on delivery unit costs. Machinable mail pieces are dispatched

to delivery units as part of the Delivery Point Sequence (DPS) mail, while the

nonmachinable mail pieces are dispatched with the residual (non-DPS) mail that

required manual processing. Postal Service delivery cost witness Kelley (USPS-T-30)

provides separate delivery unit cost estimates for machinable and nonmachinable mail

pieces to First-Class Mail rate design witness Taufique (USPS-T-32).16

This approach differs from the one employed in past dockets, where separate

delivery unit cost avoidance estimates by rate category were provided. Under the

previous methodology, the delivery cost avoidances were derived by applying delivery

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point sequence (DPS) percentages, by rate level, to the delivery costs. The DPS

percentages were by-products of the mail processing models. Both the Postal Service

and the Commission used this method to derive delivery cost savings by rate level.

For the current docket, the Postal Service rejects the past methodology as

lacking a sufficiently reliable foundation. There is no conclusive basis determining that

the DPS percentages actually vary among the machinable rate categories. USPS-RT-7

at 6; Tr. 35/11953. Furthermore, because the presort letters that fail to be DPS’d are

not individually marked to indicate their specific presort level, it would not be possible to

conduct a field study to estimate those percentages. By comparison, there is now a

conclusive basis for determining that machinability directly impacts delivery costs.17

Broadly speaking, there are no material differences in Docket Nos. R2005-1 and

R2006-1 in the way that the Postal Service disaggregates subclass estimates of

delivery cost. Rather than construct his own estimate of DALs, however, witness Kelley

updated the estimate derived on the record in Docket No. R2005-1. USPS-T-30 at 1-

14. (This has no impact on First-Class Mail, as no DALs are used by First-Class Mail.)

Witness Kelley also describes his treatment of DPS percentages in this docket. Id. at 5-

7. At the level of disaggregation employed in his direct testimony, witness Kelley notes

that his use of carrier cost systems rather than mail processing models as the source of

DPS percentages has only minimal impact because of the similarities in the estimates

16 Once again, the details of witness Kelley’s calculations and results are presented in USPS-LR-L-67. 17 The misuse of the DPS percentages methodology by several intervenor witnesses is discussed below.

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from both systems. Id. at 7. The unit delivery costs by rate category estimated by

witness Kelley appear in his Table 1. Id. at 4, 17.

c. BRM cost support Witness Abdirahman (USPS-T-22) also provides the cost avoidance estimates

that underlie the Postal Service’s proposed rates for Qualified Business Reply Mail

(QBRM) letters and cards, and the various fees for Business Reply Mail BRM. His cost

studies are contained in USPS-LR-L-69. Witness Abdirahman examines the costs of a

handwritten, single-piece First-Class Mail reply mail piece and a preapproved,

prebarcoded single-piece First-Class Mail reply mail piece, and limits the QBRM cost

avoidance analysis to the costs incurred up to the point at which each mail piece

receives its first barcoded sortation on a BCS. USPS-T-22 at 16. Witness Abdirahman

relies upon the Business Reply Mail Practices Study (USPS-LR-L-34) of witness

Loetscher. USPS-T-28 at 1.

3. Proposals for classification change a. The Commission should recommend the shape-related classification changes proposed by the Postal Service. For ratemaking purposes, the First-Class Mail stream has long been divided into

two subclasses: Letters and Sealed Parcels on the one hand, and Cards on the other.

The Postal Service does not propose the establishment of any new First-Class Mail

subclasses in this docket. However, consistent with advances in the direction of more

shape-based mail processing technology and network processes,18 and advancements

18 See generally, Docket No. N2006-1, Direct Testimony of Pranab M. Shah on Behalf of United States Postal Service (USPS-T-1).

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in shape-based rate design in previous rate dockets, witness Taufique (USPS-T-32)

proposes that rates within the Letters and Sealed Parcels subclass be designed to

move more in the direction of recognizing these shape-based differences. USPS-T-32

at 17-20.

As highlighted by witness Taufique, despite the relatively high cost coverage for

the subclass as a whole, preliminary cost data indicate that many First-Class Mail flats

and parcels do not come close to covering their costs. Tr. 16/4813. Although flats and

parcels comprise a relatively small proportion of the First-Class Mail stream relative to

letters, the combined annual volume of First-Class Mail flats and parcels, nearly five

billion pieces, exceeds that of many non-First-Class Mail subclasses. USPS-T-32 at 17.

Thus, even though limited to the Letters and Sealed Parcels subclass, the intra-

subclass consequences of the cost-to-rate disparity for both flats and parcels is not

insignificant. Accordingly, whether the mail pieces are single-piece or workshared,

witness Taufique proposes different rates for First-Class Mail letters, flats and parcels,

as those shapes are defined by the Postal Service.19 Witness Taufique proposes

initial-ounce rates for First-Class Mail letters, flats and parcels of 42 cents, 62 cents and

$1.00, respectively.

For single-piece mailers, de-averaging on the basis of shape adds an element of

complexity to the rate schedule. However, single-piece mail is overwhelmingly

machinable letter-shaped pieces, so the proportion of mail pieces for which senders will

need to determine whether the flat or parcel rates apply can be expected to remain

19 See Docket No. R2006-1 Request, Attachment B at 1, 3.

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relatively small. Workshare mailers tend to either maintain sophisticated mail

preparation operations or hire independent contractors who do. Accordingly, they can

be expected to adjust quickly to new shape-based variations in the rate schedule.

Any added complexity is offset by the proposed elimination of the nonmachinable

surcharges currently applicable to some one-ounce single-piece and workshare letters

and flats,20 and the proposed elimination of the heavy-piece discount currently

applicable to workshare mail weighing more than two ounces. And, although de-

averaging that separates the impacts of shape and weight on costs may add complexity

to the rate schedule, this de-averaging allows for the First-Class Mail additional-ounce

rate reductions proposed by witness Taufique. In every instance, the proposed rate

differences are clearly identifiable, within the meaning of § 3622(b)(7).

Some mailers may be able to reconfigure flats to letters or parcels to flats and

avoid having to pay the higher postal rates. USPS-T-32 at 22-23. Those who are able

to reconfigure will pay lower rates. And, those who cannot convert to a less expensive

mail piece shape will benefit from witness Taufique’s proposal that the initial-ounce

rates for flats and parcels reflect relatively low percentages of the estimated shape-

based cost differences.

b. The Automation Carrier Route rate categories should be eliminated. Several factors combine to support witness Taufique’s proposed elimination of

the First-Class Mail Automation Carrier Route (ACR) categories in the Letters and

20 One-ounce letter-shaped pieces that, on the basis of their nonmachinability, do not qualify for the basic letter rate would be charged the proposed rate applicable to flats.

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Sealed Parcels subclass and the Cards subclass. As witness Taufique explains,

delivery unit sortation is being supplanted more and more by delivery point sequencing

at destinating Processing & Distribution Centers. Automation Carrier Route volumes

have declined precipitously in recent years as Carrier Sequence Bar Code Sorters are

de-commissioned. The current Automation Carrier Route discount is only slightly larger

than the discount for the 5-digit Automation mail stream to which ACR mail has

migrated over the years, and with which its processing will be merged. With the

elimination of ACR rate categories, witness Taufique expects mail currently sorted to

carrier route to convert to 5-digit Automation. This would simplify mail preparation and

witness Taufique’s proposal to pass through more than 100 percent of the 5-digit

Automation cost avoidance will mitigate the impact of the loss of the larger ACR

discount for current ACR mailers. See USPS-T-32 at 20-21.

c. The Forever Stamp should be adopted.

For household mailers and small businesses that rely almost exclusively on

stamps to pay postage, the transition from one initial-ounce First-Class Mail rate to

another (most recently from 37 cents to 39 cents) can involve some inconvenience,

when their stamp inventories have not been fully depleted when rates change. While

this may not be the greatest inconvenience in customers’ lives, determining and

obtaining the necessary number of transitional “make-up” stamps to bridge the

difference between the value of “old” basic stamps and the “new” basic rate adds a level

of inconvenience that many postal customers would rather avoid. USPS-T-48 at 7, 14;

USPS Library Reference L-152, Insight #11. Several foreign postal administrations

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have made available to their customers a non-denominated, non-expiring basic rate

postage stamp that is intended to eliminate such inconvenience. OCA Library

Reference 1. The Postal Service proposes to join them.

In conjunction with the implementation of Docket No. R2006-1 rates, witness

Taufique (USPS-T-48) proposes that the Postal Service be authorized to sell a non-

denominated, non-expiring stamp -- the “Forever Stamp.” The stamp would provide

unprecedented convenience to basic rate single-piece First-Class Mail users during the

transition from Docket No. R2006-1 rates to the rates that result from the next omnibus

rate proceeding, and beyond. USPS-T-48 at 5-6, 17. The Forever Stamp would serve

as valid postage for a one-ounce First-Class Mail letter-shaped piece at the time of use,

regardless of the First-Class Mail letter rate prevailing at that time. USPS-T-48 at 5,

17.21 The availability of such stamps at the beginning of future rate cycles can be

expected to help smooth the transition to new stamp prices when postal rates change.

Id. at 5-6. The Forever Stamp would be available for purchase at the basic First-Class

Mail one-ounce letter rate established in the instant case, presumably 42 cents, and

21 That is the intended purpose for the stamp and the Postal Service plan to promote that use. Nevertheless, as reflected in proposed DMM 601.1.10 (71 Fed. Reg. 56587 (September 27, 2006), to avoid penalizing customers who affix Forever Stamps to other mail pieces to pay postage, the Postal Service will tolerate such other uses by crediting customers with postage equivalent to the First-Class Mail initial-ounce letter rate prevailing at the time of use. Nevertheless, proposed DMM 604.1.10 -- as explained and elaborated upon in response to DBP/USPS-340-42, 366-68, 457, 510, 606, 616, 619(c), 620, 622, 643-44, 647-48, 657, 674, 677, 684, and 700; as well as DFC/USPS-80-83 -- reflects the Postal Service’s determination that Forever Stamps may be applied to mail matter other than one-ounce First-Class Mail letters.

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would be available for purchase at that rate until the effective date of a subsequent rate

change. On that date, the Forever Stamp would be sold at the new prevailing rate. Id.

d. The proposed classification changes satisfy the criteria of § 3623(c).

Section 3623(c) of the Postal Reorganization Act requires the Commission to make

its decision on a proposed new mail classification or a classification change in

accordance with the following factors:

(1) the establishment and maintenance of a fair and equitable classification system for all mail;

(2) the relative value to the people of the kinds of mail matter entered into the postal system and the desirability and justification for special classifications and services of mail;

(3) the importance of providing classifications with extremely high degrees of reliability and speed of delivery;

(4) the importance of providing classifications which do not require an extremely high degree of reliability and speed of delivery;

(5) the desirability of special classifications from the point of view of both the user and of the Postal Service; and

(6) such other factors as the Commission may deem appropriate.

The establishment of separate classifications for letter, flat and parcel-shaped

single-piece First-Class Mail, and the establishment of the Business Parcels rate

categories would satisfy Criterion 1 -- fairness and equity. Due to their shapes, both

flats and parcels are significantly more expensive to process and deliver than letters.

The establishment of classifications within First-Class Mail that more closely recognize

the impact of shape upon cost leads to rates that distribute the burden of supporting the

postal system among First-Class Mail users in a more fair and equitable manner.

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Mailers who prepare non-letter shaped-pieces (flats, parcels, or some other

shape) in some cases may have the ability and may find it economically feasible to

convert these pieces to shapes that qualify for lower rates. Both the Postal Service and

those First-Class Mail customers would benefit from such conversions. It is expected

that many mailers will continue to send flat or parcel-shaped First-Class Mail pieces.

The establishment of distinct classifications for this mail reflects the value of this mail to

the Postal Service and is consistent with consideration of Criterion 2, the value to the

people of different kinds of mail matter.

The proposed classification changes also would further satisfy Criterion 5 -- the

desirability of special classifications from the user’s and Postal Service’s point of view.

Greater recognition of the cost impact of shape on mailflows and mail processing

provides more accurate signals to mailers and provides an opportunity for them to

evaluate their mail preparation options in light of such information.

Elimination of the heavy piece discount for workshare mail pieces weighing more

than two ounces, and the nonmachinable surcharge for pieces weighing one ounce or

less, both in single-piece and workshare rate categories, are classification changes that

follow from the Postal Service’s proposed shape-based classification changes. Witness

Taufique explains why elimination of these classifications is desirable from the point of

view of the Postal Service, and how the resulting rate simplicity should be seen as

desirable from the point of view of the mailer. USPS-T-32 at 45. The proposed

changes in First-Class Mail rate design give greater recognition to shape, automation

compatibility, and mailer’s work in preparing mail for lower cost processing.

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Accordingly, the Postal Service believes that the elimination of the heavy piece discount

is both fair and equitable. As a result, both Criteria 2 and 5 are satisfied.

Elimination of the Automation Carrier Route rate categories for letters and cards

also reflects consideration of Criterion 5. Automation of letters and cards has been a

great technological success and has allowed for greater control of postal costs. This is

critical to the continued viability of the Postal Service and many of its customers.

Technology has evolved to permit delivery point sequencing of letters and cards further

upstream at destinating mail processing centers, reducing carrier costs. USPS-T-32 at

20. Currently, the only letter-shaped mail processed at delivery units is the Automation

Carrier Route category. Merging this mail into the 5-Digit mail stream for delivery point

processing further upstream at larger Processing & Distribution Centers would be

desirable both from the perspective of the Postal Service and the mailers, within the

meaning of Criterion 5.

Finally, the establishment of a Forever Stamp classification would promote

several of the policies reflected in § 3623(c). Easing the ability of stamp-using retail

customers to transition from one basic First-Class Mail rate to the next would bring an

additional measure of fairness and equity to their dealings with the Postal Service.

USPS-T-32 at 47. The Forever Stamp would be desirable to retail customers and

would increase customer satisfaction, meeting the terms of Criterion 5. USPS-T-48 at

18-19. Criterion 6 permits the Commission also to take into account the likelihood that

the Forever Stamp can be expected to cause purchasers to view the Postal Service

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more favorably. USPS-T-48 at 15-16; USPS Library Reference L-152, Insights #5 and

#14.

4. The Commission should embrace the Postal Service’s “de-linking” of Single-Piece and Presort First-Class Mail rate design. The history of First-Class Mail workshare rate design reveals that neither the

Postal Service nor the Commission has ever rigidly determined that any one rate design

approach resolved all material and relevant questions regarding workshare-related cost

differences or was chiseled in stone for all eternity. In Docket No. R97-1, the

Commission affirmed that the bulk metered mail (BMM) component of the single-piece

First-Class Mail stream was an appropriate benchmark from which to base the price

differentials for the First-Class Mail letter automation rate categories. See, PRC Op.

R97-1,at 292-94, ¶ 5089, 5092, 5097. The Commission affirmed that conclusion at

PRC Op. R2000-1 at 241, ¶ 5089.22

As explained by witness Taufique (USPS-T-32 at 12-17), there are compelling

grounds for a fresh review of the benchmark issue. It is noteworthy that there has never

been an actual bulk metered mail cost estimate. Given that Postal Service data

collection systems cannot isolate a cost estimate for BMM letters, a proxy has been

used. The mail processing unit cost estimate for First-Class Mail single-piece metered

letters has been relied upon as the proxy for BMM. See Docket No. R2001-1, USPS

Library Reference J-60, page 8; Docket No. R2005-1, USPS Library Reference K-48,

page 2. Docket No. R2000-1 provided a forum for the expression of divergent and

22 And was offered no compelling basis for re-examining the issue in Docket Nos. R2001-1 and R2005-1.

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apparently irreconcilable opinions about which components of the widely diverse single-

piece mail stream should serve as a benchmark for estimating the cost differences

associated with worksharing (USPS-T-32 at 13), and which In-Office Cost System cost

pools are properly characterized as workshare-related. USPS-T-32 at 15. The unique

circumstances of Docket Nos. R2001-1 and R2005-1 muted some of the usual

evidentiary tussling among interested parties. And, although bulk metered mail has

been regarded as the type of single-piece First-Class Mail most similar in cost-causing

characteristics, other than the actual presortation, to presort letters and, therefore, most

likely to convert to worksharing, id. at 13, evidence presented in this docket support

reconsideration of whether BMM is still the primary source of conversion to worksharing.

National Association of Presort Mailers rebuttal witness Elizabeth Bell (NAPM-RT-1)

presents evidence that the single-piece First-Class Mail most likely to convert to presort

mail has the physical characteristics of collection mail, not bulk metered mail. This is

based on her daily experiences as the owner and operator of a presort bureau that is in

the business of converting single-piece mail to workshare mail. Tr. 38/12945-52. In a

similar vein, Pitney Bowes witness John Panzar (PB-T-1) makes clear that the BMM

benchmark is likely to understate, on average, the cost avoided by the Postal Service

when mailers presort at the margin. PB-T-1 at 36-37. See also Tr. 26/9307.23 The

Postal Service is not persuaded that all of the mail converting from single-piece to

23 Prof. Panzar also admits that, as a practical matter, no perfect solution to the efficient discount dilemma is likely, and therefore some level of trade-offs must be accepted. PB-T-1 at 37-39. With all of this in mind, however, Prof. Panzar ultimately endorses the Postal Service's de-linking proposal as a step in right direction. Id. at 29, 39.

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presort fits the description of the mail converted by witness Bell’s presort bureau. But,

given the heterogeneity of both single-piece and presort mail, Postal Service rebuttal

witness Taufique (USPS-RT-18) is very insightful in reminding the Commission that the

development of a benchmark cannot be as precise as some would hope. Tr. 38/13346-

47.

As witness Taufique observes, the Postal Service has historically collected and

reported separate Cost & Revenue Analysis (CRA) data for Single-Piece and Presort

First-Class Mail for rate case base year purposes,24 and has routinely forecast test year

Single Piece and Presort cost estimates through its rollforward model. USPS-T-32 at

13-14. Much of the debate in previous dockets regarding workshare rate design has

focused on the degree to which some or all of the aggregate CRA cost differences

between Single Piece and Presort could be said to be related to worksharing. As

witness Taufique emphasizes, the aggregate differences inherent in Single Piece and

Presort CRA cost estimates reflect the impact of a host of characteristics and variables

beyond simply whether mail is presorted and/or barcoded. Id. at 14.

The option of presortation to obtain lower rates has been available to First-Class

Mail users for a long time and the markets for single-piece relative to presort entry have

been fairly stable. Accordingly, rather than continue to sift through Single Piece CRA

cost data to construct a bulk metered mail benchmark proxy, the Postal Service

proposes an alternative approach, based upon the goal of obtaining similar unit

institutional cost contributions from mail in the CRA Single Piece pool and mail in the

24 And separately for the Letters and Sealed Parcels subclass and the Cards subclass.

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CRA Presort pool. Id. at 15. The objective of witness Taufique’s rate design approach

is to apply the pricing criteria in a manner designed to gradually achieve a rate design

paradigm in which both workshare and single-piece mail in the aggregate contribute

equally to institutional costs on a per unit basis. Id. at 15-16.

Witness Taufique explains:

The rate design for Single Piece First-Class Mail starts with the Test Year Before Rates (TYBR) rollforward costs for Single-Piece and Presort within the First- Class Mail Letters and Sealed Parcels subclass. A per unit contribution is simultaneously estimated for both Single Piece and Presort mail to meet the Letters [and Sealed Parcels] subclass revenue requirement. The target per- piece revenue estimate is then multiplied by the TYBR volumes to derive the target revenue for both Single Piece and Presort. USPS-T-32 at 21.

Thus, after establishing a revenue requirement for Single-Piece mail which meets

the unit contribution target, witness Taufique references rollforward Single-Piece First-

Class Mail costs and designs rates for the existing and proposed single-piece First-

Class Mail letter, flat and parcel rate categories. He uses the initial-ounce letter rate as

the benchmark for deriving single-piece discounts and surcharges. Id. at 16.

Likewise, after establishing a required revenue for Presort First-Class Mail that

meets the unit contribution target, witness Taufique references the CRA rollforward

costs for Presort and designs rates for the various existing and proposed workshare

rate categories. In contrast to past practice, he proposes that workshare rates not be

designed as discounts off the basic First-Class Mail single-piece rate. Instead, the

starting point, his benchmark for workshare rate design is internal to Presort -- the

Mixed AADC rate.

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To be clear, only in this limited sense is the rate design for workshare mail “de-

linked” from that for single-piece mail. While it is useful to describe the proposed rate

design process as having “de-linked” Single-Piece and Presort mail on the basis of their

separately reported CRA cost data, single-piece and workshare First-Class Mail remain

inextricably linked components of the Letters and Sealed Parcels subclass and the

Cards subclass for purposes of institutional cost allocation, since one of the goals of

First-Class Mail rate design under this new approach is the balancing of the unit

institutional cost contributions of Single-Piece and Presort to meet the revenue

requirement target for that subclass, as determined by witness O’Hara (USPS-T-31).25

Witness Taufique emphasizes that equalizing unit contribution between single-piece

and workshare mail is a way of maintaining fairness within the First-Class Mail rate

structure and maintaining the link between the two components of the subclass. As a

result, discounted pieces pay unit contribution comparable to that paid by the single-

piece component. Tr. 16/4799-800; see also Tr. 16/4794-95.

Consistent with past practice, witness Taufique’s determination of incremental

rate differences for successive levels of presort and other characteristics of workshare

mail is derived on the basis of Presort First-Class Mail CRA cost data. Id. at 16-17.

Given the heterogeneity of the First-Class Mail Letters and Sealed Parcels

subclass (including single-piece and presort), the increasing maturation of the market

for presort conversion of lower-cost mail pieces most often sent by large mailers, the

25 The Commission should regard any suggestion that the Postal Service is treating single-piece and workshare mail as separate First-Class Mail subclasses or “quasi-

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increased diversity in the population of mail that is converting or is on the margin of

converting to workshare status, and the long-standing debate surrounding the

identification the appropriate benchmark conversion piece, a review of the workshare

rate design benchmark issue is in order. The Postal Service’s de-linking proposal for

First-Class Mail, relying on data from the CRA, offers a viable and practical alternative

to continued reliance on the bulk metered benchmark. In addition to reflecting the

market trend, the Postal Service's approach has a number of benefits. It is a

methodology that is reproducible from one rate case to the next; it is easily verifiable

and transparent. Also, it has the virtue of relying on a robust and well-established data

source, the Cost and Revenue Analysis system. Tr. 38/13349.

subclasses” for rate design purposes as nothing more than a “red herring.” See Tr.

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5. The Commission should recommend the First-Class Mail rates proposed by the Postal Service. a. The Postal Service’s initial ounce rates for single-piece letters, flats

and parcels merit approval. The most visible postal rate is the single-piece initial-ounce rate for the First-

Class Mail Letters and Sealed Parcels, currently 39 cents. Postal Service witness

Taufique proposes that it be increased to 42-cents and applied only to the first-ounce of

machinable single-piece letters. This rate, in combination with the various related rate

differentials based upon such factors as shape, weight, prebarcoding, presorting and

machinability, allows the Postal Service to achieve the revenue target proposed by

witness O’Hara (USPS-T-31) in a manner consistent with the policies of the Act. The

proposed three-cent increase in the basic First-Class Mail rate from 39 to 42 cents is a

7.7 percent increase. USPS-T-32 at 21-22. This continues the trend of maintaining

First-Class Mail stamp rate increases below inflation, as measured by Consumer Price

Index (CPI-U). Tr. 32/10707.

As explained by witness Taufique (USPS-T-32 at 21), in light of the revenue

requirement requested in this proceeding, several factors combine to reinforce the

fairness and equity of the proposed increase from 39 cents to 42 cents. First is the

whole-cent constraint, which the Commission and the Postal Service have consistently

agreed, makes it impractical for the basic rate used by the general mailing public to be

anything other than rounded to a whole integer.26 Second is that the alternatives

16/4796, 4804.

26 See PRC Op. R97-1, Vol. 1 at 275, ¶5047; PRC Op. R94-1 at V-2, ¶5005; PRC Op. R87-1 at 438, ¶5083.

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produce unfair and inequitable allocations of institutional cost. Proposal of a 43-cent

rate essentially would unfairly and inequitably relieve other mail classes and services

from having to bear equitable shares of institutional cost burden. On the other hand, a

41-cent proposal would unfairly require that other more price-sensitive and competitive

mail classes bear unreasonably large percentage rate increases. A 41-cent rate would

also shift more institutional cost burden onto the presorted component of First-Class

Mail, which bears an already very high institutional cost allocation. Tr. 32/10709-10. In

similar circumstances, the Commission has had to balance similar considerations. See

PRC Op. R97-1, at 275, ¶5047; also PRC Op. R94-1 at V-2-3.

Witness Taufique proposes de-averaging of First-Class Mail rates by shape and

asks the Commission to recommend initial-ounce rates for flats and parcels of 62 cents

and $1.00, respectively. These proposed rates only pass through 55 percent of the

letter/flat cost differential and 15 percent of the letter/parcel cost differential for lighter-

weight flats and parcels. USPS-T-32 at 18, 23. Witness Taufique’s proposed rates

recognize some, rather than all of the apparent differences in costs between letters and

flats/parcels. He strikes a proper balance between the twin goals of (a) improving cost

and rate relationships within the diverse Letters and Sealed Parcels subclass, and (b)

mitigating the shock to flat and parcel mailers that would result from a full recognition of

such shape-based cost differences in rate design. His tempering of increases that

would otherwise be suggested by the cost data reflects consideration of the effect of

extraordinarily high rate increases on current First-Class Mail flat and parcel mail users,

and is consistent with § 3622(b)(4). At the same time, witness Taufique prudently

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proposes workshare rates for flats and parcels that reflect less than the full cost

differences, in light of the novelty of his rate design within the subclass and the

uncertainty about volume impacts. Id.

b. The Postal Service rate proposals for the remaining First-Class Mail single-piece and nonautomation presort letter categories should be recommended.

i. Qualified Business Reply Mail Letter Rate At pages 24-25 of USPS-T-32, witness Taufique testifies that QBRM is clean,

prebarcoded single-piece mail and incurs less cost than non-barcoded mail. Using

witness Abdirahman’s estimated 1.495-cent unit cost difference (USPS-T-22 at 40-41)

between handwritten single-piece First-Class Mail and QBRM as a starting point,

witness Taufique takes into account the current 3.2-cent discount and proposes a 2.5-

cent QBRM discount. This represents a 167 percent passthrough of witness

Abdirahman’s cost avoidance estimate. The resulting QBRM initial-ounce rate of 39.5

cents is 10.3 percent higher than the current rate and above the systemwide average in

terms of percentage rate increase. By recognizing cost savings associated with this

mail, the Postal Service is able to permit a broader base of customers who already

benefit from rate averaging within the single-piece mail stream to more directly share in

the benefits of automation (USPS-T-32 at 25). However, in light of witness

Abdirahman’s QBRM cost difference estimate, witness Taufique is compelled to

propose some reduction in the current 3.2-cent discount. This brings the QBRM rate

more in line with the measured cost avoidance related to the QBRM piece.

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ii. Nonautomation presort rates for letters and flats

Witness Taufique proposes that the current 1.9-cent rate differential between the

single-piece and non-automation presort letters be increased to 2.0 cents, resulting in

an increase from 37.1 to 40.0 cents for the non-auto presort initial-ounce rate. De-

averaging for shape, he proposes a 51.9-cent initial-ounce rate for flats. USPS-T-32 at

37.27

Taking into account his Mixed AADC benchmark for workshare rate design, the

1.87-cent cost difference between that Mixed AADC letters and Non-Automation Presort

letters,28 and the Postal Service’s policy of encouraging greater worksharing, witness

Taufique proposes that the current 1.9-cent difference between the single-piece rate

and the non-auto presort rate remain approximately the same. USPS-T-32 at 37-38.

Witness Taufique passes through 40 percent of letter/flat cost differential

measured by witnesses Smith (USPS-T-13) and Kelley II (USPS-T-30) to derive an

11.9-cent non-auto presort letter/flat rate differential. USPS-T-32 at 33-34, 37-38.

Adding this amount to his proposed 40-cent non-auto presort rate, he obtains his

proposed non-auto presort flat rate.

The proposed 40-cent nonautomation presort letter rate is two cents below the

proposed single-piece rate of 42 cents and 5.4 cents above the highest Automation

Letter rate of 34.6 cents for Mixed AADC Letters. Witness Abdirahman measures the

additional cost of nonautomation machinable letters at 1.314 cents. USPS-LR L-48,

27 The Postal Service does not propose the establishment of a nonautomation presort parcel rate category. 28 As measured by witnesses Abdirahman (USPS-T-22) and Kelley (USPS-T-30).

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page 29. Witness Taufique uses a passthrough of 290 percent of this measured

savings over the Mixed AADC rate for Automation Letters to propose the 40-cent rate.

The objective of this approach is to maintain the current rate relationship with the basic

42-cent letter rate. USPS-T-32 at 38.

The Postal Service seeks to encourage pieces that are compatible with its

increasingly automated work environment and prefers to maintain a rate relationship

between nonautomation presort mail similar to the relationship that it has had

historically with the Single-Piece mail.29

For operational reasons, the Postal Service is changing the presort requirements

for machinable letters in this rate category. Currently, at least 3-Digit sortation is

required. The Postal Service now proposes that AADC sortation be required. For non-

machinable letters and flat-shape pieces, 5-Digit would remain the required presortation

level. These proposed rates and mail classification changes promote the automation

goals of the Postal Service and should be recommended by the Commission.

iii. The proposed additional-ounce rate reductions are appropriate. Witness Taufique proposes that the additional-ounce rate for single-piece and

nonautomation presort First-Class Mail be decreased from 24 and 23.7 cents,

respectively, to 20 cents for both categories and for all shapes. As witness Taufique

explains, these rate reductions are one of the benefits associated with shape-based rate

de-averaging. USPS-T-32 at 25.

29 Over the last few dockets, the rate difference between nonautomation presort and single-piece has ranged from 1.8 cents to 2.5 cents.

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Additional-ounce rate design has long served as a mechanism for managing the

overall First-Class Mail revenue requirement. Revenue form First-Class Mail additional

ounces comprised 7.5 percent of total Base Year revenue for the Letters and Sealed

Parcels subclass, or approximately $3.9 billion. Id. Under witness Taufique’s proposed

rates, Test Year additional-ounce revenue would be $2.9 billion. This amount exceeds

total revenues for many non-First-Class Mail subclasses. First-Class Mail additional

ounces should not be called upon to bear an even greater revenue burden.

iv. Elimination of the nonmachinable surcharge is consistent with shape-based rate differentials. The shape-based rate design proposed by witness Taufique permits the Postal

Service to propose modification of the nonmachinability criteria in Domestic Mail

Classification Schedule § 232 for Letters and Sealed Parcels subclass mail. See

Docket No. R20056-1, USPS Request, Attachment B at 5 (May 4, 2006). This,

however, does not eliminate the justification for assessing additional postage to cover

the significant additional mail processing costs that nonmachinable pieces tend to

generate and the additional value from the ability to send more material within a heavier

weight piece.

To minimize the complexity in the proposal of letter, flat, and parcel shape-based

rate categories within the Letters and Sealed Parcels subclass, the Postal Service

proposes that, in lieu of a surcharge on the initial-ounce rate for nonmachinable one-

ounce letter-shaped pieces, that nonmachinable letters should simply be assessed the

initial-ounce rate proposed for flat-size pieces. Likewise, rather than complicate the rate

schedule with a specific surcharge for nonmachinable one-ounce flats, witness Taufique

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proposes that that such flats be required to pay the initial-ounce rate proposed for

parcels. Tr. 16/4809, 4812. For reasons explained below in subsection VI.B.5.c.iii of

this Brief relating to the proposed Business Parcel rate category, witness Taufique

proposes retention of a surcharge for nonmachinable parcels.

c. The Postal Service First-Class Mail rate design for bulk automation-based worksharing letter categories affirms the importance of automation.

In the development of First-Class Mail worksharing rate incentives, the

Commission has enunciated certain guiding principles. Among them is the notion that

the relevant mailstream be examined and that pertinent cost data be used in a manner

appropriate to the characteristics of the mail being examined. See, PRC Op. R84-1,

Vol. 1 at 361; PRC Op. R80-1, Vol. 1 at 288.

The statutory pricing criteria call for a balanced consideration of a number of

factors, including fairness and equity, and simplicity in the rate structure and impact of

rate changes on mailers. Witness Taufique is cognizant that, in the absence of other

compelling considerations, the objective should be to pass through approximately 100

percent of the costs avoided relative to the appropriate benchmark. See PRC Op.

MC95-1, at IV-135, ¶4299. And, as noted earlier, witness Taufique advocates that the

Commission use the internally derived rate for Mixed AADC automation letters as a

benchmark for deriving the cost differences associated with finer levels of sortation.

However, given the discounts implied by Abdirahman’s cost analysis, the need to send

an appropriate signal to mailers, and the adverse impact that an immediate and material

reduction in worksharing incentives could have on mailer and postal operations, witness

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Taufique proposes discounts for Automation 5-Digit letters and cards that exceed the

cost differential measured by witness Abdirahman. As a result, witness Taufique’s

Automation category rate design is not tied strictly to avoided costs, but incorporates

measured cost avoidances within the context of balancing a number of ratemaking

goals.

Automation mail is predominantly made up of Automation Letters, but also

includes Automation Flats, mail that would qualify for the newly proposed category of

First-Class Mail Business Parcels, and Nonautomation Presort. With the creation of

the First-Class Mail Business Parcels rate category, Nonautomation Presort mail is

proposed to include only letter and flat-shaped pieces.

Calculation of revenues as a percent of volume variable costs indicates

that the automation mail stream provides a relatively high contribution to the Postal

Service’s institutional costs. In the FY 2005 Base Year (which does not include the

effect of either the R2005-1 rate increases or the R2006-1 proposed rate increase), that

implicit coverage was 286.7 percent, using the PRC version of the CRA. USPS LR-L-

93, Reports\PRCBYOS, tab Page 8”, cells D15/cell D16. Using Postal Service costs,

that implicit cost is nearly 301 percent. USPS LR L-5, BYOSCRA, tab “Cost 1”, cell

P12.

Cost coverage is traditionally not calculated below the subclass level, but the

implicit cost coverage for Presort (or workshare) Letters has been significantly higher

than the comparable implicit Commission recommended cost coverage of 265.9 percent

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in Docket No. R2001-1. The comparable implicit cost coverage for Presort (workshare)

letters in Docket No. R2005-1 was 312.1 percent.30

i. Automation Letter Rates

There are five rate categories each for prebarcoded letters: Mixed AADC, AADC,

3-Digit, 5-Digit, and Carrier Route. The Postal Service proposes to eliminate the Carrier

Route category.

To be eligible for the 3-Digit and 5-Digit categories, letters must be properly

barcoded and part of a mailing of at least 500 pieces. To qualify for either the 3-Digit or

the 5-Digit rate, the mailing must have at least 150 pieces destined to the same 3-Digit

or 5-Digit ZIP Code, respectively. USPS-T-33 at 31-32. Pieces that do not meet the

150-piece minimum qualify for the Mixed AADC or AADC rate.31

As witness Taufique explains, the proposed rate for Mixed AADC is an internally

derived number based on leakages and additional costs (for flat and parcel-shaped

pieces, nonautomation presort rate letters, for example) and the estimated intra-class

revenue requirements for the Presort component of the Letters and Sealed Parcels

subclass. USPS-T-32 at 30. He calculates cost savings, as well as discounts, based

on an internal benchmark -- the Mixed AADC Automation Letter rate within Presort

letters. Id. Thus, neither the Bulk Metered Mail benchmark, nor the first-ounce single-

piece rate is used to estimate the proposed rates for Automation Letters.

30 PRC Op. R2005-1: 312.1 percent. (Revenues: PRC Op. R2005-1, Appendix G, p. 2; costs: PRC Op. R2005-1, Appendix F, p. 1.)

31 One could view the Mixed AADC rate as the bulk residual barcoded rate.

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Witness Taufique’s passthroughs and the discounts underlying his proposed

rates were selected to balance several goals, including: (1) achieving the cost coverage

target provided by witness O’Hara (USPS-T-31); (2) recognizing the value of mailer

worksharing; (3) avoiding changes in discount levels which result in unduly disruptive

rate impacts; (4) acknowledging the importance of mailer barcoding and presortation in

overall postal operations; and (5) recognizing that, overall, automated letters are a low

cost, high contribution mail stream. Id.

Had he adhered to a strict 100 percent passthrough of the 1.3-cent measured

cost savings for 5-Digit Automation letters, the proposed increase in the 5-Digit

Automation rate would have been 8.5 percent, higher than all other Automation letter

rate categories. Since the elimination of the Carrier Route category is expected to

cause that mail to shift to 5-Digit, witness Taufique’s 146 percent passthrough for

Automation 5-Digit eases the rate impact of the transition of Carrier Route mail to 5-

Digit. Id. at 31.

Such an approach is consistent with Commission precedent. Although it has

generally preferred 100 percent passthroughs, the Commission has made clear that:

[C]ircumstances may exist where strict adherence to this policy is not appropriate, and when competing policies may weigh more heavily in the decision making process.

The Commission is required to consider all of the factors of section 3622(b) when reviewing appropriate discount rates for workshared mail. . . . [D]ifferent factors receive different weights depending on the specific circumstances of the rate category under review. For instance, in PRC Op. R2000-1 . . . , where the Commission endorsed passthroughs at 100 percent of avoided costs, the Commission also recommended a discount for carrier route letters that passed through 67 percent of avoided costs to prevent a disruptive effect on the rate schedule. In contrast, the Commission

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recommended a discount with a greater than 100 percent passthrough for presort letters to moderate the impact of its recommendation to shrink that discount from 2.5 cents to 2.0 cents. In both these instances, other factors outweighed the benefits of strictly adhering to a 100 percent passthrough policy. The Commission concludes that establishing discounts to pass through 100 percent of avoided costs is an appropriate policy, but that other considerations sometimes preclude its application.

PRC Op. R2001-1 at 72-73, ¶¶3063-64.32 Witness Taufique passes through 100

percent of cost savings to propose the discounts and rates for the AADC and 3-Digit

presort levels, based not only on the measured costs of the presort levels, but also

based on consideration of the impact on mailers, and the current operational

environment for processing letters. He passes through 146 percent of cost savings

for 5-Digit Automation Letters in order to mitigate the impact of an 8.5 percent

increase in this rate and an almost 10 percent increase on the Automation Carrier

Route Letters pieces expected to shift to 5-Digit. USPS-T-32 at 32. He is also

swayed by postal mail processing operational policy favoring 5-Digit presort of

Automation rate mail. Id. at 32-33.

32 Even APWU witness Kathryn Kobe recognizes in her rate design that setting rates at greater than 100 percent passthroughs can be consistent with the policies of the Act. See APWU-T-1 at 10.

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ii. Automation Flats Rates

There are currently four rate categories for prebarcoded flats: Mixed ADC, ADC,

3-Digit and 5-Digit. Based on the data provided by witnesses Smith (USPS-T-13) and

Kelley II (USPS-T-30) for mail processing and delivery unit costs by shape, on average

presort flats cost 30 cents more to process and deliver than letters. Witness Taufique

uses a 40 percent passthrough to propose a differential between Mixed AADC Letters

and Mixed ADC Flats of 11.9 cents, which is added to the Mixed AADC Letter rate of

$0.346. The resulting rate proposed for Mixed ADC Automation Flats is $0.465. As he

explains, this is an 11.5 percent increase from the current first-ounce Mixed ADC rate

for Automation Flats. To develop rates for the various Automation flats presort tiers,

witness Taufique uses witness Miller’s (USPS-T-20) unit cost estimates for the various

presort levels. USPS-T-32 at 34. The resulting rates are fair and equitable.

iii. Business Parcels

Witness Taufique designs the rates for this new category by using the estimated

average mail processing and delivery cost differences between presorted letters and

parcels. First-Class Mail parcels (currently in the presort category, primarily in

Nonautomation Presort), on average, cost $ 3.368 to process and deliver -- compared

to automation letter mail pieces at $ 0.087. See USPS-T-13, Attachment 14; USPS

Library Reference L-53; USPS Library Reference L-99, Tr. 19/6810-17; USPS Library

References L-184 and L-185; response of witness Marc Smith to POIR 16, Question 1;

testimony of witness Kelley II, USPS-T-30. Witness Taufique adds only 15 percent of

the $ 3.28 difference (48.9 cents) to the Mixed AADC Automation Letter cost to

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establish an AADC Parcel benchmark from which to derive rates for finer presort levels.

USPS-T-32 at 36. Since the Postal Service is not proposing a Mixed ADC rate for the

First-Class levels, this benchmark is used to derive the presort level rates for ADC, 3-

Digit and 5-Digit using witness Miller’s (USPS-T-20) cost estimates.

First-Class Mail Business Parcels that do not meet specified automation

requirements are subject to a proposed nonmachinable surcharge of five cents, with the

exception of parcels that are sorted to the 5-Digit level or paying single-piece rates.

This nonmachinable surcharge is derived by using the Parcel model estimated by

witness Miller (USPS-T-20) and proposing a 15.5 percent passthrough of costs derived

from witness Miller’s (USPS-T-20) parcel cost model. USPS-T-32 at 37. First-Class

Mail Business parcels that are nonbarcorded, weigh less than two ounces or are odd

shaped (such as tubes) would be required to pay a nonmachinable surcharge. These

characteristics would make them non-machinable on the Automated Package

Processing System (APPS). If these pieces are sorted to 5-Digit level, then sorting on

APPS would not be required.

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iv. Additional-Ounce

Witness Taufique proposes that a uniform additional-ounce rate of 20 cents be

applied to the First-Class Mail Letters and Sealed Parcels subclass, except for the

Automation letter rate categories. For Mixed AADC, AADC, 3-Digit and 5-Digit

Automation letters, where shape and nonmachinability issues do not arise, he proposes

a lower additional-ounce rate of 15.5 cents. USPS-T-32 at 39; Tr. 16/4819-20. These

beneficial improvements to the rate schedule should be recommended by the

Commission.

v. Heavy-Piece Deduction

For the reasons discussed above in section VI.B.3.a relating to shape-based rate

design, witness Taufique proposed that the incremental discount for automation pieces

weighing more than two ounces be eliminated. See also USPS-T-32 at 45-46.

vi. Nonmachinable Surcharge

The shape-based rate design proposed by witness Taufique permits the Postal

Service to propose modification of the nonmachinability criteria in Domestic Mail

Classification Schedule § 232 for Letters and Sealed Parcels subclass mail. See

Docket No. R2006-1, USPS Request, Attachment B at 5 (May 3, 2006). This, however,

does not eliminate the justification for assessing additional postage to cover the

significant additional mail processing costs that nonmachinable pieces tend to generate.

To minimize the complexity in the rate schedule already resulting from the proposal of

letter, flat and parcel shape-based rate categories within the Letters and Sealed Parcels

subclass, the Postal Service proposes that, in lieu of a specific surcharge on top of the

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initial-ounce rate for nonmachinable letter-shaped pieces, those nonmachinable letters

should simply be assessed the initial-ounce rate proposed for flats. For the reasons

discussed at pages 45-46 of USPS-T-32, in relation to the nonmachinable surcharge for

single-piece First-Class Mail letters, the Postal Service proposes that the surcharge

which currently applies to nonmachinable automation rate and nonautomation presort

rate category letters be eliminated and that such pieces simply be required to pay the

corresponding initial-ounce rate for flat-shaped pieces.

d. The Cards subclass

Witness Taufique’s proposed rate increases for the Cards subclass are

somewhat higher than the increases he proposes for letters, 12.5 percent compared to

7.7 percent. This results largely from the fact that, compared to letters, the absolute

increases for cards are applied to lower base rates, starting at the single-piece level.

However, as explained at page 41 of USPS-T-32 and as seen below, witness Taufique

is able to mitigate this impact in his workshare card rate design.

i. Single-Piece Card Rate

Witness Taufique proposes to increase the basic card rate from 24 to 27

cents. Single-piece cards account for about 51 percent of card revenues. A three-cent

increase is the amount consistent with the subclass cost coverage target. USPS-T-32

at 40. His rate design, if adopted, would retain the current 15-cent difference between

the basic letter and cards rates and maintain the traditional approximately 2:3

relationship with the basic letter rate. For the sake of simplicity and convenience for the

general mailing public, the proposed increase also reflects an application of the whole-

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cent constraint. USPS-T-32 at 39-40. The proposed rate of 27 cents represents an

increase of 12.5 percent. The proposed increase imposes upon card mailers no more

than a fair and equitable contribution to the First-Class Mail revenue requirement. Id. at

40.

ii. Qualified Business Reply Mail Card Rate

Using the cost analysis of witness Abdirahman (USPS-T-22) as a starting point,

witness Taufique proposes that the current 21.1-cent QBRM card rate be increased to

24.5 cents. Assuming adoption of the proposed 27-cent basic rate for cards, and the

42-cent basic rate for letters, and the 39.5-cent rate for QBRM letters, a 24.5-cent rate

for QBRM cards would result in identical QBRM discounts for letters and cards. USPS-

T-32 at 40.

As with QBRM letters, to qualify for this QBRM card rate, prebarcoded,

automation-compatible mail piece designs must be pre-approved by the Postal Service.

For this docket, the Postal Service is proposing a rate of 24.5 cents for QBRM cards.

This 24.5 cent QBRM card rate reflects a reduction in the current 2.9-cent QBRM

card discount to 2.5 cents, which matches the proposed 2.5 cent QBRM letter discount.

Witness Abdirahman’s cost study (USPS-T-22 at 21) shows a cost avoidance of 1.495

cents, applicable to both letters and cards. Witness Taufique passes through 167

percent of this measured cost avoidance for both letters and cards. USPS-T-32 at 40.

iii. Nonautomation Presort Card Rate

To mitigate the impact of the 12.5 percent increase in the basic card rate (from

24 to 27 cents) on non-auto presort cards, witness Taufique proposes an increase in the

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degression between the single-piece card rate and the nonautomation presort rate from

the current 0.7 cent difference to 2.9 cents, resulting in 24.1-cent rate for nonautomation

presort cards. This works out to an 8.1 percent rate increase for this category. USPS-

T-32 at 41. Otherwise, as indicated below, witness Taufique proposes that the current

discount relationships for other Card rate categories be maintained at their current

levels. USPS-T-32 at 41.

iv. Automation Card Rate Categories

As with letters, there are five rate categories for prebarcoded cards: Mixed

AADC, AADC, 3-Digit, 5-Digit, and Carrier Route. Witness Taufique proposes

elimination of the Carrier Route category. As with letters, a card mailing must consist of

500 or more prebarcoded pieces to be eligible for the AADC, 3-Digit and 5-Digit rates.

Further, to be eligible for the AADC, 3-Digit or 5-Digit rate, the mailing must have at

least 150 pieces to the same AADC, 3-Digit or 5-Digit ZIP Code/scheme destination.

Pieces that do not meet the 150-piece volume minimum pay the Mixed AADC rate.

Thus, the Mixed AADC automation rate can be viewed as a rate for bulk residual

prebarcoded pieces. No changes in the qualifying piece minimums are proposed.

The cost analysis performed for this docket indicates the savings for the AADC,

3-Digit and 5-Digit automation tiers are now smaller than the current discounts for these

tiers (USPS-T-22 at 15). For example, the cost data suggest a 1.4 discount from the

nonautomation presort rate of 24.1 cents. Using a passthrough of 134 percent, witness

Taufique maintains this discount at the current level of 1.9 cents. USPS-T-32 at 42-43.

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Similarly, his discount for AADC cards is based on a 108 percent passthrough. He

proposes retention of the current 0.4 cent rate differential between the AADC

automation rate and the 3-Digit rate, notwithstanding the 0.225-cent measured cost

difference. And, his proposed 5-Digit rate represents the maintenance of the existing

difference of 0.7 cents between 3-Digit and 5-Digit cards, notwithstanding the 0.735

cents measured cost difference between the two automation tiers. USPS-T-32 at 43-

44.

If the proposed workshare discounts for AADC, 3-Digit and 5-Digit automation

cards were tied strictly to avoided costs, the proposed discounts would be reduced.

Instead, as was the case with letters, the passthroughs and the discounts that underlie

the proposed rates were selected to balance several goals, including: (1) achieving the

cost coverage target provided by witness O’Hara, (2) recognizing the value of mailer

worksharing, (3) avoiding changes in discount levels which result in unduly disruptive

rate impacts, and (4) acknowledging the importance of mailer barcoding in overall postal

operations. USPS-T-32 at 41-42. As a result of witness Taufique’s rate design, the

Postal Service’s rate proposal in this docket will maintain the AADC, 3-Digit and 5-Digit

discounts at their present levels for cards.

The overall result is a rate schedule for the Cards subclass that is fair and

equitable and that should be approved by the Commission.

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2. The Commission should reject the alternative intervenor First-Class Mail rate proposals

a. APWU’s 41-cent basic letter rate proposal does not reflect consideration of relevant factors

In her testimony, APWU witness Kathryn Kobe reviews the Postal Service’s First-

Class Mail Letters and Sealed Parcels subclass rate design and proposes an alternate

rate structure that, in her view, “could result if discounts equal to . . . costs avoided

were used to determine First Class Presort letter rate.” APWU-T-1 at 3. Based on her

review, witness Kobe argues that a 41-cent basic rate could be achieved, in conjunction

with higher presorted First-Class Mail rates. Id. at Table 2. Her proposal is premised

on an assumption that the primary goal of rate design is the development of workshare

discounts that are no greater than costs avoided when a customer prepares mail to

meet specific workshare rate requirements. This theory, often referred to as Efficient

Component Pricing, pushes economic efficiency to the forefront and, when considered

in isolation, does not result in an appropriate consideration of the pricing criteria

enumerated in § 3622(b).33

Witness Kobe, herself, recognizes that economic efficiency “may not be the only

criterion for a decision” (Tr. 20/7131) and takes steps to mitigate the “rate shock”

implied by adherence to her overriding rate design principle. APWU-T-1 at 10.

Unfortunately, her proposal still fails to consider many of the factors that have led the

Postal Service to its First-Class Mail rate design in this case.

33 Postal Service rate design witness Taufique discusses reasons why use of the bulk metered mail benchmark advocated by witness Kobe may no longer be appropriate. USPS-T-32 at 13-14; See also, Tr. 38/13346-48.

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The Postal Service did not reach its 42-cent basic First-Class Mail rate without

careful consideration. The basic First-Class Mail rate, given its widespread use by

general public, is subject to careful scrutiny. Over time, the Postal Service has made

policy choices that have worked to keep single-piece First-Class Mail as affordable as

possible, given the often competing policy considerations and the need to meet the

financial requirements of the Postal Service. As explained by Postal Service rebuttal

witness Maura Robinson, since the implementation of Docket No. R94-1, through the

anticipated implementation date of this docket, the basic rate will have increased by less

than the rate of inflation consistent with the Postal Service’s policy goals. Tr. 32/10707.

The entire process of rate design involves making difficult choices and cannot be

evaluated without reviewing all of the factors affecting a subclass of mail. PRC Op.

R2000-1 at 235, ¶5064. As Postal Service witness O’Hara explains, the fundamental

goal of pricing is to meet the Postal Service’s revenue requirement through the

application of the statutory pricing criteria. The basic First-Class Mail stamp rate plays a

key role in meeting the revenue requirement, contributing $15.9 billion, or over 22

percent of the Postal Service’s revenue in the base year, more than the combined

revenue from all non-First-Class Mail subclasses, excluding Standard Mail. USPS-LR-

L-77. However, in proposing the basic rate of 42 cents, the Postal Service did not

examine this rate in isolation. The Postal Service considered a panoply of factors,

including the historical relationships between costs and pricing, rates and rate

relationships and the policy choices embedded in its proposals.

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One of the most striking characteristics of First-Class Mail Letters and Sealed

Parcels subclass is the success that the Postal Service has achieved in controlling unit

costs, particularly for presorted First-Class Mail. From FY 2000 to 2005, single-piece

First-Class Mail unit volume-variable costs have increased ten percent, while the

increase in per-piece revenue has been slightly less, about nine percent. This

demonstrates the Postal Service’s commitment to affordable single-piece First-Class

Mail prices. However, the success in controlling presorted First-Class Mail costs has

been nothing short of striking – over the same time period, unit costs have increased

only three percent while per-piece revenue has increased by 11 percent. Tr. 32/10709.

It is within this context that the Postal Service has developed its rate proposals and asks

the Commission to evaluate alternative First-Class Mail rate designs.

The pursuit of economic efficiency is laudable. And the Postal Service has a

long history of presenting and supporting rate proposals that are consistent with all of

the pricing criteria of the Act and that send economic signals to customers about the

value of worksharing activities. However, in the context of rate design, application of a

sole pricing theory -- even if that theory is economic efficiency -- cannot trump the

application of reasoned evaluation of the pricing criteria. The Commission has

cautioned in the past against the elevation of economic efficiency to a preeminent status

in determining cost coverages. See PRC Op. R97-1 at 236-37, ¶¶4027-29. Such

caution is appropriate in rate design as well. Witness Kobe’s proposed presorted First-

Class Mail rates result in greater-than-average price increases for a customer group

(presorted First-Class mail customers) that has perhaps the most stable costs. The

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Postal Service submits that it is difficult to conclude that such a result is fair and

equitable. Witness Kobe does not disagree. Tr. 20/7131. It also is difficult to conclude

that single-piece First-Class Mail letters have been unfairly burdened with institutional

cost. As Postal Service First-Class Mail rate design witness Taufique notes, the

proposed rate increase for this rate category is only 7.7 percent, this is substantially less

than the proposed increase for any non-First-Class Mail subclass. Compare Exhibit

USPS-31D to USPS-T-32 at 3.

In developing its prices and presenting them here, the Postal Service has not

shied away from hard choices in its goal of proposing prices that, in its view, most

reasonably balance the relevant statutory pricing criteria. The Commission must also

make the same hard decisions. The visibility of the single-piece basic rate ensures

serious public scrutiny. Given the equity considerations within First-Class Mail, the

financial well-being of the Postal Service requires that this rate be increased to 42

cents.

b. GCA’s alternative rate design proposals should be rejected.

Greeting Card Association witness Clifton (GCA-T-1) appears to offer the

Commission a menu of rate design options. They are designed to either:

(a) increase Standard Mail rates sufficiently to reduce the rate increase on First-Class single piece letters from 42 to 41 cents; or

(b) increase Standard Mail rates sufficiently to reduce the rate increase

on all First-Class mail first-ounce rates by one cent.

GCA-T-1 at 59. These options are driven by Dr. Clifton’s belief that the Postal Service’s

estimated elasticities substantially understate the potential First-Class Mail volume

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response to a price change. Id. As discussed above in Section III of this Brief, Dr.

Clifton’s recommendation to the Commission relies on a fatally flawed econometric

model. It also is simply bad rate policy.

In reviewing Dr. Clifton’s proposals, it is difficult, at best, to determine what he is

proposing and how it would affect First-Class Mail and Standard Mail revenue and rate

design. In the first place, his proposal presents the Commission two options with

substantially different revenue implications – and substantially different implications for

rate policy. While witness Clifton’s rate proposals are couched as offering the

Commission alternatives, his evaluation of the proposals are not consistent with each

other or even with his stated position. Consider Postal Service rebuttal witness

Robinson’s attempt (USPS-RT-10; Tr. 38/10697 et. seq.) to reconcile Dr. Clifton’s

proposals. For simplicity, she assumes that there was no volume effect associated with

a reduction in prices. If only the single-piece basic rate were reduced by one cent, this

would result in a reduction in First-Class Mail revenue of $337 million, which is

consistent with witness Clifton’s estimate. It appears that Dr. Clifton has assumed no

volume effect in his computation. If all First-Class Mail first-ounce rates are reduced by

one cent, witness Robinson estimates a revenue reduction of $813 million (with no

volume effect). Dr. Clifton, however, estimates that the revenue effect would only be

$519 million. Compare USPS-RT-10 at Appendix to Tr. 29/9796. His computations are

either incorrect or internally inconsistent (with one assuming a volume effect and the

other assuming no volume effect). They offer the Commission little guidance. Setting

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aside these computational difficulties, Dr. Clifton’s proposals also fail to consider the

appropriate balancing of the pricing criteria.

Effectively, Dr. Clifton suggests that a reduction in First-Class Mail rates should

be funded by an increase in Standard Mail Regular rates. However, he fails to

recognize that Standard Mail Regular is already bearing a greater-than-average

percentage rate increase under the Postal Service’s proposal, and that a further

increase in this burden in not warranted. Testifying on behalf of the Postal Service, Dr.

O’Hara has proposed that Standard Mail Regular rates increase, on average, by 9.6

percent as compared to the system average 8.5 percent rate increase. Exhibit USPS-

31D. As explained by Postal Service rebuttal witness Robinson, Dr. Clifton’s proposal

would result in Standard Mail Regular increases that could range from 11.8 to 14.8

percent, without any consideration of whether this result would be consistent with the

pricing criteria. Tr. 32/10713. Effectively, Dr. Clifton’s argument is that, if the demand

for Standard Mail Regular is more inelastic than that of First-Class Mail, the

Commission should take advantage of this fact and increase Standard Mail rates even

further. In addition, he appears to suggest (contrary to fact and law) that, unlike much

of the content of First-Class Mail, the content of Standard Mail is not subject to the

Private Express Statutes (18 U.S.C. §§1693-1699; 39 U.S.C. §§ 601-606). Based upon

the faulty assumption, he regards Standard Mail Regular as an appropriate target for a

substantial rate increase. See GCA-T-1 at 58. While it is difficult to untangle Dr.

Clifton’s labyrinth of assumptions, the Commission’s position on pricing has been clear.

Pricing involves the balancing of many factors, only one of which is “value of service,”

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within the meaning of § 3622(b). Dr. Clifton’s sole focus is on only one aspect of value

of service – economic value of service as measured by elasticities. He does not

consider intrinsic value of service. He does not consider the effect on Standard Mail

Regular customers of an inordinately high rate increase.

In contrast, Postal Service rate policy witness O’Hara (USPS-T-31) considers

and balances these variables. Dr. Clifton has not considered how the Postal Service

might reasonably balance the many competing criteria within a comprehensive

Standard Mail rate proposal. On the other hand, Postal Service Standard Mail rate

design witness James Kiefer (USPS-T-36) has. Dr. Clifton does not consider the effect

of a change in Standard Mail Regular prices on Standard Mail Nonprofit rates and cost

coverage under the provisions of § 3626. Both witnesses O’Hara and Kiefer do. Tr.

32/10713-14. The only support for Dr. Clifton’s proposals can be found in his elasticity

estimates, which are discredited by Postal Service rebuttal witness Thomas Thress

(USPS-RT-2). The Commission must reject GCA witness Clifton’s rate proposals.

c. There is insufficient record support for Pitney Bowes’s postage evidencing discount. Pitney Bowes witness Lawrence Buc (PB-T-3, Tr. 30/10086 et seq.) proposes a

0.1-cent discount supposedly intended for the first-ounce of a single-piece First-Class

Mail letter, if the postage is purchased through certain retail sales channels that avoid

postal window transaction costs. PB-T-3 at 2. Witness Buc’s proposal applies to

postage obtained via permits, postage meters, and PC Postage. Id. Though he claims

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to support expanding his proposed discounts to more retail channels,34 he states that

his proposal in the current docket is limited because of the lack of data on cost

avoidance for those additional retail channels. Id.

Witness Buc’s proposal is based upon his embrace of the notion that all rate

differentials should reflect cost differences. PB-T-3 at 4. He criticizes the Postal

Service for failing to recognize postage evidencing cost avoidance in its direct case. Id.

He claims that his proposed discount would encourage consumers to use less

expensive alternative retail channels, shorten lines at post offices, and save the Postal

Service from incurring unnecessary costs. PB-T-3 at 6.

Witness Buc’s rate design is founded upon his calculation that it costs 1.6 cents

in the Base Year to sell a stamp across the window. PB-T-3 at 7. He surmises that

postage evidencing methods cost somewhat less than this, and in a magnanimous

desire to “not let the perfect be the enemy of the good,” sets his proposed discounts at

an amount less than his cost avoidance estimate. PB-T-3 at 8. According to witness

Buc, his proposed 0.1 cent discount for permit, metered, and PC Postage mail would

result in revenue leakage to the Postal Service of less than $19 million, if one were to

assume that Test Year volumes by indicia are roughly equal to the Base Year volumes.

Id.

However, witness Buc’s proposal lacks sufficient support to justify imposing this

new discount, and the record evidence suggests that the details of this proposal have

not been adequately considered or examined. For instance, he confesses that his

34 Such as the numerous alternative channels through which single-piece First-Class

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estimate of the revenue leakage under his proposal does not account for the existence

or potential existence of short paid mail. Tr. 30/10124. He further concedes that the

Postal Service would incur additional revenue protection costs associated with

preventing short paid mail. Id.

Witness Buc also admits that the Postal Service would incur additional

implementation costs related to: (1) educating postal workers on the new discounts; (2)

training postal workers on how to identify and treat short paid mail; and (3) educating

the public on the new discounts. Tr. 30/10125-27. There would also be additional costs

associated with formally accepting permit imprint mail, and at many small post offices,

this formal acceptance occurs at the retail window. Tr. 30/10128-29. Witness Buc’s

proposal provides no analysis of whether or not these additional costs would be

outweighed by the avoided cost of selling a stamp at the window. However, apparently

playing with house money, he “would bet” that it could be done. Tr. 30/10129.

The Commission should check the bet until it sees a better proposal.

Witness Buc provides no guidance on how his proposal could actually be

implemented, other than theorizing that his proposal could be implemented along with

the Postal Service’s implementation of the Forever Stamp. Tr. 30/10126. He offers no

analysis of the postage meter, permit imprint, or PC Postage markets. See Tr.

30/10092, 10110, 10116-7. Nor does he estimate the amount of retail postage

purchases that would convert to these alternative retail channels, even though this

would seem to be a fundamental pillar of such a proposal. Tr. 30/10095. In sum,

Mail postage is actually sold.

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witness Buc’s testimony either ignores or gives short shrift to several important issues

related to implementation, revenue leakage, additional implementation costs, and

additional revenue protection costs to the Postal Service.

Witness Buc attempts to excuse his inability to provide specifics on the

aforementioned issues by stating that he would be able to do so under a “fully

implemented proposal,” which would apply to additional alternative postage retail

channels. See, e.g., Tr. 30/10127. Essentially, he offers his 0.1-cent discount as a

placeholder, to get his foot in the door for purposes of proposing a significantly

expanded discount in the future. Meanwhile, he suggests that his currently modest

proposal would do little harm. Tr. 30/10130-31.

However, a closer examination of the 0.1-cent proposal in the instant docket

reveals that a discount of this magnitude makes little, if any, sense. First, the discount

is so small that it does not provide an incentive for its ostensible beneficiaries -- stamp-

affixing, single-piece First-Class Mail users -- to change their behavior by either

obtaining a postage meter, a permit account, or PC Postage device. Tr. 30/10129-30.

In reality, the discount would primarily reward businesses that already use or have

reason to use postage meters, mailing permits, or PC Postage devices,35 without

requiring them to change their behavior at all. The proposed discount would also apply

to Business Reply Mail (BRM), though witness Buc provides no justification for giving

this additional discount on top of the existing BRM discounts. Tr. 30/10120.

35 Plus, the relatively small number of household mailers that use PC Postage devices or meters.

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Despite witness Buc’s repeated claims that his proposal is intended to benefit

small mailers,36 even he admits that permit imprint mailings require a minimum of 200

pieces or 50 pounds. Tr. 30/10121-22. He concedes that this is not a “small” amount of

mail. Tr. 30/10128. Moreover, if mailers were to obtain a meter, permit, or PC Postage

device, it would require them to mail approximately 100,000 pieces of mail in order to

recoup their investment, assuming a cost of $100 for such a device. Tr. 30/10131-2. It

is difficult to imagine how the intended beneficiary of the proposed discount, the

proverbial Aunt Minnie, would be able to easily recover her investment under this

proposal, if she invested in a postage meter PC Postage device, or -- for some odd

reason -- a mailing permit.

In conclusion, it is clear that witness Buc’s proposed postage evidencing discount

is impractical in the short term. Additionally, the longer-term implications of the

proposal, in terms of cost increases or revenue leakage, have not been rigorously

examined. There is insufficient record evidence to justify creating this additional

discount at this time. Accordingly, the Commission should reject witness Buc’s

proposal.

d. MMA witness Bentley and TW witness Mitchell rely upon an overstated QBRM cost avoidance.

Major Mailers Association witness Bentley (MMA-T-1, Tr. 21/7842 et seq.)

proposes an alternative to Postal Service witness Taufique’s 2.5 cent discount for

36 Witness Buc states that his proposal is “an opportunity to democratize workshare discounts by making them available to small single-piece mailers.” PB-T-3 at 9. See also Tr. 30/10136. However, instead of a one-letter, one-vote democracy, it appears to operate more like a “democracy” with a high-volume poll tax.

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Qualified Business Reply Mail letters and cards. Witness Taufique (USPS-T-32) passes

through approximately 165 percent of Postal Service witness Abdirahman’s (USPS-T-

22) estimated 1.495 cent unit QBRM cost avoidance. Witness Bentley estimates that

the QBRM unit cost avoidance is 6.75 cents, and proposes a discount of “at least 4.0

cents.” See MMA-T-1 at 28.

Time Warner witness Mitchell (TW-T-3) similarly takes issue with witness

Abdirahman’s cost avoidance estimate, and relies upon MMA witness Bentley’s 6.75

cent estimate to propose increasing the QBRM discount to 4.0 cents for letters and 3.5

cents for cards.37 However, TW witness Mitchell improperly relies on witness MMA

Bentley’s estimate in proposing his rates because, as discussed below, witness Bentley

overstates the QBRM cost avoidance.

Witness Bentley recommends expanding the scope of the QBRM cost analysis

far beyond what is recommended by Postal Service witness Abdirahman. Specifically,

MMA witness Bentley criticizes witness Abdirahman’s decision to limit the QBRM cost

savings analysis to the costs incurred up to the point where each piece – a QBRM and

handwritten First-Class reply mail piece – receives its first barcoded sortation on a BCS.

Witness Bentley also applies a different CRA Proportional Adjustment factor in his cost

analysis. See MMA-T-1, Appendix II, p. 4-5. Finally, witness Bentley characterizes

witness Abdirahman’s analysis as an “unjustified departure” from the cost savings

methodology employed by the Postal Service and relied upon by the Commission in

prior dockets. See MMA-T-1, Appendix II, p. 1, at lines 23-24.

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However, as Postal Service witness Abdirahman’s rebuttal testimony

emphasizes, the only identifiable cost differences between a QBRM piece and a

handwritten First-Class reply mail piece are the RBCS-related costs from applying a

POSTNET barcode to the handwritten piece. See USPS-RT-7 at 14-15, Tr. 35/11961-

2; Tr. 35/12019, 12020. This is true for both large volume BRM recipients and small

volume BRM recipients. See USPS-RT-7 at 14-15, Tr. 35/11961-2. In addition, witness

Abdirahman testifies that the proper cost adjustment method is to use the BMM CRA

Proportional Adjustment factor for both QBRM pieces and handwritten reply pieces,

because all three mail types are components of the single-piece First-Class Mail

stream. See Tr. 4/563-4. Witness Abdirahman’s application of the BMM CRA

Proportional Adjustment factor is consistent with the methodology that has been used

since Docket No. R2001-1. Id. MMA Witness Bentley chooses to apply a different CRA

Proportional Adjustment factor, rather than follow the methodology that has been

employed since Docket No. R2001-1.

MMA witness Bentley also mischaracterizes Postal Service witness

Abdirahman’s cost analysis as a departure from past Commission precedent. However,

as witness Abdirahman’s rebuttal testimony states, the Docket No. R2001-1 QBRM cost

analysis was revised to follow the methodology originally presented by the Postal

Service, and approved by the Commission, in Docket No. R97-1. See USPS-RT-7 at

13-14, Tr. 35/11960-1. This methodology was also followed in Docket No. R2005-1,

and is again followed by witness Abdirahman in this docket. Id. Clearly, witness

37 Witness Mitchell also states in his testimony that, “But in any event, the current

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Abdirahman’s QBRM cost avoidance analysis is consistent with past Commission-

approved methodology. Witness Bentley, on the other hand, proposes expanding the

QBRM cost analysis beyond this accepted precedent. His analysis results in an

overstated QBRM cost avoidance estimate as the basis for his higher proposed QBRM

discount.38 Similarly, TW witness Mitchell erroneously relies on witness Bentley’s

overstated cost avoidance estimate in support of his higher proposed QBRM discount.

Therefore, the Commission should reject witness Bentley’s expanded cost analysis, and

reject the higher proposed QBRM discounts by witness Bentley and TW witness

Mitchell.

e. The OCA additional-ounce rate design should not be recommended. Office of the Consumer Advocate witness Pamela Thompson (OCA-T-4)

proposes a radical collapsing of the First-Class Mail Letters and Sealed Parcels

subclass additional-ounce rate structure that should be rejected by the Commission.

Witness Thompson’s quest for rate schedule simplicity is premised upon a misreading

of the Private Express Statutes and reflects a disregard for the potential consequences

of such a radical rate design.

At page 3 of OCA-T-4, witness Thompson asserts that the Private Express

Statutes (18 U.S.C. §1693-1699 and 39 U.S.C. § 601-606) exist “to hold down rates for

the more costly pieces of mail and provide service to all.” But, she is unable to identify

which, if any of the statutory provisions provides the basis for her assertion. Tr.

discounts should not be reduced.” See TW-T-3 at 13.

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20/7425. It is undisputed that the principal goal of the Private Express Statutes is to

restrict the private carriage of letters in competition with the Postal Service for the

purpose of ensuring that the Postal Service has sufficient letter volume with which to

generate revenue with which to cover the expense of providing universal mail delivery

service at affordable rates. However, there is no basis for the assertion that the

restrictions are “intended to hold down rates for the more costly pieces of mail” to any

degree more than for less costly mail pieces. The restrictions are directed at driving into

the postal mailstream matter with particular content. The restrictions serve to increase

the volume of “letters” (as defined by 39 C.F.R. §310.1) that are mailed. In accordance

with 39 U.S.C. § 3622(b)(5), as a part of postal ratemaking, the Commission is

responsible for ensuring that prices for mail in all classes (whether or not populated by

such letters) reflect whether non-postal alternatives exist at reasonable cost. However,

there is no basis for witness Thompson’s assertion that the Statutes are intended to

affect postal prices depending on whether a particular class or category of mail

(consisting of letters or otherwise) is, relative to other mail classes or categories, more

or less costly to delivery. In fact, heavy weight Priority Mail merchandise parcels, the

contents of which are not subject to the Private Express Statutes, may be some of the

relatively more expensive pieces to process and deliver.

For purposes of her additional-ounce rate redesign, OCA witness Thompson

incorporates Postal Service witness Taufique’s (USPS-T-32) shape-based classification

changes and rate de-averaging. But, instead of the long-standing practice of assessing

38 Further criticism of witness Bentley’s QBRM fee analysis may be found, infra, at

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additional postage for each ounce of letter or flat within the Letters and Sealed Parcels

subclass, she proposes, for example, that all single-piece letters, regardless of weight,

be subject to the proposed 42-cent letter rate, and that QBRM letters be subject to the

proposed 39.5-cent rate. At different rates than proposed by the Postal Service, she

proposes that rates increase only at the four ounce and eight ounce increment for each

flats rate category. She deviates further from her approach by concurring with the

Postal Service’s proposal to charge each additional ounce in the 1-13 ounce First-Class

Mail weight range separately for the proposed Business Parcels category. The full

details of her proposal for the subclass are depicted at Exhibit B of OCA-T-4.

Under OCA witness Thompson’s rate design, the bill for her beneficence to

senders of her single-piece 42-cent flat-rate First-Class Mail letters is charged to mailers

of flats and parcels, and to workshare mailers in the form of higher rates, especially in

those rate cells with the highest volumes. The Postal Service readily acknowledges that

its shape-based de-averaging proposal will generate significantly above-average rate

increases for some existing First-Class Mail rate elements, imposing increases as high

as 92 percent for some parcel shippers. Postal Service witness Taufique’s First-Class

Mail rate design reflects the fairness and equity inherent in a moderate approach that

significantly mitigates some of the financial impacts that would otherwise be implied by

a strictly cost-based rate de-averaging. In contrast, to achieve her goal of relieving

letter-shaped mail pieces of the burden of any additional-ounce costs, Thompson takes

an approach that rewards some single-piece letter mailers with 62 percent rate

Section VII.B.

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reductions, while punishing some parcel mailers with increases of 223 percent. As

witness Taufique explains in his rebuttal testimony, the range of rate reductions and

increases resulting from her rate design is bound to lead to significant changes in the

First-Class Mail mix, the financial and operational consequences which should be

examined before such a radical redesign is seriously considered. USPS-RT-18 at 9-10;

Tr. 38/13350-51.

OCA witness Thompson testifies that the motivation for her proposal is to simplify

the rate schedule for the convenience of all First-Class Mail customers, but neither her

direct testimony nor her responses to questions on oral cross-examination reveal any

examination of mailing practices beyond her own. See Tr. 20/7430-32. When asked

initially about how parcel mailers faced with her proposed 223 percent increase might

mitigate the impact of such an increase, she testifies that they “may seek ways to

consolidate shipments.” Tr. 20/7389. But she later concedes that she really had no

information regarding whether any such opportunities could be expected to exist in the

Test Year. Tr. 20/7433.

The rebuttal testimony of Major Mailers Association witness David Gorham

(MMA-RT-2; Tr. 38/13182 et seq.) sheds some light on the increased ability of

sophisticated high-volume First-Class Mail senders to increase piece weights,

especially if there are no adverse rate consequences. Tr. 38/13188. Witness

Thompson offers no insight on the Test Year volume and revenue impact of such

phenomena of, for instance, mailers of two-ounce pieces took measures to generate

four-ounce pieces instead. Her rudimentary assumptions about the impact of weight on

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mail processing (Tr. 20/7386) stand in stark contrast to the testimony of Postal Service

witness McCrery (USPS-RT-14 at 6-8/Tr. 34/11464-66) and Laws (USPS-RT-16 at

13/Tr. 39/13440).

f. Mr. Carlson’s Forever Stamp concerns are easily addressed. In his testimony (DFC-T-1), Douglas Carlson expresses concern about the Postal

Service’s Forever Stamp concept and offers his own alternative language, in lieu of that

proposed by the Postal Service for Domestic Mail Classification Schedule §§ 241 and

3030. Mr. Carlson also testifies that, the Postal Service is not legally authorized to offer

a stamp for sale that could ultimately be used as the Forever Stamp at any rate other

than 39 cents, before the implementation date for the Docket No. R2006-1 Forever

Stamp rate and classification.

Below, the Postal Service makes clear that Mr. Carlson’s primary concerns

regarding permitted uses of the proposed Forever Stamp have been resolved. Second,

the Postal Service also explains why it would not be prudent at this time for the

Commission to recommend an alteration of the intended purpose of the Forever Stamp.

Finally, as indicated below, there is no authority for, or merit to, Mr. Carlson’s argument

regarding when the Postal Service can begin selling stamps that could ultimately be

used as Docket No. R2006-1 Forever Stamps.

As reflected in the direct testimony of witness Taufique (USPS-T-48 at 3)

and in proposed DMCS § 241, the Postal Service has conceived the Forever Stamp

classification for the purpose of benefiting customers whose postal transactions involve

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the use of basic rate First-Class Mail stamps on one-ounce letters. Nevertheless, as

reflected in proposed DMM 601.1.10 (71 Fed. Reg. 56587 (September 27, 2006)), to

avoid penalizing customers who might affix Forever Stamps to other mail pieces to pay

postage, the Postal Service makes clear that it will tolerate such other uses by crediting

customers with postage equivalent to the First-Class Mail initial-ounce letter rate

prevailing at the time of use. This policy is reiterated in numerous interrogatory

responses that have been designated into the evidentiary record. See responses to

DBP/USPS-340-42, 366-68, 457, 510, 606, 616, 619(c), 620, 622, 643-44, 647-48, 657,

674, 677, 684, and 700; as well as DFC/USPS-80-83. The approach reflected in those

responses prudently recognizes the unlikelihood that all postal customers will always

appreciate the intended purpose of the Forever Stamp. It can be expected that some

mailers will irreversibly affix it to other mail pieces to pay other postage rates. On

balance, the Postal Service considers that there is great customer relations benefit and

administrative ease in according equal value to all Forever Stamps at the time that they

are used.

The Postal Service concedes that the path to the development of the policy

underlying its proposed DMCS language and DMM regulations for the implementation

of the Forever Stamp classification was an iterative one and – like the concept itself --

developed as this docket proceeded. However, given the merits of this proposal,

particularly the great increase in ease of use at the time of rate changes for small

customers, the Postal Service believes it was preferable to refine its proposal as it was

developed, rather than forgo proposing such a customer-friendly idea. As a

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consequence, Mr. Carlson cannot be faulted for expressing some uncertainty at the

time that he filed his testimony (DFC-T-1 at 21-28) about what Forever Stamp uses the

Postal Service might permit under proposed Domestic Mail Classification Schedule

§ 241, and at what value. However, the record developed in this docket provides the

Commission the necessary basis for concluding that the Postal Service’s intent is now

completely unambiguous.39

As reflected at page 28 of DFC-T-1, Mr. Carlson proposes that the Commission

recommend DMCS language expanding the purpose of the Forever Stamp to serve as

“postage equal to the prevailing rate, at the time of use, for Single Piece Letters, First

Ounce . . . .” Thus, it appears that he prefers that the Postal Service implement

“Forever Postage” intended for use on every stamped mail class or rate category. But,

if that were the Postal Service’s objective, there would be no reason not to also apply

“forever” value to each and every postage stamp designed primarily for a specific

classification or rate category denomination, from the First-Class Mail postcard stamp to

the Express Mail flat rate envelope stamp.

As the proponent of the Forever Stamp proposal in this docket, as the principal

source of the concept design, as a public service agency eager to enjoy the customer

39 And while some uncertainty may have arisen during the course of this docket, the resulting proposal and the now very clear implementation plan should not generate confusion for the vast numbers of individual customers who will have no exposure to the Docket No. R2006-1 record and whose understanding of the concept will be based upon implementing regulations and other rate implementation publicity materials developed by the Postal Service.

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goodwill likely to flow from the implementation of its proposal,40 the Postal Service

regards itself as second to none in its enthusiasm for the concept.41 However, the

Postal Service also is the agency charged with the burden of executing the

implementation and administration of the Forever Stamp; and bears all of the financial

risk associated with how the Forever Stamp will end up being used. Thus, while the

merits of a Forever Stamp have generated excitement, as illustrated by various press

reports, enthusiasm tempered by prudence should be the order of the day. And, it is

more prudent to use experience with the proposed Forever Stamp, as the Postal

Service intends to implement it, as a basis for future consideration of any proposal to

formally expand the scope of its intended purpose. Given the uncertainties surrounding

the post-Test Year financial impact of Forever Stamp usage identified at pages 21-23 of

USPS-T-48 by witness Taufique, the Postal Service plans to carefully monitor such use

in the interim.

At pages 28-29 of DFC-T-1, Mr. Carlson appears, at first, to grasp the Postal

Service’s concerns, but he then he blithely dismisses them as not being grounded “[i]n

reality . . . .” He also argues that:

the proposal needs to be implemented once, with one consistent message to the public. The public’s use of the stamp will depend on the rules announced for it, so it makes no sense to observe the public’s use of the stamp and then write rules. Id. at 29. Taken to its logical conclusion, his first contention is a call for the complete

avoidance of any amendment of the terms of any particular mail classification ever,

40 See, USPS-T-48 at 16; USPS LR-L-152, Insights #5 and #14.

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once it is initially established. Such rigidity in an evolving, non-static postal world is

contrary not only to the expectations of the framers of the Postal Reorganization Act, it

is also contrary to effective and responsive postal management. His second contention

can be excused for having been made before the above-referenced proposed Domestic

Mail Manual regulations and related interrogatory responses became a part of the

record in this docket.

It bears repeating that the shared enthusiasm for the Forever Stamp concept

must be tempered by some regard for understanding the extent of any measurable

downside. At page 29 of DFC-T-1, Mr. Carlson responds by advising that:

[i]f the Postal Service has serious concerns about the financial effects of the proposal, . . . [it] should conduct more research and return to the Commission when it has a clear and practical proposal. Designing and promoting the Forever Stamp concept to benefit customers who use

basic rate stamps for First-Class Mail letters is both clear and practical. The same is

true for the proposed policy of tolerating the use of the stamp by mailers to pay other

postal rates and crediting them with postage value equivalent to the prevailing basic

First-Class Mail letter rate at the time of use. The absence of absolute certainty about

the future should not discourage the adoption of the Postal Service’s prudently designed

Forever Stamp mail classification. If absolute certainty were a prerequisite to

innovation, the Postal Service would never have initiated such customer-friendly

initiatives as the Priority Mail flat-rate envelope or flat-rate box.

41 The Office of the Consumer Advocate is to be commended for proposing in Docket No. R2005-1 that the Postal Service accelerate its examination of the concept.

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At page 6 of a November 22, 2006, motion seeking to compel a further

responses to DFC/USPS-80(c) and DFC/USPS-81, Mr. Carlson imagines a scenario

under which the “Postal Service may very well be trying to enact DMCS language that

will allow it to change course later without further Commission review[,]” contrary to the

explicit statements of postal policy that have emerged on the evidentiary record, as

proposed in the Federal Register, and that will serve as a basis for the Commission’s

recommended decision and any subsequent judicial review. Mr. Carlson’s outlook lacks

any rational basis. It reflects a jaundiced view of a Postal Service unilaterally adopting

an interpretation of DMCS § 241 that is contrary to its explicitly stated intentions after

the Commission’s recommended decision, in an act of supreme self-sabotage. To the

contrary, assuming the concept is adopted as proposed, the Postal Service intends to

preserve its reservoir of Forever Stamp goodwill and avoid provoking his imagined

customer relations nightmare, political headache, and litigation before the Commission

or the Federal courts. The Postal Service acknowledges without hesitation that, should

future circumstances arise which justify consideration of whether to explicitly broaden or

limit the intended purpose of the Forever Stamp, such a classification change -- like any

other -- will be subject to applicable Commission procedures.

Finally, Mr. Carlson comments on the Postal Service’s plans, before Docket No.

R2006-1 rates are implemented, to sell postage stamps that will function as Forever

Stamps at the value of the First-Class Mail basic letter rate, once Docket No. R2006-1

rates take effect. He testifies that such action would be illegal, based on his reading of

DMCS § 241, as proposed by the Postal Service. In pertinent part, it states that “[t]he

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Forever Stamp is sold at the prevailing rate for Single Piece letters . . . .“ Presumably,

Mr. Carlson’s legal argument is based upon his reading of 18 U.S.C. § 1721. That

provision reads:

Whoever, being a Postal Service officer or employee, knowingly and willfully: sells . . . postage stamps . . . otherwise than as provided by law or the regulations of the Postal Service; shall be fined under this title or imprisoned not more than one year, or both. Since the “prevailing rate” before any Docket No. R2006-1 rates take effect is the

current 39-cent rate, Mr. Carlson appears to assert that the only rate at which a Forever

Stamp could legally be sold before R2006-1 rates take effect is at 39 cents. However,

he quickly acknowledges the likely infeasibility of such an alternative. DFC-T-1 at 30.

As Mr. Carlson is, no doubt aware, the Postal Service sells many stamps at values

other than at the prevailing First-Class Mail first-ounce letter rate. See, Domestic Mail

Manual 604.1.1 By designating the Forever Stamp design as being sold at 42 cents

prior to the implementation of Docket No. R2006-1 rates and classifications, the Postal

Service would be well within its operational prerogatives, consistent with the provisions

of the Domestic Mail Classification Schedule prior to the Postal Service’s Board of

Governors’ implementation of rates and classifications recommended by the

Commission in this docket.

Ultimately, Mr. Carlson comes close to an obvious alternative solution. He

acknowledges that the Postal Service, at any time, can sell postage stamps at any

denomination of its choosing. He then proposes that the Postal Service, before any

Docket No. R2006-1 rates take effect, could sell a particular stamp at the known

Forever Stamp denomination or designated value, and then later declare that stamp to

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be the Forever Stamp “[a] few months after the rate change . . . .” Id. However, the

reason for his proposed delay in the “conversion” announcement is not obvious.

Clearly, once the Governors have approved the Forever Stamp classification and rate,

and a particular stamp at that rate is on sale before Docket No. R2006-1 rates and

classifications take effect, there is no barrier prohibiting the Postal Service from

informing customers in advance of the effective date of the Forever Stamp

classification, that the stamp will convert to Forever Stamp status on that effective date.

Mr. Carlson expresses concern about the public’s inability to grasp that “new” rate

stamps should be used after the effective date of “new” rates and the Postal Service’s

inability to educate mailers about this concept. DFC-T-1 at 29-30. However, this

concept is neither novel nor confusing. This is the same task that faces the Postal

Service and postal customers with every change in rate regime. The Forever Stamp

may introduce a new wrinkle, but -- more importantly -- it will provide an obvious benefit

to customers.

g. The GCA square envelope test and essay on aesthetics provide no basis for rate design

Although the Postal Service and the Greeting Card Association agree that

nonmachinable letters should pay more postage than machinable letters, they dispute

the manner in which and the degree to which such additional postage should be

imposed. The Postal Service proposes that it be imposed in the form of a requirement

that nonmachinable one-ounce letters pay the proposed initial-ounce rate for flats.

Under the Postal Service’s proposed rate schedule, such letters would pay 62 cents

postage. Postal Service witness Taufique’s elimination of specific surcharges for

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nonmachinable letters and flats in the newly proposed shape-based rate schedule

(USPS-T-32) has the advantage of minimizing additional complexity.

As an alternative, GCA witness Morrissey’s proposal would continue the practice

of maintaining special nonmachinability rate elements for each shape. He not only

questions the Postal Service’s proposed application of the initial-ounce rate for flats to

nonmachinable letters, but he also asks the Commission to rely on the conclusions of

an experiment he conducted as the basis for determining “that the 13 cent surcharge

currently in place is too high or perhaps even unnecessary altogether.” Testimony of

Mr. Raymond Morrissey on Behalf of the Greeting Card Association, Docket No. R2006-

1, GCA-T-3 at 7.

At page 9 of GCA-T-3, witness Morrissey asserts that the Commission should

rely on the results of his experiment and the testimony of GCA witness Andrea Sue Liss

(GCA-T-4) about the aesthetics of squares vs. rectangles to support rejection of the

Postal Service’s rate design. As is demonstrated below, neither the GCA square

envelope experiment nor its musings on the aesthetics of squares provide any basis for

the Commission to recommend any rate design contrary to that proposed by the Postal

Service.

i. The GCA square envelope test is fatally deficient.

Through the testimony of witness Raymond Morrissey, the Greeting Card

Association (GCA) urges the Commission to modify the Postal Service’s proposed rate

structure for single-piece First-Class Mail by maintaining the nonmachinable surcharge

for square-shaped, low aspect ratio letters and cards. GCA-T-3 at 9. Mr. Morrissey

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claims that square cards display a much higher degree of machinability than flats, entail

“some” greater need for manual cancellation, and an “immaterial” amount of additional

sorting. Id. at 9. Elsewhere in his testimony, he asserts that low-aspect-ratio single-

piece (i.e. square) letters “are both cancelled and processed as letters – apparently with

a favorable if not ideal level of success so far as machine cancellation is concerned,

and with an extremely high level of success as regards machine sorting.” Id. at 8.

Witness Morrissey supports these statements about square letter machinability

through the results of an “experiment” he conducted – an experiment that is flawed,

unreliable, and does not accurately demonstrate the nonmachinability of square letters.

The GCA experiment involved eight participants, located in different geographic regions,

each mailing 63 square and 63 rectangular cards (in envelopes) to witness Morrissey.

After receiving the envelopes, witness Morrissey “examined them for visible signs of

manual or machine processing.” Id. at 4. To determine the method of cancellation,

witness Morrissey looked for either the machine-printed cancellation mark or the round

cancellation stamp indicating manual cancellation. Id. Under the rules of his

experiment, witness Morrissey concluded that the presence of a postal-applied barcode

or orange fluorescent I.D. tag was proof of automated sortation. He considered the

absence of any such barcode or I.D. tag to indicate manual sortation. Id. at 4-5.

Based solely on these observations, GCA witness Morrissey jumps to the

conclusion that the success rate for automated cancellation for square cards could have

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been as high as 80.45 percent, and for rectangular cards, as high as 91.84 percent.42

Id. at 5. He also concludes that the success rate for automated sorting for square

cards was 95.24 percent, and for rectangular cards, 100 percent. Id. at 6.

The obvious fatal flaw in this experiment is that witness Morrissey attempts to

determine how a process works, and whether or not there are additional costs, by only

observing the input and the output of the process. Witness Morrissey himself admits

that his experiment does not reveal:

• the percentage of test pieces that were rejected on the first pass on an

Automated Facer Canceller System (AFCS),

• the number of pieces that required manual facing and/or one or more additional

passes on an AFCS or other piece of cancellation equipment,

• the number of pieces I.D. tagged on an AFCS or DBCS, but rejected within

subsequent automated mail processing steps due to low aspect ratio and the

propensity of pieces to tumble,

• the number of pieces barcoded on a DBCS, but rejected within subsequent

automated mail processing steps due to low aspect ratio and the propensity of

pieces to tumble, or

• the number of pieces that were successfully processed throughout the entire

automated mailstream without the manual handling of rejects.

Tr. 21/7780-7781.

42 These numbers also could have been as low as 70.44 percent for square cards, and 80.36 percent for rectangular cards. See GCA-T-3 at 5-6.

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ii. The USPS Engineering test is the low-aspect-ratio gold standard.

As the rebuttal testimony of Postal Service witness George Laws succinctly

summarizes:

To claim that . . . [the GCA experiment] can determine the degree to which square single-piece First-Class letters are successfully processed by Postal Service automated equipment is similar to claiming that one can determine the route someone took to travel from point A to point B and how much it cost to make that trip by only looking at the outside of the vehicle to see if there is mud on it.

Rebuttal Testimony of George R. Laws on Behalf of the United States, USPS-RT-16 at

9-10.

The square letter machinability test conducted by USPS Engineering at GCA’s

request better illustrates the true machinability of square letters. Witness Laws

discusses the results of the USPS Engineering Test, which were provided to GCA two

months before witness Morrissey conducted his own square letter experiment.43 The

USPS Engineering Test shows that, on average, half of the low aspect ratio (square)

pieces mailed can be expected to require extra processing and manual handling by the

Postal Service. USPS-RT-16 at 12.

Having designed and conducted this extensive test at the request of GCA and

presented the results to GCA in May 2006, the Postal Service is disappointed that

GCA’s testimony would neither bring the test results to the Commission’s attention nor

43 All of the cards in witness Morrissey’s experiment were mailed on July 20, 2006. GCA-T-3 at 4. The Postal Service provided a final version of its test results to GCA on May 18, 2006. See Tr. 21/7673. The test report itself can be found at Tr. 21/7681–- 7712.

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even acknowledge their existence. Be that as it may, the USPS Engineering results

prove what GCA has known since May 2006 that, in comparison to letters and cards

that currently are not subject to the nonmachinability surcharge, low-aspect-ratio pieces

suffer a substantial degradation in processing when subjected to automation, in

comparison to letters and cards that currently are not subject to the nonmachinability

surcharge. The USPS Engineering test makes a mockery of witness Morrissey’s claim,

at page 8 of GCA-T-3, that nonmachinable letters “are both cancelled and processed as

letters [footnote omitted] -- apparently with a favorable if not ideal level of success a

regards machine sorting.”

iii. Witness Liss’ musings on the aesthetics of squares vs. rectangles are not compelling.

Greeting Card Association witness Liss (GCA-T-4, Tr. 28/9489 et seq.) supports

the GCA proposal by offering her opinion on the use of the square shape in the design

of greeting cards. See GCA-T-4 at 4. Witness Liss discusses the importance of the

square shape in graphic design, the history and symbolism of the square, and the

inherent appeal of the square shape in the minds of consumers. See GCA-T-4 at 6-13.

Witness Liss’ observations lead her to assert that the Postal Service’s proposed rate

increase for square cards will cause consumers to reduce the number of pieces they

mail, or to select a more standard mailing size and shape, which may not be their

preferred choice. See GCA-T-4 at 13.44 Ultimately, witness Liss warns that nothing

44 Many other mailpiece configurations that could also be “appealing” to customers are limited by specific Domestic Mail Manual regulations requiring minimum print contrast, minimum or maximum thickness or weight. These limitations are often driven by operational concerns that the Postal Service must consider.

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less than the entire future of the United States Postal Service and its relevance in

today’s economy rests upon the Commission’s decision with regard to square cards.

See GCA-T-4 at 17. (“Let us not travel down that road; rather let us remain relevant

and connected to the consumer and citizen mailer.”) Id.

Despite witness Liss’ claim that the Postal Service’s proposed rate increase for

square cards will negatively affect mail volume, there is no quantitative record evidence

in this docket that supports her statements. In fact, witness Liss explicitly states that

she has not performed any empirical studies pertaining to consumer demand for square

cards. See Tr. 28/9494, 9495, 9496. She also concedes that she has not analyzed the

cross price elasticity between square and rectangular greeting cards, even though she

states in her testimony that consumers will be “forced” to choose rectangular cards

instead of their allegedly-preferred square cards because of the proposed rate increase.

See Tr. 28/9497. Finally, witness Liss is unable to explain how the history and the

symbolism of the square might quantitatively affect consumer demand for square

greeting cards. See Tr. 28/9498-99.45

Witness Liss has no quantitative or econometric support for her theory that a

lower rate for square cards would translate into higher mail volume. In short, her

testimony adds no support to GCA’s single-piece, nonmachinable letter rate design

proposal and does not justify any change in the Domestic Mail Classification

nonmachinability criteria beyond that proposed by the Postal Service.

45 Witness Liss’ remark that “the square has a basic appeal to people beyond what they might put into words,” GCA-T-4 at page 8, lines 4-5, might also apply to her testimony’s

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h. Intervenors’ alternate approaches to First-Class Mail presort cost methodologies and cost estimates should be rejected.

i. Intervenors’ mail processing cost estimates

Pitney Bowes, through the testimony of witness Buc (PB-T-2), and Major Mailers

Association, through the testimony of witness Bentley (MMA-T-1), support the delinking

approach for the derivation of First-Class Mail presort discounts.46 But despite their

declarations of fidelity and allegiance to the Postal Service’s de-linking approach to rate

design, neither witness can resist the urge to propose that workshare discounts be

further increased. Accordingly, they both modify the Postal Service’s cost methodology

to support proposals for increased workshare discounts. In particular, each takes an

expansive and unsupported approach to cost pool classifications.

As discussed above, the Postal Service classifies cost pools as either

proportional or fixed, with the distinction being that that proportional costs are the ones

that are modeled, and fixed costs are the ones beyond the scope of witness

Abdirahman’s USPS-T-22 model. The Postal Service classifies cost pools as

proportional because the activities, and the costs thereof, captured within those cost

pools are understood to vary in known ways with the presort level, i.e. the more finely

presorted a piece is, the less the cost of processing in a given cost pool. USPS-RT-7 at

10-11.

failure to translate the “basic appeal” of square cards into even the roughest estimate of any quantitative effect it may have on mail volume. 46 MMA-T-1 at 6 and PB-T-2 at 10.

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PB witness Buc uses two cost pool classifications: (1) proportional and (2) fixed.

Witness Buc proposes cost pool classifications in PB-LR-L-1 that differ from those relied

upon by the Postal Service and the Commission in past dockets. Witness Buc classifies

more than 70 percent of the nonmodeled cost pools as proportional. See PB-T-T2 and

Pitney Bowes Library Reference L-1. His arbitrary classifications of the majority of the

cost pools as modeled/proportional lack any supporting basis. When the Postal Service

inquired whether witness Buc had, in fact, attempted to model the costs for the cost

pools that he proposes to shift to the “proportional” classifications, he replied, “I have

not modeled them but I have provided multiple reasons why they are proportional.” Tr.

20/7314. Witness Buc acknowledges that he mainly relies on his so-called “Thought

Experiment” and other flawed cost pool analysis in PB-LR-L-1. Witness Buc has

chosen to use the costs that are modeled as distribution keys for the costs that he has

not modeled; an activity that he, himself, conceded was inappropriate. Tr. 20/7349.

Witness Buc’s cost pool reclassification proposal misses the point of why the cost

pool classifications in the letter models were necessary in the first place. He classifies

the cost pools as proportional without regard to whether the activities, and the costs

therein, captured within those cost pools are understood to vary in known ways with the

presort level. Only the modeled cost pools are the ones where the more finely

presorted a piece is, the less the cost of processing in a given cost pool. Witness Buc’s

“Thought Experiment” and his other cost pool analyses are not based on a mail flow

model depicting these extraordinary changes.

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Witness Bentley also takes an aggressive stance on cost pool classification. He

uses three cost pool classifications: (1) modeled and proportional, (2) nonmodeled but

proportional and (3) nonmodeled fixed. MMA-T-1, Appendix 1 at 10. He follows

witness Buc’s lead and considers almost all cost pools as proportional. As with witness

Buc’s approach, most cost pools that were previously treated as fixed are now classified

by witness Bentley as proportional cost pools, such that the cost relationships between

rate categories are distorted. In fact, the classifications used by witness Bentley do not

even correspond to those he has relied upon as a MMA witness in past dockets. He

now states “[T]here are no nonworkshared related cost pools,” but provides no evidence

to substantiate that claim. MMA-T-1, Appendix 1 at 10. Like witness Buc, witness

Bentley presents no factual basis for shifting large sums of costs from the nonmodeled

fixed classification to the nonmodeled proportional classification. Witness Bentley also

admits that his analysis was somewhat arbitrary, because the mail flow model

presented in witness Abdirahman’s testimony in this docket did not allow him to perform

the cost pool shifts. MMA-T-1, Appendix 1 at 9 and 10.

The Commission’s analysis in Docket No. R2000-1, where cost pool

classifications were debated at length, supports the Postal Service’s approach, rather

than the flawed approaches advocated by witnesses Buc and Bentley.47 If a given cost

pool contains tasks that are included in the mail flow models, that cost pool is classified

47 In Docket No. R2000-1, the Commission analysis relied upon a methodology that classified cost pools in three categories. Even though the Postal Service’s methodology in this docket relies on two classifications, the Commission’s analysis of which cost pools should be classified as proportional or fixed is applicable in this case.

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as proportional. If not, that cost pool is classified as fixed. That same principle holds

true in this case.

A number of intervenors have presented testimony on the use of a Bulk Metered

Mail (BMM) benchmark as a method to derive mail processing cost estimates. APWU

witness Kobe (APWU-T-1) makes the BMM benchmark the centerpiece of her cost

methodology. MMA, while supporting de-linking in rate design, hedges its bets and

suggests that if the Commission should it reject de-linking, it should employ a

methodology not based on the BMM benchmark but on the Metered Mail Letters

benchmark. Not surprisingly, this would, conveniently expand the workshare discounts.

See witness Abdirahman’s rebuttal testimony, USPS-RT-7. While the new de-linking

approach does not require the use of a BMM letters benchmark, it is worth noting that

the Commission-approved benchmark for First-Class Mail letters has been BMM letters

since Docket No. MC95-1. In Docket No. R2000-1, the Commission stated that it:

continues to accept bulk metered mail as the appropriate benchmark for determining the worksharing cost savings for First Class Mail. The Postal Service provides evidence that at least some BMM does exist in the mailstream. The Commission also views a benchmark as a “two-way street”. It represents not only that mail most likely to convert to worksharing, but also, to what category current worksharing mail would be most likely to revert if the discounts no longer outweigh the cost of performing the worksharing activities.

PRC Op. R2000-1 at 241, ¶ 5089.

Even if the Commission does not adopt de-linking, these unsubstantiated views would

not warrant departure from Commission findings in past cases supporting the BMM

benchmark in favor of benchmarks apparently chosen solely because they would result

in larger estimated cost differences.

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ii. Delivery cost issues

Despite repeated warnings from postal witnesses that the DPS percentages by

presort level are specious results, three intervenors reject the Postal Service’s delivery

cost estimates. Instead, they revert to the methodology employed in past dockets in

their efforts to expand the workshare discounts. MMA, Pitney Bowes, and APWU

incorporate the use of separate DPS percentages by presort level to de-average

delivery costs to rate levels in order to derive workshare related cost avoidances. As

discussed, infra, in Section VI.B.2.b, the use of the DPS percentages to derive delivery

cost differences by rate category is highly suspect.

While the letter cost models are adequate for estimating mail processing unit

costs by rate category, they are not likely to be an effective tool for estimating DPS

percentages by rate category. The DPS percentages that were calculated in the past

were based on a premise that mail processed through a larger number of steps had

lower DPS percentages than mail processed through fewer steps because of the

cumulative probabilities of being rejected by each successive letter operation. DPS

percentages from the mail processing models were determined by BCS acceptance

rates which are not presort-specific (i.e., they are based on average data for all mail

pieces processed through a given operation). In the mail processing model, the

application of the acceptance rates makes it appear that the more steps that a mail

piece is processed through (i.e., the less finely presorted it is), the higher the probability

that the presort mail will be rejected.

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Exaggerating this effect, as the model moves from upstream to downstream

operations, the aggregate acceptance rates tend to increase. Part of the reason this

occurs is that the upstream operations contain more single-piece mail. If there are

problematic single-piece mail pieces upstream, once they are rejected they would be

processed manually, with the result that downstream acceptance rates are higher.

Given that the cost models rely on aggregate acceptance rates (single-piece and

bulk combined), less finely presorted bulk mail pieces appear to have lower DPS

percentages, even though the Postal Service has no data to indicate that this is actually

true. In other words, the DPS percentages are a byproduct of data limitations. In reality,

it is not known if prebarcoded presort mail pieces that are successfully processed in a

given operation would also be successfully processed in downstream operations.

Furthermore, no studies have been conducted in which the same mail pieces are

processed through machines multiple times in order to determine if the total number of

pieces that are ultimately rejected increases as the number of automation handlings

increases. Tr. 11/2850-2851. Moreover, a field study in delivery units would not be able

to estimate the DPS percentages by rate category because the covers of mail pieces do

not contain markings that would indicate the rate level at which a given piece was

presented to the Postal Service. Hence, the disaggregated DPS percentages by

presort category are not meaningful and should not be used to determine cost

differences by presort level for letters.

Because it is not known whether presort level directly impacts the delivery costs,

the Postal Service applied an approach based on known facts. As discussed above,

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machinability has a demonstrable impact on delivery costs. Thus the Postal Service’s

rate design appropriately relied upon delivery costs deaveraged only between

machinability and nonmachinability. Hence, the cost results presented in the

testimonies of witnesses for MMA, APWU and Pitney Bowes are relying on specious

cost differences and should be rejected.

MMA’s assessment of workshared delivery cost savings (MMA-T-1 at 14-16)

which applies DPS percentages to deaveraged delivery costs suffers from an additional

and fundamental flaw. Witness Bentley’s results are all useless because the

cornerstone of his analysis is a demonstrably false statement, indicative of a defective

methodology:

There can be no argument that Postal Service data indicate that Presorted letters cost, on average, 3.38 cents less to deliver than single piece letters.

Id. at 16. The flaws in Mr. Bentley’s analysis are revealed in the questions posed in

USPS/MMA-T1-17 and 27, and his responses thereto. Tr. 21/7885-92, 7910-14. For

starters, if “Presorted letters cost, on average, 3.38 cents less to deliver than single

piece letters” as he claims, then there must be some Presorted letters unit delivery cost

X, such that X times the Presorted letters volume equals the actual total delivery costs

for Presorted letters ($1.977 billion), and (X + 3.38 cents) times the Single Piece volume

equals the actual total delivery costs for Single Piece letters ($1.782 billion). When

asked to identify a value of X meeting these prerequisites, however, Mr. Bentley could

not. The only way he could get a single piece unit delivery cost that is 3.38 cents more

than his Presorted unit delivery cost was to assume, “contrary to fact” that 46 percent

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more Single Piece is delivered (by carriers) than is actually the case. Tr. 21/7912

(emphasis in original). This causes him to presume $827 million of total Single Piece

carrier delivery costs that do not exist. Id. It should come as no surprise to Mr. Bentley,

whether or not he is willing to admit it, that someone might appropriately “argue” with a

claim regarding average cost differences which requires him to assume in excess of

$800 million of nonexistent delivery costs for one of the two types of mail for which he is

purporting to compare delivery costs.

In reality, there are two conceptually rational measures of unit delivery costs.

Both start with the same actual total delivery cost in the numerator, but differ in the mail

volume used in the denominator. Using originating volume in the denominator

generates the unit delivery costs per originating piece. Unit delivery costs per

originating piece are useful because they can be compared to and combined with unit

costs for other functions (e.g., processing, transportation), when those unit costs are

also expressed per originating piece. Given the propensity of the mail category in

question to be delivered by carriers (as opposed, for example, to destinate at a post

office box), each additional originating piece will, on average, cause an increase in total

delivery costs equal to the unit delivery cost per originating piece.

Another potential measure of unit delivery costs, however, is to use delivered

volume in the denominator, which then generates unit delivery cost per delivered piece.

Unit costs per delivered piece are less useful than unit costs per originating piece,

because they cannot be compared to or combined with unit costs from other functions

that are expressed per originating piece. On the other hand, using costs per delivered

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piece allows for control of the differing propensities of different mail categories to be

delivered by carriers, to whatever extent that might be useful. Therefore, as long as

estimates of total delivery costs, originating volumes, and delivered volumes are

available for two categories, it is possible to calculate and compare unit delivery cost

per originating piece for both categories, and unit delivery cost per delivered piece for

both categories. (As shown at Tr. 21/7885, with respect to the Single Piece and

Presorted categories of interest, the Single Piece unit delivery cost per originating piece

is 5.15 cents, the Presorted unit delivery cost per originating piece is 4.16 cents, and the

difference between the two unit costs per originating piece is 5.15 cents minus 4.16

cents, or 0.99 cents. Similarly, for unit costs per delivered piece, the values are 8.42

cents, 4.65 cents, and a unit cost difference per delivered piece of 3.77 cents.) But the

two unit cost measures are distinct, and, in particular, one would not want to compare a

unit cost per delivered piece for one category with a unit cost per originating piece for

another category, as this would be mixing the proverbial “apples” and “oranges.”

Mr. Bentley does not make the mistake of comparing a unit delivery cost per

originating piece for one category with a unit delivery cost per delivered piece for

another category. But he does make the mistake of insisting that comparisons of unit

delivery costs per originating piece across categories with different delivery percentages

are not meaningful. Tr. 21/7886-87, 7890. In fact, as explained by witness Kelley, they

are quite meaningful. Tr. 12/3392. More disturbingly, Mr. Bentley makes the mistake of

concocting a specious measure of unit delivery costs which, he erroneously claims,

allows him to calculate a difference between unit delivery costs per originating piece

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that is different from the actual unit cost difference per originating piece (correctly

obtained by dividing actual total delivery cost for each category by the actual originating

volume for each category, and calculating the difference between the two actual unit

cost numbers). Rather than mixing “apples” with “oranges” (a practice of which he

accuses the Postal Service at Tr. 21/7911), Mr. Bentley is injecting something into the

fruit bowl which is perhaps more akin to a hockey puck than to any of the spherical

fruits.

Mr. Bentley erroneously contends that comparisons of unit delivery costs per

originating piece are only meaningful if both categories being compared have the same

percentage of mail delivered by carriers. Tr. 21/7886-87, 7912. Mr. Bentley’s proposed

solution, to circumvent the (for him) awkward fact that Single Piece and Presorted do

not have the same percentage delivered, is to counter-factually equalize those

percentages for purposes of his calculations. Tr. 21/7887-88, 7911-13. One obvious

and fatal flaw in this approach is that the result one obtains is a direct function of the

counter-factual scenario one assumes. For example, Mr. Bentley acknowledges that if

one equalizes the delivery percentage for both categories at 61 percent (which is the

actual delivery percentage for Single Piece), one obtains a unit cost difference of 2.31

cents (3.77 cents times 0.61), as opposed to the 3.38 cents (3.77 cents times 0.90) that

Mr. Bentley has obtained by choosing to equalize at 90 percent (the actual delivery

percentage of Presort). Tr. 21/7888-89. Mr. Bentley is perfectly willing to confirm the

conclusion that naturally follows, which is: according to his proposed methodology,

while Presorted letters on average cost 3.38 cents less to deliver than Single Piece

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letters, Single Piece letters on average cost 2.31 cents more to deliver than Presorted

letters. Id. This is sheer nonsense, and no amount of prestidigitation by Mr. Bentley

can obscure that fact.

In reality, once one starts to imagine counter-factual scenarios, any scenario is

as good as the next. Mr. Bentley concedes as much in his response to USPS/MMA-T1-

17.d, noting that there is “nothing magical” about either the 3.38-cent figure or the 2.31-

cent figure. Tr. 21/7889. Would he feel the same about a scenario that assumes that

26 percent of both categories are delivered, which by his methodology would yield a

0.99 unit cost difference (3.77 cents times 0.26), a figure that coincidentally also

happens to be the actual unit cost difference per originating piece? In the world of

counter-factual assumptions, there is nothing less “magical” about 26 percent than there

is about 61 percent or 90 percent.

The problem, of course, is that while Mr. Bentley is willing to acknowledge that

there is “nothing magical” about his 3.38-cent figure, the counter-factual assumptions

behind that figure are required for his methodology to generate all of the “Delivery Unit

Cost Savings” and “Incremental Unit Cost Savings” he presents on page 16 of MMA-T-

1. Different counter-factual assumptions would produce different results.

Consequently, all of the unit cost saving numbers on MMA-T-1, page 16 are equally as

flawed, and equally as useless, as the 3.38-cent figure.

In the last case, witness Bentley did not testify (presumably because of the

settlement), but the MMA Brief stated:

The problem arose because the Postal Service erred in computing the unit delivery cost by dividing total delivery costs by total originating volumes.

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However, many originating pieces bypass the delivery network and, therefore, do not incur any delivery costs because they are addressed to post office boxes. Accordingly, the result of this computation does not represent the unit cost to deliver a piece of mail; instead it simply represents total delivery costs divided by all mail pieces whether or not they were actually delivered. . . . To correct this error unit delivery costs should be computed by dividing total delivery costs by the total volumes delivered[.]

Docket No. R2005-1, MMA Initial Brief at 26-27. Thus, the MMA Brief in the last case

clearly laid out the two alternative measures of unit delivery costs, and clearly

expressed MMA’s preference for unit delivery cost per delivered piece. In the instant

case, though, Mr. Bentley is, for some reason, apparently of the opinion that unit

delivery cost per delivered piece is no longer adequate, and he therefore endorses

deviation from the method of computation advocated by MMA in the last case. Instead

of simply reverting to a comparison of the actual unit delivery costs per originating

piece, he fabricates a bogus computation that produces a number he erroneously

claims represents the unit delivery cost savings per originating piece. His claim is

wrong. Between Single Piece and Presorted letters, per originating piece, the unit

delivery cost difference is 0.99 cents, and per delivered piece, the unit delivery cost

difference is 3.77 cents. Mr. Bentley’s attempts to torture a different result out of these

numbers are simply an exercise in smoke and mirrors.

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C. The Commission Should Recommend the Postal Service's Proposed Priority Mail Classification and Rate Changes The Postal Service proposes an overall increase in Priority Mail rates of 13.6

percent, which corresponds to an overall test-year-after-rates cost coverage of 163

percent. USPS-T-31 at Exhibit USPS-31D (revised August 25, 2006). Major

classification proposals include dimensional-weight ('dim-weight') pricing for parcels

larger than one cubic foot in Zones 5 through 8, elimination of the balloon-rate category

in Zones 5 through 8, and a permanent classification for the Priority Mail flat-rate box.

Specific rate proposals include a minimum Priority Mail rate of $4.65 for pieces weighing

one pound or less and for flat-rate envelopes, and a rate of $8.80 for pieces mailed in a

flat-rate box. USPS-T-33 at 33, 57. Proposed changes to the Priority Mail rate

structure include a separate rate for Zone 3, and a 5-pound increase in the weight for

the balloon rate, to become applicable in Local and Zones 1-4. In addition, the Postal

Service is distributing certain transportation costs to rate cells on the basis of cubic

volume (instead of weight) resulting in some rate relief at 11 pounds and up, properly

distributing distance-related surface transportation costs incurred in connection with air

travel, and utilizing a novel “economic cost adjustment factor” for the distribution of air

transportation costs in Zones 5-8.

No witness has challenged either the classification changes proposed by USPS

witness Scherer (USPS-T-33), or his rate design. Only one witness, R. Richard Geddes

(UPS-T-3), has proposed any alternatives regarding Priority Mail. He proposes a cost

coverage that would result in an average rate increase of 23.6 percent. UPS-T-3 at 12.

For reasons explained in Part V of this brief, his self-serving testimony is unbalanced

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and unpersuasive. The Commission should recommend the Postal Service's proposed

Priority Mail rate and classification changes.

1. Proposed major classification changes include dim-weight pricing and a permanent classification for the Priority Mail flat-rate box.

The Postal Service proposes three major classification changes. The first is

“dimensional-weight ('dim-weight') pricing" for parcels larger than one cubic foot in

Zones 5 through 8. USPS-T-33 at 13-32. The second, which is related to the dim-

weighting proposal, is elimination of the balloon-rate category in Zones 5 through 8. Id.

at 21. The third is a permanent classification for the Priority Mail flat-rate box. Id. at 52-

60.

First, witness Scherer (USPS-T-33) proposes dim-weight pricing in the zones

that receive primarily air transportation — that is, Zones 5 through 8. USPS-T-33 at 13.

This will enable the Postal Service to cover its implicit costs on — and send proper price

signals regarding — bulky but lightweight parcels that historically have been money-

losing. Dim-weighting is a pricing method, applicable to packages, that considers the

density (weight in relation to cubic volume) of the package. Id. Relatively high-density

packages are priced based on weight while relatively low-density packages are priced

based on cubic volume (“cube”). Id. This treatment acknowledges the importance of

cube as a shipping cost determinant. Id. Historically, Priority Mail rates have been

based primarily on weight and distance shipped (zone). Id. Dim-weighting will

introduce cube as a third major Priority Mail rate element, although it is expected to

apply only to an estimated 2.3 percent of all Priority Mail volume. Id.

As explained by witness Scherer, dim-weighting is a worldwide standard for the

pricing of air freight, including parcels. USPS-T-33 at 13. It is utilized by all major

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carriers in the United States, including FedEx, UPS, and DHL. Id. at 14, 15 n. 11).

Packages are rated at the actual weight or the “dim weight,” whichever is greater. Id. at

14. The dim weight is determined as cubic volume measured in cubic inches (length x

width x height, all in inches), divided by an industry standard “dim factor” of 194 cubic

inches per pound. Id. The dim factor is simply a reciprocal of the density. Id. In this

case, it corresponds to a density constant of approximately 8.9 pounds per cubic foot.

Id. Until 2004, FedEx and UPS applied dim-weighting only to parcels exceeding one

cubic foot, and the Postal Service's proposal is so limited. Id. at 15.

For irregularly shaped parcels, i.e., parcels that are not rectangular in shape, the

Postal Service proposes a novel exception. USPS-T-33 at 21-26. Whereas FedEx and

UPS use the common method of measuring such parcels at their maximum length,

width and height cross-sections, and calculating cubic volume as the product of those

three factors, the Postal Service proposes to moderate this calculation with an

adjustment factor of 0.785, as explained by witness Scherer in his testimony. Ibid.

Second, the Postal Service proposes eliminating the 15-pound balloon rate in

Zones 5 - 8. USPS-T-33 at 21. Dim-weighting’s scope — above one cubic foot — will

cover the great majority of parcels in Zones 5 - 8 currently paying the balloon rate, most

of which are in excess of three cubic feet (see USPS-LR-L-120, Tables Z5-5, Z6-5, Z7-5

and Z8-5). Id. The balloon rate will be retained in Local and Zones 1 - 4. Id. This is

once again consistent with the market: UPS Ground, FedEx Ground and DHL Ground

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all charge a 30-pound “oversize” rate for parcels measuring more than 84 inches in

combined length and girth. Id.1 The same is not done for their air services. Id.

Third, the Postal Service proposes a permanent classification for the Priority Mail

flat-rate box, which has been offered since November 20, 2004, under experimental

conditions pursuant to Docket No. MC2004-2. USPS-T-33 at 52. The Priority Mail flat-

rate box consists of two boxes, actually, of the same size (external cubic volume) but

different shape. Id. The two boxes carry a single rate not varying by distance shipped

(zone) or weight. Id. The rate started at $7.70 on November 20, 2004, increasing to

$8.10 on January 8, 2006, following Docket No. R2005-1. Id. The boxes are available

for no fee at post offices and can be ordered from www.usps.com. USPS-T-33 at 53.

The Postal Service has also provided several mailers with customized flat-rate boxes.

Id. In these cases, the box dimensions have been altered, but the size has been

maintained at 0.34 cubic feet. Id.

Witness Scherer assessed usage of the flat-rate-box (see USPS-LR-L-119),

concluding that revenue leakage from preexisting Priority Mail pieces trading down to

the flat-rate box has proven to be tolerable owing to more-than-offsetting contribution

from some pieces trading up and from volume newly attracted to Priority Mail by the flat-

rate box (“new business”). USPS-T-33 at 54. USPS-LR-L-132 describes the market

1 UPS recently announced that, starting January 1, 2007, dim-weighting will apply to Ground parcels exceeding 3 cubic feet in lieu of the "oversize rate." See http://www.ups.com/content/us/en/resources/prepare/dimweight2007.html. FedEx and DHL have announced that they will do the same, effective February 5, 2007, and January 1, 2007, respectively. See http://images.fedex.com/us/ rates2007/DimWeight.pdf?link=4 (FedEx); http://www.dhl-usa.com/home/ home.asp (DHL).

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research conducted on the flat-rate box, showing that customers have found the flat-

rate box to be convenient and easy to use.

Witness Scherer proposes a rate increase for the flat-rate box of 8.6 percent,

from $8.10 to $8.80. USPS-T-33 at 57. The $8.80 is derived by equating the flat-rate

box’s implicit cost coverage with implicit cost coverage for the Priority Mail flat-rate

envelope. Id. at 57-58. This is based on the notion that the two products offer similar

convenience and ease of use: rate simplicity, rate immunization against variations in

weight and zone, etc. Id. at 58. Witness Scherer examined and applied the 39 U.S.C. §

3623(c) criteria, finding they were met. USPS-T-33 at 58-60.

2. Other changes improve the Priority Mail rate structure.

In addition to the three proposed classification changes described above, the

Postal Service is proposing two changes to the Priority Mail rate structure. The first is a

separate rate for Zone 3, which will bring Priority Mail in line with the rest of the package

delivery market, including the Postal Service's own parcel post. USPS-T-33 at 6-7. The

second is an increase in the balloon rate (which will only apply to Local and Zones 1-4)

from 15 pounds, where it has been since Docket No. R76-1, to 20 pounds. This move

is made to increase implicit cost coverage on balloon-rated parcels to a more

appropriate level. USPS-T-33 at 32.

3. The Postal Service properly distributes certain Priority Mail transportation costs on the basis of cube, not weight.

In this docket, the Postal Service is departing from past practice by distributing

certain transportation costs to rate cells on the basis of cubic volume, whereas in

previous Priority Mail rate filings, these costs were distributed on the basis of weight.

USPS-T-33 at 6. For this purpose, the Postal Service offers the first-ever cube-weight

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distribution key for Priority Mail. USPS-T-33 at 36. The key, which shows average cubic

volume by rate cell (i.e., for each combination of weight increment and zone), is based

on two studies in which over 8,000 Priority Mail parcels and flats were sampled. Id. at

36-37. The results of those studies as well as determination of the cube-weight

distribution key are detailed by witness Schroeder in USPS-T-29. Id. at 37. One effect

of this switch to a cube-weight distribution key is some rate relief at 11 pounds and up.

See USPS-T-33 at 33, 51.

Some other changes are proposed to more accurately reflect the Priority Mail

transportation network. For example, the traditional Priority Mail rate design has

distributed distance-related surface transportation costs only to the zones in which

trucks are typically used for transportation between the origin and destination

processing facilities: Zones 1 - 4. USPS-T-33 at 40. Further consideration of the

matter, however, reveals that some of those costs are actually incurred in connection

with air travel (surface transportation either to or from air facilities). Id. The Postal

Service has accounted for this disparity by distributing those costs to the higher zones

where they belong. USPS-T-33 at 41-49. A detailed analysis of this matter was

provided by witness Nash (USPS-T-16).

Witness Scherer also proposes to impart an upward slope to the Priority Mail

rates in Zones 5 - 8 (where air transportation is generally used) by applying a novel

“economic cost adjustment factor.” USPS-T-33 at 41-44. This adjustment factor

recognizes that while there may be no explicit distance-related element in the “day turn”

air transportation contract with FedEx, there is an implicit distance-related element.

FedEx’s own costs do go up with distance traveled. By applying the adjustment factor,

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the rates in Zones 5 - 8 can reflect “economic cost” rather than “accounting cost,” and

better price signals can be sent (e.g., a continuous cycle of increasing costs can be

avoided). Ibid.

4. A new fee for on-call and scheduled pickup On-Demand® is warranted.

Finally, the Postal Service proposes an increase in the fee for on-call and

scheduled Priority Mail, Express Mail, and Parcel Post Pickup On-Demand® service

form $13.25 to $14.25, as explained by witness Scherer at USPS-T-33 at 60.

5. The Commission should not adopt the self-serving cost coverage urged by UPS witness Geddes (UPS-T-3). None of the classification changes proposed by USPS witness Scherer (USPS-T-

33) has been challenged by any witnesses of record in this proceeding. Moreover, his

rate design -- specifically his allocation of costs to rate cells -- has not been contested

by any witness of record in this case.

Only one witness, R. Richard Geddes (UPS-T-3), representing United Parcel

Service, a competitor to the Postal Service in the market for parcel delivery, has

proposed any alternatives specifically aimed at Priority Mail. He proposes a cost

coverage that would result in an average rate increase of 23.6 percent for Priority Mail.

UPS-T-3 at 12. This may reflect UPS's pecuniary interests, but, as explained in Part V

of this brief, lacks the comprehensive evaluation of the rate making criteria performed

by Postal Service witness O'Hara (USPS-T-33 at 20-23). It also conveniently ignores

the fact that while Priority Mail volumes remain far below their FY 2000 level, from 2000

through 2004 UPS combined deferred and ground volume grew by 2.1 percent. See

Response to USPS/UPS-T3-7, redirected to UPS; UPS-T-3 at 17.

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6. Conclusion

In summary, the Postal Service’s approach to Priority Mail rate design in the

instant case was relatively empirical, relying upon special studies that characterized

Priority Mail by piece size (in relation to weight and zone) and transportation logistics.

These studies enabled a better reflection of costs, both across the zones and across the

weight increments. The distribution of transportation costs to weight increments is

specifically improved by recognizing the importance of cubic volume (size) as a cost

determinant. The new distributions promote fairness by spreading the burden of cost

recovery more evenly across the universe of Priority Mail pieces. Fairness is also

promoted by the proposal for dim-weight pricing in Zones 5 - 8. Previously, many of the

pieces that would be subject to dim-weighting were not covering their costs. This

imposed an unfair burden on other pieces. The Postal Service has also attempted to be

fair in its dim-weighting proposal by offering a novel adjustment factor that reduces the

rate assessment for irregularly shaped parcels. Another aim of the Postal Service’s

proposed Priority Mail rate design has been to send proper price signals to users,

particularly with respect to bulky, lightweight parcels (through the dim-weighting

proposal). Finally, the Postal Service continues to strive to enhance the value of Priority

Mail to customers. In particular, the proposal for a permanent flat-rate-box classification

is intended to bring convenience and ease of use.

Accordingly, the Commission should recommend the Priority Mail rates and

classification changes proposed by witness Scherer.

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D. The Commission Should Recommend the Express Mail Rates Proposed by the Postal Service

The Postal Service’s proposed Express Mail rates are designed to achieve a cost

coverage appropriate for this service and institute a logical revision to the rate structure,

while responding to Commission views expressed in Docket No. R2005-1. As

explained by witness Berkeley, the Postal Service proposes an overall rate increase of

12.5 percent for Express Mail in order to achieve a cost coverage of 191 percent

established by witness O’Hara. USPS-T-34 at 13. The Postal Service also proposes

separating the current uniform two-pound rate into discrete one- and two-pound rates

for the three Express Mail rate categories. Id. at 21-22. No party has opposed the

Postal Service’s proposed Express Mail rate design.

1. Witness Berkeley’s rate design is reasonable, supported by substantial record evidence, and responsive to prior Commission concerns from R2005-1.

With two exceptions, witness Berkeley’s rate design generally adheres to the rate

design she presented (as witness Mayo) in Docket No. R2001-1. She initially designed

the Post Office to Addressee rates, which account for the vast majority of Express Mail

volume, and then applied rate differentials across-the-board to arrive at her proposed

Custom Designed and Post Office to Post Office rates. Id. at 21-24. The Custom

Designed differential is 30 cents greater than the Post Office to Post Office differential.

This differential is identical to the one used in Docket No. R2001-1 and reasonably

represents the additional cost of Custom Designed service over Post Office to Post

Office service. Id. at 23.

Because of its importance, the first rate that should be designed in Express Mail

is the Post Office to Addressee half-pound letter rate, which represents 83.7 percent of

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Express Mail volume. Witness Berkeley proposes to increase this rate by 12.8 percent

– the result of applying the target percentage increase of 12.5 percent with a quarter

rounding constraint, rather than the nickel rounding constraint used in Docket No.

R2001-1. As she explains, this revised rounding constraint produces a more easily

remembered rate ($16.25). Id. at 21.

Witness Berkeley also deviated from her Docket No. R2001-1 rate design in the

manner by which she designed the Post Office to Addressee rates above two pounds,

in order to respond to Commission statements concerning Express Mail rate design in

the last omnibus rate case (Docket No. R2005-1). Specifically, the Commission

expressed concern that the use of minimum and maximum constraints was creating an

uneven application of the markup. See PRC Op., R2005-1, at ¶ 6009. Witness

Berkeley proposes a uniform rate increment of $3.10 for the three- to nine-pound Post

Office to Addressee rates, and a uniform increment of $2.15 for the ten-pound and

above rate cells, a design which serves to reduce the range of cost coverages for the

individual rate cells while meeting the target percentage increase. USPS-T-34 at 22.

The range of proposed cost coverages for the Express Mail rate cells is therefore

significantly smaller in this docket than in Docket No. R2001-1. Id. at 23-24.2 Witness

Berkeley has therefore taken a strong step in the direction that the Commission has

indicated is desirable, while at the same time remaining cognizant of the need to avoid

increases that are inordinately above the subclass average. The Postal Service urges

2 In Docket No. R2001-1 the range of percentage increases for the rate cells was tightly constrained, with every rate cell for Post Office to Addressee increasing between 9.6 and 9.8 percent. See Docket No. R2001-1, USPS-T-35 at 22-23. In this docket, however, the Post Office to Addressee rates increase between 3.7 percent (for the new separate one-pound rate) and 26.0 percent.

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the Commission to avoid any further movement towards more equal application of the

markup. Id. at 23-24.

2. The Commission should maintain Same Day Airport service in the Classification Schedule.

The Postal Service has not proposed any classification changes for Express

Mail. While Same Day Airport Service is currently suspended for security reasons, and

no rates are therefore proposed, witness Berkeley proposes to maintain that service in

the classification schedule in case circumstances allow for its resumption. Id. at 6-7.

This proposal is unopposed, and is consistent with Commission precedent. See, e.g.,

PRC Op., R2000-1, at App. Two, page 2.3

3. The Commission should recommend the ungrouping of the combined one-and-two pound rate.

The only structural change to the Express Mail rate schedule that witness

Berkeley proposes is the separation of the uniform two-pound rate into individual one-

pound and two-pound rates in the rate categories. As she explains, there are three

reasons why such a change is desirable. First, the difference in the per-piece costs

from one to two pounds is comparable to other differences between pound increments

where separate rates are charged, and is significant enough to warrant separate rates.

Id. at 22. Second, the use of separate rates for one- and two-pound pieces is consistent

with the practice of the Postal Service’s competitors in the expedited delivery market.

UPS, FedEx, and DHL all use separate one-pound and two-pound rates for their

domestic retail overnight and second-day products. Finally, this proposal would make

the Express Mail rate schedule consistent with the one-pound increment rate schedules 3 In that docket, the Commission maintained Same Day Airport Service in the DMCS despite its suspension for security reasons. It has followed this approach in subsequent cases.

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for Priority Mail and Parcel Post, neither of which has a combined one-and-two-pound

rate. Id. at 22. Express Mail would no longer be the only Postal Service retail product

with such a rate.

Separating the uniform two-pound rate into one-pound rate increments would

also be consistent with Commission precedent. In successive rate cases (Docket Nos.

R80-1 and R84-1), the Postal Service proposed uniform two-pound and five-pound

rates, partly based on the practices of the expedited delivery industry. See Docket No.

R84-1, USPS-T-22 at 64; Docket No. R80-1, USPS-T-10 at 168. In Docket No. R90-1,

the Postal Service proposed to ungroup the uniform five-pound rate into separate three-

pound, four-pound, and five-pound rates for competitive reasons. See Docket No. R90-

1, USPS-T-19 at 25-26. The Commission agreed, finding that the change “appears

appropriate and consistent with other Postal Service offerings as well as the expedited

delivery market.” PRC Op., R90-1, at ¶ 6538. The Commission also noted that there

was no opposition to the Postal Service’s proposal. Id.

An identical situation is presented here. The Postal Service’s competitors in the

expedited delivery market do not have a uniform rate for pieces weighing one and two

pounds, and neither do other Postal Service offerings. Additionally, no party has

opposed this proposal. The Commission should therefore recommend ungrouping this

rate.

E. Standard Mail Rate and Classification Changes

The Postal Service’s Standard Mail rate and classification proposals are shown

in the Docket No. R2006-1 Request of the United States Postal Service For A

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Recommended Decision On Changes In Rates Of Postage And Fees For Postal

Services, at Attachments A (pages 11-32) and B (pages 7-22) (May 4, 2006). The

justification for these proposals is explained in the direct testimony of Postal Service

witness James M. Kiefer, USPS-T-36.4 The Postal Service is proposing important

classification changes and will discuss them first before discussing the rate design for

Standard Mail.

1. Standard Mail Classification Proposals

Standard Mail is generally divided into four subclasses, Standard Mail Regular,

Standard Mail Nonprofit Regular, Standard Mail Enhanced Carrier Route (ECR), and

Standard Mail Nonprofit Enhanced Carrier Route (NECR).5 For the Standard Mail

Regular subclass, witness Kiefer proposes an average increase in the revenue per

piece of 9.6 percent. USPS-T-36 at 3. For the Standard Nonprofit Regular subclass, he

proposes an average increase in the revenue per piece of 9.8 percent. The overall

increase for the Regular subclasses is 9.8 percent. The cost coverage for the Regular

subclasses is 176.5 percent. Id. at 35.

For the ECR subclass, witness Kiefer proposes an average increase in the

revenue per piece of 8.1 percent. For the NECR subclass, he proposes an average

increase in revenue per piece of 8.2 percent. Combined, the two subclasses have an

average rate increase of 7.9 percent. The proposed cost coverage for the ECR and

NECR subclasses is 214.2 percent. Id. at 35-36.

4 Docket No. R2006-1, Direct Testimony of James M. Kiefer On Behalf Of United States Postal Service, USPS-T-36. 5 As discussed below, the Postal Service is recommending nominal changes to the nomenclature of the Nonprofit subclasses. Id. at 4.

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A significant feature of the Postal Service’s rate and classification design, which

is presented in the testimony of witness Kiefer, is the proposed change to the

classification structure in Standard Mail. Witness Kiefer proposes the establishment of

new rate categories within the Standard Regular and Standard Nonprofit Regular

subclasses on the basis of shape. The design retains the Letter category but

deaverages the previous Nonletter category into three -- flats, parcels, and NFMs (Not

Flat-Machinable). USPS-T-36 at 4-7.6 Witness Kiefer also proposes that the

Automation Carrier Route rate categories within the ECR and NECR subclasses be

eliminated. All of witness Kiefer’s specific rate design proposals, including these

proposed classification changes, are summarized and discussed below.

a. Changes to subclass and rate category names. As noted above Standard Mail currently has four subclasses: Regular,

Enhanced Carrier Route, Nonprofit, and Nonprofit Enhanced Carrier Route. Domestic

Mail Classification Schedule (DMCS) §§ 321-324, respectively. Witness Kiefer

proposes that the Standard Mail Nonprofit subclass be renamed Standard Mail

Nonprofit Regular. This simple change creates a parallel naming convention to the one

that already exists between Enhanced Carrier Route (ECR) and Nonprofit Enhanced

Carrier Route (NECR). Id. at 4.

6 In conjunction with this shape-based redesign, witness Kiefer advocates a related classification change. No longer will parcels be priced simply as surcharged nonletters and therefore the residual shape surcharge (RSS) is eliminated. Instead, parcels have their own rate structure. Attachment A to Request, p. 13, 15 n. 2; USPS-T-36 at 5.

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Witness Kiefer also proposes that the rate categories now known as “Presorted”

be renamed “Nonautomation.” Since all Standard Mail is presorted, the change will

make the name more descriptive of the non-barcoded mail in these categories. Id. at 4.

b. Standard Mail Regular/Nonprofit Regular. i. Letters. The rate structure for automation letters will not change in this proposal. Rates

will still be provided for four presort and three entry levels. For non-automation-rated

letters, the Postal Service is proposing distinct rate designs for machinable and

nonmachinable letters. The Postal Service is proposing expanded rate categories for

nonmachinable letters, mirroring those for automation; and a realignment of the two

presort categories for machinable letters. The proposed changes align these types of

mail with operations. Id. at 13.

The Postal Service barcodes machinable letters at the AADC, therefore finer

levels of presorting have little or no value. As such, witness Kiefer proposes that

nonautomation machinable letters have two presort rate options, MAADC and AADC.

Id.

The cost of sorting manual letters varies significantly depending on how finely

presorted the letters are when presented to the Postal Service.7 In the current rate

structure, nonmachinable letters pay a fixed surcharge over the rate paid by machinable

nonautomation letters. The Postal Service is proposing a rate structure that has

significant increase in rates for the least finely presorted manual letters and more

7 See USPS-LR-L-48, STANDARD.xls, worksheet NONAUTO NMACH SUM.

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moderate increases for highly presorted pieces. This will encourage mailers to make

their letters machinable, and if not, then to more finely presort them. Id. at 13-14.

No participant has opposed these classification changes.

ii. Flats.

The current broad nonletters shape category in Standard Mail will be replaced by

three new categories that better reflect how each type of mail is processed. Most

nonletters will continue to be processed in the flats mail stream and will be recognized

for rate treatment purposes in a separate flats shape category. Id. at 15. The two other

rate categories, parcels and NFMs, are discussed below.

Eligibility for flats rate treatment will be tightened under the Postal Service’s

proposal to better align with the flats processing. For example, pieces whose thickness

exceeds 0.75 inch will no longer qualify for automation flat rates. Id. at 15-16. Pieces

that do not meet the rigidity requirements will not be eligible for flats rates. Separating

nonletters into flats and other shape-based categories will allow the rate designs for

pieces in different mail streams to evolve toward more rational rate structures and

relationships. Id. at 15-16

The Postal Service is also proposing to de-average the presort rate categories

for automation and nonautomation flats. The finer presort discount categories will allow

deeper discounts for the most highly workshared mail and, conversely, higher rates for

the most costly, least workshared flats.

No participants have opposed these classification changes.

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iii. Standard Regular Parcels.

The Postal Service proposes the following classification changes for Standard

Mail Regular and Nonprofit Regular parcels:

• A de-averaged rate design that is independent of the flats rate design. The residual shape surcharge will be abolished. USPS-T-36 at 5, 10-12, 17-21, and 26.

• Separate rate categories for machinable and nonmachinable parcels. Id. at

18-21 and 26. • A requirement to barcode parcels; non-barcoded parcels will be subject to a

surcharge. Id. at 21 and 26. • Eligibility for DDU discounted rates for parcels. Id. at 19, 21, and 26.

The proposal for separate, shape-based classifications for parcels is of primary

importance to the Postal Service and is the Postal Service’s principal pricing and

classification goal for nonletters in this docket. Id. at 10; USPS-RT-11 at 6, 7. An

important aspect of this reclassification is that the new rate categories have meaningful

price differentials that lead to the efficiencies that the proposed changes intend to

induce. USPS-RT-11 at 6.

The Postal Service’s proposals will have significant efficiency and other benefits.

They will better align parcel mail with the way it is processed and costs are caused, will

allow rates to better reflect costs, and will encourage mailers to adopt more efficient

practices to lower Postal Service costs. USPS-T-36 at 12. They will also encourage

parcel worksharing and machinability, allow expanded worksharing opportunities for

mailers, and increase the visibility of these parcels in the Postal Service’s cost and

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volume reporting systems leading to more specific data in the future. Id. at 17. See Tr.

5/956.

The proposed changes are reasonable, lead to a more rational rate structure,

encourage efficiencies, and give expanded opportunities to mailers. No party opposes

the classification changes. The Commission should recommend the Postal Service’s

proposed parcel classification changes.

iv. Standard Regular Non Flat-Machinable Pieces (NFMs or “Hybrid pieces”)

The Postal Service proposes to create a new classification category, since the

current structure does not differentiate pieces well by mail processing path. At present,

the flats rate category contains significant numbers of parcel-shaped pieces that,

because of the UFSM 1000 standards and the lack of an appropriate recognition of

rigidity in the standards, qualify for automation flats rates. Id. at 10. Of significant

concern are pieces that are somewhat flat-shaped but rigid, or that are between 0.75

and 1.25 inches in thickness (USPS-T-36 at 21). These pieces are not commonly

processed on flat sorting machines. See Tr. 5/929. They are commonly processed in

the parcel stream, and as a consequence, these pieces are counted as parcels for cost

allocation purposes but are counted as flats for volume purposes. USPS-T-36 at 21-22;

Tr. 5/934, 956. The new category for these types of pieces is called Not Flat-

Machinable8 and have the following classification elements:

• A de-averaged rate design that is independent of the flats rate design. USPS-T-36 at 6, 10-12, 21-24 and 26.

8 In his testimony, Witness Kiefer sometimes refers to NFMs as “hybrids”. See, e.g., USPS-T-36 at 21-23.

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• A requirement to barcode NFMs; non-barcoded NFMs will be subject to a surcharge. Id. at 24, 26.

• Eligibility for DDU discounted rates for NFMs. Id. at 23, 26. The proposal for separate, shape-based classifications for NFMs, as with

parcels, is of primary importance to the Postal Service and is the Postal Service’s

principal pricing and classification goal for nonletters in this docket. Id. at 10; USPS-RT-

11 at 6, 7. An important aspect of this reclassification is that the new rate categories

have meaningful price differentials that lead to the efficiencies that the proposed

changes intend to induce. USPS-RT-11. at 6.

The Postal Service’s proposals will have significant efficiency and other benefits.

They will better align NFM mail with the way it is processed and costs are caused, will

allow rates to better reflect costs, and will encourage mailers to adopt more efficient

practices to lower Postal Service costs. USPS-T-36 at 12. They will also encourage

NFM worksharing and machinability, allow expanded worksharing opportunities for

mailers, and increase the visibility of these pieces in the Postal Service’s cost and

volume reporting systems leading to more specific NFM data in the future. Id. at 17.

See Tr. 5/956.

The proposed changes are reasonable, lead to a more rational rate structure,

encourage efficiencies, and give expanded opportunities to mailers. No party opposes

the classification changes. The Commission should recommend the Postal Service’s

proposed NFM classification changes.

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v. Customized MarketMail (CMM).

The Postal Service proposes to change the reference point for Standard Mail

Regular and Nonprofit Regular CMM mail pieces. Currently it is priced as a piece-rated

origin-entered Nonautomation Basic Nonletter, plus the residual shape surcharge. With

the proposed elimination of the residual shape surcharge, a new reference point is

needed. The Postal Service proposes using the rate for an origin-entered 5-digit

presorted NFM as the reference rate. Id at 25-27. This change in the reference rate

appropriately reflects CMM’s presort level, nonstandard shape, and rate relationships

with nonautomation flats. Id. at 26. No party opposes this change. It should be

recommended by the Commission.

c. ECR/Nonprofit ECR.

The Postal Service proposes the following classification changes for the

Standard Mail ECR and NECR subclasses:

• The Automation Basic rate category for letters will be eliminated. Witness Kiefer assumes that these pieces will migrate to the Regular subclasses and pay the Automation 5-digit letter rates. USPS-T-36 at 6, 30-31.

• The DDU destination entry discount will be eliminated for all letters. Id. at 6,

30. • The nonletter category will be deaveraged into flats and parcels. Eligibility

requirements for flats rates will follow the same revised definitions used for the Standard Mail Regular subclasses. Pieces not meeting these revised eligibility requirements will pay parcel rates. Since there are separate parcel rates, the residual shape surcharge is eliminated. Id. at 32-34.

• Detached address labels (DALs) will still be permitted for certain flats, but

mail addressed with DALs will have to pay a per-piece surcharge. Id. at 7, 32.

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i. ECR/NECR Letters.

The Postal Service is proposing to eliminate two rate categories for Enhanced

Carrier Route letters. Both proposed changes will better align the rates for these letters

with operations.

Automation Basic rate category is currently available only for letters sent to sites

that do not receive letters from the plant in delivery point sequence. The Postal Service

intends to further centralize the sequencing operations in plants to the greatest extent

possible, reducing the dependence on automated or manual sorting in delivery units.

USPS-T-36 at 30-31; USPS-T-42, Section II, Part A, discussion of CSBCS equipment).

The elimination of the Automation Basic rate aligns this mail with its expected

operational handling at the mail processing plant. The rate effect of this change is

discussed below.

The Postal Service is proposing to eliminate the discount for DDU letters in order

to promote its automation program. It intends to delivery point sequence (DPS) as

many letters as possible by machine, and since DPS equipment is mostly located at

plants, entering letters at delivery units no longer makes operational sense. USPS-T-36

at 30; USPS-T-42, Section II, Part A. Eliminating the DDU discount will remove the

economic incentive to deposit letters at delivery units when the letters are subsequently

transported back to plants at added costs. Mailers will continue to be able to drop

letters at the delivery unit, which may be of particular importance to local mailers.

However, by eliminating the discount, the volume of letters dropshipped to the plant,

where the sorting actually takes place, should increase. Id.

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ii. ECR/NECR Flats.

Under the Postal Service’ proposal for Enhanced Carrier Route, the current

classification for nonletters will be deaveraged into flats and parcels. See proposed

DMCS, Schedule 322. The eligibility qualifications for flats rates will be similar in the

ECR and NECR subclasses as in the Regular and Nonprofit Regular subclasses.

Pieces that do not meet the flats rate eligibility will become parcels and pay parcels

rates. Because there is no UFSM 1000 exception in ECR/NECR today that allows for

pieces up to 1.25” thick, for example, the number of pieces that will lose eligibility for

flats rate treatment is expected to be relatively small. Id. at 32.

The Postal Service is proposing one important change to the rate design for ECR

and NECR flats. The Postal Service has determined that it wants to encourage on-

piece addressing for all mail in furtherance of its goals of improving efficiency (see the

discussion of DALs by witness Coombs (USPS-T-44), Section 3.1). To further that

policy decision, the Postal Service is proposing that all mail that uses detached address

labels pay a surcharge. No one opposes the addition of the surcharge to the schedule,

including those likely to be most affected such as the Saturation Mailers Coalition.

SMC-RT-1 at 3. Several parties support the surcharge such as ADVO (Id.), Valpak9

(VP-T-1 at 176), and NAA (NAA-T-2 at 11).

The Postal Service’s proposed changes to the Enhanced Carrier Route

subclasses classifications for letters and flats are reasonable, encourage efficiencies,

and align the rate structure with operations. No party opposes the classification

changes for letters, the elimination of the DDU discount for letters, or the introduction of

the DAL surcharge. As discussed below, only Valpak opposes the elimination of the

9 Valpak Direct Marketing Systems Inc. and Valpak Dealers’ Association, Inc.

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Automation Basic rate. The Commission should recommend the Postal Service’s

proposed ECR classification changes.

2. Intervenors’ classification proposals.

a. PostCom’s proposals to raise the weight limit for Standard Mail automation letters from 3.5 to 4.0 ounces should be rejected.

PostCom witnesses Posch (PostCom-T-3) and Otuteye (PostCom-T-8) both

propose increasing the current maximum weight limit for automation letters from 3.5

ounces to 4.0 ounces. Witness Posch believes that “there is, plainly, no operational

rationale for the current maximum weight limits for automation letters.” PostCom-T-3 at

3. Witness Otuteye bases his proposal on the claim that pieces mailed by Money

Mailer, LLC, weighing between 3.5 and 4.0 ounces are being processed on Postal

Service automated equipment. PostCom-T-8.

The Postal Service is always looking for new ways to grow the mail, and

adjustments to the automation mail weight limit have been considered in the past. The

majority of the Postal Service’s DBCS equipment (over 5,000 machines) was designed

to optimally handle a mix of mailpieces which collectively weighs less than 3.5 ounces.10

10 A very small portion of the DBCS fleet (less than 12 percent of the entire equipment fleet) is equipped with expanded capabilities, which allow for the processing of letters with physical characteristics outside the limits of base DBCS equipment, including the processing of pieces up to 6.0 ounces. The primary function of these machines is to process thicker and heavier outgoing single-piece letters that are culled from the collection mail stream. These machines provide the opportunity to sort these originating letters to the destination in an automated operation, though with a significantly lower throughput, thereby minimizing the dependency on manual operations. Tr. 34/11464-11465.

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See Tr. 34/11527-11528. However, recognizing that expanding the number of pieces

that could be handled on automation equipment would benefit both customers and the

Postal Service, a “Heavy Letter” test was conducted to determine the maximum letter

weight that could be handled by the majority of our machines, without causing

detrimental consequences in mail processing.11 Tr. 11/3214; Tr. 34/11529-11530. The

test recommended that any proposals to raise the weight limit above 3.5 ounces should

be rejected as impractical given the current configurations of USPS mail processing

equipment. Tr. 11/2846. As witness McCrery explained, raising the weight limit above

3.5 ounces causes detrimental consequences to the mail base as whole, by both

damaging mail processing equipment, creating down time, and causing jams that

damage mail pieces. Tr. 34/11530.

Setting the weight limit at 3.5 ounces does not mean that every piece below 3.5

ounces runs without any problems, and that every piece over 3.5 causes problems. In

fact, there are pieces that weigh less than 3.5 ounces that process at unacceptable

throughput and jam rates, as well as pieces that weigh over 3.5 ounces that process

without great difficulty. See 39/13440. It is not possible to establish a weight limit on

automated equipment such that there is a certainty that all pieces below the limit will

process well and all pieces above the limit will process poorly, regardless of mail piece

construction. Id. As witness Laws states, the weight limit is “established in

consideration of the letter mail base in general, with a goal of establishing an overall

11 The test was conducted between April 20, 1999 and May 13, 1999. The results of the test were published April 6, 2001. Since the test was conducted, there have been no changes to the base DBCS equipment fleet to invalidate these conclusions. Tr. 11/2844-2845; Tr. 34/11464.

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automated letter mail stream that has a high probability of processing at an acceptable

throughput and jam rate.” Id.

b. Witness Horowitz’ proposal to expand the definition of Standard Mail to include advertising inserts beyond the 16 ounce limit fails to consider important issues with potentially harmful consequences and should be rejected.

Witness Horowitz (POSTCOM-T-6 at 10-12) proposes to allow Standard Mail

parcels to contain an additional two ounces of advertising inserts beyond Standard

Mail’s 16 ounce weight limit. This is a significant redefinition of Standard Mail. Witness

Horowitz cites as a benefit of his proposal that the additional advertising would generate

new business which would generate additional volume in several mail classes (the

multiplier effect). POSTCOM-T-6 at 10-11. His proposal would benefit mail order firms

like his that ship parcels that weigh close to the 16 ounce weight ceiling and so cannot

now include many advertising inserts. POSTCOM-T-6 at 11.

The Postal Service does not dispute that including additional advertising inserts

in parcels containing mail order fulfillment might generate additional mail pieces, but

there is no record evidence, either from witness Horowitz, or from any other party, that

the alleged benefits will be material enough to justify redefining Standard Mail. USPS-

RT-11 at 3.

Moreover, neither witness Horowitz nor any other witness has addressed several

obvious concerns on the record. These include: how the Postal Service is to determine

that the additional weight is advertising and not merchandise; the fairness of allowing

Standard Mail to breach its weight limit but not extending this same treatment to other

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subclasses of mail like Media Mail, Library Mail, Parcel Post and Priority Mail; the

rationale for limiting the inclusion of additional advertising materials to parcel shaped

mail pieces only, rather than allowing, for example, catalogs to breach the 16 ounce

weight limit also; and what extra costs this extra material would impose on the Postal

Service. USPS-RT-11 at 3-5.

Mr. Horowitz cites BPM as an example of a subclass of mail where non-print

material that does not fall within the definitions of bound printed matter can still be

included in BPM parcels. POSTCOM-T-6 at 10-11. Yet Mr. Horowitz acknowledges

that, even in BPM, extra non-BPM material cannot be included if it would cause the

BPM parcel to exceed the 15-pound subclass weight limit. USPS/POSTCOM-T6-15.

His illustration, therefore, fails to support his proposal.

Mr. Horowitz fails to provide or point to any record evidence that his proposal

would produce material benefits, or any record evidence that addresses important

issues that the Commission should consider before deciding to redefine a major class of

mail. His proposal should be rejected.

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c. Witness Mitchell’s (VP-T-1) proposal to retain the automation

basic rate category in ECR should be rejected.12

Witness Mitchell suggests that that the rate category for basic automation letters

in ECR should be retained. VP-T-1 at 123-127. However, as witness McCrery explains

in his rebuttal testimony, automation carrier route letter mail preparation should be

eliminated based on the future of mail processing and the desire to streamline the

Postal Service’s offerings and operations. Tr. 34/11472; see Tr. 34/11461-11464.

As the Postal Service takes additional steps to automate a greater percentage of

the letter mail base, along with a further centralization of delivery point sequencing on

DBCSs in postal plants, the limited additional value of automation carrier route sortation

is further eroding. Tr. 34/11462. In addition, the Postal Service is in the early stages of

an additional phase of DBCS purchases that will completely phase out the CSBCS fleet.

See response to POIR No. 8, Question 15(a)-(c)/Tr. 11/3021. Even prior to the

retirement of CSBCS equipment, there are many instances where the value of the

carrier-route sortation is not fully realized. Tr. 34/11463. If the trays are not labeled

properly or identified such that they can be directed in an appropriate manner, or it is

determined that it would be more efficient to consolidate these letters to the appropriate

12In his testimony, Valpak witness Mitchell states that the Commission should consider creating an unrestricted category of basic automation letters. See Testimony of Witness Mitchell, VP-T-1, at page 126, lines 12-13. He then retracts this recommendation and states he is not proposing an unrestricted Automation Basic rate category. Tr. 25/8998, See Tr. 25/8888 (Response to Witness Mitchell to USPS/VP-T1-3(d)). The negative operational impact of the creation of an unrestricted Automation Basic rate category is discussed within the rebuttal testimony of Postal Service witness McCrery. Tr. 34/11461-11464.

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CSBCS schemes on DBCS equipment, the carrier-route sort provides no value. Id.

Since CSBCS equipment can process up to six routes on a single sort plan, processing

the automation carrier route volume labeled to these multi-carrier schemes first on a

DBCS is more likely to occur, since pure carrier-route sorting is suboptimal. Id. Smaller

volumes of letters from multiple mailings will then be combined in significantly fewer

trays for more efficient dispatch, transport, and CSBCS induction. Id.

Once automation carrier route preparation is eliminated and automation letters

shift from carrier route to 5-digit automation trays, the fewer resulting trays will be

directed to the proper destination plant where the trays will then be processed on the

appropriate incoming secondary sort plans. Letter volume that is further sequenced on

CSBCS equipment will be grouped on the DBCSs to the CSBCS sort plans and then

directed to this equipment. Id.

Continuing the preparation of automation letters in pure carrier-route trays no

longer comports with current operational realities, and the additional trays that are

created under this preparation are costly. Id. An expansion of this category makes

even less sense. Furthermore, Witness Mitchell’s rate design proposal would result in

automation letters migrating to the nonautomation Enhanced Carrier Route Basic

category. See Tr. 25/8998-8999. This would be an undesirable result, since letters in

this category are neither required to be automation compatible nor barcoded.

Furthermore, ten or more letters must be prepared to the appropriate carrier route under

this category, a sort that provides no value for a vast majority of delivery zones that are

sequenced on DBCS equipment. Tr. 34/11464.

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3. The Postal Service’s proposed Standard Mail classification

changes meet the requirements of the Act and the Commission should recommend them.

The current classification schedule for Standard Mail, as recommended by the

Commission and approved by the Governors, complies with the requirements of 39

U.S.C. § 3623. The Postal Service’s proposed changes are also consistent with

Section 3623. Consistent with the advances in the direction of more shape-based mail

processing technology, the proposed classification changes move the schedule more in

the direction of recognizing these shape-based differences. Furthermore, the changes

offer a greater opportunity for worksharing and aligning the mail better with operations.

The changes are fair and equitable, and provide classifications that are desirable.

The shape-based classification changes, although significant, were not opposed

by any intervenor and were specifically adopted by Valpak and Advo in their rate

designs. As discussed below, intervenors oppose elements of the rate design

associated with the new shaped-based design. The other classification changes were

similarly not opposed, except for the limited objection of Valpak to the elimination of the

Automation Basic rate category for ECR/NECR letters. See discussion supra.

The Postal Service’s proposed classification schedule, including the proposed

changes should be recommended by the Commission.

4. The Postal Service’s rate proposals meet its revenue needs under the Act and appropriately reflect the policies and practical objectives embodied in its classification initiatives.

The rate changes proposed for Standard Mail satisfy the needs to make

appropriate contributions to the Postal Service’s revenues, as well as to combine and

achieve various goals underlying the important classification initiatives described

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generally above. These goals include the promotion of increased operational efficiency

and effectiveness through the establishment of a shape-based framework that sends

clear pricing signals to mailers. The resulting rate structures will facilitate sound

business decisions beneficial to the individual postal customer and the Postal Service,

as well as to all mailers. At the same time, the rates will fairly recognize cost

differences among types of mail and mailing practices, and pay appropriate attention to

the effect of rate increases on the mailers using categories resulting from the proposed

classification changes. In these respects, the Postal Service’s rate proposals succeed

on several levels.

First, they meet the Postal Service’s revenue requirement by covering the costs

attributable to the pertinent categories within the class and making reasonable

contributions to institutional costs. Second, the process of rate design fairly balances a

complex array of considerations related to operations and mailer behavior, rather than

focusing on a single principle or a narrow range of considerations. Third, the rates

recognize and maintain important rate relationships. Fourth, the rate design recognizes

and incorporates cost and operational differences among the various mail categories.

Fifth, the rates strike a fair balance between cost recognition and mitigation of the

adverse effects of rate increases. Sixth, the rates fairly recognize the worksharing

efforts of mailers and send appropriate pricing signals. Seventh, the rates reinforce the

logic and policies underlying the move toward shape-based rate structures. Finally, the

proposed rate structures establish a practical foundation for the advance of greater

automation and more efficient operations in the future.

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Furthermore, the Postal Service believes that the rate design process that

produces the various rate levels recognizing worksharing within Standard Mail need not

conform to an artificially constrained presort tree analysis, as is discussed in a later

section.

a. The Postal Service’s proposals meet its revenue needs by

reasonably increasing rates in accordance with the Postal Reorganization Act (Act).

The direct testimony of Postal Service witness James M. Kiefer (USPS-T-36)

summarizes the financial effects of the proposed rates for Standard Mail. USPS-T-36 at

35-36. The Act requires that each class (subclass) of mail or type of service cover its

attributable costs and make a reasonable contribution to all other costs. 39 U.S.C. §

3622(b)(3). As presented in detail in witness Kiefer’s workpapers, in accordance with

the test year cost allocations described in the testimony, exhibits, and workpapers of

Postal Service witness Waterbury (USPS-T-10), the rates proposed cover attributable

costs. They also contribute to all other costs, in accordance with the rate policy

determinations for allocation of institutional costs outlined and justified in the testimony

of Postal Service witness O’Hara (USPS-T-31).

Witness Kiefer summarizes (USPS-T-36 at 35) the following average increases

(calculated at constant volumes) for the subclasses within Standard Mail:

Standard Mail Regular 10.8% Standard Mail Nonprofit Regular 10.0% Standard Mail Enhanced Carrier Route 8.4% Standard Mail Nonprofit Enhanced Carrier Route 8.1%

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b. The proposed rates fairly and effectively balance multiple

considerations.

The Postal Service’s proposed rates meet the challenge of reconciling and

balancing a number of sometimes conflicting objectives presented under the ratemaking

criteria in the Act, as well as numerous practical considerations. In the current

proceeding, several participants have advocated designing rates for the various

worksharing categories by focusing on a relatively narrow principle of economic

efficiency, namely, efficient component pricing, as that concept has been employed and

accepted in prior proceedings. As discussed by Postal Service witnesses, and

elsewhere in this brief, however, this narrow focus risks lack of appropriate attention to

other important considerations. In Standard Mail, the testimony of Postal Service

witness Kiefer explains how all significant considerations are balanced appropriately

under the policies of the Act in designing rates. In particular, he discusses: (1) how the

rates recognize and maintain important historical and future relationships among rates

for various categories and types of mail, both inside and outside the Standard Mail

class; (2) appropriate reflection of cost differences; (3) the importance of assessing and

mitigating the adverse effects of rate increases; (4) the need to recognize mailer

worksharing efforts and send appropriate price signals consistent with economic goals,

including ECP; and (5) the role of Standard Mail rate design in building a sound

operational foundation for the Postal Service’s automation programs.

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c. The Standard Mail rates recognize important rate

relationships.

As noted repeatedly by the Commission in the past, existing rates embody

relationships recognized through application of the statutory criteria to practical

circumstances in prior cases. While relationships among costs, volumes, mailer

practices, and postal operations evolve over time, existing rate relationships are the

starting point for evaluating pricing decisions and classification proposals. Among

numerous factors, they reflect the relative status and uses of the different classes of

mail, such as between First-Class Mail and Standard Mail, relationships dictated by

statute, such as between the Standard Mail Regular and Standard Mail Nonprofit

Regular subclasses (39 U.S.C. § 3626), and the operational distinctions and economic

objectives represented by the rates and classifications for different worksharing

categories. In these respects, witness Kiefer’s testimony presents numerous examples

in which his rate design judgmentally balanced the ratemaking criteria and other

considerations, in light of important rate relationships. For instance, in designing rates

for nonmachinable (manual) and machinable and automation letters to meet the

revenue and policy determinations established by the Postal Service’s cost coverage

targets, he kept in mind the need to maintain the appropriate relationships between

presort and drop-shipping levels, in light of the minimum per-piece/piece-pound

structure for the proposed rates.13 He passed through a significant portion of the cost

avoidance estimates for the different categories in order to maintain the appropriate

signals to encourage mailer behavior with the potential to reduce Postal Service costs.

13 USPS-T-36, at 14, n. 5. See witness Kiefer’s response to VP/USPS-T36-1(i), (k) (Tr. 5/962-63).

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Id., and n. 6. His approach to maintaining appropriate relationships was similar in

establishing levels for rate elements reflecting different shapes.14 He also reconciled

the statutory average revenue relationships dictated for Standard Regular and Nonprofit

subclass rates with the operational objectives embodied in the worksharing categories,

and the effects of higher rates, by adjusting the piece and pound rate elements for

Nonprofit to maintain acceptable relationships. Id. at 27. He made similar adjustments

in designing letter and flat rates for the ECR and NECR subclasses.15

Witness Kiefer’s workpapers reflect numerous other instances in which his

judgmental rate design choices represent the need to maintain appropriate rate

relationships, in light of various policy and practical objectives (e.g., revenue targets,

pricing signals, operational distinctions). While alternative proposals have been

presented in this proceeding, no participant has successfully demonstrated that witness

Kiefer’s rate design establishes or maintains inappropriate rate relationships.16 Rather,

as we argue below, the alternatives presented are inferior to the integrated rate and

classification proposals presented by witness Kiefer.

14 See witness Kiefer’s response to VP/USPS-T36-1(e) (Tr. 5/961-62), and VP/USPS-T36-7(d) (Tr. 5/978-79). 15 To maintain the correct statutory relationship between ECR Regular and Nonprofit letters and flats, he adjusted both commercial and nonprofit rate elements to produce the appropriate average revenue ratios (Id. at 31, 33), and to maintain the desired worksharing signals. Id. at 32. See also, witness Kiefer’s response to NAA/USPS-T36-4 (Tr. 5/909). 16 One exception consists of an observation made by United Parcel Service (UPS) in an interrogatory directed to witness Kiefer, UPS/USPS-T36-1(b). Tr. 18D/6668. UPS noted that the rates for a nonmachinable parcel that has been presorted to 3-digits is lower than a comparable machinable parcel sorted to BMCs. The Postal Service acknowledges that the most effective way to achieve the goal of encouraging machinability would be to establish rate relationships in which the rates for nonmachinable parcels presorted to 3 digits were equal to or greater than the proposed rates for BMC presorted parcels.

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d. Postal Service rate design recognizes appropriate cost

distinctions.

Recognition of actual cost distinctions among the various categories of mail is a

key feature of the Postal Service’s rate design. Id. at 10-12. In this regard, witness

Kiefer’s testimony cites numerous instances in which the Postal Service’s classification

and rate proposals are consistent with the transportation, handling, and delivery costs

for Standard Mail representing different shapes, weight, and entry profiles. For

example, in designing rates for Standard Mail Regular and Nonprofit flats, witness

Kiefer de-averaged the presort rate categories for automation and nonautomation flats,

reflecting the cost savings differentials at different presort levels and sending price

signals to influence more efficient mailer behavior. Id. at 16. Rather than relying on

rigid models that evaluated costs solely on a linear depiction of processing steps,

however, his approach to design reflected operational realities resulting in actual cost

differences. For instance, his design for nonautomation machinable letters proposed

discounts for letters presorted only to the MAADC and the AADC levels. This decision

conformed to the actual operational practice whereby the Postal Service barcodes

machinable letters at the AADC, eliminating the value of a finer level of presort. Id. at

13.

Furthermore, witness Kiefer applied available cost information to reflect both

expected cost savings results, as well as operational objectives. For example, in

designing parcel rates, he increased discounts for drop-shipping parcels above the

discounts for letters and flats. According to witness Kiefer, this

[R]ecognize[s] the fact that parcels are generally more costly to transport and move about due to their larger size, so

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avoiding these operations would be expected to result in larger postal savings. I am also proposing that parcels entered at the Destination Delivery Unit (DDU) be eligible for an additional discount that is not available to flats.

Id. at 18-19. He also passed through only a small fraction of the cost differential

between machinable and nonmachinable parcels since the least-workshared

machinable parcels were already receiving a large increase. Limiting the add-on for

nonmachinability tempers the proposed price increase, while still creating an incentive

for mailers to convert to machinable parcels. Id. at 20.

Use of cost information did not in all respects result in rates that conformed

rigidly to cost differences. In most instances, however, the proposed rates moved in the

direction of greater recognition of measured costs. Departures from this principle were

adequately explained and justified in witness Kiefer’s testimony.

e. The rate design process fairly balances cost recognition and

other considerations in light of the adverse effects of rate increases.

In designing Standard Mail rates, witness Kiefer was sensitive to the impact on

mailers of rate increases resulting from the Postal Service’s classification change

proposals and accompanying rate structures. This awareness particularly influenced

his judgment in designing rates for the new parcel categories. His rate design tended to

respect the effects of increases in two ways. First, concern about adverse impacts

influenced the applicability of the classifications themselves. Second, consideration of

impact moderated the degree to which cost distinctions were reflected in the rate

design.

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For example, witness Kiefer proposed to extend temporarily the eligibility for the

NFM category to mail that will no longer qualify as flats and would ordinarily by

considered a “parcel”. In this regard, pieces that formerly qualified as flats because

they met the published standards for the UFSM 1000 machines would, during a

transition period, qualify for rates as NFMs even though they are typically handled as

parcels. Id. at 11, 22.

Full cost recognition between categories was also moderated in light of the

adverse impacts of rate increase proposals. For example, the extra costs caused by

nonmachinable parcels were only partly reflected in proposed rates. Id. at 20. Witness

Kiefer also designed rates for NFMs to mitigate the impact of increases represented by

that category. Id. at 23. The piece and pound rates for NFMs, and the discount

proposals, avoid the effects of recognizing the full costs of manual processing that

would be expected for NFMs. Id. A similar approach was taken in designing rates for

nonmachinable letters, which would experience more substantial increases if the prices

reflected the full additional costs of manual processing. Id. at 15. Also, witness

Kiefer’s flats rate design “selected passthroughs for the various presort levels to

mitigate somewhat the effects of de-averaging on rates.” Id. at 16.

While the inevitable consequence of moving to purely shape-based rates would

be to impose large increases on mail arguably previously underpriced, the Postal

Service’s rate design attempted to fairly balance those results with the overall beneficial

objectives of the classification change proposals for mailers as a whole.

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f. The balancing of considerations present in the Postal Service’s rate design reasonably reflected worksharing efforts by mailers and send appropriate pricing signals.

The corollary to full recognition of cost differences in worksharing is that, not only

does efficient worksharing tend to minimize total costs and benefit all mailers in the long

run, but it fairly recognizes the efforts and expenses of mailers who participate in

worksharing activities. It also promotes the principles of economic efficiency embodied

in ECP. In this regard, as discussed further below, the Postal Service’s rate design

incorporates the beneficial objectives sought by advocates of strict adherence to ECP,

while balancing it with other important considerations. Balancing also helps influence

future mailer behavior leading to greater efficiency and lower costs. Id.

This approach is reasonably employed in the Postal Service’s rate design for

Standard Mail. Witness Kiefer’s testimony contains substantial examples of rate design

choices intended to recognize existing mailing practices and influence future mailer

behavior. The objectives sought by this rate design include additional presort (Id. at 13-

14, 16, 19), drop-shipping and entry patterns (Id. at 17, 18-19, 30), automation

compatibility, including barcoding (Id. at 20, 21), and mailpiece design (Id. at 23-24, 32,

33 at n. 16).

Of particular note, several of witness Kiefer’s rate design initiatives result in

mailers having more choices for worksharing leading to lower rates. For example, he

proposes to extend the deaveraging of automation letter rates (Mixed AADC, AADC, 3-

digit, and 5-digit) to nonmachinable letters, and also create more presort tiers within the

rates for flats. Id. at 12. He also proposes to extend de-averaging for automation mail

from letters to flats. Id. at 16.

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In some instances, new options mitigate some of the adverse effects of shape-

based deaveraging of the rate design. Witness Kiefer’s proposals create new

worksharing options for parcel mailers. He has extended new drop-ship options to

parcel mailers and has increased the discounts for drop shipping parcels above

discounts for letters and flats. Id. at 17-18, 19, 21. NFM category pieces will also be

allowed an additional discount for dropping mail at a DDU. Id. at 23.

g. The proposed rates effectively implement the Postal

Service’s shape-based classification proposals.

The proposed shape-based classification and rate structure reforms are the

central feature of the Postal Service’s Standard Mail initiatives. These proposals are

fundamentally designed to facilitate creation of more efficient transportation and

processing networks that benefit from more coherent mail streams and maximum use of

automation technology. While the shape-based classifications create the framework for

movement in this direction, several features of witness Kiefer’s rate design are intended

to facilitate the transition to a more modern system by creating appropriate incentives

for mailer behavior and mitigating the adverse rate effects of de-averaging by shape.

In the first instance, it is important to note that the rates were designed based on

reliable cost information or reasonable proxies, and revenues were projected using the

results of an extensive field study. As discussed above, the Postal Service’s proposed

classification design deaverages nonletters into three categories—flats, parcels, and

NFMs. To project the volumes of these three categories in the test year, witness Kiefer

relied on the Non-ECR Standard Non-Letter Redefinition Study (USPS-LR-L-33),

presented by Witness Loetscher (USPS-T-28) and which utilized a national sample of

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non-letter mail to measure detailed physical characteristics of non-letters. A sample of

50 routes/box sections was drawn and all non-letters were sampled for one day.

Physical characteristics (length, height, thickness, weight, deflection, and rigidity) of

each sample piece were recorded. The sample data were then used to analyze the

composition of non-letters based on piece compatibility with existing processing

machinery and carrier casing practices. Witness Miller (USPS-T-20) provides the

estimated test year mail processing costs for Standard Mail NFMs and parcels in USPS-

LR-L-45. Witness Abdirahman provided the Standard Mail letter mail processing costs

in USPS-LR-L-48.

Furthermore, as noted above, witness Kiefer has attempted through his rate

design to mitigate the adverse rate effects of separately pricing parcels and flats. He

creates new presort and drop-shipping opportunities for parcels and sets discounts

“significantly higher than the discounts for presorting machinable letters and flats – in

recognition of the higher costs of sorting parcels.” Id. at 19. He states:

The effect of these adjustments is a strong incentive for mailers to give the Postal Service lower-cost workshared parcels. The workshare discounts also offer mailers a way to significantly offset a large portion of the rate increases: machinable parcels sorted to 5-digit ZIP Codes and presented at the DSCF (or DDU) will see only moderate rate increases, despite what may appear to be large increases for non-workshared, non drop-shipped parcels.

Id.

Witness Kiefer also designed the category of NFMs (referred to as “hybrid” flats

in portions of his testimony) to facilitate transition to the new system and mitigate the

effects of reclassification. He states:

I based my “hybrid” flats rate design on a piece rate that was below the rate for machinable parcels and used the same pound rate I used for

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parcels. These rate elements represent heavy mitigation of the costs of processing in the manual mail stream which, I understand, would be the typical path for these pieces. I also propose generally higher discounts for “hybrid” flats than for parcels so as to lower the piece rates further. The destination entry discounts for hybrid pieces are the same as I am proposing for letters and flats. To provide a way for mailers to reduce their postage costs further, I also have proposed a DDU discount for “hybrid” pieces.

Id. at 23. For certain pieces that were formerly classified as machinable flats, but would

not qualify as flats or hybrid flats under the new rate structure (“hybrid” parcels), he

proposes to apply hybrid flat rates (the NFM prices) for a temporary transitional period

until the next rate changes take effect. Id. at 22.

In the ECR subclass, witness Kiefer also attempts to mitigate the effects of a

shape-based rate structure through his rate design. He

selected piece and pound rates for ECR and NECR parcels that represent a fixed increment over the prices these pieces would have paid, had they remained in the flats rate categories. This approach will help to mitigate the impact of moving from flats-rate treatment to parcels-rate treatment. The rate differential, $0.200 per piece, is slightly less than the current ECR and Nonprofit ECR residual shape surcharge.

Id. at 33-34 (footnote omitted)..

h. The Postal Service’s rate design promotes its automation

programs and machinability of mail in general.

The maintenance and growth of an operating system benefiting from the use and

expansion of automation technology represents a key consideration in the Postal

Service’s rate design. While it could be argued that this objective is subsumed under

the consideration of cost distinctions and fair recognition of mailer worksharing efforts,

the conscious goal of promoting automation as the best hope for future efficiency in

operations pervades both the shape-based classification proposals and several specific

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elements of rate design in this proceeding. Witness Kiefer’s testimony provides

numerous examples of how this goal influenced features of his rate design for letters17,

flats18, and parcels19. No participant has contended that the goal should not be a pre-

eminent influence on postal rates in the future.

Postal Service witness McCrery provides comprehensive descriptions of existing

and, to some extent, future networks for the transportation and processing of various

types of mail. USPS-T-42. He organizes his overview according to the mailflows and

processes that have evolved for handling various shapes: letters and cards (Id. at 2-

13); flats (Id. at 13-22); and parcels and containers. Id. at 22-32. In describing this

operating environment, he emphasizes the roles of the various automation technologies

and equipment, and he highlights the more costly processes created by the need to

handle different shapes manually.20

Witness McCrery’s testimony amplifies the importance of increased use of

automation and mechanization in the evolution of an efficient operating system. In this

regard, his testimony and discovery responses highlight the special problems that have

led to the proposals to reclassify Standard Mail by shape. He emphasizes in particular

the issues surrounding rigid mail pieces that impede more efficient operations.21

In numerous important ways, the Postal Service’s rate proposals support the

efforts to control costs through the automation programs described in witness McCrery’s

17 Id. at 13-14 and responses to NAA/USPS-T-36-1 (Tr. 5/906), NAA/USPS-T36-13 (Tr. 5/920) VP/USPS-T-36-9(b), (c), (g)(Tr. 5/984-85). 18 Id. at 24 and responses to NAA/USPS-T36-1, 13, VP/USPS-T36-9, supra. 19 Id. at 17, 18, 20, 21, 24. 20 See Id. at 11-12 (letters and cards); 19-21 (flats); 24-25 (parcels). 21 See witness McCrery’s responses to POSTCOM/USPS-T42-6, Tr. 11/2986; POSTCOM/USPS-T42-9, Tr. 11/2990-91. See also, witness McCrery’s rebuttal testimony, USPS-RT-14, at 8-13.

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testimony, by creating incentives to make mail machinable, and by aligning the rate

design with the ways the Postal Service transports and processes mail. These

initiatives, furthermore, affect all types and shapes of mail. In particular, witness

Kiefer’s proposed rate structure creates significant increases for “the least finely

presorted manual letters and more moderate increases for highly presorted pieces.” He

states:

This rate design will encourage mailers to make their letters machinable. If possible, it will encourage mailers to present nonmachinable letters as finely presorted as possible.

Id. at 13-14. Other classification changes are also designed to induce mailing patterns

for letters that are more consistent with modern processing operations. For example,

witness Kiefer proposes eliminating the DDU discount for ECR letters to “remove the

economic incentive to deposit letters at delivery units when the letters are subsequently

transported back to plants at added costs.” Id at 30. He also proposes eliminating the

Automation Basic rate category for ECR letters. He explains that the Postal Service

intends to continue the centralization of sequencing operations in plants to the greatest

extent possible, and to reduce the dependence of manual or automated sorting in

delivery units. Since the Automation Basic rate is currently only given to mail sent to

sites that do not receive letters pre-sequenced to delivery points from the plant, there is

no need for a two-tracked pricing scheme. Id. at 30-31.

Witness Kiefer also developed separate rate structures for machinable and

nonmachinable parcels. See Id. at 18-19. While certain features of his rate design

were intended to mitigate the effects of reclassification, and do not pass through the full

cost differential between machinable and nonmachinable parcels, he does create

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incentives for mailers to convert to machinable parcels where possible, and he expects

that the differentials will increase significantly in the future. Id. at 20. He also expects

that his rates for ECR and NECR parcels will create an incentive for ECR mailers to

reconfigure their pieces not eligible for the flats category to avoid being reclassified as

parcels. Id. at 33, n. 16.

i. The presort tree is not a necessary component of Standard

Mail rate design or rate development methodology.

In its NOI No. 2, the Commission requested the views of participants on the

question of whether the presort tree was “needed to provide a systematic way of

analyzing each rate differential within a subclass in terms of the rate-setting criteria of

the Act?”22 The Postal Service and several parties addressed this question.23 While

several parties emphasized the presort tree can be a useful tool24, no party claimed that

the presort tree was necessary. The Commission asked further whether the presort

tree was needed to avoid rate anomalies. Only the Postal Service responded to this

22 Notice of Inquiry No. 2, Docket No. R2006-1, at 7 (July 21, 2006) (“NOI No. 2”) 23 See Response of United States Postal Service to Notice of Inquiry No. 2 (August 21, 2006); Parcel Shippers Association (PSA) Response to PRC’s Notice of Inquiry No. 2 (July 26, 2006); Response of United Parcel Service to Notices of Inquiry Nos. 2 and 3 (August 17, 2006); Comments of Time Warner in Response to NOI No. 2 and NOI No. 3 (August 17, 2006); Comments of Valpak Direct Marketing Systems, Inc., and Valpak Dealer’s Association, Inc., In Response to Notice of Inquiry Nos. 2 and 3 (August 17, 2006). 24 UPS Response at 4; Valpak Response at 10; USPS Response at 8. See also, witness Kiefer’s response to POIR No. 5, question 3(a), Response of United States Postal Service to Presiding Officer’s Information Request No. 5, Questions 2-19 (June 29, 2006), Tr. 5/941-43.

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question. The Postal Service’s view is that the presort tree can never provide assurance

that all rate anomalies were uncovered.25 USPS Response to NOI No. 2, at 10.

With the introduction of shape-based rates and with the expansion of presort rate

categories, the presort tree’s usefulness as a guide becomes limited primarily to the rate

relationships that go down the branches of the tree (representing worksharing levels),

rather than between branches (representing shapes/mail processing categories).26

Witness Mitchell’s presort tree evidently also recognizes that the key relationships are

those that go down the branches, since his passthroughs are only calculated at the top

of each branch and not between rate cells further down adjacent branches, much less

between rate cells in non-adjacent branches.27

In any event, with the multiplication of rate categories, the presort tree becomes

less useful. The expansion of Standard Mail rate categories, primarily with the

introduction of shape based rates, has expanded the number of branches in the presort

tree. It is no longer obvious which branches appropriately relate to each other.28

Moreover, the multiplication of rate categories in Standard Mail has led to a

multiplication of branches in the presort tree, so that the tree is no longer a simplifying

25 NOI No. 2 provides an illustration where the original 2 x 2 presort tree could be used to uncover a potential rate anomaly. Notice of Inquiry No. 2, at 3, n. 2. With the expansion of the presort tree to more than two branches (See USPS Response to POIR 5, question 3b, Tr. 5/943-45; or, see witness Mitchell’s workpaper, VP-LR-1, VP-RWM-Workpaper-8.xls, “Inputs” tab), not all presort levels are adjacent, so the capability of spotting rate anomalies between all rate categories is lost. 26 USPS Response to POIR 5, question 3a, Tr. 5/941-43. 27 See VP-LR-1, VP-RWM-Workpaper-8.xls, “Inputs” tab. See also, PSA’s comment that the traditional presort tree can be misleading when used to calculate cost recognition ratios (passthroughs) between some shapes. PSA Response to NOI No. 2 at 3. 28 USPS Response to NOI No. 2, at 9, n. 9,12-13. See also, USPS Response to POIR 5, question 3b, Tr. 5/943-45.

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visual tool. Indeed, witness Mitchell’s Regular subclass presort tree spans three pages

of his testimony (VP-T-1, at 131, 147, 158), with the whole tree spreading over 15

columns of his Inputs worksheet. While the presort tree may once have been a simple

tool, witness Mitchell’s complex web of cells and arrows show that the presort tree has

morphed into a sprawling mass.29

The Postal Service does not deny that the presort tree may have some use.30

But, if a presort tree is developed, it should have multiple benchmarks.31 Furthermore,

while the Postal Service proposes that any presort tree that is used for Standard Mail be

set up with multiple benchmarks, that does not mean that the benchmark rates should

be set in isolation, or without regard to relative costs or other interrelationships.32

In fact, witness Mitchell’s own rate design, in effect, consists of a multiple

benchmarks approach. While his Regular subclass rates do tie back mathematically to

his minimum-per-piece rate for an origin-entered nonautomation flat (see VP-LR-1, VP-

RWM-Workpaper-8.xls, “Inputs” tab), this tie apparently exists only as a formality. For

29 See VP-LR-1, VP-RWM-Workpaper-8.xls, “Inputs” tab. 30 USPS Response to NOI No. 2, at 8. 31 UPS Response to NOI Nos. 2 and 3, at 4; USPS Response to NOI No. 2, sections 4 and 5; USPS Response to POIR 5, question 3a, Tr. 5/941-43. Consider also the implication of PSA’s comment, “[t]he ‘presort tree’ approach remains appropriate for evaluating worksharing discounts within a mail shape.” PSA Response to NOI No. 2, at 2. Also, while not explicitly endorsing multiple benchmarks, Valpak comes relatively close to the Postal Service’s position when it comments on the use of multiple, less complex, trees organized along the same shape or product definition. Valpak Response to NOI Nos. 2 and 3, at 10-11. 32 See USPS Response to NOI No. 2, at 13-16. See, in particular, page 16 of the response:

As these several examples show, the multiple benchmark approach does not set benchmark prices in arbitrary or unconstrained fashion. Cost and non-cost relationships between the separate trunks were given appropriate consideration as they always have, despite the evolution of the model from the traditional single-trunk to a multiple-trunk framework.

Id.

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example, witness Mitchell argues that the estimated cost differential between letters and

flats should properly be marked up by the subclass cost coverage when passed through

into rates. See VP-T-1 at 118. This would mean a passthrough of the letter-flat

differential of 180 percent under witness Mitchell’s proposed cost coverage. VP-T-1 at

97. Yet, despite his theoretical arguments, he actually proposes only a 95 percent

passthrough. VP-T-1 at 119.

The wide disparity between witness Mitchell’s “theoretical” passthrough and his

actual proposal is de facto evidence that even witness Mitchell recognizes that the rates

for letters and flats must be developed based upon consideration of a host of factors

other than simple cost differences. In reality (as opposed to theory), letters and flats are

priced separately, yet with appropriate consideration given to cost and rate relationships

between the two categories. Both witness Mitchell and witness Kiefer derive separate,

judgmental flats and letters “benchmarks.” The essential difference between the Postal

Service’s approach and witness Mitchell’s is that witness Mitchell presents his flats and

letters benchmarks via a cost and passthrough framework, whereas the Postal Service

does not.

j. The Postal Service’s proposal for an alternative approach for

charging for Standard Mail Forwarding is unopposed, and should be recommended.

The Postal Service proposes a new approach for calculating postage due for

forwarded Standard Mail letters and flats, when electronic or automated address

correction service is requested. Using information provided by mailers in the keyline or

barcode, the Postal Service would be able to charge them for each mailpiece that is

forwarded. This new approach would provide an alternative to the application of a

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multiplicative factor to the postage due on the pieces returned to the mailer, as

described in DMCS 353. USPS-T-40 at 47.

Witness Mitchum proposes rates of 35 cents and $1.05 cents, respectively, for

forwarded Standard Mail letters and flats. He applies a cost coverage of 230 percent,

similar to that for First-Class Mail, to the costs for forwarding Standard Mail letters and

flats derived from the Undeliverable as Addressed costs sponsored by witness Cutting

(USPS-T-26, Appendix A). Witness Mitchum also proposes notes to Rate Schedules

321, 322, 323, and 324, along with the appropriate classification changes to amend

DMCS 353, and add DMCS 321.9, 322.9, 323.9, and 324.9. USPS-T-40 at 47-51. All

of these proposals are unopposed, and should be recommended.

5. Intervenors’ Pricing Proposals

a. The proposed parcel and NFM price increases are not unreasonably high, and the Commission should reject the opposition to, and alternatives for, the Postal Service’s Standard Mail shape-based rate proposals.

i. Witness Glick’s criticisms on behalf of PSA/PostCom

do not withstand scrutiny.

Witness Glick criticizes the Postal Service’s parcel pricing because he claims it

passes through more than 100 percent of the estimated cost difference between parcels

and flats. PSA/POSTCOM-T-1 at 3-4. Witness Glick’s position is equivalent to asserting

that unit contributions should be the same for both flats and parcels, or that the efficient

component-pricing (ECP) rule should apply to shape-based cost differences. USPS-RT-

11 at 8-9.

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Witness Glick’s position misapplies the ECP rule. The ECP rule does not apply

to shape-based cost differences as it can to worksharing cost differences. USPS-RT-11

at 9; NAA-T-1 at 11. USPS Response to NOI No. 2 at 4. Passthroughs of shape-based

costs that exceed 100 percent do not necessarily indicate economically inefficient

pricing or price discrimination. USPS-RT-11 at 9. USPS Response to NOI No. 2 at 3-8.

The ECP rule is only applicable for pricing worksharing activities where a mailer

performs some activity that the Postal Service would otherwise have performed and the

Postal Service avoids doing that work. In the case of shape-based cost differences

there is no outsourced work component that can be priced, so the ECP rule cannot be

applied. NAA-T-1 at 11-12; USPS Response to NOI No. 2 at 3-4.

Despite witness Glick’s criticism, the Postal Service’s proposals reasonably

recover the volume variable costs of parcels plus make a reasonable contribution

toward the Postal Service’s institutional costs. Witness Kiefer, on cross examination,

pointed out that the cost coverage for Standard Mail parcels under his proposals would

only be 116 percent. Tr. 5/1121.

Glick cannot appeal to ECP or any sound theory to support his preference for

limiting the recognition of flat-parcel cost differences to 100 percent. Moreover, the

Postal Service’s methodology produces reasonable contributions for parcels. Witness

Glick’s criticism should be rejected. USPS-RT-11 at 10.

Witness Glick testifies that the Postal Service’s proposed rate increases for

parcels are too large and may be larger than the Postal Service estimates.

PSA/POSTCOM-T-1 at 4-5. Witness Glick’s testimony ignores several important

considerations that serve to justify the rate increases and mitigate the impact of rate

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increases on customers. First, parcels are not now covering their costs. Tr. 5/1124-5. It

is reasonable and fair to ask these mail pieces to cover their costs and make a

reasonable, yet modest, contribution to institutional costs. Tr. 5/1121-2. Second, when

mail pieces that are not covering their costs are reclassified, higher than usual rate

changes should be expected. USPS-RT-11 at 7. Third, the Postal Service has already

significantly mitigated the potential impact on mailers and the rate increases proposed

could have been much higher. USPS-RT-11 at 6-7. Fourth, the Postal Service’s parcel

proposals contain deeper drop-ship options and higher drop-ship discounts than are

available to flats, both of which can reduce the impact of the price changes on mailers.

USPS-T-36 at 18-19; USPS-T-36 at 20-21. See, also USPS-LR-L-36, WP-STDREG-27.

Nevertheless, the Postal Service believes that the Commission will exercise its

judgment on the appropriate level of rate mitigation to apply. USPS-RT-11 at 7. The

Postal Service’s principal goal in proposing parcels rates in this docket is to establish

separate classifications with meaningful price differentials that lead to the efficiencies

that were the intention of the proposed changes. USPS-RT-11 at 6.

Witness Glick criticizes the Postal Service’s parcels cost data as having

“substantial uncertainty” and testifies that the proposed rate increases for parcels are

too high in light of that uncertainty. PSA/POSTCOM-T-1 at 5-8. Witness Horowitz joins

in the criticism, but merely cites witness Glick and provides no independent analysis of

his own. POSTCOM-T-6 at 9.

Witness Kiefer has acknowledged that the Postal Service’s data are imperfect,

but points out that this fact, while true for all data estimates, does not make them

unreliable. Tr. 5/1126, Tr. 33/1102-3, 1093-4, 1092. Moreover, in fact, postal witness

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Smith made adjustments to improve the parcel cost estimates. USPS-T-13, pages 34-

35.33 While witness Glick suggests that the parcels cost data have “substantial

uncertainty,” neither he nor any other witness has provided record evidence to show

that the Postal Service’s cost estimates are high—they could just as well be too low. Tr.

5/1125 . While witness Glick tries to insinuate that the data used are too high by citing

some anomalous data for Standard Mail ECR parcels (PSA/POSTCOM-T-1 at 6), he

concedes that this anomalous data was not used by the Postal Service to price

Standard Mail parcels. USPS/PSA-POSTCOM-T1-2.

The rates proposed for Standard Mail parcels reflect significant mitigation of cost

data. USPS-RT-11 at 6. Witness Glick suggests that the rate increase should be

mitigated further, but provides no evidence to prove that any potential errors in the data

are not already adequately addressed by the Postal Service’s prior mitigation efforts.

Witness Glick argues that data imprecision should lead to a limit of 30 percent on

rate increases. PSA/POSTCOM-T-1 at 8-9. But he supplies no rationale to tie these

two notions together. Merely suggesting data imprecision without giving any evidence

that the imprecision is material is insufficient grounds for limiting necessary rate

increases. Witness Glick suggests that greater cost-precision should be required for

33 Witness Glick argues that the adjustment done by Postal Service witness Smith (shifting the 23 percent of the parcel costs to flats) is too small. PSA/PostCom-T-1 at 7-8. Witness Glick proposes an alternative, larger, adjustment, based on POSTNET barcodes. Id. His suggested alternative is inappropriate, however, because there is no demonstrated link between the presence of POSTNET barcodes and flats rated pieces. See Tr. 14/4268-69, 4275, 4283-84, 4290-92 (Note: The second page of witness Smith’s revised response to PSA/USPS-T13-6, revised 8/22/06, which should appear behind page 4275 in the transcript, is missing. The page which appears as 4276 is actually the second page of the previous response, PSA/USPS-T13-5, also revised 8/22/06.) Witness Smith’s adjustment is reasonable and consistent with available evidence (Tr. 14/4280, 4290-4292), and Mr. Glick’s alternative proposal should be rejected.

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large rate increases. PSA/POSTCOM-T-1 at 5. But that argument is a two-edged

sword: suggestion is not enough—witness Glick offers no evidence to indicate that the

costs are substantially overstated, or even that they are not understated. If his proposal

to limit the rate adjustments to 30 percent on the basis that data are imprecise is to be

taken seriously, he needs to clarify his own cost-precision threshold by showing just

how imprecise they are and that his 30 percent cap is appropriate, rather than a 40, 50,

or 60 percent cap. Witness Glick does not provide any evidence that the remedy is at

all appropriate to the alleged data imprecision. Ironically, his own claims and assertions

are, at best, imprecise and should be rejected.

Witness Glick proposes that Standard Mail parcel rate increases should be

limited to a maximum of 30 percent because the Postal Service used a 30 percent

increase cap when designing Parcel Post rates. PSA/POSTCOMT-T-1 at 8-11.

Witness Glick’s proposal is flawed for two reasons. First, there is no evidence that

Parcel Post rate categories are not covering their costs, whereas this is not the case for

Standard Mail. Tr. 5/1124-25. When a mail category that is not covering its costs is

reclassified, larger rate increases should be expected. USPS-RT-11 at 7. Furthermore,

the application of the 30 percent rate increase cap is not rigid, even in Parcel Post.

There are certain rate cells for Parcel Post where the rate increases exceed 50 percent.

USPS-RT-11 at 7, footnote 2.

Second, while witness Glick’s testimony focuses on the percentage change, it

ignores the base entirely. Tr. 5/1117, 1118. A 50 percent increase on an 80-cent

parcel is a postage increase of only 40 cents. In contrast, the current rate for a one-

pound DBMC Zone 3 machinable parcel is $2.38. ATTACHMENT A to Request, page

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43. A 30 percent increase for this piece is 71 cents, much higher than the postage

increase on an 80-cent Standard Mail parcel receiving a 50 percent increase.

Witness Glick’s proposal to “borrow” the rate design elements from one class of

mail to use in another is ill-advised. Different circumstances apply to different classes of

mail and Glick offers no rationale why design elements from Parcel Post are appropriate

to use in Standard Mail. USPS-RT-11 at 7. His proposal is flawed and should be

rejected.

Witness Glick asserts that NFM data are less reliable than Standard Mail parcel

data. He then claims that this provides an even stronger reason to limit the NFM rate

increases than the arguments in favor of limiting the parcels rate increases.

PSA/POSTCOM-T-1 at 11-13. Witness Glick’s testimony regarding the reliability and

uncertainty of Postal Service NFM data suffers from the same flaws as his testimony on

the uncertainty of parcel data. Virtually all Postal Service data of any complexity have

some uncertainty and contain a margin of error. While imprecise at some level, the data

used were not unreliable. Tr. 5/1126, 1102-3, 1093-4, 1092. Moreover, witness Glick

has not provided record evidence to show that the Postal Service’s NFM cost estimates

are too high—they could just as well be too low. Tr. 5/ 1125.

As with parcels, the rates proposed for Standard Mail NFMs reflect significant

mitigation of cost data. USPS-RT-11 at 6. Witness Glick suggests that the rate

increase should be mitigated further, but provides no evidence to prove that any

potential errors in the data are not already adequately addressed by the Postal

Service’s prior mitigation efforts.

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Witness Glick’s testimony ignores the fact that the reasons for increasing NFM

rates are even stronger than for parcels. These pieces do not even pay the residual

shape surcharge today (like current “parcels” do), but they are typically processed in the

parcels mail stream. USPS-T-3 at 21-2. Moreover, the UFSM1000 machines are being

redeployed, so that the original justification for granting these pieces automation flat

rates has vanished. USPS-T-36 at 22, footnote 11.

Witness Glick further asserts that the Postal Service doesn’t know very much

about NFM volumes and presort breakdowns. PSA/POSTCOM-T-1 at 11-13. The fact

that the Postal Service estimates of volumes by presort level are imprecise is a red

herring. Witness Kiefer uses estimates of volumes to estimate revenues, not in

designing rates. See USPS-LR-L-36, WP-STDREG-30, 31, 32. Witness Glick fails to

provide any convincing evidence that imprecise volume estimates should be a reason to

mitigate rate increases. In fact, if the goal is not to leave the Postal Service short of

funds, the presence of imprecise volume estimates would rather support higher

increases, just in case revenues projected from imprecise volumes have been

overstated. Witness Glick’s criticisms of the reliability of NFM data fails for the same

reasons as his criticisms of parcels data and should be rejected.

ii. Witness Knight’s and witness Horowitz’ claims that

the proposed parcel and NFM rates will have adverse impacts on their businesses are not necessarily disputed, but are an insufficient reason to reject needed price adjustments.

Witness Knight and witness Horowitz assert that the Postal Service’s proposed

increases for Standard Mail parcels and NFMs will make it uneconomical to deliver mail

order purchases using the Postal Service. Current mailers, they say, will either go out

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of business, reduce the number of parcels shipped, or use other shippers. Doing this

would, in turn, lead to lower usage of the mails for advertising and customer acquisition.

POSTCOM-T-7 at 2; POSTCOM-T-6 at 2, 6, 7-8.

The Commission should note that these mailers’ testimonies do not oppose the

proposed classification changes that de-average Standard Mail nonletters into separate

flats, parcels and NFM categories with their own rate designs, only the size of the

proposed increases. See, for example, POSTCOM-T-6 at 9. The Postal Service is

aware that its proposed increases may have a major impact on some mailers. USPS-

RT-11 at 7. Nevertheless, these parcels and NFMs have not been adequately covering

their costs. Both the need to have these pieces appropriately priced and the need for

appropriate mitigation were taken into account when the rates were developed. USPS-

RT-11 at 6. The result of these considerations is that the Postal Service’s proposals

contain significant rate change mitigation. USPS-RT-11at 6-7.

Witnesses Knight and Horowitz argue that the higher parcels and NFM rates

might result in reduced volumes of parcels or NFMs. Yet they fail to explain any

economic rationale for the Postal Service to continue to maintain or expand volumes in

rate categories that lose money. They do not explain why the Postal Service would not

be better off to handle a smaller volume of parcels that cover their costs rather than

larger volumes of money-losing pieces.

Both witnesses also suggest that higher parcel and NFM prices might lead their

businesses to seek alternate means to deliver their products and to reduce the amount

of other mail categories used for marketing. See, for example, POSTCOM-T-7 at 9-10;

POSTCOM-T-6 at 8. While these arguments appear alarming, they lack merit: they fail

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to demonstrate why it makes economic sense for mailers to curtail economically

productive promotional activities just because they are using alternative delivery

channels. It is rational for mailers to use the most cost-effective promotional means.

Witnesses Knight and Horowitz fail to explain why the choice of an alternate delivery

system should rationally lead their businesses to avoid advertising mail if the most cost-

effective promotional mix includes advertising mail.34 Conversely, if mailers find

alternative promotional channels to be more cost-effective, the Postal Service doesn’t

expect that a freeze in parcels rates would dissuade them from replacing mail with

electronic substitutes for promotional purposes. See USPS/POSTCOM-T6-13.

All price increases are expected to have some impacts on mailers. Witnesses

Knight and Horowitz have failed to demonstrate why the adverse impacts they foresee

should forestall needed price adjustments for Standard Mail parcels and NFMs. The

Postal Service understands that the degree of rate increase recommended by the

Commission is a matter of judgment. USPS-RT-11 at 7. Yet it reminds the Commission

that the rates it has proposed are already significantly mitigated to soften the impact on

mailers. USPS-RT-11 at 6.

Witness Horowitz claims that the Postal Service’s enhanced discounts for drop-

shipping and finer presorting will not work for some mailers, if their volumes are

insufficient to take advantage of these discounts. POSTCOM-T-6 at 2, 6, 7. Witness

Horowitz’ testimony fails to justify rolling back the Postal Service’s proposed parcel

pricing on two grounds. First, he claims that “few, if any, mailers can benefit from the

34 In spite of the Postal Service’s proposed rate increases, the proposed rates are still below the rates charged by alternate delivery services. USPS/POSTCOM-T6-10b; USPS/POSTCOM-T6-14. Witness Horowitz has also testified that the proposed rates are significantly below Cosmetique’s shipping charges. USPS/POSTCOM-T6-18.

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DSCF and DDU discounts” proposed by the Postal Service. POSTCOM-T-6 at 2.

Witness Horowitz provides no evidence whatsoever that this assertion is true. He has

presented no surveys of the mailing community, or other data, to support his claim.

Simply put, the record lacks any evidence that this assertion is anything other that

witness Horowitz’ opinion, extrapolated from his own company’s experience. Second,

witness Horowitz’ claim that his company cannot take advantage of the enhanced drop

ship discounts represents no new information. It has always been the case that some

mailers do not have the volumes needed to take advantage of the Postal Service’s drop

shipment discounts directly. It is well known that intermediaries exist to offer mail

consolidation services for such mailers. Cosmetique’s inability to achieve finer presort

and drop ship levels on its own is insufficient grounds to reject needed parcel price

adjustments. Witness Horowitz’ arguments lack merit and should be rejected.

Witness Horowitz claims that the Postal Service does not provide evidence that

costs increase linearly by shape and weight, so not to consider the revenue differences

between flats and parcels is both economically irrational and unfair. POSTCOM-T-6 at

9-10.

Witness Horowitz’ claim recalls witness Glick’s recitation of the Commission’s

statement in NOI No. 2 that “it is often difficult to separate the cost effects of shape from

weight.” PSA/POSTCOM-T-1 at 3. Yet witness Horowitz goes on to extend this

statement in a way that is completely unsupported. Mr. Horowitz offers no explanation

why the linearity of the relationship has anything to do with charging more for heavier

weight pieces, or whether it would matter if the Postal Service had demonstrated that

the costs for parcels were to increase, for example exponentially, rather than linearly,

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with weight. Furthermore, witness Horowitz provides no justification for his assertion

that increasing rates for heavier weight pieces is unfair. Following witness Horowitz’

reasoning, the pound rate should be totally abolished for both flats and letters and the

difference between flats and parcels should be a fixed charge. Given the Commission’s

reluctance to lower the pound rate even moderately absent substantial evidence that it

should be lowered (e.g., Op.&Rec.Dec., R2000-1, at pg. 362-393), Horowitz’s statement

seems to turn the Commissions past reasoning on its head. In any event, there is

nothing on the record to support anything other than a linear pound rate.

iii. Witness Wilbur’s proposal that the rate changes for

parcels should be implemented gradually fails to address the many issues that need to be considered before phased rates can be recommended and so should be rejected.

Witness Wilbur’s testimony states that the Postal Service’s proposed rate

increases are too sudden and proposes that they should be implemented gradually.

MBI-T-1. The implementation of non-phased rates is a decision reserved by law to the

Board of Governors and is not a subject for decision in this rate case.

Witness Wilbur is essentially requesting the Commission to recommend phased

rates. The Postal Service has not requested the establishment of phased rates in this

case and there is no evidence on the record for the Commission to consider and decide

the many issues that establishment of phased rates would open up. There is simply no

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basis for the Commission to make a decision on phased rates in this docket. Witness

Wilbur’s proposal should be rejected.

iv. Witness Angelides’ testimony that the price elasticity of Standard Mail parcels may be different from the subclass average is insufficient to support an alternate rate proposal.

Witness Angelides testifies that there is reason to believe that, in terms of

response to price changes, Standard Mail Regular parcels may behave differently from

letters or flats. POSTCOM-T-4 at 3 – 10. As discussed previously in this brief in the

section on volume forecasting, as a general theoretical proposition, witness Angelides’

claim of differing elasticities may well be true, since subclasses include broad ranges of

mail pieces. But witness Angelides has not demonstrated that his claim for Standard

Mail Regular parcels could not also be claimed for almost any identifiable subgroup of

mail.35 Furthermore, his testimony begs, and fails to answer, the critical questions:

what are the consequences for pricing, and what can and should be done about it? For

example, discovering that parcels have a higher elasticity than anticipated might prompt

movement to raise parcels’ prices even higher, in order to achieve the same given

35 Witness Angelides suggests that the higher Parcel Select price elasticity is a

reasonable proxy for the Standard Mail parcels elasticity. POSTCOM-T-4 at 6 – 7. The earlier section of this brief regarding forecasting explained why this suggestion is not persuasive. One of the reasons cited by Dr. Angelidies to support his claim is witness Kiefer’s testimony that one goal of the Postal Service is to facilitate merger of Standard Mail parcels into a general parcel class. Id. at 6. But there is no reason to equate witness Kiefer’s mention of the Postal Service’s desire to simplify its parcel offerings with the idea that the Postal Service considers the market price responses of all groups of parcel products that might be consolidated to be the same. Dr. Angelides’ testimony fails to provide adequate evidence to conclude that Parcel Select and Standard Mail parcel categories are sufficiently alike, though in separate subclasses, that the Parcel Select price elasticity should be used for Standard Mail parcels. His suggestion in that respect should be rejected.

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target contribution. See, for example, the discussion of pricing a price elastic product,

VP-T-1 at 47, especially the conclusion at line 18.

Witness Angelides is correct that the Postal Service does not have enough data

at present to develop parcels forecasts comparable to forecasts developed for certain

other rate categories. USPS-T-36 at 21-22; POSTCOM-T-4 at 3, 8-9. With the Postal

Service’s new, separate rate design for parcels, these kinds of data should become

available, and specific forecasts may be available at some time in the future. USPS-T-

36 at 17. Witness Angelides’ criticism that the Postal Service’s Regular subclass

elasticity may not apply perfectly to parcels within the subclass does not, in itself,

support changing the Postal Service’s proposed rates.

b. ECR proposals.

i. NAA witness Ingraham’s criticism of the ECR rate design is without merit

NAA, through the testimony of witness Ingraham, NAA-T-2, criticizes three

aspects of the Postal Service’s rate design for ECR flat mail. First, witness Ingraham

argues that the Postal Service’s proposed rate differential between ECR Saturation

Flats and High Density Flats is unreasonable and conflicts with ECP. He maintains that

the price difference between the two rates is 2.2 cents, while the cost differential is only

0.1 cent. Id. at 7, 8-10. Second, he states that the Postal Service’s rate design is

flawed because witness Kiefer makes an unrealistic assumption regarding future DAL

usage and therefore the proposed DAL surcharge cannot be considered a reasonable

“offset” for the proposed High Density / Saturation flats rate differential. Finally, he

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argues that the ECR pound rate should be kept at its current level. He then proposes

an alternate set of rates. These arguments have no merit and his rate design is flawed.

Witness Ingraham’s estimate of the cost differential between High-Density and

Saturation flats is too low. It is based on de-averaging the Basic-High Density delivery

costs but using the same combined mail processing cost for High Density and

Saturation flats. Id. At 18, fn. 21; Tr. 24/8725; Tr. 24/8718. ECR flats are already

sorted to carrier routes, so the predominant mail processing costs would be material

handling and movement. And, since High Density flats have (by definition) fewer pieces

to a carrier route (cf. DMM 245.6.9.2 to DMM 245.6.9.4), it is likely to have relatively

higher mail processing costs than Saturation flats. Witness Ingraham ignores this.

Therefore, his pricing approach is flawed using his own criteria: he is failing to reflect

the true cost differences.

Dr. Ingraham’s use of deaveraged delivery costs, yet combined mail processing

costs, weakens or invalidates NAA’s alternate proposed rates that he presents for High-

Density and Saturation flats, including his 1.4 cent alternate DAL surcharge proposal.

Despite his claims (NAA-T-2 at 7) that he is passing through 100 percent of cost

differences (and that witness Kiefer passes through more than 100 percent ), he fails to

do so, since he makes no acknowledgment that using average mail processing costs

understates true cost differences (See USPS-LR-L-36, WP-STDECR-1, INPUTS [8] and

[9]). Under these circumstances, a passthrough other than 100 percent may be

appropriate.

Witness Ingraham (NAA-T-2) supports the proposal for a separate charge for

DALs . Id. at 11. Dr. Ingraham, however, criticizes Postal Service witness Kiefer’s

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(USPS-T-36) assumption that no current DAL users will change their behavior and all

will pay the proposed DAL surcharge. For this reason, witness Ingraham maintains that

the proposed DAL surcharge cannot be considered a reasonable “offset” for the

proposed High Density / Saturation flats rate differential. He maintains that Witness

Kiefer’s rate design is therefore flawed. NAA-T-2 at 11-16.

Witness Ingraham misinterprets witness Kiefer’s plainly stated rationale for his

no-change assumption. The assumption was made solely for the purposes of estimating

net revenue—so that the cost and revenue assumptions for DALs would be consistent

with each other. Tr. 5/1007. The rate design does not depend on the level of DAL

usage, as can be seen by witness Kiefer not changing the rate design when he changed

his usage assumption. (See original LR-L-36, WP-STDECR.XLS versus revised WP-

STDECR-R0621.XLS). Witness Ingraham was asked to explain the rationale for

changing the rate design because of a change in his assumption about DAL usage. He

merely asserted that this was a relevant factor without providing any evidence or

argument that it was, in fact, relevant. Tr. 24/8733. Witness Kiefer also states that it is

likely that there will be mailers switching from DALs, but that the switch would, in

parallel, reduce costs. Tr. 5/1008. Finally, Dr. Kiefer explained that the modest rate

increase proposal for Saturation flats took into consideration the impacts of the on-piece

addressing requirement (to avoid the surcharge) on mailers—as a cost mitigation effort.

See Tr. 5/1079-80; also see SMC-T-1 at 10-12. Moreover, witness Ingraham agrees

that it is legitimate to take non-cost factors into consideration (e.g. impact of a price on

mailers) in developing rates. Tr. 24/8731.

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Finally, witness Ingraham argues that since there is no record evidence

explaining why the pound rate was changed, it should be kept the same. NAA-T-2 at 18,

ln. 8-11. Witness Ingraham’s argument is facile and self-serving. Witness Kiefer

discussed the minor adjustment to the pound rate. Tr. 5/901, 909. The rationale was in

keeping with past Postal Service efforts to adjust the ECR pound rate lower—which

were recommended by the Commission. Op.&Rec.Dec, R2000-1, at pg. 359. As SMC

witness Crowder (SMC-RT-1) points out, witness Ingraham has not attempted to show

quantitative support for his proposed pound rate, nor has he assessed its impact on the

market. SMC-RT-1 at 14. Indeed, she testifies that his high pound rate would unfairly

favor letters over flats. Id. at 15.

NAA’s witness Ingraham proposes two alternate rate designs, based solely on

the response to the DAL surcharge. Tr. 24/8733. His proposals would lead to an odd

rate relationship in which the rates for saturation flats using DALS will be higher than the

rates for High Density Flats. It would be preferable to avoid such a relationship.

ii. Valpak’s argument that the ECR basic letter rate should be decoupled from the Standard Mail Regular rates is without merit.

Valpak witness Mitchell (VP-T-1) challenges witness Kiefer’s rate design for ECR

basic letters by arguing that it should be decoupled from the Standard Mail Regular

rates. Id. at 121-122. He states that the USPS pricing proposal ignores the cost

differences between ECR Basic letters and flats, and sets the letter rate equal to the

flats rate without justification. Id. In the view of witness Mitchell, witness Kiefer’s

comments that this rate design would support the Postal Service’s goal of promoting

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automation and sequencing of letters at plants is an inadequate explanation. Id. at 121.

Witness Mitchell argues that, in its Opinion in Docket No. R2005-1, the Commission

“found persuasive” witness Mitchell’s arguments for decoupling the ECR Basic letter

rate from the Regular 5-digit Automation rate and expanding recognition of the cost

differences between letters and flats at the ECR Basic level. Id. at 39, fn. 16 and at

116-117.

The Postal Service understands the Commission’s concerns and general

preference for recognizing cost differences in rates where there are not overriding

reasons not to. The Postal Service believes that in this case there are strong reasons to

keep ECR Basic letter rates below Regular Automation 5-digit rates. These reasons

have been discussed thoroughly in the past. Op.&Rec.Dec., Docket No. R2000-1, at

pg. 359-62. The Postal Service’s position has not changed in this docket. Witness

Kiefer has reiterated the Postal Service’s concerns that setting the ECR Basic letter rate

below the Automation 5-digit rate would provide mailers with an incentive to prepare

smaller containers of carrier route letters. Tr. 5/920. Since the Postal Service has a

major goal of sequencing as many letters as possible in its plants (USPS-RT-14 at 3-6),

giving mailers a price incentive to prepare relatively higher cost carrier route letter

bundles or containers rather than lower cost full 5-digit trays of letters would only serve

to frustrate that goal. The pricing mechanism advocated by the Postal Service to

achieve its goal is appropriate. Witness Mitchell concedes that because the Automation

5-digit rate is cheaper than the ECR Basic rate, automation compatible letters have

largely migrated to the Automation 5-digit rate, leaving largely non-automation

compatible letters in the ECR Basic category. Tr. 25/8999. To the extent these pieces

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are not compatible with the Postal Service’s automation equipment, they have to be

cased manually. For this reason, it is reasonable to price them similarly. Finally,

witness Mitchell uses the Commission’s Opinion that his “arguments” in Docket No.

R2005-1 on this topic were “persuasive.” But, apparently, witness Mitchell has

abandoned at least one of his key arguments from the last rate case in this docket. In its

Docket No. R2005-1 Opinion, the Commission summarizes his argument:

Mitchell believes that the Service is implying that if the ECR rate were lower, automation mail would migrate from Regular 5-Digit Automation to ECR Basic and no longer bear a barcode. Witness Mitchell asserts that this possibility is unlikely because mailers would need much higher density to use ECR basic rather than Standard Regular 5-digit, and the two groups of mailers are “different in kind” from one another. Op. Para. 6068.

In the current docket, Mr. Mitchell seems to be backing away from this

“persuasive” argument. In his testimony he asserts that ECR Basic letters should pay

rates at a level that recognizes “their characteristics and their costs, in line with

accepted ratesetting principles. Once this is done, mailers should be allowed to decide

what mail to send and what rate categories to use, and the Postal Service should be

happy to process the resulting mail.” VP-T-1 at 121. This newer argument implicitly

acknowledges that setting ECR Basic letter rates as Mr. Mitchell recommends would

likely induce mailers to “decide…what categories to use.” Presumably they would

decide to migrate from Regular 5-digit Automation to ECR Basic, at a higher cost and

lower revenue to the Postal Service. And, despite witness Mitchell’s picture of the

Postal Service happily accepting whatever mail is tendered regardless of the impact on

automation goals, the Postal Service does, not surprisingly, prefer to handle mail in the

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most efficient manner possible. It therefore does not want to offer incentives that would

result in less efficient processing.

Witness Mitchell also argues that one of the consequences of setting the ECR

Basic letter rate above the 5-digit automation letter rate is that it has the effect of

pushing up the rates for High Density and Saturation letters also. Id. at 122. Witness

Mitchell qualifies this argument by saying this would be the outcome unless an

“extraordinary” adjustment is made. He then goes on to admit that witness Kiefer did

adjust the passthrough between ECR Basic and High Density letters costs to offset the

exogenous setting of the ECR Basic letter rate equal to the ECR Basic flat rate. Id.

Notwithstanding Witness Mitchell’s description, there is nothing extraordinary

about this adjustment. It is simply common sense to adjust the passthrough to limit the

impact of the policy decision to support the letter automation program to Basic letters

only.36

36 Saturation Mailers Coalition and ADVO, Inc. witness Crowder (SMC-RT-1)

supports the ECR rates proposed by the Postal Service. SMC-RT-1 at 2. However, noting that Valpak witness Mitchell (VP-T-1) and Newspaper Association of America witness Ingraham (NAA-T-2) propose ECR rate designs that, in her words, "have a severe bias against Saturation flat mailers," SMC-RT-1 at 1, 10, she presents an alternative set of ECR rates with, among other features, a lower on-piece addressed Saturation flat-rate. SMC-RT-1 at 2, 17-19. She argues that "[i]f the Commission decides it must make changes to the USPS-proposed ECR rates, then it should make them in this direction." SMC-RT at 6. Insofar as witness Crowder supports the Postal Service's ECR rates, the Postal Service does not deem it necessary, at this time, to critique her proposed alternative in detail. However, it bears noting that the Postal Service does not agree with the application of ECP principles to hold that each shape-density rate category should generate the same average piece contribution to institutional cost. SMC-RT-1 at 15. While ECP principles may warrant consideration on matters, such as presorting, where the mailer and the Postal Service can perform the same function, shape is different. A mailer can decide to alter the shape of a mailpiece. The Postal Service cannot do so.

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c. Drop-ship alternate rate design.

i. Intervenor proposals to increase Standard Mail letter and flat dropship passthroughs to 100 percent fail to address adjustments already made in the rate design for lightweight pieces.

Postcom witnesses Glick (Postcom-T-1) and Pursley (Postcom-T-2) propose a

simplistic application of efficient component pricing to the dropship cost differences for

Standard Mail letters and flats, with resultant passthroughs of 100 percent. Witnesses

Glick and Pursley support these proposals by claiming they will encourage palletization

and reduce container handling costs. Postcom-T-1 at 3; Postcom-T-2 at 6. Witness

Glick adds that greater palletization constitutes “a major USPS goal.” Postcom-T-1 at 3.

Both witnesses also point to the Postal Service’s Evolutionary Network Design (END)

initiative, claiming that mailer costs will increase because of the need to drop mail at

additional DBMCs. Postcom-T-1 at 2-3, Postcom-T-2 at 6.

Neither witness addresses why the Postal Service proposes passthroughs for

DBMC, DSCF and DDU pieces as 87, 85 and 85 percent, respectively. Witness Kiefer

states that the passthroughs “were adjusted as needed to maintain reasonable rate

relationships between the different rate categories.” USPS-T-36 at 14. He goes on to

state:

The less than 100% passthrough for the destination entry savings reflects, in part, the fact that piece-rated pieces (of all shapes) are given discounts for drop shipping as if they weighed 3.3 ounces, regardless of their actual weight. Despite this reduced passthrough, I have increased all destination entry discounts from current levels in my rate proposals. The drop-ship passthroughs selected are shown in my Proposed Rates worksheet in workbook WP-STREG.XLS (USPS-T-LR-36).

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Id. n. 6. Adjusting the passthroughs as Postcom proposes would amount to giving

double credit for the avoided costs. Tr. 5/912.

Postcom’s justifications are themselves weak, as well. First, what Postcom

proposes is essentially blanket application of efficient component pricing (ECP) to

dropship cost differences, while divorcing the pricing decision from the criteria of the

Act. Increasing those passthroughs to 100 percent, when the piece rates have already

been suppressed by using 3.3 ounces to calculate the discount, would not be fair and

equitable since the net effect would be a greater than 100 percent passthrough.

The Postal Service agrees that, on the whole, mailpieces entered on full pallets

closer to destination are less costly to deliver. But these facts do not themselves justify

mechanically decreasing rates for dropshipped pallets at the expense of origin entered

mail. So, while it costs the Postal Service less to process and deliver a mailpiece

entered nearer to its destination, witness Glick himself cites to the fact that 87 percent of

destination entered Standard Mail pounds are already entered on pallets. Postcom-T-1

at 3, n. 6, citing to library reference USPS-LR-L-88, Appendix C, Table 6. That

percentage is a consequence of existing rates and their passthroughs, and witness

Kiefer proposes to increase the passthroughs. So, 1) the desired mailer behavior

already occurs, 2) under discounts today that are smaller than those proposed by

witness Kiefer, and 3) somehow Postcom thinks that behavior can be increased with

even larger discounts. Postcom does not provide evidence – because it can not – that

its proposed increases in dropship discounts are necessary to avoid a decrease in

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destination entered mail. Increasing the dropship passthroughs will simply provide a

windfall to existing dropship mailers at the expense of origin mailers – who may not

have the necessary density to dropship anyway.

Postcom’s reliance upon the impact of END is similarly misplaced. Witness Glick

cites to an institutional interrogatory response regarding the impact of END in the test

year ((PSA/USPS-T42-1), see Postcom-T-1 at 2). PSA witness Finley similarly relies

on this interrogatory response, and in fact constructs an entire hypothetical study based

on the Postal Service’s statement that the parcel sorting activities currently conducted at

the Postal Service’s 21 BMCs and 7 ASFs will, under END, likely be carried out at from

28-100 RDCs. The fact is, the impact of END upon the test year simply is not known

with any specificity. See Tr. 18D/6616-23. There may be more DBMCs (id. at 3, no 6),

just as there may be fewer DSCFs. The test year savings the Postal Service will

achieve through END are also unknown. What is known is that the evidentiary record in

this docket does not provide any answers, nor does the record in Docket No. N2006-1.

In any event, dropship discounts are not based on mailers’ costs, so increasing the

dropship discounts because of mailers’ supposed increased costs, as both Postcom

witnesses argue, is not appropriate.

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ii. De-averaging of Standard Mail presort flats entails rate shock considerations that preclude recommendation of Postcom’s proposal to set the passthrough for the new 5-digit automation flats discount, a new rate category, to 100 percent.

Postcom witness Pursley proposes another simplistic application of efficient

component pricing (ECP) in setting the passthrough for the 5-digit automation flats

discount to 100 percent. Postcom-T-2 at 7-8. Witness Pursley relies on two arguments

to support the proposal. First, she resorts to the general tautology that bigger discounts

for finer presortation and deeper dropshipment increase the potential incentive for

mailers to perform those activities. Second, she claims that the Postal Service’s

installation of Flat Sequencing System will make the Postal Service more efficient in

handling flats.

Witness Pursley completely fails to address the reasoning applied by witness

Kiefer in proposing lower discounts for 5-digit automation flats. Witness Kiefer states:

In my flats rate design, I have selected the passthroughs for the various presort levels to mitigate somewhat the effects of de-averaging on rates. Without these adjustments the Mixed ADC and 3-digit presort rates would have been at even higher levels than I am proposing. As a consequence, the ADC and 5-digit presort levels will receive higher increases than if I had not mitigated the effects of de-averaging. Nevertheless, the rates for the ADC and 5-digit presort categories do increase significantly less than comparable Mixed ADC or 3-digit pieces. My rate design also gives flats the same per-pound drop ship discounts as letters. Details of these calculations and adjustments, including passthrough adjustments, are in the Proposed Rates worksheet of my workbook WP-STDREG.XLS (USPS-LR-L-36).

USPS-T-36 at 16-17.

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The 5-digit discount constitutes a new rate category created by de-averaging the

3-digit/5-digit rate. Whenever a rate is de-averaged, one rate is pushed up and the

other is pushed down. In this case, 3-digit auto flats are proposed to increase by 18.5 to

19.3 percent for minimum-per-piece pieces. At the same time, 5-digit pieces are

proposed to increase only 7.3 to 9.1 percent. To give 5-digit pieces 100 percent

passthroughs without increasing 3-digit rates more would mean reducing 5-digit rates.

The Postal Service’s view is that 3-digit rates are increasing as fast as is reasonable

and that 5-digit rates should not decrease when the overall average increase is above

10 percent. See library reference USPS-LR-L-36, workpapers WP-STDREG-26 and

WP-STDREG-27. Accordingly, witness Pursley’s proposal is at least premature, and

should definitely not be recommended.

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F. THE POSTAL SERVICE’S PACKAGE SERVICES RATE PROPOSALS SHOULD BE RECOMMENDED

1. Parcel Post a. The rates designed by witness Kiefer are reasonable and

supported by substantial record evidence.

The Parcel Post rates proposed by Witness Kiefer represent an average increase

of 13.8 percent, with a corresponding cost coverage of 115 percent. USPS-T-37 at 3.

On average, Inter-BMC Parcel Post rates would increase 13.1 percent, Intra-BMC rates

would increase 17.7 percent, and Parcel Select rates would increase 12.0 percent.

Within Parcel Select, average DBMC rates would change by 15.9 percent, DSCF rates

16.3 percent, and DDU rates 11.1 percent. Parcel Return Service RBMC and RDU

rates would increase 12.0 and 9.1 percent, respectively. Id. In developing the Parcel

Post rates, Witness Kiefer relied on cost estimates developed by witnesses Miller

(USPS-T-21) and Mayes (USPS-T-25). Id. at 8-16.

Witness Kiefer proposes to maintain the existing rate design with one minor

modification, in that all DBMC machinable parcels will be required to be barcoded, with

the cost savings from barcoding reflected in the rates instead of being separately stated.

Witness Kiefer also proposes raising the weight for balloon parcels from 15 to 20

pounds, in line with the changes proposed for Priority Mail by witness Scherer (USPS-T-

33). Id. at 7.

Witness Kiefer’s testimony provides an explanation of his rate design

methodology, as detailed in his workpapers. Id. at 8-16. He also explains the rate

change constraints and rate adjustment factors that he applied in order to mitigate

excessive changes between particular existing and proposed rates and to preserve

reasonable rate relationships between Priority Mail and Parcel Post on the one hand,

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and among the Parcel Post rate categories on the other. Witness Kiefer’s proposed

Parcel Post rates are supported by record evidence and merit recommendation by the

Commission.

b. UPS witness Luciani’s criticism of witness Kiefer’s rate design methodology is unfounded.

UPS witness Luciani (UPS-T-2) criticizes the Postal Service’s Parcel Post rate

design methodology for applying a markup factor to transportation costs by rate

category. The Postal Service’s methodology, according to witness Luciani, “marks up

transportation worksharing cost differences,” and he claims that this approach “is

directly contrary to sound Commission policy.” UPS-T-2 at 5-6. Witness Luciani’s

criticisms are, however, based on a flawed understanding of the Postal Service’s Parcel

Post transportation cost data.

Witness Kiefer’s rebuttal testimony (USPS-RT-11) explains that these categories

are not themselves pure worksharing categories for transportation purposes and that

they do not control for the differences in mail that use these five rate categories.

Accordingly, the differences in transportation costs between the different categories are

influenced by a variety of factors and cannot simply be identified as worksharing cost

avoidances, as witness Luciani does. See USPS-RT-11 at 11-12. Moreover, witness

Kiefer demonstrates why zone designations cannot be directly compared across these

Parcel Post rate categories. Id. at 12-13. Witness Luciani misidentifies the cost

differences between the average transportation costs for “workshared” and the average

transportation costs for “non-workshared” parcels as solely (or even primarily) due to

worksharing, and therefore as “avoided costs.” Id. at 14. As witness Kiefer explains,

“The Postal Service’s methodology is a reasonable way to approach the problem posed

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by the complex nature of Parcel Post rate categories.” Id. Moreover, despite witness

Luciani’s claim, the Postal Service’s approach is consistent with the Commission’s

precedent in Docket No. R2000-1. Id. Accordingly, witness Luciani’s critique should be

disregarded.

c. Witness Miller’s Parcel Post cost model is reliable and should not be used to justify a lower passthrough for Parcel Select.

As noted above, witness Kiefer relies on the test year mail processing cost

estimates, cost avoidances, and cost savings estimates for Parcel Post developed by

witness Miller (USPS-T-21). Witness Miller’s model updates and refines the study first

presented by witness Eggleston in Docket No. R2001-1. See USPS-LR-J-64.

Consistent with past practice, it employs a hybrid cost methodology to estimate the test

year mail processing unit costs for the Parcel Post rate categories, and more narrowly

tailored cost avoidance methodologies to estimate test year Parcel Select window

service cost savings, BMC presort mail processing cost savings, Origin BMC (OBMC)

cost savings, and pre-barcode cost savings. USPS-T-21 at 6-10. Also, for the first

time, the model includes mail processing cost estimates, and cost savings estimates, for

the Parcel Return Service rate categories. Id. at 3-4. The results of witness Miller’s

model, presented on page 11 of USPS-T-21, are used to support the retail Parcel Post,

Parcel Select, and Parcel Return Service rates, as well as the OBMC, BMC-presort, and

pre-barcode discounts.

UPS witness Luciani criticizes various inputs used in witness Miller’s model as

being outdated or as being based on “significant assumptions that have not been

subject to any study.” UPS-T-2 at 7. He also criticizes the size of the CRA adjustment

factor used in the model and the fact that it was revised several times in this proceeding

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as a result of errata. Id. at 9-12. He believes that for these reasons the model

produces unreliable cost avoidance estimates, and therefore that the passthroughs for

Parcel Select should be set at 90 percent, rather than the 100 percent used by witness

Kiefer. Id. at 18-19. He also proposes a revision to the model relating to the modeled

costs of parcel sortation at the delivery unit. Id. at 13-15. As discussed below,

however, witness Miller’s model reliably estimates the costs underlying the Parcel Post

and Parcel Return Service rate design of witness Kiefer, and witness Luciani’s criticisms

should be disregarded.

i. Witness Luciani’s view that various cost inputs are materially “outdated” is unsubstantiated on the record and is proven incorrect by Witness Miller.

Though witness Luciani criticizes various model inputs as being “outdated,” he

does not specify how the operations measured by the inputs have changed or whether

any such change would have a material effect on the cost model results. Instead, he

simply recites when the data was collected as it that fact alone means it is no longer

reliable. Id. at 7-9. He later admitted, however, that the age of data by itself does not

compel a conclusion that it is no longer reliable, particularly when the relevant

operations have not materially changed. Tr. 27/9429, 9439. Thus, as rebuttal witness

Miller (USPS-RT-8) notes, it is wholly insufficient for witness Luciani to criticize the cost

model solely on the fact that some of its inputs are supposedly “outdated,” without

attempting to demonstrate that those inputs have actually changed, and, if they have

likely changed somewhat, whether any such changes would have a material effect on

the model results. Tr. 33/11012.

Rebuttal witness Miller examines the model inputs that witness Luciani has

criticized, and shows that any changes to parcel processing operations that may have

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occurred since the inputs were derived do not indicate that reducing the Parcel Select

passthroughs is the appropriate response. Tr. 33/11011. For some cost model inputs

that witness Luciani criticizes, witness Miller shows that the operation involved has not

changed appreciably since the input was developed. Tr. 33/11013, 11014. For those

operations that witness Miller indicates may have changed somewhat, he shows that

any changes that may have occurred would not have a material effect on the cost model

results, or would not indicate that reducing the passthroughs is the appropriate

response. Tr. 33/11012, 11013-14, 11014-15, 11015, 11016-17.1 Finally, for the parcel

keying productivity figure that witness Luciani criticizes, witness Miller uses a Methods

Time Measurement (MTM-4M) analysis to show that the model estimate is reasonable.

Tr. 33/11017-18. For these reasons, witness Miller concludes that witness Luciani’s

criticisms of the supposedly “outdated” model inputs should not be used as a basis for

reducing the Parcel Select passthroughs.

ii. The size of the CRA adjustment factor is not a meaningful indicator of the model’s reliability.

While witness Luciani suggests that the size of the CRA adjustment factor helps

to demonstrate the unreliability of the Parcel Post cost model, in rebuttal witness Miller

shows how the size of the factor is not a meaningful indicator of the model’s reliability.

Tr. 33/11018-20. As witness Luciani agrees, the Parcel Post cost model represents a

simplified version of reality, and thus does not include tasks that occur in the real world

of parcels processing. Tr. 27/9436, 9443. Therefore, some of the tasks that are

1 For example, one input that witness Luciani criticizes is the model’s estimate that 12.3 percent of parcels are dispatched directly to the delivery unit from the BMC. UPS-T-2 at 8; Tr. 27/9438. Witness Miller notes that if this input was updated today, the percentage would likely decrease. Tr. 33/11015. The end result would be, however, that the DDU cost avoidance would increase. Id.

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included in the proportional cost pools may not be modeled, even though as a general

matter proportional pools contain operations that are modeled. Tr. 27/9436.2 For these

reasons, as witness Miller notes, it is unproblematic for a CRA adjustment factor to

deviate from 1.000. Tr. 33/11019. Nor is the use of a 1.194 factor problematic from the

standpoint of those factors utilized in past parcels models. When asked what an

acceptable CRA adjustment range would be, witness Luciani declined to do so. Tr.

27/9437.3

iii. Witness Luciani’s selective delivery unit parcel sortation cost pool revision should be disregarded.

The only revision that witness Luciani proposes for the Parcel Post cost model is

to replace the modeled cost for parcel sortation at the delivery unit with a figure he

derives from a tally analysis of the non-MODS MANP cost pool, the cost pool to which

the delivery unit parcel sortation task is mapped. UPS-T-2 at 13-14. As witness Miller

notes in rebuttal, however, performing such a selective analysis on a single cost pool

without concomitantly examining other cost pools could lead to a model that is biased.

Tr. 33/11020-21. He specifically points to the fact that Parcel Select DDU parcels likely

avoid certain MODS costs that are currently classified as fixed by the model, and which

are therefore included in the adjusted costs for every rate category. Tr. 33/11020.

Witness Luciani also admits that DDU parcels likely avoid such costs. Tr. 27/9444,

9466, 9468. Since no comprehensive examination of the cost pools has occurred on

this record by UPS or any other party, however, witness Luciani’s proposed revision

2 Witness Miller identifies one such task that would be included in the proportional cost pool estimates but not in the model cost estimates. Tr. 33/11019. 3 Witness Luciani seems to agree with the point that a CRA adjustment factor of 1.194, as is used in USPS-LR-L-46, is not per se unreasonable. Tr. 27/9437, 9443. Instead, he appears to base his criticism of the CRA adjustment factor simply on his more

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should be disregarded by the Commission. Tr. 33/11021.

d. Witness Luciani’s proposed revision to the Parcel Select window service cost savings model is inappropriate.

Witness Miller’s model for estimating the window service cost savings for Parcel

Select includes PRS pieces in the volume for Parcel Select. See USPS-LR-L-46, page

34. Witness Luciani argues that these pieces should be counted as “Non Parcel Select”

in that cost study since PRS pieces are not entered via dropshipment. UPS-T-2 at 16-

17. This would, however, lead to inconsistent treatment of PRS costs and volumes in

the window service cost savings model, since PRS costs were systematically assigned

to Parcel Select in the base year by IOCS. Tr. 3/333, Response of Postal Service to

PSA/USPS-2. Treating those costs and volumes inconsistently would inappropriately

skew the model.4

2. Bound Printed Matter

Witness Yeh proposed an average increase of 11.7 percent for Bound Printed

Matter with no fundamental changes to the rate design. The proposed increase would

yield a cost coverage of 124.9 percent. Witness Mayes (USPS-T-25) provided witness

Yeh with estimated transportation costs per pound by zone and Witness Miller (USPS-

T-20) provided witness Yeh with the estimated cost differences underlying the flats

differential and worksharing discounts that are reflected in her proposed rates. USPS-

T-38, at 8-10. Witness Yeh mitigated unacceptable rate increases for non-dropshipped

mail and maintained reasonable rate relationships by lowering slightly the passthrough

general dissatisfaction with the model inputs. 4 Witnesses Luciani and Glick (PSA-RT-1) both suggest the need to separately identify PRS costs in the future. USPS-T-2 at 16-17; Tr. 27/9477-78; Tr. 33/11272. The Postal Service agrees, and would like to note that IOCS is now separately identifying PRS pieces; this practice began with the start of FY 2007, the first full fiscal year after PRS

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of cost savings for DSCF and DDU mail. USPS-T-38, at 11.

Witness Yeh’s testimony demonstrates that her proposed rates are in

accordance with the policies of the Act. The Commission should recommend these

rates, which are supported by substantial evidence on the record.

a. Amazon.com witness Haldi’s proposal to allow CDs and DVDs to be mailed as Bound Printed Matter is fatally flawed.

Amazon.com witness Haldi (AMZ-T-1) proposes that CDs and DVDs be allowed

to be mailed as Bound Printed Matter. He also proposes that the name of the subclass

be changed to “BPM,” no doubt to disguise the fact that CDs and DVDs are not “bound

printed matter.” Witness Haldi’s proposal is intended to allow pieces containing DVDs

and CDs to migrate from Media Mail to Bound Printed Matter. He believes that this

migration will be “profitable” for the Postal Service, because the unit contribution of

Bound Printed Matter is $0.03 more than that of Media Mail. AMZ-T-1, at 16-17.

However, he also proposed lowering the cost coverage for Bound Printed Matter. Id. at

28. Witness Haldi confirmed that his proposed BPM cost coverage will result in a lower

unit contribution from pieces that migrate from Media Mail to Bound Printed Matter.

Witness Kiefer’s rebuttal testimony demonstrated how the convergence of these

proposals is fatally flawed. As Witness Kiefer stated, “The Postal Service processes

and delivers similarly presorted and entered bulk Media Mail and BPM in the same way,

so the cost would be the same, regardless of the subclass.” Therefore, “[i]f migration

does not change the costs, and postage goes down, it follows unambiguously that,

ceteris paribus, allowing currently non-qualifying pieces to migrate from Media Mail to

BPM will reduce Postal Service contribution.” USPS-RT-11, at 28-29.

became a permanent part of the classification schedule.

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Witness Kiefer also explained that Bound Printed Matter’s attractive cost

characteristics rely crucially on its inherent physical characteristics as “bound, printed

matter.” Witness Kiefer testified:

Bound printed matter is by its very nature dense. High-density parcels and flats have favorable cost characteristics that have led to the low rates that make BPM so attractive. To allow low-density non-printed matter parcels into BPM would erode and perhaps, eventually destroy BPM’s low cost profile.

USPS-RT-11, at 32. Witness Kiefer pointed out that, “Nowhere in witness Haldi’s

testimony, or elsewhere in the record is there any estimate of the cost impacts of

bringing in low-density CDs and DVDs into a subclass that consists largely of relatively

high-density books and catalogs.” His conclusion was: “This is a serious shortcoming

in Haldi’s testimony and renders it inadequate to use as the basis for restructuring

BPM.” USPS-RT-11, at 31. For these reasons, witness Haldi’s radical proposal should

not be recommended.

3. Media Mail and Library Mail Library Mail’s rates are required to be set, as nearly as practicable, five percent

lower than the corresponding Media Mail rates. 39 U.S.C. § 3626(a)(6)(A); see USPS-

T-38, at 13-14. The rates developed by witness Yeh for Media Mail represent an

average increase of 17.9 percent, and for Library Mail a 18.2 percent increase. Since

Media Mail and Library Mail costs are available only on a consolidated basis, the

combined cost coverage is 109.0 percent. Witness Miller provided witness Yeh with

the estimated cost differences underlying the worksharing discounts that are reflected in

her proposed rates. USPS-T-38, at 17-18.

Witness Yeh proposed no fundamental changes to the Media Mail rate design.

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The proposed rates were derived from a per-piece and per-pound rate construction

manifested in a three-part structure that resulted in one rate for the first pound, a

separate lower rate for additional weight up to 7 pounds and the same lower rate for

additional weight over 7 pounds. USPS-T-38, at 13; Tr. 8/1908-9. The Commission

should recommend these rates, which are supported by substantial evidence on the

record.

a. PostCom witness Angelides provides no basis for disturbing witness Yeh’s Media Mail rate structure.

On behalf of PostCom, Witness Angelides proposed to change the longstanding

Media Mail rate design to include half-pound rate increments instead of whole pound

rate increments for pieces weighing more than one pound and less than five pounds.

POSTCOM-T-5, at 6. Witness Angelides argued that full pound rate increments at low

weights “can result in dissimilar packages paying the same rate.” POSTCOM-T-5 at 5.

In his rebuttal testimony, Witness Kiefer pointed out that “[d]issimilar mail pieces pay the

pay the same rates in all mail classes offered by the Postal Service.” USPS-RT-11, at

33. As Witness Kiefer stated:

Apparently, witness Angelides finds weight variations this big to be unacceptable, since he proposes to reduce them by setting up half-pound weight steps between 3.0 and 5.0 pounds. But if 23 percent variation is not acceptable in a full pound weight step, why is 27 percent variation acceptable in his half-pound step between 1.0 and 1.5 pounds? At what point exactly does a weight variation within a rate step become unacceptable?”

USPS-RT-11, at 34. Witness Angelides proposal appears to be both internally inconsistent and lacking in

consideration for the implications of applying his principle throughout the postal rate

structure.

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G. The Periodicals Rates Proposed by the Postal Service Are More Balanced than any Alternatives, and Should Be Recommended

Witness Tang (USPS-T-35) presents the Postal Service’s rate and classification

proposals for the Periodicals Outside County and Within County subclasses. These

rate proposals would result in an overall increase for Periodicals of approximately 11.9

percent. Outside County rates would increase by 11.7 percent, and Within County rates

would increase by 24.2 percent. USPS-T-35 at 2.

1. The Postal Service’s proposals for the Outside County subclass should be adopted.

The Postal Service’s proposal for the Outside County subclass reflects a

balanced movement towards greater incentives for improved mail preparation, while

remaining cognizant of the interests of publications that currently are less able to

change their preparation practices. The Postal Service’s proposal is preferable to the

alternatives proposed by the intervenors, and should be recommended.

a. The proposed container rate promotes efficiency and lower costs.

The Postal Service is proposing a new container rate, along with the appropriate

classification change, in proposed DMCS 421.35. The container rate would apply to all

Outside County mail, based on its preparation. Tr. 7/1616-18. Because pallets

generally carry much more mail than a sack, charging for each container effectively

provides a pallet discount. The container rate thus would replace the experimental co-

palletization discounts, as well as the other pallet discounts. USPS-T-35 at 6.

Therefore, witness Tang proposes to delete DMCS 421.48 (Pallet Discount) and 421.49

(Dropship Pallet Discount). Moreover, DMCS 421.50 (Co-palletization Dropship

Discounts) will expire upon the implementation of the proposals in this rate case. The

Postal Service urges the Commission to recommend the requested DMCS changes.

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In rebuttal, witness Taufique provides additional support for the Postal Service’s

proposed container rate. The container rate would send a consistent and clear signal

to mailers, encouraging more efficient mail preparation and worksharing. Tr. 39/13456.

All mailers would understand that one goal they should strive for is to prepare their mail

in as few containers as practical. In some cases that would mean switching from sacks

to pallets (since a pallet holds more mail than a sack). But in other cases it would

create an incentive for a sack mailer to prepare the mail in fewer sacks, and for a pallet

mailer to prepare the mail in fewer pallets. All of these actions generally would reduce

Periodicals costs. USPS-T-35 at 6.

b. The piece-pound split should be adjusted as proposed.

Witness Tang proposes a 37.5/62.5 percent split between revenue to be raised

from pounds and pieces. This split better reflects actual cost incurrence than the

traditional 40/60 percent split. USPS-T-35 at 6-7.

c. The Postal Service’s proposals will promote more dropshipping.

Witness Tang proposes separate editorial pound dropship rates for the

destinating ADC, SCF, and DDU. The flat editorial pound rate would be retained,

however, since Zones 1&2 through 8 would continue to have one editorial pound rate.

USPS-T-35 at 7. But the proposed destinating ADC, SCF, and DDU rates for editorial

pounds will encourage more efficient practices for publications, especially those with

high editorial content. Id. at 8.

Consistent with the introduction of destination entry rates for editorial pounds, the

Postal Service proposes editorial pound rates for Science of Agriculture, at 75 percent

of the comparable Outside County rates. Id. at 10.

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A major goal of the Postal Service’s proposal is to maintain or increase the

incentives to dropship, in particular for the farthest zones. Witness Tang therefore

allocates 50 percent of the transportation costs to advertising pounds, instead of a lower

amount. She also proposes to raise the passthrough for advertising pound dropship

cost differences from 50 percent to 80 percent. Id. at 9. For the piece rates, she

proposes to increase the destination ADC discount by 37.5 percent, and the destination

SCF discount by 50 percent. Id. at 11. Thus, additional dropshipping will be

encouraged.

d. The Postal Service’s proposals promote co-mailing and co-palletization.

The current pallet discounts, including the experimental co-palletization

discounts, share the same purpose: to encourage more efficient mail preparation and

more dropshipping. But the co-palletization discounts are experimental, and the design

of the other pallet discounts was criticized by the Commission in Docket No. R2001-1,

when they were introduced. PRC Op., R2001-1, at 109. Witness Tang therefore

proposes to replace these discounts with a combination of editorial pound dropship

rates, increased per-piece dropship discounts, and a container rate. USPS-T-35 at 11.

Witness Tang assessed the impact of these rate design changes, and concludes that

mailers would have comparable if not better incentives. This proposal would also

eliminate the restrictions on publications eligible for discounts related to co-palletization,

as well as the documentation requirements. This alone should lead to more co-

palletization. Id.

e. The proposed presort discounts should be recommended.

The Postal Service believes that presortation to the 5-digit automation flat and

carrier route basic levels will continue to have value in future mail processing and

delivery environments. Witness Tang therefore proposes to maintain these discounts at

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their current levels, by increasing the passthroughs to well above 100 percent.

Maintaining the level of these discounts is important while the operational environment

for flats continues to evolve. USPS-T-35 at 12. In addition, the proposed 3-digit and 5-

digit presort rates reflect witness Miller’s mail processing and witness Kelly’s and

witness Talmo’s delivery cost studies, using 100 percent passthroughs. Id. The Postal

Service urges the Commission to adopt these discounts.

2. The Postal Service opposes the alternative Periodicals Outside County proposals by Time Warner, Inc., the Magazine Publishers of America and Alliance of Nonprofit Mailers, and the National Newspaper Association.

The Magazine Publishers of America and the Alliance of Nonprofit Mailers

(MPA/ANM) and Time Warner, Inc. (TW) present two alternative rate proposals for the

Periodicals Outside County subclass, as well as alternative versions for the Periodicals

Outside County flats cost model. The National Newspaper Association presents an

alternative for applying the Postal Service’s proposed container rate. The Postal

Service opposes each of these proposals, as discussed below.

a. The MPA/ANM and TW rate proposals fall short of the balance found in the Postal Service proposal.

The MPA/ANM proposal follows the general rate design of the Postal Service

proposal, with the following changes.

• Replaces the proposed container rate with a deeper pallet discount; • Reduces automation discounts; • Increases the dropship incentive by basing it on a different estimate of the costs

avoided by dropshipping; • Introduces a discount for pieces that are entered on 5-Digit pallets; and • Reduces the proposed Ride-Along rate so that the percentage increase in this

rate matches the subclass average.

MPA/ANM-T-2 at 5-6.

TW proposes a variation on the major restructuring of Periodicals rates proposed

in Docket No. C2004-1. While TW backs away from zoning of the editorial pound rate,

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they still propose a complete overhaul of the Periodicals rate design, including

container, bundle, and piece charges based on presort level and machinability. TW-T-1

at 22-26; Exhibit TW-1-A.

In rebuttal testimony, witness Taufique explains why the Postal Service believes

its proposals will best meet the interests of the entire Periodicals class. He shows that

the Postal Service’s recent rate design philosophy for the Periodicals Outside County

subclass has been to move gradually in the direction of lower-cost preparation, by

providing incentives for reducing the number of containers, and for destination entry.

This gradual approach reflects the Postal Service’s desire to limit the rate impact of the

changes on publications that currently are less able to change their preparation and

destination entry practices. Tr. 39/13453. So far, the Postal Service’s approach, to the

extent adopted by the Commission, has substantially increased dropshipping, and

increased the efficient use of containers. Tr. 39/13454. As witness Taufique concludes,

“gradual change has been proven to be very successful, so we’ll want to continue with

that approach.” Tr. 39/13512. The Postal Service’s current proposal thus is a logical

continuation of this use of modest incentives for improved mail preparation, while

avoiding large rate impacts for non-participants. Tr. 39/13455.

Witness Taufique compares the three Outside County rate proposals in this

docket, and finds that the Postal Service’s proposal is the most balanced one. He

chooses standard deviation as the key statistic in comparing the proposals. Id. at 5.

The Postal Service proposal has the lowest standard deviation overall, and for large and

medium mailers. Moreover, after excluding one outlier, it would have the lowest

standard deviation for small mailers. Id.

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At his hearing, witness Taufique discussed the fact that the percentage rate

increase from the Postal Service proposal for four of the 259 publications is greater than

the largest rate increase from the MPA proposal. He indicated that these four

publications are Within-County publications, and that the large percentage increases

pertain only to the limited Outside County portion of these Within County mailings.

Therefore, the dollar increase in actual postage for the Outside County portion would

not be large. Moreover, given postal reform legislation’s making Within County rates

available to some Outside County portions of Within County publications (the Postal

Accountability and Enhancement Act, § 1003(2)), and possible flexibility in

implementation rules, it is likely that the significant percentage rate increases may not

materialize or be sustained.

ABM witnesses Bradfield and McGarvy also criticize the MPA/ANM and TW

proposals. Witness Bradfield recognizes that “[e]ach of the three rate proposals here

moves in the direction requested by the Commission by increasing those incentives [for

moving from sacks to pallets].” Tr. 35/12059. But, focusing on the need to “assure

adequate protection from destructive rate increases for the many publications that

cannot . . . co-mail or co-palletize,” he finds that the Time Warner and, to a lesser

extent, the MPA/ANM proposals fall short. Tr. 35/12060. He also finds that “[t]he Time

Warner proposal is far worse for all but the largest publications.” Tr. 35/12067. Finally,

witness Bradfield agrees with Postal Service witness Taufique that “[g]reat progress in

co-mailing and co-palletizing has been accomplished and will be accomplished with a

level of incentives at or near the level in today’s rates.” Tr. 35/12067-68.

Witness McGarvy also concludes that “the Time Warner proposal, and, to a

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significantly lesser extent, the MPA proposal still provide inadequate protection to

mailers of Periodicals that cannot escape sacks, at least in the next couple of years.”

Tr. 35/12175. She explains why comailing and co-palletizing are not currently available

to a large number of Periodicals publications. Tr. 35/12176-80. But she is “hopeful that

once the Postal Service has completed its ongoing automation efforts with the FSS

program, and as more and more titles that can be co-mailed or co-palletized are in fact

prepared that way, opportunities for our publications to get out of sacks and into either

alternative containers or co-mailing or co-palletizing programs will materialize.” She

also notes that many ABM members may be switching to pallets in the near future. She

therefore concludes that the current incentives to palletize “are doing their job. It is

unnecessary to expose those that cannot move from sacks to punishing rate levels in

order to increase the incentives and rewards for palletizing too much and too soon.” Tr.

35/12180.

b. MPA/ANM’s proposal for a 5-digit pallet discount should be rejected.

Witness Taufique specifically criticizes the alternative 5-digit pallet discount that

is part of MPA/ANM’s proposal. He calls this proposal “premature.” Tr. 39/13455-56.

Because the Periodicals cost coverage is so close to 100 percent, only the most

effective discounts can be added. A 5-digit pallet discount, however, would reward

existing mail preparation on 5-digit pallets, rather than being focused on cost-reducing

behavior. 5-digit pallets are limited to high-density publications, or those publications

which can co-mail or co-palletize as part of a high-density pool. Witness Taufique

concludes that “it is important to construct the incentives such that they are obtainable

for a wide range of mailers, especially those that are producing high-cost mailings.” Tr.

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39/13456.

In addition, witness McCrery identifies operational problems with MPA’s 5-digit

pallet discount proposal. His rebuttal testimony (USPS-RT-14) focuses on the fact that

the proposal would apply to all 5-digit pallets, regardless of their entry location or

weight. He asserts that, for 5-digit pallets entered upstream from the destination SCF or

delivery unit, transportation to the destination “can negate much of the benefit of the

pallet.” Tr. 34/11460. MPA’s proposal also would give customers “an incentive to

prepare small 5-digit/scheme pallets to the greatest extent possible while depositing

those pallets at an origin facility.” Tr. 34/11461. Finally, witness McCrery is concerned

about pallets containing less than 250 pounds, even when deposited at destination

SCFs. Id.

For all of these reasons, the Postal Service does not support MPA’s proposal for

a 5-digit pallet discount.

c. The Postal Service’s proposed Ride-Along rate follows established ratemaking practice, and is superior to MPA/ANM’s alternative proposal.

Witness Taufique defends the Postal Service’s proposed Ride-Along rate as

consistent with the traditional pricing approach for this rate. Tr. 39/13462 (USPS-RT-12

at 10). MPA/ANM proposes a lower Ride-Along rate simply to keep its increase similar

to the overall increase for the Periodicals Outside County subclass. MPA/ANM-T-2 at

35. The Ride-Along rate, which applies to matter that otherwise would be sent using

Standard Mail rates, was originally developed to respond to customer demand for an

effective and affordable advertising medium for Periodicals mailers. Its revenue is

included in the total Periodicals revenue and improves the overall class contribution. Tr.

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39/13462. Thus, it should be developed based on accepted principles, rather than to

just match the overall increase for the Outside County subclass.

d. The container rate should apply to all Periodicals mailings, including those entered in flats tubs and in unsacked bundles.

As explained by witness Tang, the container rate is an integral part of the Postal

Service’s proposed Outside County rate structure, whose existence allows for other rate

elements (specifically, the piece rates) to be lower. Tr. 7/1648, 1656, 1740, 1839.

Therefore, it should apply to all Outside County mailings, not just those involving a sack

or a pallet. The Postal Service has explained how the container rate would be applied

in those situations not involving a sack or a pallet, such as when a mailing is entered in

a flats tub or in unsacked bundles. Tr. 7/1617-18.

NNA witness Heath argues that the container rate should not apply to Outside

County mailings that utilize a flats tub or that are entered as unsacked bundles at the

delivery unit. NNA-T-1 at 17-18. Mailers utilizing flats tubs and unsacked bundles do, of

course, pay the same piece rates as all other Outside County mailers, as witness Heath

admits. Tr. 29/9604. They therefore benefit (in terms of lower piece rates) from the

existence of the container rate. In addition, the container rate can have efficiency

benefits not confined to the usual sack/pallet paradigm. Thus, it is improper not to apply

the container rate to these mailings. In addition, witness Heath has not presented

compelling record evidence that would justify treating these mailings differently from all

other Outside County mailings.

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i. The record does not support witness Heath’s assertion that

the container rate would be a material disincentive for mailers to switch from sacks to flats tubs.

Witness Heath admits that a flats tub is a container, and that applying the

container rate to flats tubs should encourage the more efficient use of those containers

by mailers already using them. Tr. 29/9601. His argument therefore boils down to the

notion that the container rate should not apply to mailings entered in a flats tub because

he believes that it would provide a disincentive for mailers to make the beneficial switch

from sacks to tubs. NNA-T-1 at 17.5 The record, however, demonstrates that the

container rate would not create a material disincentive to such a switch.

First of all, witness Heath admits that service is the paramount determinant of

container usage for newspaper mailers. As he notes, newspapers like to use the

container that provides them with the best service. Tr. 29/9601, 9637. Newspapers

therefore have a non-financial incentive to use tubs over sacks, since as witness Heath

notes they are easier for mailers to use and handle, and provide service improvements

over sacks. NNA-T-1 at 16-17; Tr. 29/9638-39. Witness Heath even went so far as to

say that a tub is “mandatory if you want good service.” Tr. 29/9655. Because service is

vitally important for newspaper mailers, and tubs provide service improvements over

sacks, it stands to reason that the only way the container rate would slow the movement

from sacks to tubs is if it provides a material financial disincentive to switching; that is, if

moving from tubs to sacks would appreciably increase the number of containers that

5 Specifically, he states: “I believe the Commission should reject the proposed charge on [tubs] altogether and allow the Postal Service to capture greater savings through sack abandonment before slowing a positive trend with a surcharge on tubs.” NNA-T-1 at 17.

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newspaper mailers would be required to use for a given mailing (therefore increasing

the total postage resulting from the container rate).

The record does not show, however, that switching from sacks to tubs would in

fact require materially increased container usage by mailers. First, moving from sacks

to tubs is unlikely to have a material effect on presort level, given the typical mailing

profile of a community newspaper and the Postal Service’s 24-piece rule for sacks. The

typical mailing profile for a community newspaper is a concentration of addressees in

the local ZIP Codes of its trade area, with the rest of the addressees dispersed

throughout the country. Tr. 29/9639.6 Sacks are used primarily for papers destined to

the latter group of addressees, who reside outside the trade area of the newspaper. Tr.

29/9599, 9639. While newspapers commonly prepared a number of small 3-digit and

some 5-digit sacks, in addition to ADC sacks, prior to the advent of the 24-piece rule,

that rule has led to fewer 3-digit and 5-digit sacks and more ADC, mixed ADC, and

origin mixed ADC mail. Tr. 29/9641-42. These are the same presort levels that postal

standards currently allow for flats tubs. Tr. 11/3275-76; DMM 705.9.2.6.

Second, the record indicates that the number of newspapers that can be placed

in a flats tub may not differ materially from the number typically placed by community

newspapers in sacks. Witness Heath states that 35 pieces are typically placed in sacks

by his newspaper company. Tr. 29/9599. Tubs, meanwhile, can hold anywhere from

20 to 200 pieces, with the typical paper putting around 40 to 50 pieces in a tub. Tr.

29/9599, 9642-43.

6 Witness Heath did note that there is sometimes a concentration of addressees outside a newspaper’s trade area in particular locales where people from a community tend to move. Tr. 29/9639-40.

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Thus, the record indicates that community newspapers switching from sacks to

tubs will in many circumstances not experience an attendant material increase in the

number of containers required for their mailings, since the presort levels of the sacks

that are increasingly typical in the post-24-piece-sack-rule environment do not differ

from the allowable presort levels for tubs, and because tubs can often hold a

commensurate number of papers as the typically prepared sack. Because the container

rate is the same for an individual sack and an individual tub, Tr. 7/1617, 1858, it cannot

be said on this record that the container rate would provide an appreciable financial

disincentive to switch from sacks to tubs.

The Postal Service agrees with witness Heath that flats tubs often provide

benefits to both mailers and to the Postal Service over sacks. Tr. 11/3276-77.

However, witness Heath’s protest that applying the container rate to flats tubs would

materially slow the movement away from sacks and towards tubs is not supportable on

this record. Instead, the record indicates that the container rate would likely be not be a

material disincentive, nor a material incentive, to the making of this switch.

ii. The record indicates that the container rate will likely play little to no role in the usage of unsacked bundles.

Witness Heath also argues that the container rate should not apply to unsacked

bundles (or loose copies) entered at the delivery unit because there are no container

handling costs associated with that mail, and because it could create a disincentive for

mailers to utilize this practice. NNA-T-1 at 18. These justifications for not applying the

container rate to such mailings are, however, unconvincing based on the record.

First, the fact that this mail is “uncontainerized” does not mean, ipso facto, that

the container rate should not apply to it. As noted above, the container rate is an

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integral part of the rate structure, which allows for other rate elements to be lower. Tr.

7/1648, 1656, 1740, 1839. It is also a price signal, designed to encourage the efficient

preparation of Outside County mailings, rather than necessarily a means of recouping

the costs of handling containers. Tr. 7/1859. Second, the record indicates that the

container rate would likely not constitute a financial disincentive for mailers to use

unsacked bundles. According to witness Heath, newspapers generally use one

container per 5-digit ZIP Code, meaning the number of containers would equal the

number of 5-digit ZIP Codes to which the mail is destined. Tr. 29/9603, 9643-44. Since

the container rate will be applied based on the number of 5-digit ZIP Codes to which the

mail is destined, Tr. 7/1617,7 this means that, according to the record, the container rate

would likely be a financial wash in the case of unsacked bundles, neither encouraging

nor discouraging the practice. 8 For example, if unsacked bundles were prepared for a

delivery unit serving a single 5-digit ZIP Code, one container rate would be assessed,

similar to the same bundles prepared on a pallet or in a sack, regardless of the number

of bundles.

From a financial standpoint, therefore, the record does not support witness

Heath’s argument that applying the container rate to unsacked bundles would give him

“no leverage to push this practice further.” NNA-T-1 at 18. Instead, the record indicates

7 If, for example, the mail in the unsacked bundles dropped at a delivery unit are destined to two 5-digit ZIP Codes, then two container rates would be applied. Tr. 7/1837. If the mail is destined to one 5-digit ZIP Code, then a single container rate would apply. Tr. 7/1857. 8 In addition, if the number of containers exceeds the number of ZIP Codes to which the mail is destined, the container rate would provide an incentive to utilize unsacked bundles. Tr. 29/9603. As witness Heath notes, unsacked bundles can hold more papers than sacked bundles. Tr. 29/9644.

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that a mailer’s decision to use unsacked bundles rather than some other container, or

vice versa, will likely be made independently of the existence of the container rate.

e. The Commission should adopt Postal Service Witness Miller’s flats mail processing cost model over those proposed by MPA/ANM and TW.

Witness Tang uses Outside County mail processing costs that are presented by

witness Miller (USPS-T-20). Witness Miller provides comprehensive test year mail

processing unit cost estimates for the First-Class Mail presort flats, Periodicals Outside

County flats, and non-ECR Standard Mail presort flats rate categories. The model

updates and refines the flats cost model that was first presented by witness Miller in

Docket No. R2001-1. See USPS-LR-L-61. Consistent with past practice, the test year

unit cost estimates are developed using a hybrid cost methodology. Id. at 6. Three

modifications were made to the model, concerning the incorporation of base year mail

characteristics studies, the inclusion of mail processing cost estimates for First-Class

Mail presort parcels in the First-Class Mail model, and the de-averaging of the Standard

Mail rate categories in the Standard Mail model. Id. at 4-5.

Witness Miller's cost models provide the most comprehensive and accurate mail

processing unit cost estimates for the First-Class Mail presort flats, Periodicals Outside

County presort flats, and the Standard Mail non-ECR presort flats rate categories on

this record. Witnesses Glick (MPA/ANM-T-2) and Stralberg (TW-T-2) both criticize

witness Miller's Periodicals Outside County flats model, and present their own versions

of the model. See MPA/ANM-LR-2; TW-LR-2. While many of their criticisms of the

model are identical, the approaches that they used to address those criticisms in their

revised models often diverge. Their models both have the same result, however: in

nearly every case, their modifications move the costs in a direction that greatly expands

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the cost differential between a nonautomation 5-digit flat and a nonautomation carrier

route flat. Tr. 33/10993-94.9 As discussed below, the Commission should utilize

witness Miller’s model rather than those of witness Glick or Stralberg.

i. Arbitrary incoming secondary factors should not be included in the model.

Witnesses Glick and Stralberg both criticize witness Miller’s decision to remove

the incoming secondary flats coverage factors from the cost model prior to Docket No.

R2005-1, and attempt to incorporate such factors back into the model. See MPA/ANM-

T-2 at 17-19; TW-T-2 at 11-14. Both justify the inclusion of these factors on the fact that

Postal Service witness McCrery, responding to an interrogatory, provided MODS and

FLASH data estimating that 44.7 percent of incoming secondary flats were finalized

manually. Tr. 11/2853.

In his rebuttal testimony (USPS-RT-8), witness Miller describes what this figure is

used for and why it is unsuitable for cost modeling purposes. He explains that the figure

witness McCrery provided is not used for cost modeling, but is instead used by

operations management to estimate the percentage of all flats finalized in incoming

secondary operations in order to gauge year-to-year performance. Tr. 33/10994. While

the data are appropriate for the use for which they are derived, witness Miller explains

that they are not appropriate for cost estimating. Id.

Witness Miller demonstrates the unsuitability of using witness McCrery’s figure

for cost modeling purposes in his comparison of the volumes that underlie that figure

with RPW volumes. This comparison shows that the manual percentage is suspect

9 Witness Glick expands this differential by 2.452 cents (6.778 compared to 4.326 cents), while witness Stralberg expands this differential by 5.424 cents (9.750 cents compared to 4.326).

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because the estimated volume of incoming secondary flats exceeds the total RPW

volume for candidate incoming secondary flats. Tr. 33/11023. While witness Miller

may have errantly excluded some other candidate incoming secondary volume from his

analysis, Tr. 33/11046-50, the incorporation of these volumes still result in an

unexplained gap between the RPW and FLASH manual volume figures underlying

witness McCrery’s figure.

As witness Miller notes, there is simply no data that indicate the true percentage

of total flats that are finalized in incoming secondary operations. Tr. 33/10995. He

concludes that manipulating the cost model through the inclusion of arbitrary incoming

secondary factors, based on a misused estimate, is inappropriate and should be

rejected by the Commission. Tr. 33/10999, 11026-27.

ii. The flats model should use CRA flats costs rather than combined flats and parcels costs.

Witnesses Glick and Stralberg both propose that the Periodicals Outside County

flats model abandon the use of CRA flats cost by shape estimates in favor of a mixed-

shape (flats and parcels) cost estimate. See MPA/ANM-T-2 at 20-21; TW-T-2 at 24-25.

As witness Miller notes in rebuttal, however, this modification is especially problematic

because it represents a methodological change that could impact the models for all

classes and shapes of mail. Tr. 33/11000-01. Furthermore, the CRA cost-by-shape

estimates for flats have already been modified to account for differences in how mail

pieces are categorized in Postal Service data collection systems. Id.

iii. Proportional cost pool classifications should be based on whether the tasks are modeled.

Witnesses Glick and Stralberg both propose that some cost pools should be

classified as proportional even though they do not represent any piece or bundle

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distribution operations that are depicted in the mail flow models. See MPA/ANM-T-2 at

20-21; TW-T-2 at 25. The Postal Service and the Commission have, however,

historically relied upon a classification approach in which cost pools have only been

classified as proportional if they contain costs for operations depicted in the mail flow

models. USPS-T-20 at 6.10 As witness Miller notes, deviating from a conservative

approach in classifying cost pools is inadvisable, and represents a methodological

change that implicates the cost studies for all other classes and shapes of mail. Tr.

33/11001-02.

iv. The proposed selective cost pool adjustments should be rejected.

Witnesses Glick and Stralberg both attempt to manipulate CRA data at the cost

pool level. Both suggest that a portion of the 1FLATPRP cost pool should be classified

as proportional, though they differ in the manner by which to accomplish this task. See

MPA/ANM-T-2 at 22-23; TW-T-2 at 9-14. As witness Miller explains, however, flat

preparation costs do not generally vary for the non-carrier route rate categories, while

the AFSM100 Automatic Induction (AI) modification will ultimately reduce the difference

in preparation hours between carrier route and non-carrier route mail. Tr. 33/11003-05.

Consequently, he believes that the 1FLATPRP cost pool should be classified as fixed.

Both witnesses also propose that a portion of the non-MODS ALLIED cost pool

be classified as proportional, based on tally analysis which estimated that 37 percent of

the tallies associated with that cost pool are related to bundle sorting operations. See

MPA/ANM-T-2 at 22; TW-T-2 at 24. As witness Miller explains, however, selective

10 While proportional pools can contain costs that are not modeled, every proportional pool contains at least some costs related to tasks actually represented by the cost models. Tr. 33/11006.

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attempts to disaggregate costs below the cost pool should be discouraged. Tr.

33/11006-07. He shows that a similar tally analysis conducted on two proportional cost

pools demonstrates that a portion of those pools could be, if the Glick and Stralberg

approach is used, classified as fixed, indicating that performing such a detailed analysis

on all the cost pools would lead to modifications that would probably balance out. Tr.

33/11007.

Finally, witness Glick (but not witness Stralberg) proposes that the 1SUPP_F1

cost pool should be classified as proportional. See MPA/ANM-T-2 at 22. Witness Miller

notes, however, that this contradicts how the Commission classified this cost pool in

Docket No. R2000-1, wherein the proper classification for this cost pool was extensively

debated. Tr. 33/11007-08.

v. Witness Stralberg’s bundle breakage revision should not be accepted.

Witness Stralberg proposes that the bundle breakage assumption for manual

operations be modified. See TW-T-2 at 19-22. In rebuttal, however, witness Miller

suggests that witness Stralberg's revised manual bundle breakage assumption is based

on incorrect information concerning manual bundle sorting operations and should

therefore be rejected. Tr. 33/11008-09.

3. The Postal Service’s proposed rate design for Within County Periodicals is reasonable and should be recommended.

a. Witness Tang’s rate design is reasonable and balanced.

Like its Outside County counterpart, the Postal Service’s rate proposal for the

Within County subclass represents a reasoned and balanced approach to rate design.

Witness Tang designs rates that lead to a 24.2 percent increase for Within County mail

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and a cost coverage of 103.6 percent. USPS-T-35 at 14. As she notes, the size of the

rate increase for Within County is driven by the increased costs for the subclass, while

the cost coverage is determined by applying the “half markup rule.” Id. at 2, 14.11

Witness Tang also notes that her rate design is generally consistent with prior practice.

Id. at 14.

One anomaly produced by the Postal Service’s rate design is that the 5-digit

automation letter rate, as proposed, is slightly higher than the proposed 3-digit

automation letter rate. Id. at 15. The Postal Service believes that the 5-digit rate should

be lower than the 3-digit rate, and would support Commission adjustments to witness

Tang’s proposal to correct this anomaly. Besides this one change, however, the

Commission should accept witness Tang’s rate design.

The major concern that animates witness Tang’s rate design is a desire to

achieve a balanced proposal; that is, to avoid percentage increases well above the

subclass average for individual rate categories. Tr. 7/1869. She designed the presort

discounts with this goal in mind, using Outside County costs as a proxy since no Within

County cost study is available, and applying different passthroughs than are used in

Outside County rate design in order to reflect the inherent differences between the two

subclasses. Id. at 14; Tr. 7/1726. In particular, the passthroughs she uses to create the

discounts for carrier route presorted mail reflect a measured increase in the

passthroughs, and resultant discounts, over what the Commission has recommended in

the past for such mail, while also protecting lower-presort publications from inordinate

11 These issues are discussed in the Costing and Rate Level sections of this brief, respectively.

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rate increases. Tr. 7/1727, 1731.12

A desire to achieve a balanced rate proposal also led to witness Tang’s reduction

in the percentage of revenue derived from the piece side from that used in prior

proceedings. She proposes to derive 53.5 percent of revenue from the piece side, Tr.

7/1729, whereas in recent cases the ratio has generally been 60 percent from the piece

side, and 40 percent from the pound side. See PRC Op., R2005-1, at 149, n.68. The

billing determinants show, however, that the weight per piece for Within County has

increased, which has caused the percentage of revenue derived from the piece side to

decline markedly to 54.2 percent. See USPS-LR-L-126.13 Because this has occurred,

returning to a 60/40 ratio would lead to very high piece rate increases combined with

low pound rate increases. Therefore, in order to achieve a balanced increase between

the piece and pound rates, and therefore between heavy and light weight publications,

witness Tang uses a ratio of 53.5/46.5.

b. NNA’s proposed revisions result in an imbalanced rate design and should be rejected.

NNA witness Siwek proposes to revise witness Tang’s rate design by increasing

the passthroughs for Carrier Route Basic and Carrier Route High Density over that

proposed by the Postal Service, and by increasing the amount of revenue to be derived

from the piece rates to match the piece/pound ratio proposed for the Outside County

12 Compare the discounts and passthroughs for the carrier route categories in USPS-LR-L-126 with the same discounts and passthroughs recommended in Docket No. R2000-1, PRC-LR-14 and Docket No. R97-1, PRC-LR-11. 13 In FY 2000, the weight per piece was 4.6 oz, and 58.8 percent of revenue was derived from the piece side. See USPS-LR-J-107. In FY 2005, the weight per piece was 5.3 oz, and only 54.2 percent of revenue was derived from the piece side. See USPS-LR-L-126. This is consistent with the fact that as weight per piece increases, the proportion of revenue from the pound rates increases as well. See PRC Op., R2000-1, at ¶ 5675.

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subclass. NNA-T-3 at 24-28. These revisions, however, lead to a completely

unbalanced rate proposal, with inordinate increases for non-carrier piece rates, and

minimal increases for the pound rates relative to the piece rates.

i. NNA’s proposed passthrough for Carrier Route Basic is inconsistent with prior Commission rate design and leads to inordinate increases for non-carrier route mailers.

NNA witness Siwek proposes to increase the passthroughs for Carrier Route

Basic and Carrier Route High Density to 100 percent and 70 percent, compared to the

Postal Service’s proposed passthroughs of 58 percent and 65 percent, respectively. Id.

at 27.14 This proposal to nearly double the passthrough and resulting rate discount for

Carrier Route Basic over that proposed by the Postal Service is wholly inconsistent with

past Commission practice. It would also lead to rate increases for Within County

mailers who do not presort to carrier route that are way above the subclass average.

First, NNA’s proposal leads to a large increase for the Carrier Route Basic

passthrough and rate discount over that recommended by the Commission in Docket

Nos. R2000-1 and R97-1. In those cases, the Commission recommended that this

passthrough be set at 50 percent, resulting in rate discounts of 3.6 and 3.7 cents

relative to 5-digit Nonautomation. See PRC Op., R2000-1, at ¶ 5721; PRC Op., R97-1,

at ¶ 5856. There is no indication that witness Siwek considered this prior accepted rate

14 NNA’s proposed passthrough for High Density deviates only slightly from the Postal Service’s proposal, and would lead to a discount of 1.7 cents off the Carrier Route Basic rate compared to the Postal Service’s proposed 1.6 cents discount. Instead, NNA seeks to benefit High Density mailers by substantially increasing the passthrough and discount for Carrier Route Basic. Therefore, this section concentrates on witness Siwek’s proposed passthrough for Carrier Route Basic. The Postal Service notes, however, that its High Density discount is consistent with the discount of the prior two omnibus cases, and is higher than the discount recommended by the Commission in the last two non-settled rate cases.

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design before proposing his dramatic increase in the size of the passthrough and

discount for carrier route mail. Tr. 29/9717.

When shown the Commission’s prior recommended passthroughs, witness

Siwek attempted to dismiss them as immaterial, since in those cases Nonprofit costs

were used as a proxy for Within County costs, whereas in the current proceeding

Outside County costs are used as the proxy. Tr. 29/9719-20. This is a complete red

herring, however, since NNA’s proposed rate design would not only double the size of

the passthrough for Carrier Route Basic, it would also nearly double the size of the rate

discount for Carrier Route Basic over that recommended in Docket Nos. R2000 and

R97. The following table, which shows the rate discount for Carrier Route Basic

(relative to 5-digit Nonautomation) that was recommended by the Commission in the

past several cases, along with the rate differences proposed by the Postal Service and

NNA in this case, illustrates this point:

Docket

Rate Discount for CR (relative to 5-D)

R97 $0.037 R2000 0.036 R2001 0.037 R2005 0.036 R2006 (USPS) 0.038 R2006 (NNA) 0.066 Sources: USPS-LR-L-72; USPS-LR-L-126; NNA-T-3

Clearly, the fact that Within County presort discounts now use Outside County costs

rather than Nonprofit costs as a proxy does not explain away nearly doubling the

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passthrough over what has been previously recommended by the Commission, as it

would lead to a dramatically higher rate discount.

Second, and more importantly, witness Siwek’s proposed passthrough and

discount for Carrier Route Basic would also cause increases well above the subclass

average for mailers who do not presort to carrier route. NNA mailers almost exclusively

presort to carrier route, Tr. 29/9611, so it is understandable why NNA seeks to increase

this discount. However, non-carrier route mail accounts for roughly 22 percent of the

subclass. See USPS-LR-L-126. Mailers who tend to have higher percentages of non-

carrier route mail include, according to NNA witness Heath, city, business, and regional

magazines. Tr. 29/9634. Small newspapers may also be presorting to something other

than carrier route. Tr. 29/9633. As witness Tang noted, the passthrough chosen for

Carrier Route Basic helps to mitigate the rate increases for these mailers. Tr. 7/1731.

NNA’s proposal would, on the other hand, benefit its membership while leading to

dramatic rate increases for non-carrier route mailers. Moreover, non-carrier-route

mailers generally lack the density to convert to carrier-route presort, so this is not an

effective incentive for more efficient mailings.

Looking at the rates that would result from NNA’s passthrough revision in

isolation from its piece/pound ratio revision, the revised carrier route passthroughs

would lead to a median increase of 61.22 percent for the non-carrier route piece rates,

including an increase of 76.92 percent for the 5-digit automation flats piece rate. Tr.

29/9707. This is well above the median increase of 10.20 percent for the carrier route

categories (which would increase by 10.20 percent and 12.12 percent for Basic and

High Density, and decrease by 3.70 percent for Saturation Mail). Id. If this revision is

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combined with the piece/pound ratio revision that NNA also proposes, such an extreme

imbalance remains: the non-carrier-route piece rates would increase by a median

percentage of 83.10 percent, including a whopping 93.85 percent for 5-digit automation

flats, while the carrier route piece rates would increase by a median percentage of

37.04 percent (32.65 percent, 45.45 percent, and 37.04 percent, respectively). Tr.

29/9702 (NNA-T-3, Appendix D, page 10). This belies witness Siwek’s assertion that

there is “ample room” to increase the passthroughs for Within County. NNA-T-3 at 24.

Witness Siwek seeks to justify his proposal by pointing to the fact that the Within

County passthroughs are much lower than the passthroughs for Outside County, even

though Outside County costs are used as a proxy for Within County costs. Id. at 24, 26-

27. This ignores the fact that Within County rate design has long been characterized by

lower passthroughs than the subclass that serves as its source for cost avoidances.15

This is due to the fact that the nature of the Within County mail subclass simply does

not allow for as much de-averaging as is possible in the Outside County subclass. Tr.

7/1731, 1868-69.

ii. The Postal Service’s proposed piece/pound ratio for Within County leads to a balanced increase between the piece and pound sides, whereas NNA’s does not.

NNA witness Siwek criticizes the Postal Service’s proposed Within County

piece/pound ratio due to the fact that it deviates from the ratio for Outside County, and

proposes that the Outside County ratio be used instead. NNA-T-3 at 25. This would

15 In Docket No. R97-1, for example, the Commission recommended passthroughs for the Within County piece rates that were for the most part much lower than the passthroughs used for the Nonprofit piece rates. See PRC Op., R97-1, at 542, 547-548. In particular, the Carrier Route Basic passthrough was 95 percent for Nonprofit and 50 percent for Within County. Id. Subsequent cases have exhibited this same pattern.

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lead, however, to a wholly imbalanced rate proposal. Implementing this revision would

cause the delivery unit pound rate to not increase at all, and the General pound rate to

increase by only 2.82 percent. Tr. 29/9708. This would benefit heavier weight

publications at the expense of lighter publications.

Witness Tang’s rate design, on the other hand, strikes a more appropriate

balance between the piece and pound rate increases. As noted above, the billing

determinants demonstrate that the weight per-piece for Within County mail has

increased over time, leading to an increase in the importance of the pound rates, and

making it impossible to return to a ratio around 60/40 without creating highly unbalanced

increases between the piece and pound rates. Deviating from a traditional ratio in this

manner in order to achieve rate balance also finds support in past Commission practice.

See PRC Op., R97-1, at ¶ 5799.

Overall, the Commission must ensure that the rate design it recommends is

balanced and considers the concerns of all Within County mailers, including those small

mailers who are not represented in this proceeding and who do not presort to carrier

route. The Postal Service’s rate design achieves such a balance between carrier route

and non-carrier-route mailers through its choice of passthroughs and resulting rate

discounts, which provide appropriate discounts for carrier-route presorted mail without

unduly impacting non-carrier route mail. In addition, the Postal Service’s rate design

provides an appropriate balance between the rate increases on the piece and pound

sides, and thus balances the impact of the rate increase between lighter and heavier

weight publications. The Commission should accept the Postal Service’s balanced

approach and reject NNA’s proposals.

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VII. THE PROPOSED FEES AND CLASSIFICATIONS FOR SPECIAL SERVICES ARE FAIR AND EQUITABLE, COST-BASED, AND CONSISTENT WITH THE OTHER STATUTORY RATE AND CLASSIFICATION CRITERIA

The Postal Service’s special services provide an array of options for customers

of all of the classes of mail. Several Postal Service witnesses developed special

service cost analyses, and pricing witnesses Susan W. Berkeley (USPS-T-39), Drew

Mitchum (USPS-T-40), and Kirk T. Kaneer (USPS-T-41) designed the fees, and

proposed many classification changes. As demonstrated by these witnesses, the

Postal Service’s special service classification and fee proposals satisfy the statutory

classification and pricing criteria, and meet the needs of customers. Therefore, all of

the Postal Service’s classification and fee proposals should be recommended by the

Commission.

Extensive cost studies provided a solid foundation for the Postal Service’s

proposals. Witness Waterbury (USPS-T-10) summarized volume variable costs for

those special services included in the Postal Service’s CRA reports.1 Witness Pifer

summarized volume variable costs, and developed incremental costs for those special

service costs included in the Postal Service=s CRA reports.2 These costs are used for

overall cost coverage analyses for each of those special services. In addition, these

costs, along with corresponding volumes, are used for fee design for Certified Mail,

collect-on-delivery, money orders, Registered Mail, and special handling.

When CRA data are not available, special service cost studies are used by the

pricing witnesses for both cost coverage and fee design purposes. Several Postal

Service witnesses prepared these special service cost studies. Witness Mayes

presents the cost study for bulk parcel return service. USPS-T-25 at 15-16. Witness

Cutting presents the cost studies for address correction service. USPS-T-26 at 9-13.

1 These special services include certified mail, collect-on-delivery, insurance, money orders, post office box and caller service, registered mail, special handling, stamped cards, and stamped envelopes. USPS-T-10, WP-E, Page D-1. 2 USPS-T-18, Table 1A.

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Witness Abdirahman presents the cost studies for business reply mail, permits, and the

account maintenance. USPS-T-22 at 17-21. Witness Page provides cost studies for

caller service, certificates of mailing, Confirm, correction of mailing lists, Delivery

Confirmation, insurance, money order inquiries, Periodicals applications, post office box

key replacement and lock changes, restricted delivery, return receipts, Signature

Confirmation, stamped cards, stamped envelopes, and ZIP Coding of mailing lists.

USPS-T-23; LR-J-59, Attachments 1, 2, 3, 4, 6, 7, 8, 9, 10, 11, 12, 13, 15, and 17.

Using the results from witness Page, witnesses Smith and Kaneer further develop the

costs for caller service. USPS-T-13 at 30-31; USPS-T-41 at 25-26.

Postal Service witnesses Berkeley, Mitchum, and Kaneer used sound

professional judgment to develop fees and fee designs for the special services. Witness

Berkeley presents pricing proposals for the annual account maintenance fee, bulk

parcel return service, business reply mail, certified mail, collect-on-delivery, Delivery

Confirmation, merchandise return service, money orders, Periodicals application fees,

permits, restricted delivery, return receipts, Signature Confirmation, stamped cards, and

stamped envelopes. USPS-T-39. Witness Berkeley also proposed and testified in support of several classification

changes for these special services, including the account maintenance fee,

merchandise return service, and meter service. She proposes to rename the

accounting fee as “account maintenance” fee. This change would more accurately

describe the service, which involves account maintenance activities, rather than

accounting activities related to daily withdrawals from an account. USPS-T-39 at 5.

The classification changes for merchandise return service and meter service are

discussed in their respective sections, below.

Witness Mitchum proposes classification changes consistent with his proposed

fee structure changes for address correction service, Confirm service, and insurance, as

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discussed below. His testimony also proposes classification changes for address

correction service, Confirm service, and insurance, corresponding to the proposed

changes described below.

Witness Kaneer proposes a clarification on Group E fee availability in footnote 1

of the post office box service fee schedule. USPS-T-41 at 29-30. This clarification is

not intended to change any aspect of Group E fee availability. Tr. 15/4350, 4354.

Presiding Officer’s Information Request No. 12, Question 8 raised the issue of

reorganizing the Domestic Mail Classification Schedule (DMCS) for special services,

primarily to include a complete listing of the special service combinations for each

special service. The Postal Service repeated its concerns about including these

combinations in the DMCS. In particular, the Postal Service wishes to retain flexibility to

change special service combinations to meet customer needs, without the delay from

first preparing and litigating a case for Commission review. The Postal Service also

suggests some alternative, more customer-friendly approaches for the Commission to

exercise control over the combinations of special services, should the Commission wish

to pursue them after the rate case. Tr. 19/7027-32. The Postal Service notes that no

participants have indicated an interest in changing the DMCS language as proposed by

the Commission in Docket No. R2001-1.

The Postal Service filed errata to its Request, much of which corrected special

service provisions.3 The Postal Service urges the Commission to recommend the

changes in the errata notice.

3 Notice of United States Postal Service of Filing Second Errata to the Proposed Changes in the Proposed Rate and Fee Schedules and the Domestic Mail Classification Schedule (September 20, 2006).

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Witness Mitchum proposes and testifies in support of fee changes for the

following special services: address correction service, certificates of mailing, Confirm,

insurance, mailing list services, parcel airlift, registered mail, and Special Handling.

USPS-T-40. He also presents the Postal Service’s proposal for a new Standard Mail

forwarding charge, which is discussed in the Standard Mail part of Section VI of the

brief.

Witness Kaneer presented and supported the Postal Service’s proposals for

Post Office Box and Caller Service. For post office box and caller service, witness

Kaneer forecasts volumes, by fee group and box size. USPS-T-41 at 3-7. He also

allocates CRA post office box costs by box size and ZIP Code. Id. at 7-14. He

proposes making the caller service fees reflect location, consistent with the current

approach for post office box service. Id. at 24-26.

Witnesses Berkeley, Mitchum, and Kaneer demonstrate that the Postal Service=s

proposed cost coverages satisfy the criteria of the Act. USPS-T-39, USPS-T-40, and

USPS-T-41. Only one cost coverage, and one implicit cost coverage, have been

challenged in this proceeding. Intervenor challenges to the proposed cost coverages

for collect-on-delivery (COD) and electronic return receipts are addressed below.

Intervenors have challenged the Postal Service proposals for the following

special services: business reply mail (BRM), COD, Confirm, and return receipts. The

issues for these special services are presented below, along with a brief discussion of

five other special services in which significant changes are proposed, specifically

address correction service, insurance, merchandise return service, meter service, and

Registered Mail. The Postal Service urges the recommendation of all of its special

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service proposals, including those that are not addressed below. The Postal Service

also recommends the approval of the DMCS changes proposed in the direct testimonies

of witnesses Berkeley (USPS-T-39), Mitchum (USPS-T-40), and Kaneer (USPS-T-41).

A. The Proposed Fee Redesign for Address Correction Service Should Be Recommended

Address correction service helps mailers correct their bad mailing addresses, by

providing a forwarding address, corrected address, or a reason why mail is

undeliverable. Witness Mitchum proposes both pricing and classification changes to

improve the service. These include the addition of an automated option, with lower

fees, along with fee differentiation by class of mail for both the electronic and proposed

automated options. The automated option would rely on address corrections being

processed automatically by the Postal Automation Redirection System (PARS). USPS-

T-40 at 8.

As a result of these changes and a new cost study, witness Mitchum proposes a

33 percent fee reduction for manual correction notices, a 71 percent fee reduction for

electronic correction for First-Class Mail, and a 19 percent fee increase for electronic

corrections for other classes of mail. USPS-T-40 at 6. The fee increase for electronic

corrections for classes other than First-Class Mail is offset because this fee would apply

even when electronic option customers receive manual notices. Id. at 8. The proposed

fees for the automated option are lower for First-Class Mail than for Standard Mail, as

well as for the first two notices, compared to additional notices, for a particular address.

Witness Mitchum also proposes the DMCS changes needed to implement the proposed

changes. Id. at 10-11.

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These proposals, with their generally lower prices, are intended to encourage

mailers to improve the quality of their mailing lists by using address correction service.

USPS-T-40 at 9. All of these address correction service proposals are unopposed, and

should be recommended.

B. The Proposed Business Reply Mail Fees Should Be Recommended. Witness Berkeley proposes fee decreases for three of the Business Reply Mail

(BRM) fee categories (the per-piece fees for Qualified BRM (QBRM) without a quarterly

fee and Regular BRM with an accounting fee, and the quarterly fee for QBRM with a

quarterly fee), and fee increases for four fee categories (the per-piece fee for QBRM

with the quarterly fee, the per-piece fee for Regular BRM without an accounting fee, and

the monthly and per-piece fees for weight averaged nonletter-size BRM). Increases are

also proposed for the account maintenance (accounting) fee and the annual permit fee.

The proposed percentage increase, overall, is only 0.14 percent, resulting in a proposed

cost coverage for BRM of 185.5 percent. USPS-T-39 at 14-15. Witness Berkeley’s fee

proposals are based on the BRM cost estimates of witness Abdirahman. USPS-T-22 at

17-21.

Only one fee proposal is challenged. The Major Mailers Association opposes the

proposed increase, from 0.8 cents to 0.9 cents, of the per piece fee for Qualified BRM

with a quarterly fee (also known as High Volume QBRM). MMA witness Bentley (MMA-

T-1) proposes to eliminate the High Volume QBRM per piece fee entirely, or reduce it to

no more than 0.5 cents. MMA-T-1 at 27. Witness Bentley bases his fee proposal on his

own calculation of the High Volume QBRM per piece cost, which results in a drastically

lower cost estimate than what is provided by witness Abdirahman. Witness Bentley

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estimates that the High Volume QBRM per piece cost “ranges from 0.012 cents to 0.070

cents.” MMA-T-1, Appendix II, at 7, line 23. He testifies that he finds the lower end of

the range, 0.012 cents, “more reliable.” Id. at line 24. Witness Abdirahman, on the

other hand, calculates a unit cost of 0.458 by following the same cost methodology as

the one employed in Docket No. R2005-1. USPS-T-22 at 21.

Witness Bentley arrives at his lower unit cost estimate by combining various

methodologies and assumptions. MMA-T-1, Appendix II, at 7, lines 10-20. In witness

Bentley’s view, his alternative calculation is necessary because he “suspects” that the

Postal Service’s estimate of the percentage of High Volume QBRM that is manually

counted is “simply wrong.” MMA-T-1 at 28, lines 24-25. Witness Bentley uses some of

the results of Postal Service witness Loetscher’s BRM Practices Study (USPS-T-28;

USPS-LR-L-34). However, instead of using the manual counting productivity, he

applies the productivity for counting machines or weight averaging techniques. MMA-T-

1, Appendix II, at 7, lines 11-14. He also assumes the counting methods by percentage

from Postal Service witness Miller’s High Volume QBRM survey from Docket No.

R2001-1, rather than accepting the manual counting results from witness Loetscher’s

study in this docket. Id. at lines 14-17.

However, as witness Loetscher’s rebuttal testimony (USPS-RT-9, Tr. 38/13263 et

seq.) points out, witness Bentley is incorrect in asserting that the manual counting

estimates presented in USPS-LR-L-34 are flawed. Witness Oronzio (USPS-RT-15, Tr.

36/12226 et seq.) also supports witness Loetscher’s manual counting estimate from an

operational perspective. Thus, there is no need for witness Bentley’s alternative unit

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cost estimate, with his “pick-and-choose” method of using different assumptions and

methodologies from prior dockets.

In his rebuttal testimony, witness Loetscher discusses how witness Bentley

ignores basic characteristics of the High Volume QBRM category. Tr. 38/13269-71.

For example, witness Loetscher explains how the volume of High Volume QBRM

depends on how much each customer expects to receive each quarter, rather than the

amount they actually receive. Tr. 38/13269. There is also no minimum volume

requirement for High Volume QBRM eligibility. Tr. 38/13270. Therefore, High Volume

QBRM can be received in small volumes on any given day, based on a variety of factors

that contribute to fluctuations in mail volume. Id. Witness Bentley demonstrates his

misunderstanding of these facts by stating, “I do not understand how an office can

process and deliver High Volume QBRM but does not receive a ‘significant volume of

QBRM.’” Tr. 21/7880-2.

As witness Loetscher’s rebuttal testimony makes clear, if it is not already clear

from his direct testimony (USPS-T-28) and library reference (USPS-LR-L-34) alone,

witness Loetscher’s BRM Practices Study in this docket is the most statistically sound

study of the BRM universe available today. Tr. 38/13276-9. Witness Loetscher’s

estimate of the percentage of QBRM letters is consistent with operational practice, as

witness Oronzio testifies. Tr. 36/12272 at lines 17-18. However, the study by witness

Campbell in Docket No. R2000-1 and the survey by witness Miller in Docket No. R2001-

1 both suffer from selection bias and measurement bias. Tr. 38/13271-6. The selection

bias in those studies exists because both excluded lower volume recipients from their

analysis of High Volume QBRM. Tr. 38/13271-4. Similarly, both studies exhibit

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measurement bias because they assumed away manually counted volumes. Tr.

38/13274-6.

On the other hand, witness Loetscher’s BRM Practices Study in this docket

(USPS-LR-L-34) provides unbiased estimates based on sound statistical methods. Tr.

38/13276-79. Witness Oronzio supports the manual counting estimates in his rebuttal

testimony by explaining that in certain situations, it is more efficient to manually count

High Volume QBRM that is received in smaller volumes. Tr. 36/12272-3. Nevertheless,

witness Bentley chooses to assume the counting methods by percentage from Postal

Service witness Miller’s survey in Docket No. R2001-1, and refuses to accept the

manual counting estimates of witness Loetscher, in favor of flawed estimates from prior

dockets. MMA-T-1, Appendix II, at 7, lines 10-20. Because witness Bentley’s

calculation of the High Volume QBRM per piece costs is based on assumptions from

flawed statistical studies in prior cases, rather than following witness Loetscher’s

statistically-sound BRM Practices Study, the Commission should reject witness

Bentley’s unit cost estimate. Therefore, the Commission should also reject witness

Bentley’s High Volume QBRM fee proposal, which is based on his flawed unit cost

analysis.

C. The Proposed Fee Changes for Collect-On-Delivery (C.O.D.) Should Be Recommended

Witness Berkeley proposes fee increases ranging from 2.2 to 21.1 percent for

Collect-On-Delivery (COD) mail valued up to $400, no fee change for COD mail valued

from $400 to $500, and fee decreases of 1.8 to 6.6 percent for COD mail valued above

$500. Overall, a 10.6 percent fee increase is proposed. See USPS-T-39 at 26-27. The

largest fee increase, for COD mail valued up to $50, reflects the relatively high

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percentage of claims filed in this fee category. This fee increase also provides a base

from which other fee categories can face smaller increases, or even decreases. Id. at

29.

Witness Berkeley proposes a low cost coverage of just 113 percent, down from

the 129 percent cost coverage that resulted from Docket No. R2005-1. USPS-T-39 at

26; PRC Op., R2005-1, Appendix G, page 1. In proposing a relatively low cost

coverage, witness Berkeley balances the value of service for customers with the fact

that declining volume and revenue suggest reduced relevance in the marketplace.

USPS-T-39 at 30.

Growing Family presents the testimony of its Vice President, Operations, Robert

Paul (GF-T-1). In essence, Mr. Paul raises complaints about how the Postal Service is

paying claims by Growing Family when it sends a package by COD, but receives

neither the money the addressee would pay if purchasing the package, nor a return of

the package if the addressee refuses it. Mr. Paul testifies that until May 2005, the

Postal Service would reimburse Growing Family in an amount equal to what was to be

collected from the addressee, but that since May 2005 the amount has only equaled the

reproduction cost of Growing Family's items (along with postage and COD fees). GF-T-

1 at 2-3.

Witness Paul recognizes that some of the claims issues he raises are not

suitable for Commission action in this rate case. GF-T-1 at 8, 15. He formulates only a

few links to the rate case, none of which should have an effect on the pricing of COD

service.

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First, he argues that the COD revenue requirement and fees in the Test Year

should be reduced to reflect the impact of the Postal Service's alleged new claims

payment practice in relation to Growing Family, which began in May 2005, during the

Base Year.4 This argument suffers from a failure of proof. Growing Family did not

submit any evidence that could be used to quantify the impact of this new practice on

the Postal Service's projected total COD claims payments in TY 2008; much less did it

propose any alternative projected costs for the Test Year. While witness Paul states

that Growing Family represents "about 10% of the total COD volume," GF-T-1 at 2, he

does not show what percentage of the Postal Service's total COD claims payments go

to Growing Family, by what proportion Growing Family’s claims payments would

decrease since the base year, or even that Growing Family’s claims dispute would have

a significant impact on total COD costs. In the absence of such evidence, there is no

basis to alter the Postal Service's projected Test Year COD claims payments.

Second, witness Paul believes the already low cost coverage for COD should be

reduced even further to reflect a low value of service, as portrayed in his testimony.

GF-T-1 at 16. He does not, however, counter witness Berkeley's testimony that COD

service is a high value service because all sellers, even ones that do not accept credit

cards, can utilize it, and all recipients, regardless of their economic classification, are

able to have merchandise mailed to them without prepaying. USPS-T-39 at 30.

Moreover, Mr. Paul testifies that Growing Family's historical claim rate has declined.

GF-T-1 at 2. Indeed, the only argument he makes about a lower value of service is

1 GF-T-1 at 8-9, 15-16. Witness Berkeley explains that any change in May 2005 was "due to a clarification of the Postal Service's policy," as explained in the March 10, 2006, letter from Postal Service Consumer Advocate Delores Killette to David Straus, attorney

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limited to the new payment practice as it relates to his own company. Tr. 23/8251.

Growing Family, once again failing to support its argument with record evidence, fails to

show why the decrease in COD's cost coverage from 129 percent to 113 percent should

go even further.

Third, Mr. Paul argues that the fee should be calculated based on the

reproduction cost of the item mailed. GF-T-1 at 6, 16. To begin with, this standard

would unduly complicate the application of the fee schedule, as each mailer would have

to calculate, in advance, how much it would cost to replace each item mailed by COD.

More importantly, COD indemnities to mailers are not always limited to reproduction

costs. In two of the four scenarios described in the March 10, 2006, letter from Postal

Service Consumer Advocate Delores Killette to David Straus, attorney for Growing

Family, the Postal Service will reimburse the mailer for the full amount that was to have

been collected from the recipient. Tr. 15/4484-85. Accordingly, it is appropriate to base

the fee calculation on that amount.

The Postal Service therefore submits that the Commission should recommended

the rates proposed by witness Berkeley, and that Growing Family’s claims dispute

should have no effect on the pricing of COD service.

D. The Postal Service Proposal for Confirm Service is the Only One Likely to Cover Attributable Costs

Pricing for Confirm service has received considerable attention in this

proceeding. Contrary to initial expectations, the Postal Service is faced with a pricing

structure that never produced sufficient revenue to cover costs since its introduction via

Docket No. MC2002-1. Subscription and other fees have been insufficient to cover

for Growing Family. Tr. 15/4482-85.

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costs because fewer subscribers than anticipated signed up.5 In particular, many

potential subscribers instead chose to obtain Confirm service through resellers. Very

little incremental revenue is generated when customers use resellers, because the

structure includes an unlimited scan tier. When a reseller adds a customer, neither the

reseller nor the customer pays the Postal Service any additional fees, with the limited

exception of fees for additional IDs.6

The Postal Service supports resellers, having anticipated their existence, and

welcomes their provision of value added services to consumers.7 However, the number

of subscriptions and the proportion of direct subscribers to resellers have consistently

left the Postal Service with revenue insufficient to cover attributable costs.

As a consequence, the Postal Service proposes a single subscription tier with

declining block fees for “units” which are exchanged for scan information.8 While this

would eliminate the option to pay a fixed fee for unlimited scans, the declining block

fees make the incremental fees low. A million units costs as little as $17.50, which,

although not free, results in a very low effective price per scan.9 Nonetheless, this

pricing structure provides some Postal Service revenue if, as expected, resellers

continue to play a significant role in providing Confirm service. By generating at least

5 USPS-T-40 at 19. 6 USPS-RT-13 at 16. 7 USPS-RT-13 at 10 and 15. 8 Witness Mitchum also proposed classification changes consistent with his pricing proposal. USPS-T-40 at 18-19, 21. One of these changes, concerning the electronic notice requirement in DMCS 991.31, has been controversial. The Postal Service is willing to retain the status quo with the notification requirement in DMCS 991.31, consistent with the interest of Office of the Consumer Advocate and some customers. 9 USPS-T-40 at 18.

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some incremental revenue for the provision of the data, this structure helps protect

Confirm service from failing to cover costs.10

The Postal Service and the Commission cannot simply expect higher prices to

overcome the failure of the existing structure to recover costs since fees were

implemented in September of 2003. Instead, the Postal Service urges the Commission

to follow the prudent course of altering the pricing structure in a manner that helps

assure compliance with the statutory cost coverage requirement in 39 U.S.C. §

3622(b)3).

1. The Postal Service’s proposal improves fairness and equity.

A wide variety of customers (in terms of scan usage) currently use the unlimited

tier. Within that group, the proposal would shift the fee burden toward the largest

users.11 This shift complies with the fairness and equity ratemaking criterion: 12 those

that make greater use of the service would pay more. As an illustration, currently, a

customer receiving data on 164 million scans pays 61 times more per scan than a

customer obtaining data on one billion scans. Under the Postal Service proposal,

instead of the smaller customer paying 61 times as much per-scan as the larger user,

she would pay less than twice as much per scan.13

The Postal Service also proposes to improve fairness and equity by making

Standard Mail (and other class) customers pay a greater share of the Confirm costs,

relative to First-Class Mail customers. Witness Mitchum proposes to charge five units

10 USPS-RT-13 at 17. 11 USPS-T-40 at 20; Tr. 14/3918-19. 12 39 U.S.C. § 3622(b)(1). 13 As shown in USPS-RT-13 at 18, the cost per million scans for 164 million scans is $91.95, while the cost per million scans for 1 billion scans is $56.03. Thus, the smaller

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for each Standard Mail scan, compared to one unit for each First-Class Mail scan.14

Today, the relative values of First-Class Mail and Standard Mail are distinguished by the

availability of more special services, features built into its price, and speed of service for

First-Class Mail; the Postal Service proposal for Confirm service builds additional value

for First-Class Mail by – as proposed for Address Corrections (see proposed Fee

Schedule 911) – providing a lower effective price for First-Class Mail.15 MMA witness

Bentley evidently agrees, as his Confirm proposal would charge First-Class Mail

customers less than Standard Mail customers. Witness Bentley states:

[I]t makes sense to add such value only to First-Class Mail workshared mailers that make a unit contribution to institutional costs that is more than twice the unit contribution to institutional costs that Standard mailers make.16

2. Unit-based pricing facilitates adding other information-based

services under the Confirm umbrella. Witness Mitchum proposes to charge for units rather than scans, in part to

provide flexibility for future Confirm enhancements, such as the provision of data

generated by manual scans of containers of mail.17 Establishing this system of unit-

based prices now will ease any modification that expands Confirm service beyond

today’s piece-scan information. It will allow the Postal Service to update its Confirm

software just once, likely saving development costs that would otherwise have to occur

if a separate option were developed to provide other forms of data. Tr. 33/11369-71.

mailer would pay only 64 percent more per million scans. 14 USPS-RT-13 at 17. 15 Tr.14/3934, 3959-62, 4125, and 4131. 16 Tr. 21/7900. While the Postal Service does not believe an unlimited tier is consistent with covering costs, if an unlimited option is nonetheless retained, it would be advisable to limit it to First-Class Mail usage, as supported by witness Bentley. See Tr. 33/11310-11.

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The unit structure proposed by witness Mitchum is sufficiently flexible that it can

accommodate other possible Confirm fee proposals that may be made. For example,

MMA witness Bentley agreed that his proposal to charge just an annual fee for First-

Class Mail scans could be implemented using the unit fee structure proposed by

witness Mitchum. Tr. 21/7953-54.

3. The existing fee structure has so many shortcomings that it would still fail to cover Confirm costs, even if fees are increased.

The Office of the Consumer Advocate (OCA) proposes to retain the existing fee

structure. GrayHair Software supports that proposal.18 But the OCA’s proposed fees

are unlikely to generate adequate revenues to cover costs. Witness Callow proposes to

generate almost all the needed additional revenue to cover costs by increasing the fee

for the unlimited (Platinum) tier by 95 percent. Since he assumes that all current

subscribers would accept this increase, he shows an increase in revenue of 95 percent

from the unlimited tier. While this assumption conveniently helps meet the cost

coverage threshold on paper, it runs an unacceptable risk of being wrong, jeopardizing

the alleged cost coverage.

Since the current fees are modest, and have not changed since the

implementation of Confirm, customers have had little reason to re-evaluate their

selection of a service tier. However, an increase of 95 percent, to $19,500 for the

Platinum tier, would likely cause customers to review their options. Certainly, the

inordinate amount of attention that the price increase has garnered leads one to think

that customers would indeed seek ways to at least lower their out-of-pocket expense for

17 USPS-T-40 at 16-17; Tr. 33/11307-08. 18 GHS-T-1 at 2-7.

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using Confirm. If that is the case, faced with a 95 percent increase in the unlimited tier,

many subscribers might drop out, switch to resellers, or buy down to the Gold tier.

Because of the price advantage that would be offered by choosing the Gold tier

under the OCA’s prices, only 15 Platinum subscribers would be expected to remain

Platinum subscribers at the $19,500 fee,19 producing $406,500 less revenue than

witness Callow projects.20 Costs therefore would not be covered.

MMA witness Bentley agrees that Confirm users who require 61 million or fewer

scans “would more than likely have chosen to become a gold subscriber.”21 Witness

Bentley also disagrees with witness Callow’s assumption that a 95 percent increase in

the Platinum tier fee would not reduce the number of Platinum subscribers.22

Retaining the existing structure with even higher fees than the OCA proposes

also would not assure costs are covered, and would impose too large a burden on

moderate users of the unlimited tier. Witness Mitchum’s rebuttal testimony explains that

the Platinum fee would need to increase to $42,500 (and even higher to reflect

additional consequent switches to the Gold tier) to cover costs. But to cover costs, 8

Platinum users would need to continue to subscribe when faced with this 325 percent

increase in fees. The Postal Service fears that these fee increases needed to cover

costs under the existing fee structure would drive even more customers to resellers.

19 USPS-RT-13 at 22. 20 The revenue decrease assumes: no loss in the number of subscribers overall; 30 Platinum subscribers would switch to Gold in order to save money; and, on average, these Gold subscribers would need to purchase one additional block of 6 million scans each. Under these assumptions, the Platinum subscription revenue decreases from $877,500 to $292,500, for a revenue decrease of $585,000. Gold subscription revenue increases by $156,000 to $774,800, and Additional Scan revenue increases from $750 to $23,250. The net effect of these changes is $406,500 less revenue. 21 Tr. 21/7894.

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Costs would not be covered if almost all Platinum users stop subscribing at that level,

no matter how high the fee.

Any attempt to preserve the existing fee structure must also consider the risk that

arbitrage will limit the revenue that fee increases produce. As witness Mitchum explains

in rebuttal, arbitrage is the process by which someone purchases a commodity and then

resells the commodity so as to profit from a pricing discrepancy. In the case of Confirm

service, a reseller takes advantage of the availability of unlimited scans for a fixed price

by acting as a middle man for several subscribers, offering each of them a savings over

what they would pay the Postal Service to subscribe directly to the service.23

While arbitrage has not been a substantial problem for Confirm to date,24 its risks

would increase as fees for the unlimited tier increase. Increasing the Platinum fee to

$42,500 would appear on the surface to recover the revenue lost from customers

buying down to the Gold tier, but it ignores the likelihood that resellers would attract

business from Gold tier customers paying up to $42,500, and Platinum tier customers

paying $42,500. The fee would accordingly need to increase even more, causing more

customers to switch to the Gold tier or a reseller.25

Hence, there is no assurance that the current structure would actually produce

revenues that cover costs, regardless of the level of the Platinum fee.

22 Tr. 21/7896. 23 Tr. 33/11298-99 (USPS-RT-13 at 14-15). 24 Tr. 33/11299 (USPS-RT-13 at 15); GHS-ST-1 at 4. 25 Tr. 33/11300-01.

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4. The Postal Service proposal would not diminish the utility of Confirm service for service performance assessment.

The Postal Service goal is for Confirm service to cover costs while balancing the

other ratemaking criteria. The record shows that Confirm service does not work well

for the Postal Service as a performance assessment tool, which explains why the Postal

Service developed its own process of adding Planet Codes to pieces in the mail stream

to assess service and make adjustments to improve it.26 While this use does not

generate revenue for Confirm service, nor are its costs attributed to Confirm. By

agreeing informally with the OCA not to push elimination of the electronic notice

requirement in DMCS 991.31, the Postal Service is signaling its intention not to reduce

the utility of Confirm service for assessing service performance. In any event, the

Postal Service is open to using any number of tools to improve measures of service

performance. The proposed price structure for Confirm service does nothing to change

the potential role that the Confirm infrastructure may or may not play in such

improvements.

5. Witness Bentley’s proposal for a specific subscription just for workshared First-Class Mail may be worth examining, but it does not appear to be supported on the record.

MMA witness Bentley proposes that, for workshared First-Class Mail, Confirm

service should provide unlimited scans for a fixed annual fee, such as $2,000.27 The

basis for witness Bentley’s proposal is that Confirm service need not directly cover its

costs, given the value that it adds to First-Class Mail.28

26 Tr. 14/3942-43. 27 MMA-T-1 at 33. 28 Tr. 21/7921-22.

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But Docket No. MC2002-1 established Confirm service as a special service, with

OCA and mailer support. No participant is proposing in this docket a classification

change that would bundle Confirm service with one or more classes of mail. As a

special service, Confirm service is required by statute to cover its costs.29 So while

Bentley’s proposal may be interesting in concept, record evidence does not appear to

permit its specific adoption in this docket. For example, it is not clear whether a mailer

of multiple classes of mail would subscribe to Confirm by purchasing the $2000

subscription for workshared First-Class Mail, and another subscription for the other

classes of mail. No fees for Standard Mail customers are proposed in conjunction with

the $2000 fee for First-Class Mail presort mailers, nor is any attempt made to show that

such a fee would recover all Confirm attributable costs. Accordingly, it does not appear

to constitute a viable alternative in this proceeding.

E. The Enhancements to Insurance Service Allow Fee Reductions and Should Be Recommended

Witness Mitchum proposes significant changes for insurance service. The

proposal would add a barcode and delivery scan for the current unnumbered ($0-50)

category in order to facilitate the claims process. The proposal also would eliminate the

signature requirement for insurance for items valued between $50 and $200, but retain

the delivery scan. The result is to reduce costs enough to justify fee decreases for all

but two fee categories. USPS-T-40 at 24, 28-29.

Consistent with the addition of a barcode and delivery scan for insurance for

items valued up to $50, witness Mitchum proposes to increase its fee from $1.35 to

$1.65. However, the proposed fee for insuring items valued between $50 and $100

29 39 U.S.C. § 3622(b)(3).

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would decrease from $2.30 to $2.05, and the proposed fee for insuring items valued

between $100 and $200 would decrease from $3.45 to $2.45. The fee for items insured

for $200.01 to $300 would increase from $4.40 to $4.60. Consistent with the

restructuring of the prices for insurance service, witness Mitchum proposes a 14 percent

reduction in the incremental fee for each additional $100 of insurance above $300, from

$1.05 to $0.90. This would produce a price reduction for all items insured for more than

$400. Id. at 22, 25-26.

Witness Mitchum also proposes a redesign of the insurance fees for Express

Mail. The fees for Express Mail insurance (above the $100 of insurance included in

postage) are proposed to change from the current $1.05 per $100 of coverage, to $0.75

for the first additional $100 increment, $2.10 for items insured from $200.01 to $500,

and then $1.35 for each $500 increment above $500. The result is a significant fee

decrease for most increments, with no increase for any level of coverage. Id. at 26.

Consistent with his proposed changes, witness Mitchum proposes just one bulk

insurance discount, of 80 cents, reflecting the cost savings realized by the Postal

Service. Id; See USPS-LR-L-59, Attachment 6, page 1.

In addition to the fee increases, witness Mitchum proposes classification changes

specifying that a signature is obtained only for items valued above $200. For items

valued at $200 or less, a delivery scan, rather than a signature, is sufficient to protect

the customer’s and Postal Service’s interests in insuring a mail item. Moreover, postal

customers may prefer that delivery be made without requiring the recipient to come to

the door or the Post Office to sign for the item. USPS-T-40 at 26-27. He also proposes

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to extend the limitation on coverage of negotiable items, currency, or bullion from

Express Mail insurance to all insurance. Id. at 26-27.

These changes improve the product, have not been opposed, and should be

recommended.

F. The Proposed Classification Changes for Merchandise Return Should Be Recommended

Witness Berkeley proposes clarifications to the DMCS language for merchandise

return service (MRS). She proposed changes for the merchandise return service

classification, to clarify that the service is not limited to the return of parcels, but is also

available for sending parcels. Id. at 40-41. These proposed changes have not been

opposed, and should be recommended. G. The Proposal to Eliminate Meter Service Should Be Recommended

Since on-site meter service was discontinued on February 28, 2006, witness

Berkeley proposes to remove Fee Schedule 933 and DMCS 933 pertaining to the fees

and classifications regarding meter service. USPS-T-39 at 42. The proposed changes

have not been opposed and should be recommended.

H. Registered Mail Fees Should be Based on Costs Estimated in Accordance with the Postal Service’s Methodology

The Postal Service proposes a 50 percent increase in Registered Mail fees in

order simply to raise the revenue from this service above its cost. Under the Postal

Service version of the Cost and Revenue Analysis (CRA), this service has been priced

below costs for the past few years. The proposed fee increases therefore do not result

from recent increases in Registered Mail costs. Rather, they reflect the need to recover

an existing shortfall between revenues and Postal Service CRA costs.

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In past rate cases the Commission has moderated Registered Mail fee

increases, compared to Postal Service proposals, based on a different allocation of

costs between customer and Postal Service usage of Registered Mail. In prior cases,

this different allocation produced lower Registered Mail costs under the previous PRC

methodology, compared with the Postal Service methodology. However, for the base

year in this proceeding, the base year Registered Mail costs using the previous

Commission methodology are actually higher than the costs using the Postal Service

methodology. This reversal reflects a change in the data collection in the redesigned In-

Office Cost System (IOCS). This change in data collection more effectively isolates

customer Registered Mail costs from Postal Service Registered Mail costs. Tr.

18D/6487-88. Registered Mail costs under the previous Commission methodology are

higher than under the Postal Service methodology, probably because all overhead costs

for Registered Mail are distributed to subclasses and services, including Registered

Mail, rather than to fixed costs. Tr. 18D/6489.

It is perfectly reasonable for the Commission to re-evaluate its methodology in

light of the change in information generated by the redesigned IOCS. The Postal

Service believes that the Commission should adopt the Postal Service’s approach to

estimated Registered Mail costs, and that Registered Mail fees thus should be based on

costs using the Postal Service methodology, holding the fee increase below that which

would be required under the previous Commission methodology.

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I. The Commission Should Recommend the Substantial Reduction in the Electronic Return Receipt Fee Proposed by the Postal Service, But a Greater Reduction Is Not Justified

The Postal Service has proposed increases of 10 to 16 percent for three of the

four return receipt categories. At the same time, the Postal Service is proposing a fee

decrease of 37 percent for the electronic return receipt category. USPS-T-39 at 61.

The proposed fee decrease primarily reflects the cost estimate for the products, which,

was adjusted downward from the Docket No. R2005-1 estimate by 45 cents. Unlike the

Docket No. R2005-1 cost analysis, witness Page assumed that the email transaction

contributes no costs to electronic return receipts. USPS-T-23 at 15. The result was a

45 cent reduction in costs. Compare USPS-T-39 at 63 ($0.44) with Docket No. R2005-

1, Exhibit USPS-27F, page 6, col (2), ($0.89). In response, witness Berkeley proposed

to lower the electronic return receipt fee by 50 cents, from $1.35 to $0.85. While this

increases the implicit cost coverage to 194 percent, the unit contribution decreases from

$0.46 to $0.41. This would leave the per unit contribution at only about three-fifths of

the 68-cent per-unit contribution from basic return receipt service. Tr. 38/13400.

Douglas Carlson criticizes the costing for electronic return receipts. DFC-T-1 at

4-8. He focuses on the window acceptance time of about 25 seconds. He speculates

that the purchase would involve one or two questions by the window clerk, and one or

two brief replies by the customer, taking about 10 to 15 seconds. Id. at 6-7. But that

ignores the wide variety of questions that a customer might ask. Tr. 23/8202. Witness

Berkeley reports on discussions with several people who have observed electronic

return receipt transactions at a retail counter. The typical transaction takes much

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longer, especially for new customers.30 Thus, it is more likely that the typical electronic

return receipt transaction is longer than 25 seconds, rather than shorter. So a new cost

study for electronic return receipts would tend to increase the cost estimate provided in

this docket.

Carlson ultimately uses the Postal Service cost estimate, but proposes a lower

cost coverage because of the cost uncertainty, and because there is no evidence that

the value of service for electronic return receipt is higher than that of green card return

receipt service. DFC-T-1 at 14. But value of service is not the only criteria to consider

in determining an implicit cost coverage for electronic return receipts. Fairness and

equity (criterion 1), effect of rate increases on customers (criterion 4), and degree of

preparation of mail (criterion 6) also should be weighed. Tr. 38/13401.

The over 50 percent fee reduction (from $1.35 to $0.65) proposed by Carlson

would skew the contributions so much as to be uneconomic. Under Carlson’s proposal,

the contribution from electronic return receipt is cut nearly in half (from 41 cents to 22

cents). The resulting contribution would be less than one-third the contribution from

basic return receipt service. This would create a perverse financial disincentive for the

Postal Service from encouraging more usage of electronic return receipts. Id. And, as

witness Berkeley concludes, under Carlson’s proposal, “there would be considerable

risk that the fee would not cover costs for any transactions in which the customer has

significant questions for the clerk.” Tr. 38/13401.

30 Tr. 38/13396-97. Since the volume of electronic return receipts is still low, and the Postal Service is promoting greater awareness of the electronic return receipt option, it is likely that many transactions involve new customers. Tr. 39/13396, 13399-400.

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For all these reasons, the Postal Service’s proposed fee for electronic return

receipt is far superior to Douglas Carlson’s.

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CONCLUSION For the reasons stated above, the rates for postal services, fees for special

services, and the modifications of the domestic mail classification schedule proposed or

endorsed by the United States Postal Service are supported by the evidentiary record

and are in accord with the applicable provisions of the Postal Reorganization Act.

WHEREFORE, the Postal Service requests that the Postal Rate Commission

recommend under 39 U.S.C. § 3624(d) the rates and fees and changes in the Domestic

Mail Classification Schedule requested by the Postal Service in this Docket.

Respectfully submitted,

UNITED STATES POSTAL SERVICE

By its attorneys:

Daniel J. Foucheaux, Jr. Chief Counsel, Ratemaking

____________________ ____________________ ____________________ Frank R. Heselton Kenneth N. Hollies Eric P. Koetting ____________________ ____________________ ____________________ Nan K. McKenzie Sheela A. Portonovo Elizabeth A. Reed ____________________ ____________________ ____________________ Brian M. Reimer Scott L. Reiter David H. Rubin ____________________ ____________________ Michael T. Tidwell Keith E. Weidner 475 L'Enfant Plaza West, S.W Washington, D.C. 20260-1137 December 21, 2006

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CERTIFICATE OF SERVICE

I hereby certify that I have this day served the foregoing document upon all participants of record in this proceeding in accordance with section 12 of the Rules of Practice.

___________________________________ Daniel J. Foucheaux, Jr.

475 L'Enfant Plaza West, S.W. Washington, D.C. 20260B1137 December 21, 2006