February 16, 2018

But what is the proposed new business model?

The headline in an article quoting Postmaster General Megan Brennan on the Federal News Radio website this week: “Postal Service: ‘Flawed business model’ to blame for first-quarter loss.” We have been hearing that the USPS “business model” is broken, flawed, unsustainable, or obsolete for many years. The conclusion dates back to at least eight years ago to March 2010 when the USPS issued a report: “Ensuring a Viable Postal Service for America: An Action Plan for the Future.”

What is the USPS “business model?”

What is the “business model” that everyone is talking about? Arguably, our 242-year-old post office had a successful “business model” for about 30 years: the 1970’s, 80’s, and 90’s. With the Postal Reorganization Act of 1970, the name was changed to the United States Postal Service and revenue was to make USPS largely self-sustaining through postage. Governance was changed to the Board of Governors, the Postal Rate Commission regulated pricing based on costs, and 80 percent of postal costs were determined through nonpublic collective bargaining with unions.

How did it work?

How did the “business model” work well for three decades? The creators of the Postal Reorganization Act of 1970 had perfect timing. The USPS business model really only worked during a period of superhuman growth in mail volume. Most attribute the unusual growth rate to the takeoff of both direct mail marketing and private sector work-sharing with the USPS. But a business model that only works with the steepness of the volume curve for those three decades obviously is not a sustainable business model.

Indeed, the steepness of the curve in the 70’s, 80’s, and 90’s can be viewed as an aberration rather than a norm that we could expect to continue.

Why does the USPS business model depend so much on such rapid volume growth? Because the growth of this high-volume, low-cost per-piece product must outpace the 80 percent labor-intensity of USPS.

Why are many business models successful today?

A goal of most currently successful business models is to compete by, among other things, bringing and keeping costs as low as possible. They do this through strategies such as automation, self-service, innovation, robotics, downsizing, outsourcing, reducing or limiting compensation, and global supply management. But businesses that rely on human work in fixed locations as their primary mode of operation have limitations in their access to these strategies. In the three decades of amazing mail volume growth, USPS was able to prosper because extreme volume growth covered ever-increasing labor-intensity costs.

Concurrent with rapid growth was an also unsustainable culture of not worrying too much about controlling costs or growing business through marketing and product innovation. If people were going to mail what they were going to mail, and they had few or no alternatives, why worry too much? The culture was reinforced and enabled by a triannual cost-of-service rate increase process. Why innovate, introduce new products, take out costs, if success only means a lower revenue requirement in the next rate case? And profits were not retained anyway.

2006 law aimed to increase businesslike incentives

The Postal Accountability and Enhancement Act (PAEA) of 2006 aimed to change the culture by changing the incentives. Prices would be set by the Postal Service as long as each class of mail did not rise faster than the general rate of inflation as measured by the Consumer Price Index. And the USPS was allowed, but not required, to retain any net profits it would make. The goal was to align the USPS with the private sector business norm of competing by bringing and keeping costs as low as possible and innovating in pricing and products.

Postal Service leadership embraced the change for a short period of time, until the financial meltdown and recession of 2007-2009. The management abandonment of the PAEA model was memorialized in the March 2010 USPS Action Plan.

2010 USPS Action Plan for the Future

The 2010 USPS Action Plan for the Future specifically identified the broken “business model” and the need to make changes in a declining volume environment. But, the 2010 report did not really define or advocate a new business model for the Postal Service. The report eight years ago started a process that continues today.

Instead of proposing a new business model, the USPS approach asks for more management “flexibility” and a laundry list of assistance from Congress and the regulator.  It is really a list of things to do to try to make the current business model work better. And the list from eight years ago is very familiar to anyone following the USPS.

Below is the executive summary of the report (emphasis added), which said that the old business model worked because of growing mail volume, without which the new business model requires greater flexibility.

“EXECUTIVE SUMMARY

For over 200 years, the Postal Service has fulfilled its mission to deliver trusted, affordable service to the nation. Its business model worked well because mail volume increased steadily as the nation grew. In recent years, however, as customer preferences have rapidly evolved and new technology has changed how Americans communicate and transact business, the model has faltered. Mail volume, instead of increasing, is declining dramatically, even as the cost of delivering mail to an expanding number of addresses continues to grow. As a result, the Postal Service’s ongoing ability to finance universal service is at great risk.

In the face of these challenges, the Postal Service has responded aggressively, saving over $1 billion every year since 2001, including $6.1 billion savings in 2009 alone. Yet these savings are not sufficient to counter underlying shifts in the business of mail. A loss of more than $7 billion is projected for 2010, and with current trends expected to worsen over the decade, the Postal Service will be pushed more deeply into crisis. Without fundamental change, cumulative losses could reach more than $238 billion by 2020.

To avoid potential insolvency, the Postal Service has developed an ambitious but achievable plan, taking steps allowed under current law to reduce the projected gap by $123 billion. These savings would be unprecedented, even by the standards set over the last several years. And even if its plan was to succeed in every action that present legislation allows, the Postal Service would still face unsustainable losses of at least $115 billion by 2020. This remaining gap can be closed, and the Postal Service can continue to fulfill its mission at no cost to American taxpayers, but only with additional flexibility that would have to come through legislative changes. They include:

1. Retiree Health Benefits Prefunding. Restructure retiree health benefits payments to “pay-as-you-go,” comparable to what is used by the rest of government and the private sector. This equates to an average of $5.6 billion in cash flow per year through 2016. Address overpayments to the Postal Service’s Civil Service Retirement System pension fund.
2. Delivery Frequency. Adjust delivery days to better reflect current mail volumes and customer usage. Survey data show that the public favors 5-day delivery over using taxpayer funds and other alternatives.
3. Expand Access. Modernize customer access by providing services where the customers are. Increase and enhance customer access through partnerships, kiosks, and improved online offerings, while reducing costs.
4. Workforce. Establish a more flexible workforce that is better-positioned to respond to changing demand patterns as over 300,000 employees become eligible to retire in the coming decade.
5. Pricing. Ensure that prices of Market Dominant products can be based on the demand for each individual product and its costs, rather than capping prices for every class at the rate of inflation. In addition, pursue a moderate exigent price increase effective in 2011.
6. Expand Products and Services. Permit the Postal Service to evaluate and introduce more new products consistent with its mission, allowing it to better respond to changing customer needs.
7. Oversight. Reinforce these changes with more clearly defined, appropriate, agile oversight roles and more streamlined processes.

Without question, the current situation is a crisis for the Postal Service, the mailing industry, and indeed for all postal stakeholders. It is also an historic opportunity — providing a chance to make positive and very practical changes that not only meet the present crisis, but also lay the foundation for a leaner, more market-responsive Postal Service that can thrive well into the future.”

What is a business model?

Maybe the Postal Service has never really defined a new business model to replace the failed one, because a business model is not really what is called for. In fact, there are many definitions of a business model, but the most common theme is something like, how will the business make enough money to provide a suitable return on investment for the owners.

An article in the MIT Sloan Management Review titled, The Hard Truth About Business Model Innovation, describes a business model as follows:

“A business model is made up of four elements: (1) a value proposition for customers; (2) resources, such as people, money, and technology; (3) the processes that the organization uses to convert inputs to finished products or services; and (4) the profit formula that dictates the margins, asset velocity, and scale required to achieve an attractive return. Interdependencies, represented here by bidirectional arrows, describe the integration required between individual elements of the business model. They require that every component of the model be congruent with every other component.”

Is a list a business model?

When we hear about the flawed USPS business model, the usual follow-on is not a definition of a new business model that would respond to the new reality of falling mail volume. What we normally hear is a list very similar to the one in the 2010 report, that enumerates all of the increase flexibility that postal management would like to employ.

If you go down the 2010 list, or very similar lists used since then, you end up talking about why the items could not be done. In most cases Congress or the Postal Regulatory Commission stood in the way. As you narrow down the possibilities to a shorter list, more focus goes on the remaining items. In fact, this week, the PMG cited #1 and #5 above, retiree prefunding and pricing, as the remaining hopes to respond to a flawed business model.

Is a business model what is needed?

Perhaps the continuous focus on a business model is misplaced. The MIT definition of a business model targets “an attractive rate of return.” Is that why we have the USPS? And would a private sector business that developed a plan to turn itself around after its original business model failed, and was stymied in achieving any of the listed strategies, stay in business? Would a business projecting a cumulative ten-year loss of $238 billion, or $123 billion without needed legislation, stay in business? Of course not.

The Postal Service is not a going concern because it has a great business model that yields a great rate of return for its owners. It is going strong because it is a government agency that provides a necessary business-like public service.

All of the focus on a “flawed business model” and a list of “solutions” to give its managers greater flexibility is misplaced. USPS is not a business whose goal is to make a rate of return for owners, and it is not a business that shuts down when it cannot maintain a profitable business model.

To summarize what we can glean about the old and new USPS “business models:”

Old Business Model: Very rapidly growing mail volume fueled by work-sharing and direct marketing, with few digital alternatives, easily funds ever-growing 80 percent labor costs. Prices are raised roughly every three years based on projected revenues of USPS.

New Business Model: Declining mail volume with many digital alternatives requires covering 80 percent labor costs in other ways. The incentives of the CPI price cap and the potential to retain earnings are not strong enough to create success. The model that USPS seems to advocate has three main components:

• Grow the package delivery market, that is booming due to electronic commerce, mainly through Negotiated Service Agreements with large shippers like Amazon. Also, emphasize the “last mile” that USPS covers most cost-effectively by dint of its daily mail deliveries. But always caveat that competition is fierce and could take volume away without notice. And the return from packages in not nearly enough to counter the loss of mail volume.
• Try to implement low-pain cost savings or revenue gain initiatives, such as Medicare integration of retiree health benefits, investment of assets in higher-yielding securities, use of postal-specific demographics for retirement obligations, and sharing images of mail through Informed Delivery.
• Obtain supra-inflation pricing authority to “milk the cash cow” of existing mailers. The assumption is that remaining mailers will continue to mail based on considerations other than price. In other words, they are captive customers without viable alternatives. Any lost volume due to above-inflation price increases would easily be offset but the higher revenue from remaining mail volume, at least in the short run. A death spiral would not happen soon.

PRC acting on the pricing item alone: a huge gamble

We are not aware of a comprehensive description of the new “business model” that the USPS believes it needs to employ in order to replace its “flawed business model.” But our description of a new model is gleaned from listening to Postal Service leadership talk for the last eight years about what needs to be done for a “serious but solvable” problem.

We are neither inspired by this model, nor do we believe it is really a viable business model. It is more of a list of actions that could yield short-term improvements to the existing business model. But what really worries us is that the list really is a big gamble with the future of our postal system.

The fact that the Postal Regulatory Commission has taken up, with a vengeance, the pricing item that has been on every USPS list since 2010 is troubling. It is especially troubling that the PRC seems to believe this one item can fix USPS finances. No business in need of a turnaround and a new business model, that we know of in history, has ever succeeded mainly by raising its prices way above general inflation.