How the Postal Service Is Being Gutted
The United States Postal Service just announced that it is cutting Saturday delivery in August, moving to a five-day schedule as part of a multiyear effort to reduce costs and remain viable.
That's not the only change coming down in 2013. The USPS will close half of its processing centers, shutter more than 3,000 local branches, and eliminate about one-third of its workforce -- nearly 220,000 employees. It won't surprise you to learn that these moves will slow the delivery of first-class mail (i.e., letters) by one to three days, making citizens less reliant on the postal service and hastening its demise.
Why would the USPS take such radical measures? The simple truth is that the postal service is a fundamentally sound business, though not without its challenges. If you look closely, you'll see a concerted campaign to drive USPS out of business, despite the fact that it operates without government subsidies and, potentially, at a profit. It's being subjected to a politically manufactured crisis in order to ram through drastic change. But without the USPS, citizens will face much higher costs without better service. Below, I outline three common misconceptions about the USPS and explain why they're misleading.
Myth 1: The USPS' losses show that it's not a viable business
In the last decade or so, the USPS has been dogged by two significant changes. The most obvious is the advent of email, which has hurt postal volumes, especially first-class mail. That's a secular change that's not going away, and all the better for the many benefits it provides (spam notwithstanding).
The other change is political and imposes un-needed stress. In 2006, Congress passed the Postal Accountability and Enhancement Act, forcing USPS to pre-fund the present value of 75 years of its pension and health-benefit fund in 10 years -- about $5.5 billion annually for a business mandated to break even.
Listen only to the recent headlines and you might think the USPS is about to drop off the face of the earth. After all, officially it spurted red to the tune of $15.9 billion in 2012. Look closer.
Exactly $11.1 billion of that loss was due to the pre-funding mandate and half of that ($5.5 billion) was deferred from 2011 when the USPS defaulted on its payment in order to fund operations. Below are the official numbers and my adjusted figures accounting for Congress's mandate.
Adj. operating expenses*
Adj. net loss
Source: USPS. *Subtracts $11.1 billion for 2012 due to delayed funding of 2011's mandate, $0 for 2011, and $5.5 billion for 2010.
The net losses look daunting. But adjust them for pre-funding to see the actual operating situation instead of the deeply red figures hyped by most media outlets.
That 75-year pre-funding mandate adds substantially to the post office's losses. This is a requirement that no other government agency, let alone a private company, must face. In short, the USPS is paying for people who aren't even employees yet -- in fact, may not even be born yet!
And the USPS has been a model for prudent squirreling. As of Feb. 2012, it had more than $326 billion in assets in its retirement fund, good for covering 91% of future pension and health-care liabilities. In fact, on its pensions, the USPS is more than 100% funded, compared to 42% at the government and 80% at the average Fortune 1000 company. In health-care pre-funding, the USPS stands at 49%, which sounds not so good until you understand that the government doesn't pre-fund at all and that just 38% of Fortune 1000 companies do, at just a median 37% rate. The USPS does better than almost everyone.
Pre-funding is a burden that other government-linked firms don't have to face, notably defense companies. Lockheed Martin's pension was underfunded by $13.3 billion as of Aug. 2012 -- nearly half of its market cap. Raytheon's was underfunded by $6 billion, more than one-third of its market cap, and Boeing's by $16.6 billion, almost 30%. They have the luxury of profitability and time to fund their obligations. Another advantage: They can invest in a wide range of securities, while the USPS is forced to invest in only government bonds. Yeah, those bonds that, in some cases, pay less than 1% interest. So USPS has to save a lot more money now for the same payout later.
The cuts USPS is being forced to make are like eating dog food when you have a million bucks in the bank. The pre-funding mandate is completely ridiculous for a business that is mandated to break even. Where is the surplus cash going to come from, since it's not from profits? In addition, this mandate forces USPS to cut investments in technology that would increase productivity and competitiveness, making USPS viable longer term. Even Congress is not so dense as not to see that its law creates a crushing burden.
Myth 2. Everyone knows that snail mail is dead, so USPS can't survive
Now, none of this denies that the USPS faces legitimate business challenges. Revenue declined 3% from 2010 to last year, though USPS did hold the line on overall costs. While mail volume has declined with the rise of email, it's still way more than 20 years a go, and certain segments, such as parcels, are actually growing. That fits with anecdotal evidence: Amazon.com and eBay, to name just two, are dead without efficient parcel delivery, but I now receive my bank statements via email.
One potential solution is to raise revenue. Currently, almost all revenue comes from the sale of postage. Why isn't the USPS raising postal rates? Consumers already receive a fabulous deal: Send a letter anywhere in the U.S. for a mere 46 cents. Compare that to European rates near $1 to deliver on the Continent. A back-of-the-envelope (ha!) calculation suggests that to break even USPS would have to raise rates 7% -- not quite 50 cents to send that letter to Hawaii in a few days. Hardly drastic.
Now, admittedly just raising postage is an overly simplistic solution, but it gets to a basic truth: lack of sales. Rates are overseen by the Postal Regulatory Commission (PRC), and prices must not rise faster than inflation. A postage stamp has increased just 12% in six years. That's another way that the USPS's mandate to operate like a business is stymied by overseers. Another major type of mail, bulk rate (ads), receives big discounts in exchange for pre-sorting mail, and could withstand higher postage, since they receive much more value than what USPS saves from pre-sorting. Fix: Allow USPS to price correctly.
Proper pricing is important for a business mandated to deliver everywhere for a fixed price, a burden not faced by private services. Of necessity, many locations, such as rural ones, lose money -- part of the price of a national postal service. Private services can simply leave a location if it's not profitable. In fact, private services rely on USPS to deliver to unprofitable locations for them.
Anything short of a massive rate hike would still give USPS cheaper service than FedEx and UPS . Finding a postage price on their websites is byzantine and opaque. Try it if you've got a half-hour. And if traditional mail is dead, why are FedEx and UPS continuing to do so well?
The short answer is that they can price postage to be profitable (partially why their sites are so complex) and invest in growth areas -- both of which USPS can't do. Whenever USPS tries to enter a new arena, private competitors bleat to Congress. Examples abound: plans to develop an online payment system in 2000 (Internet industry cried foul); public copy machines (office supply stores); in-store sales of phone cards and money transfers; selling postal meter cartridges (Pitney Bowes objected). And, of course, rivals such as UPS complained, ultimately leading Congress in 2006 to restrict USPS to mail delivery.
The effects are huge -- costing USPS billions. And new services, it's estimated, could increase sales by nearly $10 billion annually, potentially covering the earnings gap. But Congress would have to agree to those changes after already tolling the USPS bell. In its latest annual report, USPS begs Congress, in the most obsequious bureaucratese possible, to let it raise revenue. The odds look slim.
Myth 3. Privatized mail delivery would be cheaper and more effective
This myth is often advanced by those who advocate privatizing the postal service, often invoking unions that are strangling the company or an inefficient bureaucracy. But USPS has continued to compete well as a business despite being run ragged by a Congress backed by big money.
USPS has invested heavily in modern systems to speed distribution, and, in fact, has partnerships with FedEx and UPS for "last mile" delivery. In particular, FedEx relies heavily on USPS, which delivered more than 30% of FedEx Ground shipments in 2011. To reframe this, the USPS provides service that is cheaper than what UPS and FedEx can provide for many locations. That's an implicit subsidy.
It's bad enough that USPS is forbidden from entering new markets. When it does well on its home turf, rivals turn to Congress, silencing USPS when it delivers better rates. As economist Dean Baker explains, "About a decade ago, the Postal Service had an extremely effective ad campaign highlighting the fact that its express mail service was just a fraction of the price charged for overnight delivery by UPS and FedEx. [They] went to court to try to stop the ad campaign. When the court told them to get lost, they went to Congress. Their friends in Congress then leaned on the Postal Service and got it to end the ads."
And when USPS tried to take advantage of web shopping? As Elaine Kamarck at Harvard's Kennedy School of Government explains. "But parcel shipments were generated by large organizations and the USPS was not allowed to negotiate discounts and thus lost business. It was forbidden by law from lowering prices to get more business. This resulted in the entirely incredible situation in the 1990s where the United States government negotiated an agreement for the delivery of U.S. government package services with Fed Ex because the USPS was not allowed to negotiate for lower prices!"
So, if USPS is just government bloat, as some ideologues would have it, then why would efficient free market players such as UPS and FedEx resort to the government? Shouldn't they simply compete USPS out of that express business?
This paradox reveals in stark detail the industry's game plan. Compete effectively where possible and then use political power to grab market share from USPS, with the ultimate goal of privatizing the postal system, or at least its profitable parts. This goal is emblematized by the Cato Institute, a Washington think tank founded by Charles Koch advocating the privatization of public services such as the post office. Frederick W. Smith, founder and CEO of FedEx, was on Cato's board, and FedEx funds Cato.
The results of this game plan are well-documented and disastrous for citizens. Want to know what will go down if the postal service is privatized? (Not postage!) Take a look at the 2008 Chicago parking meter fiasco, where the city leased its meters for 75 years to an investor group. The city gave the concession while estimating lifetime revenue at just half what investors expected. Now 2013 marks the fifth year in a row that meter prices have gone up, and Chicago boasts the highest prices in the U.S. The final middle finger: Whenever the city closes streets (as for a parade), it has to pay investors the lost meter revenue.
Expect the same for postage rates and with reduced service.
So I envision two basic ways to privatize the postal service:
Full privatization -- a private company swallows the whole enchilada and operates delivery under some kind of regulatory oversight.
Partial privatization -- a private company takes over the core infrastructure (a high-value, high-throughput distribution component), leaving less profitable and money-losing components such as labor-intensive physical delivery. This strategy is probably ideal since it privatizes the most profitable parts and sticks less desirable or money-losing bits to citizens.
Both strategies likely result in much higher prices. The first strategy sees the acquirer adding a profit markup, which USPS currently doesn't price for. The second strategy would not allow the USPS to offset less profitable areas with stronger areas, meaning government or citizens would be forced to cough up substantially more money to maintain service, and that's on top of the acquirer's profit markup.
Now whichever strategy is chosen, there are two hidden plums in all this. First, USPS has the largest union in the U.S. For an investor, part of the return on this deal would come from busting the union, lowering wages, and shifting that profit into investors' hands, something Cato already supports highly.
Second, and perhaps sweeter, that well-funded USPS retirement account might be opened for raiding. An acquirer could invest in higher-return securities and adjust their return assumptions (not even unfairly), freeing tens of billions that could then be returned to investors. For context, FedEx and UPS have a combined market cap of $110 billion against nearly $330 billion in USPS retirement assets.
Foolish bottom line
If capitalism is about delivering the best goods and services at the cheapest prices -- and not about plutocrats wringing profits from the rest of us -- then why is the USPS being forced to slowly kill itself?
The privatization of public assets is something we've seen over and over and it rarely, if ever, works for the public. The example of Chicago parking meters is just repeated time and again. With a strong profit motive, private companies are highly incentivized to cut service to the bone and raise revenues as fast as possible. That's not in the interest of good public service, where the origins of the post office are.
Congress created the post office as a cabinet-level office in 1792 under specific Constitutional authority. In the past, its expansion into other services was seen as desirable, for instance in banking, when Congress formed the Postal Savings System. From 1911 to 1967, citizens deposited money at the post office and received interest. In 1970, the post office became the quasi-independent U.S. Postal Service. This move was significant, since USPS became a legal monopoly and forced it to operate without subsidies (good!), which were 25% of the 1971 budget. It also allowed the USPS to act more business-like, to borrow and invest.
But now especially, Congress, backed by big money sponsors, refuses to let the USPS act as a business. There's no reason, apart from political will, that reasonable changes -- yes, including modest price increases -- couldn't sustain a public postal system even with its significant challenges.
So the next time you hear about the postal service losing billions of dollars or being unable to compete, remember that it doesn't have to be this way.
The article How the Postal Service Is Being Gutted originally appeared on Fool.com.
James Royal has no position in any stocks mentioned. The Motley Fool recommends FedEx and UPS, and owns shares of Lockheed Martin and Raytheon Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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