Response to PRC Inquiry Reveals New Cost Coverage Proposal for Flats

As previously reported, the Postal Service submitted its Annual Compliance Review for fiscal 2018 to the Postal Regulatory Commission at the end of December. Given the span and scope of such a document, it’s normal for the PRC staff to pore over it carefully and ask about data or statements that they believe need further clarification. These questions, officially know as “Chairman’s Information Requests,” or CHIRs, generate a response by the USPS.

The occasional nugget

For example, a typical CHIR might ask about the source of a data point or why two figures don’t agree with each other, or ask for clarification or further supporting detail for a statement the USPS made in the ACR. The average reader who’s peruses the ACR doesn’t often delve later into the CHIRs; the topics are often technical minutiae that, once resolved by the Q&A, satisfy the clarification objectives of the commission and aren’t pursued further.

However, there’s a handful of assiduous industry observers who do read the CHIRs and the Postal Service’s responses and who, as a result, turn up nuggets of information that otherwise might escape notice. One such careful student is our anonymous colleague, D. Eadward Tree, the pen name for the unknown writer of the well-respected Dead Tree Edition blog.

In digging though the Postal Service’s January 11 reply to the PRC’s CHIR No. 1, issued January 4, Mr. Tree took note of an interesting statement in response to Question 15 of the CHIR:

“15. The Postal Service states that it ‘intends to evaluate combining Flats, Carrier Route Flats, and High Density Flats into a single Non-Saturation Flats product.’ FY 2018 ACR at 18.

a. Please provide a timeline of when the Postal Service’s evaluation will be complete.
b. Please provide historical data to demonstrate that ‘[b]ased on feedback from industry representatives, which is supported by volume trends, flats volume has migrated from the Flats and Carrier Route products into High Density Flats because of comailing.’ FY 2018 ACR at 17.
c. Please estimate the cost coverage of the ‘Non-Saturation Flats product’ for FY 2018, include all assumptions used to estimate the cost coverage.

“RESPONSE:

a. The Postal Service is in the process of evaluating a merger of Flats, Carrier Route, and High Density Flats into one ‘Non-Saturation Flats’ product. The evaluation is ongoing; the Postal Service does not currently have a timeline for completion.
b. The following data demonstrate that High Density Flats has experienced volume growth year over year between FY 2015 and FY 2018, with significant growth of over 20 percent in the last two fiscal years. At the same time, Flats and Carrier Route Flats volumes have generally declined.

c. As shown below, the estimated cost coverage of a Non-Saturation Flats product that combines Flats, Carrier Route, and High Density Flats, would have been approximately 88 percent in FY 2018.

 

“This cost coverage assumes that all Carrier Route volume, including a small amount of Carrier Route letter- and parcelshaped pieces, would be subsumed in the new product. … Revenue per piece for High Density Flats was derived by dividing Revenue by Volume.”

Though the 22-word sentence in the ACR about which the commission was inquiring was right there for any reader to see, the lack of any detectable reaction to it suggests that either very few people actually read the ACR, or at least not carefully, or that anyone who did read it didn’t catch the import of that brief statement.

Regardless, the PRC did catch it and thought it worth exploring further. In doing so, it allowed observers a second chance to consider what the USPS was evaluating and, as Mr. Tree noted, form their own opinions about it.

The trouble with flats

It’s no secret that several types of flats are chronically “underwater,” as most sadly exemplified by Periodicals, a class of mail almost entirely made up of flats, whose cost coverage has been under 100% since at least 2006; in FY 2018 it was less than 68%.

Standard (Marketing) Mail, as a class consisting of letters and parcels as well as flats, had a class-level cost coverage of over 142% but, as noted in the ACR, that figure included some exceptions: parcels, with a 57.53% cost coverage, and flats with a 68.65%. Of course, “flats” in this context are the less finely-presorted pieces (e.g., not carrier route or High Density) whose cost coverage is safely into triple digits.

Understandably, given the higher work content of less presorted pieces, keeping their cost coverage in the black is more challenging. In the opinion of many analysts of postal costs, the chronic albatross around the neck of flats as a category, and especially those pieces requiring postal sorting, is the flats sequencing system – the 100-unit fleet of mammoth machines that the USPS has been trying for years to make efficient. Purchased at a time before flats volume collapsed, the FSS has yet to yield the cost savings expected of it, and has become a liability rather than an asset for purposes of cost coverage – especially for Periodicals and less finely presorted Standard Mail flats.

“Fixing” the FSS has been a Postal Service campaign virtually since the machines went into service but the agency’s efforts haven’t produced the results (e.g., cost reductions that ease rate pressure) that it and ratepayers seek. (See Mr. Tree’s January 6 blog “The FSS Slows, and the Red Ink Flows,” and his next blog this week about what the USPS is evaluating.)

Meanwhile, the PRC, as well as grilling the Postal Service about what it’s going to do to remedy flats processing costs, has required it to increase some rates over-CPI to improve cost coverage. As the USPS explained in the ACR:

“The Commission’s FY 2010 ACD directed the Postal Service to present a schedule of above-average CPI price increases for Flats in each subsequent ACR and Notice of Market Dominant Price Adjustment. Since then, the Postal Service has presented and adhered to a schedule of above-average price increases for Flats. … Further, as demonstrated in Table 8 below, the Postal Service has surpassed its commitment to increase Flats by 1.05 times CPI in each price adjustment since Docket No. R2013-10.”

 

A curious strategy

With all of this in mind, therefore, there’s the question of why the USPS would use the strategy it said it was evaluating as the solution to some flats’ underwater cost coverage.

In a way, the USPS is suggesting that if it lashes two watertight boats to a sinking vessel it will save the sinking ship. While that may work as an emergency measure in some specific nautical situations, it’s not a strategy for correcting the basic problem that causes sinking. Worse, in this case, the sinking ship’s lack of buoyancy will more than overcome the other boats, causing the entire configuration to become underwater. If that were to happen unexpectedly would be one thing, but to deliberately plan for such an outcome seems poorly thought through to say the least.

Translating this into postal terms, merging two “profitable” categories of mail with one that isn’t – while knowing upfront that the resulting agglomeration won’t cover its costs – seems counterproductive if not pointless. Presumably, while each categories of mail should to cover its costs through appropriate rates and effective cost management, it should do so on its own, without intra-class cross-subsidization by other categories (inter-class cross subsidization is prohibited).

In this case, what the USPS is envisioning is simply a recombination of rate categories in the hope that the net cost coverage will be a positive number – which the agency already stated it won’t be. Such a solution is hollow and ignores the real problem – excessive costs. To reprise the naval analogy, the USPS is seeking to remeasure the water level of the ships instead of fixing the hole that’s causing the sinking.

Signals

The USPS also makes an ironic comment about mailer behavior when it states “flats volume has migrated from the Flats and Carrier Route products into High Density Flats because of comailing.” The irony is that such migration is the direct result of the prices established by the Postal Service to encourage worksharing.

“Price signals” are what the agency has used for decades to prompt what it calls “desirable mailer behavior.” Simply put, discounts encourage mailer worksharing to reduce USPS processing costs; doing the math has led mail producers to develop equipment and business strategies (like “comailing”) to optimize their discount opportunities by aggregating volume and building presort density.

So now, having seen the “desirable mailer behavior” manifest in the migration of less presorted flats toward the more finely presorted, lower rate categories (like High Density), the USPS is solving the cost coverage problem for what’s left by essentially voiding the benefits of the worksharing it encouraged – lumping the efficient and inefficient mail together. (“Thanks for staying afloat, now you’re being lashed to a sinking ship.”)

This cross-subsidization approach is counterintuitive, counterproductive, and illogical, fails its own purpose (88% is still less than 100%), and avoids tackling the real problem.

However, if such an approach makes sense or is acceptable to the ratepaying community and the PRC, then perhaps it should be expanded: Periodicals and Marketing Mail could be merged so that the new “class” will (maybe) have a cost coverage of 100% or more.

That won’t “fix” the FSS or do anything to control flats processing costs, of course, but it could result in a mathematically better cost coverage number – which would be just as illogical as what the USPS is considering.


 

Excerpted from the Jan 21, 2019 edition of the Mailers Hub NewsFor the full newsletter, please visit the Mailers Hub News archives. 

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