USPS-RT-2

BEFORE THE

POSTAL RATE COMMISSION

WASHINGTON, DC 20268-0001

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  [Special Services Reform,             Docket No. MC96--3
  1996]{.smallcaps}                     

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REBUTTAL TESTIMONY

OF

ALTAF H. TAUFIQUE

ON BEHALF OF

UNITED STATES POSTAL SERVICE

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| AUTOBIOGRAPHICAL                                                      |
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| I. PURPOSE OF                                                         |
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| II\. Witness Thompson's Criticisms aPPEAR TO BE INconsistent          |
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| III\. MARKET PRICES CAN BE USED TO DETERMINE                          |
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| THE VALUE OF POSTAL                                                   |
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| IV\. THERE IS NO EVIDENCE THAT THE POSTAL SERVICE                     |
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| HAS MONOPOLY POWER IN THE BOX                                         |
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| V. LOCAL MARKET FACTORS COULD BE USED TO SET                          |
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| PRICES FOR POST OFFICE                                                |
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  AUTOBIOGRAPHICAL SKETCH

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My name is Altaf H. Taufique. I currently serve as an economist in the
office of Pricing at the United States Postal Service. Prior to joining
the Postal Service in July 1996, I was employed by the Gulf States
Utilities Company (GSU) in Beaumont, Texas from 1980 to 1994. At GSU, I
served as an economic analyst in the Corporate Planning department and
was subsequently promoted to Economist, Senior Economist and finally to
the position of Director, Economic Analysis and Forecasting. My
responsibilities at GSU included the preparation of the official energy,
load and short-term revenue forecasts, and the economic forecasts for
the regions served by the Company. I have testified before the Public
Utility Commission of Texas in Austin and the Federal Energy Regulatory
Commission in Washington, D.C. My testimony defended GSU\'s official
energy and load forecasts. This is my first appearance before the Postal
Rate Commission.

I received a Master's Degree in Economics from Central Missouri State
University in Warrensburg, Missouri in 1976, and a Bachelor's degree in
Economics & International Relations from Karachi University in Karachi,
Pakistan. I have also completed thirty-three credit hours of coursework
towards a Ph.D. in Economics at Southern Illinois University. I taught
economics at Chadron State College in Chadron, Nebraska between 1978 and
1980, and during my employment at GSU in Texas, I taught courses in
economics at Lamar University in Port Arthur, Texas.

I. PURPOSE OF TESTIMONY

The purpose of my testimony is to rebut the testimonies of OCA witnesses
Sherman and Thompson, which oppose the Postal Service's fee and
classification proposals for selected special services. I begin by
demonstrating an apparent inconsistency between witness Thompson's
criticism of the proposal to increase fees for selected special services
while maintaining rate stability for First-Class Mail with Dr. Sherman's
past writings. Next, my testimony shows why the use of market prices as
a means of determining value is appropriate in postal ratemaking. My
testimony then challenges Dr. Sherman's contention that the post office
box proposal is an exercise of the Postal Service's monopoly or market
power in the box market. Finally, I address Dr. Sherman\'s concern
regarding the pricing of post office boxes with a single rate structure.

II\. Witness Thompson's Criticisms appear to be inconsistent with Dr.
Sherman's Past Writings.

Witness Thompson reserves her harshest criticism for the decision to
maintain First-Class Mail rate stability while increasing fees for the
selected special services. Her testimony labels this aspect of the
Postal Service's proposal as \"unfair," \"inequitable,\" and
\"capricious.\"[^1] Witness Thompson's criticism is baffling because it
appears to be inconsistent with concerns expressed by several observers,
including OCA witness Sherman, that postal cost allocations and pricing
have operated to the detriment of those mailers, particularly
First-Class mailers, whose alternatives to mail delivery are limited by
the Private Express Statutes. It is ironic that, in a case in which the
Postal Service would obtain additional revenues from categories other
than First-Class Mail, Dr. Sherman has opposed such a proposal.

Dr. Sherman has written extensively on postal pricing issues in the
past,[^2] and has appeared as an expert witness in several Commission
proceedings. His past writings and testimony reveal a consistent theme
that appears to be inconsistent with his and witness Thompson\'s
analysis of the proposals in this docket. The gist of his writings is
that monopoly products, especially First-Class Mail, have contributed
the lion\'s share of the recovery of institutional costs, and other
postal products have received rather favorable treatment at the expense
of this low elasticity, monopoly product. For instance, in an article
written with James C. Miller, III, Dr. Sherman criticized excessive
institutional cost burdens borne by First-Class Mail:

> We do not mean to imply that attributing cost to classes of mail is a
> simple task for, as Fuss indicates, the problem is a difficult one.
> But if costs are traced only partially to mail classes and inverse
> elasticity rule is applied, resulting prices may exploit the classes
> of mail where monopoly power is greatest. Prices will be high, not
> necessarily because costs of providing services are great but because
> monopoly power is high as indicated by less elastic demand. And where
> demand is more elastic, perhaps because competing services exist,
> prices may be set low, even below true marginal costs.[^3]

Dr. Sherman and his co-author reaffirmed their criticism when they quote
the administrative law judge in Docket No. R74-1 with approval:

> The Postal Service has become a tax collecting agency, collecting
> money from \[F\]irst-\[C\]lass mailers to distribute to other favored
> classes. Every time a person pays 10 cents to mail a
> \[F\]irst-\[C\]lass letter he is paying his appropriate attributable
> cost plus his proportionate share of residual cost, and in addition,
> he is contributing almost 2 cents to pay the costs of other
> services.[^4]

Dr. Sherman re-emphasized these criticisms in another essay:

> The USPS initially argued that most of its costs were fixed and
> independent of the volume of mail it handled; it claimed it could
> assign or attribute less than half its total costs to individual mail
> services, with the result that the fractions of costs that varied with
> volumes of those services were very low. When used as a basis for
> setting welfare-maximizing Ramsey prices, these cost representations
> would lead to a relatively high rate for first class mail, where the
> postal monopoly resulted in the lowest elasticity of demand, and low
> rates for other classes, where there was more competition.

\* \* \* \* \*

> For its part, the USPS presented cost analyses at rate hearings that
> quite obviously were designed to sustain the long existing rate
> structure, to keep the rate high where monopoly power was greatest, on
> \[F\]irst-\[C\]lass mail, and to offer relatively low rates on other
> classes of mail. [^5]

Dr. Sherman has not changed his view on this subject. As recently as
Docket No. R94-1, when discussing the relative merits of Ramsey pricing
versus equal markups, Dr. Sherman warned against pricing "monopolized
services," presumably First-Class Mail, too high:

> The temptation then to choose low markups for more competitive
> services with high perceived demand elasticities could be very great,
> and the result might be underpricing of those services relative to
> their true costs, while monopolized services are overpriced.[^6]

Dr. Sherman's past writings cautioned against the adoption of pricing
approaches that led to higher rates for First-Class Mail while keeping
rates for more competitive products lower. The fee change proposals for
post office boxes and certified mail in this case appear to be
consistent with Dr. Sherman's view, because fees for these services, for
which there are alternative providers of similar types of services,[^7]
are being raised to achieve modest objectives, *i.e.,* to cover their
attributable costs or provide a reasonable contribution to institutional
costs, or both.[^8] Thus, one would expect the OCA to view the fee
change proposals more charitably, particularly given Dr. Sherman's
writings on this subject.

III\. MARKET PRICES CAN BE USED TO DETERMINE THE VALUE OF POSTAL
PRODUCTS.

Dr. Sherman states that, \"\[t\]he Postal Service proposal in Docket No.
MC96-3 has features that are unusual. First, it focuses on only a few
special services, rather than all services. Second, it gives attention
to something called marketplace considerations . . . ."[^9] He finds the
terms used by witness Lyons to describe the Postal Service's proposals,
such as \"economically rational\", and \"businesslike basis,\"[^10] to
be "vague."[^11] Dr. Sherman dismisses witness Lyons' statement that
prices for services at issue here reflect marketplace considerations, as
well as the cost of providing services, as "nice sounding but still
vague."[^12] He further goes on to say that, \"\[i\]t is not at all
clear what market-based prices are. They are not defined well enough to
be related to principles of optimal pricing.\"[^13]

Dr. Sherman's professed unfamiliarity with the meaning of market-based
prices in this case appears to contradict his previous, published
remarks. In his highly regarded text on antitrust, Dr. Sherman wrote:

> market prices actually can guide production. For example, suppose a
> good\'s competitive market price were well above the long-run cost of
> production. This would mean that consumers valued that good at more
> than it would cost to produce it on a long-run basis. So there would
> be high profit that would spur expansion by existing producers and
> invite entry by new producers. A system of competitive markets would
> move resources \-- capital, workers, managers, materials \-- to
> increase the production of these goods that consumers valued so much.
> The expanded quantities would make the goods more plentiful and force
> market prices down again until it was again close to the cost of
> production so further expansion of output no longer was
> motivated.[^14]

The Postal Service's fee proposals in this docket combine market
information with the pricing criteria in section 3622 to better reflect
value to customers and to have the services at issue here make more
reasonable contributions. Indeed, the Postal Service collected
substantial research on marketplace conditions to inform its pricing
proposals. For example, with respect to the post office box proposal,
the Postal Service conducted a post office box study,[^15] a study of
CMRAs,[^16] and market research to measure customer reaction to a range
of fee increases for post office boxes.[^17] These studies have enabled
the Postal Service to acquire new information about the box market,
including supply and utilization rates, the presence of competition, the
value of this service to its own customers, and the revealed preference
of its competitors\' customers.

The terms \"marketplace considerations\", \"businesslike basis\" and
\"economically rational\" are neither "vague,\" nor unfamiliar. They are
the standards of basic economics and have well-defined meanings.
Socially optimal pricing must rely upon them.

IV\. THERE IS NO EVIDENCE THAT THE POSTAL SERVICE HAS MONOPOLY POWER IN
THE BOX MARKET.

Dr. Sherman states that, \"\[s\]ince the Postal Service has economies of
scope in providing post office box service, and may even avoid some cost
of delivery in doing so, there is little doubt that alternative box
services are more costly. The Postal Service has market power, in other
words, in the market for post office boxes."[^18] In his written
testimony, Dr. Sherman defines market or monopoly power in the context
of the Postal Service as follows:[^19]

> Having alternative services available only at higher prices means the
> Postal Service has market power. The point has been made often:
> monopoly power is present when a firm is sufficiently insulated from
> competitive pressures to be able to raise prices . . . without concern
> for its competitors actions because its rivals cannot offer customers
> reasonable alternatives.[^20]

Dr. Sherman cites Fisher, et al., [Folded, Spindled, and
Mutilated]{.smallcaps}*:* [Economic Analysis of US vs. IBM,]{.smallcaps}
in support of his definition of market and monopoly power. The
underlying source Dr. Sherman cites, however, is not consistent with his
monopoly theory. Indeed, during oral cross-examination, Dr. Sherman
essentially conceded as much.[^21] A more complete definition of market
or monopoly power is found on page 20 of [Folded, Spindled, and
Mutilated]{.smallcaps}. In essence, market power involves more than the
mere power to raise price; rather, it is exhibited when the firm has the
ability to raise price above competitive levels without losing market
share.[^22] Fisher, *et al*., observe:

> A firm has monopoly power when it is sufficiently insulated from
> competitive pressures to be able to raise its prices or withhold the
> introduction of new technology, either in product innovations or in
> process (cost reducing) innovations, without concern about the actions
> of its competitors and with relative impunity because its customers
> lack reasonable alternatives to which to turn. Monopoly power is the
> ability to *raise* prices above competitive levels or to market
> inferior products while excluding competition. This is the
> economist\'s version of the law\'s definition of monopoly as the
> \"power to control prices or exclude competitors.\" The ability to
> gain business through lower, remunerative prices or through better
> products is not monopoly power but the manifestation of \"superior
> skill, foresight, and industry.\"[^23]

The authors add that, "\[m\]onopoly power is not present when a firm can
keep its business only by means of *lower prices* or better products
*than* its competitors\'

\...\"[^24]

In order for the Postal Service to exercise market or monopoly power, it
must have the power to raise prices above competitive levels without
losing market share. For Dr. Sherman to prove his claim that the post
office box fee proposal is a manifestation of the Postal Service's
monopoly power, he would have to show that prices charged by the Postal
Service are presently at or above competitive levels, or that the
proposed fees would qualify as such, and that the Postal Service would
not lose market share. No information provided in this docket, however,
supports those conclusions.

Indeed, statements made by Dr. Sherman appears to suggest a contrary
view. First, Dr. Sherman confesses that his conclusions about CMRA costs
are drawn from a review of CMRA *prices*.[^25] Second, in order to draw
conclusions about costs from prices, Dr. Sherman must also be assuming
that the box market is in long run equilibrium, since he supposes that
the only circumstance in which one can draw conclusions about costs, on
the basis of prices, is when a market is in long run equilibrium.[^26]
These statements imply that Dr. Sherman believes that existing CMRA
prices are at competitive levels. If so, as the Postal Service\'s
proposed fees are well below those of CMRAs, their adoption could not
constitute an exercise of market power.

Notwithstanding what Dr. Sherman\'s views may be, my own review of the
available information suggests that the competitive equilibrium prices
for post office boxes will fall somewhere below the prices currently
charged by CMRAs. Although it is tempting to say that the competitors'
box prices are at "competitive levels," the evidence shows that these
types of retail outlets are experiencing phenomenal growth.[^27] Such
growth is indicative of a market that is not yet in long-run
equilibrium, but rather one in which suppliers are earning economic
profits. Long-term equilibrium in a competitive market occurs when
prices equal marginal costs. When a market is in long-run equilibrium,
sellers are unable to earn economic profits, thereby discouraging new
entrants to that market. The substantial growth in Commercial Mail
Receiving Agency (CMRA) outlets demonstrates that there are no
significant barriers to entry in this industry and the firms in the
market are earning economic profits. It is not, therefore, a market in
long run equilibrium.

The very idea of determining competitive prices in the absence of market
forces reminds me of an old economist\'s joke made during the height of
the

Cold War. It was said that the Soviets wanted to conquer the world, but
they wanted to let Switzerland continue to operate in a free market
environment. The reason: they wanted to know market prices. The
information provided in this docket is not sufficient to definitively
establish the competitive price for post office boxes. It does, however,
permit drawing general inferences. I can say that the competitive prices
in the post office box market are above the current and proposed fees in
this docket, but probably below the prices charged by CMRAs. The reasons
for this assessment are as follows. First, CMRAs are growing at a
spectacular rate, which would lead one to believe that economic profits
are being earned. CMRA prices have to be above long-run marginal costs.
Second, Postal Service reported costs and fees are below what a
competitive CMRA market would ultimately generate, for three reasons: 1)
Economies of scope, as asserted by Dr. Sherman,[^28] may give the Postal
Service a cost advantage;[^29]

2\) CMRA costs must reflect the full costs of sorting mail to individual
boxes, while the Postal Service can offset those costs with reduction in
sorting costs that have already been paid by the mailers;[^30] and 3) As
witness Lion points out, space provision costs for CMRAs should be
higher than those reported by the Postal Service, because of the
utilization of book costs rather than market costs.[^31]

Ultimately, we can only speculate whether the proposed fees are above or
below hypothetical fee levels under \"perfect competition.\"
Fortunately, however, the applicable rate making standards do not
require us to address, much less resolve, this question. The existence
and rapid growth of CMRAs, offering box rentals at significantly higher
fees, provide direct support for the Postal Service\'s proposals under
the statutory ratemaking standards. For example, the impact on
customers, 39 U.S.C. 3622(b)(4), cannot be considered undue when other
consumers are already paying higher fees to CMRAs. Moreover, for many
customers, CMRAs do constitute an available alternative, 39 U.S.C.
3622(b)(5). In addition, if box service did not have a high value of
service, 39 U.S.C 3622 (b)(2), customers would not be flocking to
CMRAs.[^32] Lastly, given the situation with CMRAs, it is untenable to
assert that a fee increase that will result in a cost coverage that is
still below the systemwide average is either \"unfair\" or
\"inequitable\", 39 U.S.C. 3622(b)(1).

Moreover, there are apparently no overwhelming barriers to entry in this
market, as evidenced by the explosive growth of private post office box
providers.[^33] To the extent that there might be more limited barriers
to entry, they are unintended consequences of the current fee levels.
Increasing fees to the proposed levels might actually stimulate
additional entry. [^34] More importantly, the current fee levels may
constitute the practical equivalent of a barrier to entry in some
markets against the Postal Service. As discussed in witness Lion\'s
testimony, there are situations in which customers want boxes, are
willing to pay for boxes, but the Postal Service cannot expand its box
operations (or establish new box operations) and still cover its
additional costs at the current fees that the Postal Service is required
to charge. These situations represent a serious breakdown of the
regulatory process, and cause real harm to the Postal Service, its
current customers who could have their institutional cost burden spread
over a broader base, and to prospective customers whose needs go
unfulfilled. This leads me to my conclusion on this subject: The Postal
Service is not exercising monopoly or market power in seeking to
increase fees for this service to the levels proposed.

V. LOCAL MARKET FACTORS COULD BE USED TO SET PRICES

FOR POST OFFICE BOXES.

Dr. Sherman commented on the difficulty of pricing post office boxes
with a single rate structure that must apply nationwide.[^35] To
stimulate thinking along these lines I offer the following comments.

The Postal Service acknowledges that a \"one price fits all\" approach
may not be the most efficient method of pricing post office boxes. The
current proposal is designed to begin taking differences in costs and
demand into account. A comprehensive consideration of the demand,
supply, and cost differences of post office boxes could evolve into
local adjustments to prices at each facility depending upon market
factors. This task, of course, would present administrative burdens due
to the sheer size of this business, given that there are over 30,000
facilities with approximately 20 million boxes of various sizes. One
approach could be a framework that ranks postal facilities based on
factors such as capacity utilization, cost of providing the service,
population or population density, per capita or household income,
presence of competitive providers and the level of service, such as
lobby access hours.

As the Postal Service evaluates various approaches to pricing post
office box service in the future, it may be useful to have feedback and
suggestions from interested parties, including the Commission.

[^1]: Tr. 5/1364.

[^2]: *See* Tr. 7/2308-13.

[^3]: J.C. Miller, III, & R. Sherman, *Has the 1970 Act Been Fair to
    Mailers*, *in* [Perspectives on Postal Service Issues]{.smallcaps}
    62-63 (R. Sherman, ed., 1980) (footnote omitted).

[^4]: *Id.* at 64 (quoting Docket R74-1, vol. 1. p. 13).

[^5]: R. Sherman, *Competition in Postal Service,* in [Competition and
    Innovation in Postal Service]{.smallcaps} 193-94 (M.A. Crew & P.R.
    Kleindorfer, eds., 1990).

[^6]: Docket No. R94-1, OCA-T-400 at 9, Tr. 12B/5516.

[^7]: *See, e.g.,* USPS-RT-3 at 17, USPS-T-4 at 15-33, USPS-T-7 at 39
    and USPS-T-8 at 72-73.

[^8]: *See generally* USPS-T-1, USPS-T-7 and USPS-T-8.

[^9]: Tr. 7/2274.

[^10]: USPS-T-1 at 2.

[^11]: Tr. 7/2274.

[^12]: Tr. 7/2274.

[^13]: Tr. 7/2275.

[^14]: R. Sherman, [Antitrust Policies and Issues]{.smallcaps} 7 (1978).

[^15]: USPS-T-4, at 3-13.

[^16]: USPS-T-4, at 15-33.

[^17]: USPS-T-6.

[^18]: Tr. 7/2303.

[^19]: Dr. Sherman uses the terms "market power" and "monopoly power"
    interchangeably. *See, e.g*., Tr. 7/2354.

[^20]: Tr. 7/2277.

[^21]: When asked if monopoly power was exhibited when a firm had the
    power simply to raise price, or to raise price above competitive
    levels, Dr. Sherman conceded that \"\[a\]bove competitive levels
    would be preferable, more exact.\" Tr. 7/2449.

[^22]: A common misconception is that market share is, in and of itself,
    indicative of monopoly power. Fisher, *et al*., in [Folded,
    Spindled, and Mutilated]{.smallcaps}*,* the same source Dr. Sherman
    cites in his testimony, explain that the two do not necessarily go
    hand-in-hand. The authors state that \"market share can be high for
    more than one reason. One such reason, of course, is monopoly power.
    However, a firm may have a large market share by reason of being
    there first.\" Fisher, et al., [Folded, Spindled, and Mutilated: An
    Economic Analysis of U.S. v. I.B.M]{.smallcaps} 99 (1983). Indeed, a
    large market share does not, in and of itself, confer monopoly
    power:

    > a firm\'s large market share does not imply power if firms not in
    > the market can readily enter or if existing firms (whatever their
    > share) can readily expand so that customers will have realistic
    > alternatives if the given firm attempts to raise prices or hold
    > back technology.\"

    *Id*. at 99. They also add that \"\[t\]he crucial question is not
    what market share *is* but what it would *become* were the firm to
    attempt to exercise monopoly power. This is the question of ease
    with which buyers can turn to other sellers and substitute products
    and the readiness with which competitors will expand output if it
    appears that monopoly returns are being gained.\" *Id.* at 100.

[^23]: Fisher et al., [Folded, Spindled, and Mutilated: An Economic
    Analysis of U.S. v. I.B.M]{.smallcaps} 20 (1983).(footnotes omitted)

[^24]: *Id. 99* (emphasis added).

[^25]: Tr. 7/2431-2433.

[^26]: Tr. 7/2434.

[^27]: USPS-RT-3.

[^28]: Tr. 7/2303

[^29]: Of course, CMRA operators can (and do) mitigate this effect by
    also providing other services besides box rental.

[^30]: The fact that much of the labor costs have already been paid by
    the mailer minimizes the impact of what are probably lower hourly
    labor rates paid by CMRAs.

[^31]: USPS-RT-3

[^32]: One standard approach to evaluating 39 U.S.C. 3622 (b) (2) is
    comparing own price elasticities of demand. This allows the
    \"value\" of different postal services to be compared. Elasticities
    have not customarily been used in this respect for post office
    boxes, however, because of the effects of the unique relationship
    between demand and supply for this service on observed time series.
    The absence of elasticity information makes it more important to
    observe other market features such as growth of CMRAs, their fee
    levels, etc., when contemplating the value of post office box
    service.

[^33]: USPS-RT-3.

[^34]: Tr. 7/2390.

[^35]: Tr. 7/2296.