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STATEMENT BY

ADVO, INC.

TO THE PRESIDENT'S COMMISSION ON THE

UNITED STATES POSTAL SERVICE

February 12, 2003

"For nearly 50 years, ADVO, Inc. relied exclusively on the Postal
Service to deliver our household advertising products. Recently,
however, ADVO has moved more than 7% (or 240 million mail pieces) of our
annual three billion shared mail package volume into private delivery,
through a combination of our own delivery networks and joint
partnerships with newspapers. As the largest customer of the Postal
Service, we obviously prefer the mail, but postage cost is a critical
competitive factor for our company, constituting half of our total
expenses. Our private delivery operations can deliver our products for a
cost that is 33-50% below postal distribution costs. As postal rates
rise, that spread can become the determining factor in our ability to
remain price-competitive with non-postal advertising distributors such
as newspapers and private delivery companies. Let there be no doubt,
whatever happens we *will* grow our business. We *want* to grow our
*postal* volume, but we can only do so if postal rates are predictable,
affordable and competitive."

Gary M. Mulloy

Chairman & Chief Executive Officer

ADVO, Inc.

**EXECUTIVE SUMMARY**

The long-term viability of the Postal Service is uncertain. It faces
increasing competition for core products, from both electronic
alternatives and hard-copy delivery competitors, but has little control
over its pricing or costs, and faces large long-term liabilities. Reform
is essential to preserve the Postal Service and ensure that it can
continue to reliably and affordably serve the needs of the American
public, businesses, and the economy in the 21st Century. To accomplish
this, ADVO recommends the following:

**[PRESERVE UNIVERSAL SERVICE]{.underline}**

-   Mail delivery to all households six days a week is a key element of
    the value of the Postal Service to senders and recipients,
    businesses and citizens alike. The Commission should identify the
    structure and tools the USPS needs to ensure the survival of
    universal service.

**[STRENGTHEN THE POSTAL SERVICE'S BALANCE SHEET]{.underline}**

-   The current overfunding of pension costs must be corrected by
    legislation to remove the deferred retirement liability from the
    balance sheet. The passage of this legislation will provide the time
    necessary for the recommendations of the Commission to be debated,
    enacted, and executed.

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-   Workers' Compensation costs must be brought under control, perhaps
    by switching from the current civil service program to those used by
    numerous states and private commercial firms that close cases rather
    than leaving them unresolved and open-ended.

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-   The unfunded retiree health benefits liability should be transferred
    to the U.S. Treasury on a one-time basis as a means of strengthening
    the business to be self-funded going forward.

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-   Employee benefit costs, incurred from this point forward, should be
    accrued and funded under generally accepted accounting principles
    just as is done in private industry.

**[EMPOWER A PROCESS THAT YIELDS A COMPETITIVE PRICING
STRATEGY]{.underline}**

-   Encourage partnerships and create incentives for reseller
    relationships.

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-   Rebalance priorities: Marketing and Sales should have parity with
    Operations.

**[THE POSTAL SERVICE SHOULD OFFER PAYMENT TERMS TO
MAILERS]{.underline}**

-   Consistent with the common practice of commercial firms, the Postal
    Service should allow mailers to pay postage 14-30 days after
    mailing, subject to revenue protection safeguards.

**[POSTAL SERVICE COSTS MUST BE CONTROLLED]{.underline}**

-   At a minimum, arbitration rules should be changed to reflect the
    fact that the USPS must meet competition and cannot simply pass
    through all costs.

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-   Both postal wages and benefits should be subject to negotiation.

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-   Employee compensation should focus more on performance and
    incentives.

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-   The Postal Service should control costs and automate wisely.

# INTRODUCTION

The Postal Service is the heart of the \$900 billion mailing industry.
Nearly 9 million workers service our Nation\'s need for a hard copy
delivery system. Our customers require reliable delivery service and
well designed products, and market-based rates that are set in a way to
encourage competition. If right choices are made this year, the industry
has tremendous growth potential, growth that will benefit not only the
Postal Service and our industry but can help drive the U.S. economy as
well.

Some of the "right choices" to make the Postal Service more viable that
ADVO hopes this Commission will recommend are:

-   Enhance the value of the postal enterprise and preserve universal
    service.

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-   Create a stronger/more balanced balance sheet.

-   Develop and execute a competitive pricing strategy.

-   Offer modern, competitive payment terms.

-   Reform the cost structure to be comparable with private sector
    competitors.

**[WHO WE ARE]{.underline}**

ADVO, one of the Postal Service\'s important partners with annual
revenues of \$1.1 billion, is the largest direct mail marketing company
in the world. Our postage payments represent half of our revenue and
nearly 1% of the USPS\' total revenue. We firmly believe we have the
potential to triple our business within the next five years.

ADVO specializes in mailing pre-printed advertising circulars for
retailers, product manufacturers, merchants, service providers, and
professionals. Our more than 25,000 customers cover the spectrum from
national retail chains to 20,000 small businesses. Their transactions
with us range from less than \$500 to more than \$60 million per year.

Our mail volume consists of two components: (1) Solo mail, where ADVO
mails a single advertising circular on behalf of a customer who pays the
postage cost directly; and (2) Shared mail, where ADVO combines many
customers' advertisements into a single mail package. In the latter
case, we bear the risk of covering the postage costs, maintain a
nationwide sales effort, establish a weekly network, and, because it is
necessary for over 80% of our revenue, provide customers with flexible
payment terms.

Solo mail has become increasingly less competitive with other media
alternatives. Shared mail, by competitive necessity, has become the
largest part of our business, representing more than 90 percent of our
total mail volume and revenues. Our future in the retail mail preprint
market rests on the ability of our shared mail programs to compete with
media alternatives. Direct mail is the second largest advertising medium
in the United States, having achieved that position in 2001. Today,
direct mail has the potential to become number one -- or to lose market
share as competitiveness erodes. Growth will require a healthy,
market-driven hard-copy delivery system.

ADVO has 23 mail processing facilities and 50 sales offices nationwide.
Our shared mail programs reach 65 million U.S. households weekly and
over 100 million households monthly. Our customers distribute more than
29 billion pieces, which represents less than 2% percent of the home
delivered print advertising business in the United States.

ADVO launched the America\'s Looking For Its Missing Children® program
in partnership with the National Center for Missing & Exploited Children
and the Postal Service in 1985. Our missing child cards are responsible
for safely recovering 122 children.

**[RETAIL MAIL]{.underline}**

\"Retail Mail\" is printed advertising circulars distributed through the
Postal Service. The basic tenet of the retail business is \"mass
merchandising\" \-- selling a variety of products with mass consumer
appeal. Retailing is a low margin business, and our clients need to
generate high frequency sales volumes. The best way to do that is to
bring many people into the stores. Because retailers are mass
merchandising hundreds, or even thousands of products, their basic
advertising medium is print advertising (preprints).

\"Preprints\" permit retailers to display many products at the lowest
advertising cost per item. The use of preprint circulars by retailers
has grown dramatically from 1 billion pieces in 1960 to more than 100
billion pieces today. These inserts are distributed seven days a week,
52 weeks a year, and are principally carried by newspapers and private
carrier delivery services. Mail has a relatively low share of these
inserts. Because of the retail industry\'s low profit margins, retailers
will use the mail only if it is cost-competitive with other delivery
methods. Although ADVO is the largest mailer of insert material, we
estimate that our revenue accounts for just 7% of the total annual
insert revenue in the country.

Advertisers have many media choices; they and we are increasingly
delivering preprints to the home through partnerships with newspapers or
via private carrier delivery. ADVO alone distributes 240 million pieces
annually outside the USPS, representing seven percent of our total
shared mail volume. This represents a weekly revenue loss to the USPS of
over \$500,000 or an annual loss of more than \$25 million. Despite the
overall advertising recession that caused advertising spending to
contract two percent from 2000 to 2002, direct mail revenue was up 1.4%,
one of only two mediums to garner more of advertisers' budgets during
this period. We are positioned to grow our business significantly, and
if necessary we are prepared to grow outside the Postal Service. The
Commission has the opportunity to make recommendations that will allow
the Postal Service to be partners in our growth to our mutual benefit.

**[THE NEED FOR CHANGE]{.underline}**

The challenges facing the Postal Service are enormous and unprecedented.
Mail volume declined 4.6 billion pieces in FY2002 compared to 2001,
significantly eclipsing two previous declines. In 1975, during one of
the worst recessions in history, mail volume declined by one billion
pieces, but quickly recovered. In 1991, also a recession year, there was
a 450 million-piece decline. In every other year since postal
reorganization in 1971, mail volume has increased. To date this fiscal
year, total mail volume (excluding Standard Mail) is down 2.2 percent.
Standard mail volume, on the other hand, is up 6.6 percent from last
year's levels even as the overall economy continues to languish. This is
why we know there is opportunity to grow the mail in the future provided
that postal costs can be managed down and that postal rates for
competitive products can be kept stable and affordable.

For the third year in a row, the Postal Service reported a net loss in
FY2002. Yet income from operations was positive in each of those years.
In fact, the USPS has had positive income from operations in every year
since 1990. Even in bad times, the Postal Service was able to more than
cover its operating costs. The USPS lost money in eight of the years
between 1990 to 2002, principally because of government transfer costs
such as the interest payment on the unfunded retirement liability (now
recognized by the GAO, OPM and others as being overfunded). While the
"death spiral" that some are predicting for the Postal Service could
happen, it is not inevitable. The Postal Service's basic operating model
of delivering hardcopy, printed materials to homes and businesses is
economically sound and, importantly, capable of supporting substantial
growth provided that its liabilities and costs can be restructured to
ensure affordable postal rates.

**[ENHANCE THE VALUE OF THE POSTAL ENTERPRISE]{.underline}**

While there are legitimate issues in defining the universal service
"obligation", the Commission should also consider the commercial value
that could potentially be realized by a national network that has access
to every American home and business six days per week. If universal
service is reduced as a cost saving measure, the Postal Service's
viability will be weakened. The Postal Service is of value to the mail
industry because it delivers our advertising messages to every home six
days a week without charge to the recipient. We know that Americans read
or scan their mail every day, making it an incredibly powerful
communications medium. The Commission should reject any steps that would
weaken the relationship between the American people and their mail. To
the contrary, the Commission should recommend techniques that would
strengthen that bond, e.g., the timing and frequency of daily delivery
and the expansion of delivery to seven days. Five percent of ADVO's
packages are delivered on Saturday (none on Sunday). We estimate that
over 60% of insert material is delivered on the weekend primarily via
newspapers and other delivery options.

The Postal Service's marketability is enhanced by the police powers
vested in the Postal Inspection to protect the safety and security of
the mail. While events in the fall of 2001 may have temporarily shaken
people's trust in their mail, ADVO\'s independent research of consumer
readership demonstrates that their trust has never wavered and is in
fact stronger now than at any time since we began that research.

**[STRENGTHEN THE BALANCE SHEET]{.underline}**

The Postal Service must have a strong balance sheet to properly
reorganize. This should have been ensured when the Service was created
30 years ago. However, its September 30, 2002 balance sheet reported a
\$30 billion deferred retirement liability. The Office of Personnel
Management, the General Accounting Office, and the Treasury agree that
this liability is actually much smaller due to the charges assessed by
the Treasury. They also agree that the amounts paid by the Postal
Service over the past 20 years have actually resulted in the Postal
Service greatly overfunding its retirement obligations. On the other
hand, obligations for post-retirement health care are not reported on
the balance sheet while a \$6 billion reported liability associated with
workers' compensation is. To ensure viability, the true extent of these
liabilities must be calculated and properly funded. Past mistakes or
miscalculations must not penalize the future operating results for the
business going forward.

The Postal Service should not be required to cover through rates those
costs imposed by Congress that private sector companies do not incur.
Costs resulting from the Service's status as a government agency should
be covered by the U.S. Treasury. This will put the Postal Service in a
position, going forward, to deal with those issues in the same way other
businesses deal with them -- in a way that is fair to employees but
which allows it to become commercially viable.

Today's mailers can cover the cost of delivering today's mail --
including a retirement benefit package for current postal employees --
and remain competitive. What today's mailers cannot afford to do is
cover costs imposed on the Postal Service that are not related to
delivering today's mail. The Postal Service should be moved to GAAP
accounting, and retirement benefits (including health care) should be
accrued each year to cover the current year's workers. The Postal
Service's customers cannot afford and should not be required to pay for
liabilities created by policy decisions made in the past. Recently
proposed legislation regarding the Civil Service Retirement System
(CSRS) liability is a major step in the right direction, but all
liabilities need to be addressed in a way that is fair to postal
customers.

**[DEVELOP A COMPETITIVE PRICING STRATEGY]{.underline}**

The Postal Service needs pricing flexibility and a competitive pricing
strategy. The Consumer Price Index rose just 2.4% in 2002 despite a
10.7% increase in energy costs. The costs of many business products and
services have been stable or have even declined in recent years. Our
company receives significant discounts for many of the products we buy,
and similarly, our customers look to us for discounts. Because the
advertising business is competitive and our customers have choices, they
have price leverage. We have similar price leverage with many of our
vendors, but not with our most important vendor \-- the United States
Postal Service.

The Postal Service doesn't think of itself as selling a service that can
be "resold," but ADVO and other saturation mailers are resellers of
Postal Services, and even more, market makers and sales forces for the
USPS. In most industries, wholesalers get the best prices because they
pay costs (such as sales and marketing) that would otherwise be paid by
the producer. Additionally, wholesalers typically have contractual
relations that encourage business growth, producing stronger business
results and outlook for both parties. Finally, the wholesaler is taking
an entrepreneurial risk that the producer's product will sell. ADVO and
other saturation mailers play that role for the Postal Service. Our
marketing and sales force are out selling the Postal Service every day.
When we open up a new territory or increase delivery frequency we often
do so initially at a loss, as we build a market to profitability. A
pricing strategy that provides resellers with incentives to grow
business would benefit the Postal Service and those mailers.

The Postal Service also needs to rebalance its priorities to give
marketing and sales an equal voice with operations. It needs more
freedom to set rates according to market and demand conditions,
particularly for its more competitive services. It should be free to
negotiate volume discount contracts and / or performance rebates with
mailers when the result will increase the bottom line.

The Postal Service's need for greater pricing flexibility is critical.
Under the current statute, the Postal Service must go through a complex
ten-month proceeding before the Postal Rate Commission before it can
change rates. Its competitors are among the most active participants,
urging higher rates for products with which they compete. The
proceedings themselves are complex, exploring in excruciating detail
every imaginable aspect of postal revenues, costs, and operations. No
other business in America must wait that long to adjust its rates, or go
through such an entangling, unpredictable process, only to see the
majority or the entirety of its proposed rates, in the end be amended
and set by an outside regulatory body.

**[OFFER MODERN PAYMENT TERMS]{.underline}**

The Postal Service requires that postage be paid at the time of mailing.
This is done in the name of "protecting the revenue," but the prepayment
requirement drives business away. Our competitors for preprint
distribution routinely give advertisers 14, 30, or even 60 days to pay.
The Postal Service does not even give us a few hours. This has led to a
complicated and costly audit trail of estimated postage payments
followed by debits and credits. As a result, we often require our
customers to prepay based on our estimated postage costs. Our standard
terms are prepayment which makes us less competitive. Once the final
accounting is done we must send out second bills seeking additional
payment or providing a credit. This "double-billing" is confusing and
irritating. We are forced to provide credit terms to our (and therefore
the Postal Service's) largest customers at a significant additional cost
to ADVO. Giving reliable customers the ability to pay after the mailing
would make the Postal Service more user-friendly. Sending a bill for
services rendered has been a common business practice for decades for
businesses of all sorts around the world.

**[CONTROL COSTS]{.underline}**

The Postal Service must contain its costs in order to move from a
cost-plus pricing system to one more oriented to the market. We applaud
the efforts of Postmaster General Potter to keep expenses in line and we
wish him continued success.

There is a limit, however, to what he can do without changes in the law,
particularly with regard to labor costs, 79 percent of total costs. The
USPS needs more freedom to manage its labor and other resources
appropriately. Specifically, the binding arbitration provision should be
amended. At a minimum, arbitration rules should be changed to reflect
the fact that the USPS must meet competition and cannot simply pass
through all costs. Both wages and benefits should be up for negotiation.
Employees should be rewarded for performance and should be given
incentives to improve. A more flexible workforce able to change jobs or
perform a variety of tasks will keep the Postal Service viable even if
volume continues to fall. Greater flexibility in work rules will allow
the workforce to expand and shrink (if necessary) through attrition
instead of through more disruptive downsizing.

Mailers have assisted the USPS with cost savings through worksharing.
ADVO has been a leader advocating carrier route, saturation, walk
sequence, drop ship and sub-class discounts. The Postal Service intends
to increase cost savings by applying its letter automation experience to
flat mail. Technological innovations can enhance efficiency, but
automation is not the solution for every type of mail. Automation for
automation's sake may drive financially rewarding business away from the
Postal Service or any business. ADVO's core product, the shared mail
package, which is drop shipped at our expense to the destination
delivery office is a case in point. Our package is open on three sides,
making it easy for our clients' customers to access its contents and to
achieve its primary role of consumer readership. Our mail covers
virtually every residential address, is sorted in walk sequence, and we
ship the vast majority directly to the delivery unit. We provide the
Postal Service with regular, predictable, high volume mail that makes a
substantial contribution to USPS fixed costs. Yet our product may not
fit into the increasingly automated postal environment. While we do not
expect the Commission to resolve this uncertainty, we would caution
against any recommendation that would see technology investment alone as
a universal solution to cost containment.

**[FOCUS ON THE CORE BUSINESS]{.underline}**

The Postal Service is in business to deliver hard copy to homes and
businesses. Not only is this a viable business, there is untapped
potential and opportunities for tremendous growth even with all of the
recent changes in communications and the increasingly competitive
environment. The Postal Service should be discouraged from seeking
opportunities far afield from its core business. While ongoing
innovation, investments, and development of new products and services is
essential to success in the modern economy, the postal service should
not try to become something it is not -- such as in internet service
provider or a clothing retailer.

Again, we applaud your commitment to a viable Postal Service. ADVO
shares that commitment and is ready to assist the Commission in any way
we can.