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Testimony of John Waller

Director of Office of Accountability and Compliance

on Behalf of the Postal Regulatory Commission

Before the U.S. House of Representatives Committee on Oversight

and Government Reform Subcommittee on Federal Workforce,

Postal Service and the District of Columbia

May 12, 2010

Chairman Lynch, Ranking Member Chaffetz, and members of the Subcommittee, 

thank you for the opportunity to appear before you to discuss postal pricing 

issues that are raised in the Commission’s Fiscal Year 2009 Annual Compliance 

Determination.

In fiscal year 2009, the Postal Service experienced an unprecedented drop in 

volume and narrowly avoided defaulting on its financial obligations. This was 

due to the rapid economic downturn that was especially damaging for some of 

the primary users of the mail, and the continued diversion of valuable letter mail 

to electronic forms of communication.

The Postal Service is no longer able to depend on volume growth to 

counterbalance the large amount of fixed costs in postal operations. It has had 

to explore ways to modify its business model, generate new sources of revenue, 

and modify methods of operation to accelerate the reduction of costs. In the 

meantime, the Postal Service has responded to the financial crisis with extensive 

cost cutting efforts, some of which may have contributed to the avoided costs 

dropping below their workshare discounts. Price modification is only one 

potential component of the solution set. The need is to bring total costs and 

revenues into line. While the Postal Service decided this year not to pursue the 
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regularly scheduled May price adjustments, it has announced an intention to file 

a notification of an exigent price change to take effect in 2011. The Commission 

concludes in its Annual Compliance Determination that the upcoming general 

price adjustment is the appropriate time to address the specific pricing issues 

that were identified.

Workshare Discounts in Excess of Avoided Costs

Worksharing has proven to be a very successful initiative for the Postal Service. 

Each new workshare discount has been followed with an increase in volume, 

beginning with the First-Class Mail discounts introduced in the 70s, Standard 

Mail discounts in the 80s and then parcel discounts in the 90s. An example of 

this success involves parcel post which experienced a complete turnaround after 

workshare discounts became available in 1991. From 1970 to 1990, parcel post 

volume declined an average of 7.5 percent per year. But for the period 1991 

through 2009, volume increased on average 4.8 percent per year.

Workshare discounts, as defined in the Postal Accountability and Enhancement 

Act (PAEA) are “provided to mailers for the presorting, prebarcoding, handling, or 

transportation of mail, as further defined by the Postal Regulatory Commission.” 

39 USC 3622(e)(1). When the mailer performs one or more of these functions, 

the Postal Service does not have to perform certain mail processing functions, 

such as cancellation, barcoding, and multiple sorting operations.

When properly designed, workshare discounts can not only increase mail volume 

and revenue, they can increase net revenue – revenue exceeding attributable

costs – and help to defray the institutional costs of the Postal Service. Other 

mailers are not disadvantaged because the discounts equal the costs avoided or 

driven out of the system, and the Postal Service retains the same unit 

contribution to institutional costs. Thus, properly designed workshare discounts 

act to control costs and create competition within mail processing.
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Under the previous postal law, the Commission attempted to consistently 

recommend workshare discounts equal to the costs avoided by the Postal 

Service as a result of preparatory work performed by mailers. This pricing 

principle, which has also used in other regulated industries, is often referred to as 

Efficient Component Pricing or ECP. As the name suggests, the idea is to 

develop prices for the individual components of a service with the goal of 

promoting the efficient use of each component. In the case of worksharing, each 

discount is effectively the price of a processing or transportation step in the 

Postal Service’s mail handling chain. When a mailer prepares mail to qualify for 

worksharing rates, it is choosing to perform one or more of those steps itself, 

rather than pay the price of having the Postal Service do the work.

Worksharing can also benefit the overall economy and society at large. When 

workshare discounts equal avoided Postal Service costs, mailers can choose to 

do the work themselves when it is cheaper to do so, or let the Postal Service do 

it. For example, mailers can sort addresses in computer data bases and then 

print addresses on mail pieces in ZIP Code or delivery sequence order during the

production of mail pieces, which is often much cheaper than physical sorting of 

the mail pieces by the Postal Service. In this manner, workshare discounts 

incent mailers to take advantage of technology and utilize Postal Service 

products at the lowest possible cost. The realized savings can then be used to 

expand their businesses and perhaps increase their mail volume. This is real 

productive efficiency.

When discounts exceed avoided costs, the mailer has price incentives to perform 

postal functions that the Postal Service can perform at a lower cost. In that 

instance, the discount can introduce inefficiencies in the mail process. The 

PAEA explicitly requires the Commission to ensure that this does not occur. 
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As an example of worksharing, consider a set of First-Class letter mail that 

satisfies Postal Service automation requirements and is presorted to the 5-digit 

ZIP Code level. The average Postal Service cost to process a piece of this mail 

from intake through delivery is 8.7 cents. However, if the same mail had not 

been presorted and otherwise workshared, the Postal Service cost to process a 

piece of this mail is 18.2 cents. The 9.5 cents difference is the Postal Service 

cost avoided as a result of a mailer's preparatory work. The current discount for

this type of workshared mail is 10.5 cents. 

The difficult computational task is to correctly identify the Postal Service cost of 

handling mail that is similar except for being workshared. Methodologies to 

determine the cost of various types of worksharing have been developed by the 

Commission over the years and refined through public hearings with input from 

the Postal Service and other interested persons. Due to continual changes in 

postal operations, it is necessary to periodically review how workshare costs are 

developed. Last year, 30 proposed changes to costing methods were publicly 

reviewed by the Commission, and 29 were approved.

Also, the actual costs of the potentially avoided operations are updated each 

fiscal year with data filed by the Postal Service in an Annual Compliance Report. 

These data are examined by the Commission, are available for public review and 

comment, and are used to produce the Annual Compliance Determination. This 

process ensures an accurate measurement of the costs that are actually being 

avoided by each workshared operation and allows the Postal Service to develop 

discounts that do not exceed avoided costs. Because the cost of some 

operations decreased during fiscal year 2009, some existing discounts ended the 

year exceeding avoided costs. A reduction in postal costs is desirable in these 

difficult financial times. Identifying these contractions in cost avoidances on an 

annual basis, and making suitable realignments as soon as practicable, is one of

primary purposes of the Annual Compliance Determination.
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For Fiscal Year 2009, the Commission found that 30 of 189 workshare discounts 

exceeded avoided costs, and that 17 of these were justifiable under current law. 

The PAEA, building on practice under the previous postal law, recognized that 

under certain situations it is appropriate to have a discount exceed avoided 

costs, and provided four types of exceptions to the limitation in section 3622(e). 

They are:

1) The discount is (i) associated with a new postal service, a change to an 

existing postal service, or with a new workshare initiative related to an 

existing postal service; and (ii) necessary to induce mailer behavior that 

furthers the economically efficient operation of the Postal Service. The 

portion of the discount in excess of the cost that the Postal Service avoids 

as a result of the workshare activity will be phased out over a limited 

period of time;

2) The amount of the discount above costs avoided (i) is necessary to 

mitigate rate shock; and (ii) will be phased out over time;

3) The discount is provided in connection with sub-classes of mail 

consisting exclusively of mail matter of educational, cultural, scientific, or 

informational value; or

4) The reduction or elimination of the discount would impede the efficient 

operation of the Postal Service.

The Postal Service provided reasons why it believed each of the 30 questionable 

discounts satisfied one or more of the exceptions. For instance, the shortfalls 

pertaining to Periodicals meet criteria in exemption 3.

In some instances, the Postal Service could identify how operations would 

deteriorate and harm overall efficiency if the specific discounts were reduced and 
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cited exception 4. An example of this is the workshare discount for Standard 

Mail machinable parcels presorted to the 5-digit ZIP Code level. The Postal 

Service explicitly identified how operations would become more inefficient without 

the extra inducement to presort these parcels. The Commission found that 

justifications provided for 17 of the 30 questionable discounts were acceptable 

under the PAEA.

For the other 13 discounts, the Postal Service did not provide adequate 

justification for the discounts exceeding avoided costs. In most of these 

instances, the Postal Service stated that a rate adjustment would harm efficiency 

without identifying how this would occur. The Commission determined, however, 

that while rate adjustments represent a possible remedy to workshare discounts

greater than avoided costs, such adjustments are not, of themselves, a cause for 

inefficiency in Postal Service operations.

Once a determination is made that a workshare discount that exceeds avoided 

costs is not justified by one of the four exceptions in the PAEA, the Commission 

is authorized under section 3653(c) to order appropriate remedial action. In the 

fiscal year 2008 Annual Compliance Determination, the Commission found 

several workshare discounts that exceeded avoided costs without adequate 

justification. However, at that time the Commission also was reviewing a general 

price adjustment in which the Postal Service was remedying the identified 

problem discounts. Thus, no additional action was necessary on the part of the 

Commission. This year, however, there was no regularly scheduled May price 

increase in which the questionable discounts could be modified. But on March 

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nd of this year, the Postal Service stated that a notice of an exigent price 

adjustment for early 2011 would be forthcoming. The Commission determined 

that the adjustment of all or some of the 13 questionable discounts could be best 

addressed at that time.
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Products Not Covering Costs in FY 2009

Postal Service costs fall into two categories: those caused by specific products, 

referred to as attributable costs, and the remaining costs that are commonly 

referred to as institutional costs. Revenues from many postal products exceed 

their attributable costs and make a contribution to the institutional costs. But last 

year, contributions from the various postal products were insufficient, and the 

Postal Service had a loss of $3.8 billion. Of that loss, $1.7 billion is due to 14

market dominant products that did not even cover their attributable costs. Most 

businesses cannot continue to operate over long periods with products that do 

not cover attributable costs.

For the Postal Service, this shortfall problem is somewhat confined. Nearly $1.5 

billion of the loss from products not covering attributable costs comes from just 

three products: Periodicals, $642 million; Standard Mail Flats, $616 million; and 

Standard Mail Non-Flat Machinables (NFMs) and Parcels, $205 million. Losses 

for the two Standard Mail products have significantly increased from the prior 

year. Also, there is an important cost causing factor common to these three 

products. Specifically, they all involve the handling of flats for which the Postal

Service has long standing cost control problems.

In the fiscal year 2000 rate case, the Commission required the Postal Service to 

explain why the cost of handling flats was increasing so rapidly, and how the 

Postal Service intended to solve this problem. The answer was new machinery 

and better management techniques. That equipment, the Advanced Flats 

Sorting Machine, did make some dent in the problem, but the flats handling cost 

problem has continued. The new Flats Sequencing System equipment now 

being deployed is frequently cited by the Postal Service as a future source of 

cost savings. This remains to be seen. In the interim, the Postal Service, has 

given Standard Mail Flats less than average increases for the last two years in 

hopes of retaining flats volume until the cost savings can be realized. The impact 
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has been a rapid increase in the losses from Standard Mail Flats with a near 

tripling in 2009. While this pricing strategy has been provided an opportunity to 

succeed, the Commission in recent Annual Compliance Determinations has 

cautioned against less than average increases for loss making products without a 

plan or justification for demonstrating how net revenue is helped over the long 

run. The 2009 Annual Compliance Determination notes that while Standard Mail 

Flats experienced a significant loss, First-Class and Bound Printed Matter Flats 

do cover attributable costs so it is not an unsolvable problem.

Standard Mail NFMs and Parcels consist of approximately 1.3 million NFMs and 

5.5 million parcels both of which are costlier to handle than letters and flats. The 

product consists of boxes of checks, boxes of gift cards, and other promotional 

items. If these products were handled through Parcel Select, a competitive 

product, the price to the mailer can approximately double that of the Standard 

Mail rate. Recognizing the high cost of processing these items, the Postal 

Service has provided pricing incentives to have the product workshared to 

facilitate the most efficient handling by the Postal Service. At the same time, the 

Postal Service has attempted to increase revenue through price increases: a 

16.4 percent increase last May and a 9.7 percent increase the year before. 

These increases were well above the average Standard Mail increases of 3.7 

and 2.8 percent, respectively. Without these increases, the losses would have 

been even greater. The Commission has requested that the Postal Service 

develop a plan this year to resolve this cost and revenue imbalance.

Periodicals Mail revenue has not covered attributable costs since 1997. 

Revenue nearly equaled costs in 2003, but the gap has steadily increased since. 

For fiscal year 2009, revenue covered only 76.1 percent of the costs directly 

attributable to Periodicals Mail. As required by the PAEA, the Commission and 

the Postal Service are jointly studying Periodicals costs and operations to identify 

opportunities to fix the chronic cost and revenue imbalance. This study should 

be completed later this year and sent to the Congress for consideration. What 
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has become obvious is that the problems in handling Periodicals flats are even

more pronounced than in Standard Mail. The Periodicals industry also has been 

seriously impacted by the recent economic and technology-driven changes. 

These changes have caused significant drops in the advertisement in Periodicals 

and less weight per piece. These changes negatively impact postage revenue 

since the non-advertising portion of a Periodical receives lower rates and over 30

percent of Periodicals revenue is based on weight.

The Commission directed the Postal Service to address the issue of products 

that were found to not cover costs in its next general market dominant price 

adjustment. In instances where a problem cannot be fully resolved at that time, 

the Postal Service is to provide a detailed plan for future resolution.

In summary, the overall losses are not solely the problem of these three 

products. The cost and revenue of all products need to be addressed. As the 

Commission emphasized in its 2009 Annual Compliance Determination, the 

financial difficulties of the Postal Service is a multifaceted problem, not just a 

matter of prices, but of operating costs, legacy costs, business model, and a 

changing mail market. In the meantime, the Commission is responsible for 

providing transparency on the revenue and costs of postal products and 

recommending appropriate actions when problems are identified.

This completes my testimony. I will be glad to answer any questions you may 

have.

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