jurisdiction: US

text: b' Parallel Tracks?\n Lessons from the Railroad Industry\n\n\n\n\n August 13, 2012\n\n\n\n\nPrepared by U.S. Postal Service Office of Inspector General\n Report Number: RARC-WP-12-014\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\n\n Parallel Tracks?\n Lessons from the Railroad Industry\n\n\n Executive Summary\n\nThe Postal Service is currently facing a financial crisis. The combination of the great\nrecession and increased competition from electronic diversion has created the \xe2\x80\x9cperfect\nstorm\xe2\x80\x9d of rapidly declining mail volumes. Despite the fact the Postal Service has\nundergone some substantial cost cutting and some new product innovation, neither\nhave been enough to counteract the falling revenues that stem from the huge volume\nloss. While some mail volume appears to be returning as the economy improves, some\nof the mail volume, especially high contribution First-Class Mail volume, faces a likely\npermanent loss to electronic diversion.\n\nAlthough severe, the Postal Service\xe2\x80\x99s predicament does not seem to be entirely unique.\nThere are many parallels to the rail industry, which suffered a significant loss of market\nshare to the trucking industry in the 1950s, while it was burdened with an overbuilt\nnetwork. A comparison of the two industries could be useful in illuminating today\xe2\x80\x99s\npostal predicament.\n\nThe Office of Inspector General asked Christensen Associates, an economic consulting\nfirm with expertise in regulated industries that have faced disruptive technologies, to\nprovide a historical perspective of the rail industry and to co-author a paper that\ncompares the two industries.\n\nThe key findings of the paper are\n\n \xef\x82\xa7 The freight rail industry\xe2\x80\x99s recovery does not provide an exact blueprint for the\n postal industry\xe2\x80\x99s recovery, but the comparison of the two industries provides\n some interesting insights into the prioritization of recovery efforts.\n\n \xef\x82\xa7 It took over 50 years to develop and implement reform that resulted in a\n financially viable freight rail industry.\n\n \xef\x82\xa7 Freight rail reform was not successful until it recognized the industry as being in\n crisis, and focused on restoring railroads\xe2\x80\x99 financial health. The means were\n sometimes unpopular and challenging, and they included spinning off the\n obligation to provide passenger rail service to the newly formed government-\n owned corporation, Amtrak.\n\n \xef\x82\xa7 There were three critical, interrelated components that allowed freight rail to be\n financially viable: 1) productivity improvement, 2) revenue generation, and 3) cost\n containment. None of the three would have been successful in isolation.\n\n\n i\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\n However, it was the strength of productivity gains that allowed rail recovery to be\n a story of shared gain, as customers benefited through lower prices.\n\n \xef\x82\xa7 Unlike the freight rail industry, the Postal Service does not have the same\n potential for rapid productivity improvement under the Postal Service\xe2\x80\x99s present\n service obligations and current network structure. Therefore, Postal Service\n recovery will be more likely a story of shared pain than shared gain.\n\n \xef\x82\xa7 It is unlikely that the Postal Service will benefit from something akin to the\n increased demand for low-sulfur coal that boosted revenue for freight rail. It is\n difficult to imagine a market disruption that would lead to a dramatic long-term\n increase in demand for hard copy mail, particularly the First-Class Mail that\n traditionally bore the bulk of the Postal Service\xe2\x80\x99s institutional costs.\n\n \xef\x82\xa7 While it is possible that in the future, the Postal Service will offer new ancillary\n and nonpostal products with considerable revenues, the Postal Service is\n unlikely to benefit from significant new sources of revenue for several years.\n\n \xef\x82\xa7 The first and foremost element of postal recovery needs to be cost containment\n \xe2\x80\x94 addressing the retiree prefunding issue and rightsizing the network.\n\n \xef\x82\xa7 It is unlikely that the Postal Service and its stakeholders can wait over 50 years\n for a full recovery. The prioritization of restructuring and speed of recovery are of\n utmost importance to restore the Postal Service\xe2\x80\x99s critical role in communications\n and commerce.\n\n\n\n\n ii\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\n Table of Contents\n\nIntroduction ..................................................................................................................... 1\xc2\xa0\n\nBackground ..................................................................................................................... 2\xc2\xa0\n The Railroad Industry ........................................................................................... 2\xc2\xa0\n The Postal Service ............................................................................................... 4\xc2\xa0\n\nParallel Problems ............................................................................................................ 6\xc2\xa0\n Disruptive Technologies Drove Market Share Loss .............................................. 8\xc2\xa0\n Regulatory Restrictions Limited Revenue Generation ........................................ 10\xc2\xa0\n Regulatory Controls Limited Ability to Adapt to Changing Market\n Conditions .......................................................................................................... 12\xc2\xa0\n Inability to Adapt to Market Conditions Led to Huge Financial\n Losses ................................................................................................................ 13\xc2\xa0\n\nParallel Solutions .......................................................................................................... 15\xc2\xa0\n\nConclusion .................................................................................................................... 20\xc2\xa0\n\n\n\n\n iii\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\n Tables\n\nTable 1 Parallel Problems .................................................................................... 7\xc2\xa0\n\nTable 2 Parallel Solutions .................................................................................. 16\xc2\xa0\n\n\n Figures\n\nFigure 1 Index of Railroad Freight and Passenger Traffic (1 = 1910).................... 8\xc2\xa0\n\nFigure 2 Volume Shares of Freight Traffic by Mode .............................................. 9\xc2\xa0\n\nFigure 3 First-Class Mail, Standard Mail, and Total Mail Volume .......................... 9\xc2\xa0\n\nFigure 4 Average Annual Growth in Inflation and Railroad Operating\n Revenue and Expense .......................................................................... 14\xc2\xa0\n\nFigure 5 Average Annual Growth Rates in Inflation and Postal\n Operating Revenues and Operating Expenses ..................................... 15\xc2\xa0\n\n\n Appendices\n\nAppendix A\xc2\xa0 History of the Railroad Industry ............................................................. 23\xc2\xa0\n\nAppendix B\xc2\xa0 Common Carrier and Universal Service Obligations ............................. 29\xc2\xa0\n\n\n\n\n iv\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\n Parallel Tracks? Learned from the Railroad Industry\n\n\nIntroduction\nThe U.S. Postal Service is currently facing the most significant financial challenge since\nits establishment as an independent agency by the Postal Reorganization Act of 1970\n(PRA). The current crisis results largely from a dramatic decrease in mail volume and\nrevenue. Since a substantial portion of the Postal Service\xe2\x80\x99s cost is fixed with respect to\nmail volume, the Postal Service has incurred losses despite significant workforce\nreductions and other cost-cutting efforts. While some of the mail volume decline reflects\nthe recent economic recession, much of the mail volume loss likely reflects structural\nchanges in communications markets that were caused by improvements in information\ntechnologies. At the very least, the Postal Service faces a more competitive landscape\nfor its services.\n\nU.S. railroads spent much of the mid-20th century in states of financial crisis as rapid\ndevelopment of highway transportation and commercial aviation led to sizeable losses\nof freight market share to over-the-road trucking and of passenger volumes to the\nautomobile and airlines. While the competitive threat and deteriorating financial\nconditions were immediately recognized, it took three decades and several rounds of\npiecemeal legislative efforts before comprehensive reform legislation \xe2\x80\x94 the Staggers\nRail Act of 1980 (the Staggers Act) \xe2\x80\x94 was enacted, and for the railroad industry to stop\nthe financial bleeding. It has taken nearly three more decades after the Staggers Act for\nthe railroad industry to regain its financial health.\n\nThe freight railroad industry\xe2\x80\x99s lengthy effort to gain control of the situation demonstrates\nthat making structural changes in the industry, such as consolidating industry assets,\nshedding track and routes, and reducing employment, does not happen overnight.\nFurthermore, political and regulatory factors restricted the ability of the freight rail\nindustry to get control of the situation.\n\nThis paper examines parallels between the railroad industry as it moved from crisis to\nrecovery and the Postal Service\xe2\x80\x99s current state of affairs. The objective of these\ninvestigations is to look for insights that may help the Postal Service and other\nstakeholders manage, and perhaps shorten, the road from crisis to recovery.1\n\n\n\n\n1\n David Levy and Matthew Field have also compared the Postal Service and the railroads, arriving at \xe2\x80\x9clessons for\nrevitalizing the Postal Service.\xe2\x80\x9d See David M. Levy and Matthew D. Field, \xe2\x80\x9cThe United States Postal Service Business\nModel: Lessons from the American Railroad Industry,\xe2\x80\x9d in Reinventing the Postal Sector in an Electronic Age, eds.\nMichael A. Crew and Paul R. Kleindorfer (Cheltenham, UK and Northampton, MA: Edward Elgar, 2011), pp 306-318.\n\n\n 1\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nBackground\n\nThe Railroad Industry\n\nSince their genesis in the early 1800s, railroads have been central to America\xe2\x80\x99s social\nand economic development.2 Prior to the railroads, economic geography reflected the\nhigh cost of surface transportation, with economic activity centered on natural ports and\nother locations with access to navigable waterways. Railroads greatly reduced the cost\nand increased the speed of ground transportation and expanded rapidly during the\n19th century.\n\nIn the absence of other modes of mechanized ground transportation, and given railroad\ncost structures that restricted entry of competitors, railroads faced little competition\nacross much of the nation\xe2\x80\x99s geography. Consequently, the railroads exercised\nconsiderable market power. This led to concerns that railroads charged unfairly high\n(monopolistic) prices, particularly to captive shippers served by only one railroad. The\nrailroads also engaged in price discrimination, charging higher rates to captive shippers\nand lower rates to shippers with rail or water alternatives. The railroads sometimes\npracticed price discrimination by giving larger shippers rebates not available to the\nsmaller shippers.3\n\nShippers and the general public resented the railroads\xe2\x80\x99 pricing practices. Agrarian\ninterests known as the Granger Movement, resulted in Midwestern states passing\nlegislation to regulate the railroads by establishing maximum rates and outlawing some\nforms of price discrimination. Between 1871 and 1874, Illinois, Iowa, Wisconsin, and\nMinnesota enacted legislation regulating the railroads. Between 1875 and 1878, the\n\xe2\x80\x9cGranger laws\xe2\x80\x9d were repealed or weakened, but these states kept some regulatory\nlegislation and, by 1890, 34 states had passed some railroad regulation laws.4\n\n In 1886, the U.S. Supreme Court ruled in Wabash v. Illinois that the federal\ngovernment, rather than the states, has the authority to regulate railroads engaged in\ninterstate commerce.5 The Wabash decision provided the impetus for the Interstate\nCommerce Act of 1887 (the Interstate Commerce Act),6 which established the Interstate\nCommerce Commission (ICC) to oversee the railroads. Thus, railroads became the first\nmajor U.S. industry to be subject to economic regulation.7\n\nUnder the Interstate Commerce Act and subsequent amendments, the ICC eventually\nregulated maximum and minimum rail rates, as well as entry, exit, and abandonment of\n\n2\n A more detailed history of the rail industry can be found in Appendix A.\n3\n See, e.g., John F. Stover, American Railroads, Second Edition, (Chicago: University of Chicago Press, 1997)\npp. 116-117 and Ross M. Robertson, History of the American Economy, Third Edition (New York: Harcourt Brace\nJavonovich, 1973) pp. 281-282.\n4\n Ross M. Robertson, History of the American Economy, pp. 284-285.\n5\n Wasbash, St. L. & P.R.Co v. Illinois, 118 U.S. 557, 577, Sup. Ct. 4, 30 L. ed. 244 (1886).\n6\n Interstate Commerce Act of 1887, ch. 104, 24 Stat. 379, approved 1887-02-04.\n7\n Clyde Aitchison, \xe2\x80\x9cThe Evolution of the Interstate Commerce Act: 1887-1937,\xe2\x80\x9d George Washington Law Review 5\n(1936-1937): pp. 289, 300, citing Wabash, St. L. & P. R. Co. v. Illinois, 118 U. S. 557, 7 Sup. Ct. 4, 30 L. ed. 244\n(1886).\n\n\n 2\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nrail lines. Railroads were not allowed to engage in some forms of price discrimination,\nsuch as charging differential rates based on shipper size or for high-density versus low-\ndensity routes. However, rates could vary by commodity. Rate differences between\ncommodities reflected \xe2\x80\x9cvalue of service\xe2\x80\x9d principles, under which rates and markups for\nhigh-valued shipments such as manufactured goods were high, while rates for\nagricultural products and other bulk commodities were low. Common carrier obligations\nand restrictions on the ability of railroad operators to stop serving markets ensured the\nprovision of services to small shippers and rural areas.8\n\nThe railroad industry\'s golden age as the dominant mode of overland transportation\nended early in the 20th century. Mass production of automobiles led to declines in rail\npassenger traffic as early as the 1920s. With the onset of the Great Depression,\nrailroads faced increased financial pressures as the economic collapse caused both\nfreight and passenger traffic to plummet. Furthermore, the railroads faced increasing\ncompetition from a rapidly growing, publicly funded network of paved highways. Many\nrailroads went bankrupt or became distressed and were purchased by stronger\ncompanies.\n\nWorld War II-related rail demand traffic gave the railroads a temporary boost, but it was\ninsufficient to resolve the railroads\xe2\x80\x99 financial difficulties. Through the 1950s and 1960s,\ncompetition from government-funded construction of the interstate highway system and\ncommercial aviation intensified as railroad finances worsened and the rail network\ndeteriorated.\n\nA presidential commission had identified the regulatory system as imposing major costs\non railroads and shippers in its 1955 Weeks Report9 but the regulatory reform process\nwas slow. Initial efforts in the late 1960s and early 1970s focused on restructuring\nbankrupt railroads and relieving railroads of obligations to provide passenger service.10\nThe Railroad Revitalization and Regulatory Reform Act, called the \xe2\x80\x9c4R\xe2\x80\x9d Act of 1976,\ntook initial steps toward deregulating railroad pricing by allowing some negotiated\ncontracts between railroads and shippers and by allowing categories of traffic to be\nexempted from regulation.11 The Staggers Act12 completed the reform process by\ngenerally allowing rail rates to be set according to market demands, streamlining exit\n(abandonment) procedures, and making the financial health of the industry a central\nfocus of remaining regulation. Today, the rail industry\xe2\x80\x99s future appears bright as\nsignificant private investment in modernization, rising fuel costs, and labor cost\nadvantages are giving rail significant advantages over the trucking industry.\n\n\n\n\n8\n Interstate Commerce Act of 1887, ch. 104, 24 Stat. 379, approved 1887-02-04.\n9\n Presidential Advisory Committee on Transport Policy and Organization, Revision of Federal Transportation Policy\n(Washington, DC: U.S. Government Printing Office, 1955).\n10\n Appendix B gives a detailed description of the common carrier obligations of the rail industry and the elimination of\nthe passenger service obligation.\n11\n Railroad Revitalization and Regulatory Reform Act, Public Law 94-210, 90 Stat. 31, 1976.\n12\n Staggers Rail Act of 1980, Public Law 96-448, 94 Stat. 1895.\n\n\n 3\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nThe Postal Service\n\nThe Postal Service\xe2\x80\x99s roots date back to colonial times. A centralized system of post\nroads and post offices was developed during the 18th century. After independence from\nGreat Britain, responsibility for the postal system was vested with the United States\ngovernment. Congress established the Post Office Department as an executive branch\ncabinet department in 1872.13\n\nThe modern Postal Service\xe2\x80\x99s product offerings and service obligations reflect several\nrounds of service expansion. Originally, the Post Office only delivered mail to and from\nits own facilities. In 1863, it began providing free city delivery with payment of postage.\nIn 1896, the Post Office inaugurated a system of rural free delivery to provide service to\nthe most isolated communities. The range of mail services offered by the Post Office\nhas gradually expanded as well. Magazines and pamphlets were formally admitted to\nthe mail in 1794, but only when they could be transported conveniently. Classes of mail\nwere formalized in 1863 \xe2\x80\x94 First-Class Mail included letters, Second-Class (now\nPeriodicals) covered publications issued at regular intervals, and Third-Class (now\nStandard Mail) included all other mailable materials. Parcel Post service was\ninaugurated in 1913.14\n\nBy the mid-1960s, the Post Office was in financial and operational trouble. Postal rates\nbore little relationship to costs, and substantial appropriations were needed to cover the\ndepartment\xe2\x80\x99s deficits. Meanwhile, growing mail volume was overwhelming postal\noperations, which still relied primarily on manual processing.15 The PRA reconstituted\nthe Post Office as the United States Postal Service, vesting operational responsibility\nwith the Postal Service\xe2\x80\x99s management and Board of Governors rather than with\nCongress. 16 It established a system of collective bargaining with postal unions. Finally,\nthe PRA mandated \xe2\x80\x9cthat total estimated income and appropriations should equal as\nnearly as practicable total estimated costs.\xe2\x80\x9d17\n\nThe PRA established a \xe2\x80\x9ccost of service\xe2\x80\x9d postal ratemaking system, whereby the Postal\nService\xe2\x80\x99s governors determined rates, subject to regulation by the independent Postal\nRate Commission. Under the PRA, postal ratemaking effectively followed a two-step\nprocess. First, the estimated total cost of the Postal Service determined a \xe2\x80\x9crevenue\nrequirement\xe2\x80\x9d to be recovered through postal rates and (to a much smaller extent)\nappropriations. Second, a set of rates would be determined that would approximately\ngenerate sufficient revenues while observing ratemaking policies set forth in the PRA.18\n\n\n\n\n13\n Postal Service Publication 100, \xe2\x80\x9cThe United States Postal Service: An American History 1775-2006,\xe2\x80\x9d\nhttp://about.usps.com/publications/pub100.pdf.\n14\n Ibid.\n15\n Ibid.\n16\n Public Law 91-375, 1970.\n17\n Quote from the Postal Rate Commission Opinion and Recommended Decision, Docket No. R71-1, p. 3.\n18\n Public Law 91-375, 1970.\n\n\n 4\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nAfter ensuring break-even revenues, the foremost considerations in PRA ratemaking\nwere a requirement that postal rates cover \xe2\x80\x9cattributable\xe2\x80\x9d costs while value of service\nprinciples were used, among other things, to assign responsibility for covering fixed\ncosts of the Postal Service to classes of mail.19 Under PRA ratemaking, markups on\nhigh value-of-service First-Class Mail covered the bulk of the Postal Service\xe2\x80\x99s fixed\ncosts.20\n\nDuring the early PRA period, mail volume continued to grow; total mail volume doubled\nbetween 1970 and 1990, and peak volume in 2006 was 2.5 times the 1970 level.21\nPopulation growth and associated household and business formation also triggered\ngreat expansion in the Postal Service\xe2\x80\x99s delivery network. The Postal Service underwent\na major operational transition as its mail processing operations were increasingly\nautomated. The Postal Service also effectively outsourced a considerable amount of\nmail processing and transportation via worksharing discounts offered to business\nmailers.22\n\nThe PRA ratemaking system succeeded in allowing the Postal Service to break even\nalmost entirely on revenues from postage and related fees, but it led to a number of\nstakeholder concerns that drove a regulatory reform effort. The cost-of-service\nratemaking system was viewed as providing insufficient incentives for the Postal\nService to pursue productivity improvements. Mailers found the irregular timing and size\nof rate increases disruptive and were concerned about the potential for rate shocks for\nproducts priced close to cost floors.23 Efforts to extend the Postal Service\xe2\x80\x99s business\nmodel beyond traditional mail services had little success, while diversion of mail\nvolumes to electronic alternatives was a major threat. Competitors feared that the\nPostal Service would use its monopoly revenues and status as a government entity to\nprovide unfair advantages to its own competitive products.24 The Postal Accountability\nand Enhancement Act of 2006 (PAEA) implemented major changes to the postal\nregulatory system. Among its chief features, the PRA cost-of-service ratemaking system\nwas replaced with a system of price caps based on the Consumer Price Index (CPI) for\nmarket-dominant products,25 while the regulation that applied to pricing competitive\nproducts was greatly reduced.26 The Postal Service was allowed, but not required, to\n\n19\n Ibid.\n20\n For example, the recommended rates for Docket No. R2006-1, the last PRA rate case, assigned 55 percent of\n\xe2\x80\x9ccontribution to institutional cost\xe2\x80\x9d to the First-Class Letters and Sealed Parcels subclass. Postal Rate Commission\nOpinion and Recommended Decision, Docket No. R2006-1, Vol. 1, 5228 (p. 167); Vol. 2, Appendix G.\n21\n Data from 1970 to 2005: Docket No. R2006-1, USPS-LR-74; Data from 2006 to 2011 U.S. Postal Service Revenue,\nPieces, and Volume (RPW) Reports.\n22\n Presorting services offered by consolidators and other mailing service providers substitute for Postal Service\nsorting operations. In some cases, worksharing uses the same general technology as Postal Service operations,\nsuch as OCR and barcode sorters; in other cases, mailers or their agents can incorporate \xe2\x80\x9cworksharing\xe2\x80\x9d activities into\nthe process of producing mailpieces by (say) printing mailpieces in sort order. Similarly, \xe2\x80\x9cdrop shipments\xe2\x80\x9d normally\ninvolve mailers providing transportation and material handling services that the Postal Service would provide for non-\nworkshared mail.\n23\n Transcript from 2002 Rate Making Summit cosponsored by the U.S. Postal Service and Postal Rate Commission at\nhttp://www.prc.gov/prc-docs/library/archived/day1-transcript.pdf.\n24\n Embracing the Future, Report of the President\xe2\x80\x99s Commission on the United States Postal Service, July 31, 2003,\np. 67.\n25\n Public Law 109-435, 120 Stat. 3202, 2006.\n26\n Public Law 109-435, 120 Stat. 3205 \xe2\x80\x93 3207, 2006.\n\n\n 5\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nearn and retain a profit.27 The Postal Service was prohibited from offering new\nnonpostal products.28 While the PAEA reversed the 2003 law that required the Postal\nService to pay for military service and put money into an escrow account starting in\n2006,29 it required the Postal Service to make large payments to the U.S. Treasury to\nprefund its retiree health benefits.30\n\nThe financial crisis of 2007-2008 and the subsequent severe economic recession led to\na sharp decline in mail volume, and the Postal Service rapidly swung from moderate\nsurpluses at the end of the PRA period to large losses.31 The Postal Service\xe2\x80\x99s losses\nhave persisted, as mail volume \xe2\x80\x94 particularly for First-Class Mail \xe2\x80\x94 has not recovered.\n\n\nParallel Problems\nAs can be gleaned from this brief history, the Postal Service currently faces a crisis\nsimilar to what the rail industry experienced several decades ago. Table 1 describes\nsome of the parallels between the two crises.\n\nDisruptive Technologies Drove Market Share Loss\n\nBoth rail and the Postal Service suffered a dramatic Both rail and the Postal\nmarket share loss due to a decline in the economy Service suffered a dramatic\nand increased competition from disruptive market share loss due to a\ntechnologies \xe2\x80\x94highway systems for the railroads, decline in the economy and\nelectronic communications for the Postal Service. increased competition from\n disruptive technologies.\nIn the 1930s, most railroads faced financial pressure\nfrom the Great Depression, causing them to go into receivership or be purchased by\nstronger companies, which resulted in an overall decline in the level of demand.\n\n\n\n\n27\n Public Law 109-435, 120 Stat. 3201, 2006.\n28\n Public Law 109-435, 120 Stat. 3200, 2006.\n29\n Public Law 109-435, 120 Stat. 3253, 2006.\n30\n The Postal Civil Service Retirement System Funding Reform Act of 2003, Public Law 108-18 was passed in\nresponse to a finding that the Postal Service was paying too much into its CSRS Retirement Account. Public Law\n108-18 changed the payment stream but dictated that, starting in 2006, the Postal Service must put the \xe2\x80\x9csavings\xe2\x80\x9d into\nan escrow account, and may not spend that money without the approval of Congress. Public Law 108-18 also\ntransferred from the Treasury to the Postal Service the financial responsibility of retirement benefits earned by postal\nemployees when they were members of the military, a $27-billion obligation. The PAEA reversed the decision on the\nmilitary obligation and eliminated the escrow account. See Congressional Research Service, Pension Issues Cloud\nPostal Reform Debate, Order Code RL32346, January 14, 2005.\n31\n U.S. Postal Service, \xe2\x80\x9c2011 Annual Report to Congress and Comprehensive Statement on Postal Operations -\nDelivering the new reality.\xe2\x80\x9d http://about.usps.com/publications/annual-report-comprehensive-statement-\n2011/html/welcome.htm.\n\n\n 6\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n Table 1: Parallel Problems\n Parallel Rail (1930 to Staggers) Postal Service (Now)\n Market Share Both suffered a Great Depression led to volume Recession caused large\n Loss dramatic market share loss; failed to recapture the decline in volume. Unlikely\n loss due to the market share due to increased to recoup all lost volume as\n recession/depression competition from government- some communications have\n and competition from funded highway expansion and permanently migrated to\n disruptive technologies. the airline industry. electronic alternatives.\n Product Mix Both depended on Higher contribution merchandise Electronic diversion drove a\n Changes monopoly profits from volume declined as mandated sharp decline in First-Class\n \xe2\x80\x9chigh-valued\xe2\x80\x9d services prices not competitive. Railroad Mail, the Postal Service\xe2\x80\x99s\n to fund service product mix retrenched around monopoly product, which is\n obligations, such as where railroads retained the biggest contributor to\n service to rural significant cost and/or cover \xe2\x80\x9cfixed\xe2\x80\x9d costs related\n communities, and operational advantages such as to the universal service\n service features such as bulk commodity shipments. organization.\n uniform rates. Passenger volume declined.\n Restrictions on Both industries have ICC set maximum and minimum The Postal Service has\n Pricing been subjected to price rates for rail shipments that were price cap restrictions on 86\n Flexibility regulation that limited unrelated to costs or demand. percent of its revenue. The\n pricing flexibility and Regulation kept similar rates for Postal Service has limited\n ability to raise sufficient routes between two points, even ability to engage in\n revenues. when costs differed. contracts with customers.\n Network Both exhibit \xe2\x80\x9ceconomies As volume fell, unit costs The combination of\n Related of density.\xe2\x80\x9d Increased increased. In response, the declining volume and a\n Economies of (decreased) volume railroads began to consolidate growing network of delivery\n Density relative to network size and drop unprofitable lines; points means that unit costs\n tends to reduce however, the process was often for the remaining mail\n (increase) unit costs. slow and difficult. volume are growing.\n Limited Both face resistance to Abandonment of lines was slow Achieved only limited\n Network rationalizing the and faced political resistance. network rationalization.\n Rationalization network. ICC took over a year to rule on Faces substantial\n abandonments. resistance to closing\n facilities.\n High Labor Both had fairly high Prior to deregulation, labor was Delivery is labor intensive.\n Costs labor costs. 50 percent of its costs. Labor makes up\n approximately 80 percent of\n total costs.\n Universal Both have obligations Common carrier obligations and USO requirements limit\n Service that limit ability to cut regulatory restrictions limited ability to reduce costs\n Obligations costs. efforts to reduce capacity. (deliver to every delivery\n and Common Passenger service obligation point, 6 days a week as\n Carrier became costly as passenger practicable).\n Obligations volume declined.\n Deferred Financial distress Lacked the funds to properly Has an aged fleet of\n Maintenance limited ability to make maintain their tracks \xe2\x80\x93 resulting delivery vehicles, many\n *\n investments, even for in less efficient operations. reaching the end of their\n \xe2\x80\xa0\n required maintenance. expected operational life.\n Little Incentive Regulation limited or Regulation prohibited charging Until 2006, break-even\n for Innovation prevented both lower rates for \xe2\x80\x9cunit trains,\xe2\x80\x9d highly requirement lacked\n industries from moving efficient sets of 50 or more cars incentive to innovate.\n toward innovative to move freight between two Attempts to innovate and\n solutions to gain market points, delaying rail from move beyond hard-copy\n share and lower costs. introducing this innovation. mail are often met with\n resistance.\n *\n By 1976, more than 47,000 miles of tracks had to be operated at reduced speeds because of unsafe\n conditions.\n \xe2\x80\xa0\n U.S. Government Accountability Office, Strategy Needed to Address Aging Delivery Fleet, Report\n No. GAO-11-386, May 2011, http://www.gao.gov/assets/320/318032.pdf.\n\n\n\n\n 7\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nDespite a spike in demand due to World War II mobilization activities and gasoline\nrationing, the railroads failed to recapture market share because of increased\ncompetition from the publicly funded highway system and increased production and use\nof the automobile, the bus, long-distance trucking, and the airplane.\n\nFigure 1 provides a view of railroad freight and passenger traffic over most of the\n20th century. As can be seen, the competition affected passenger rail more significantly\nthan freight rail. While passenger revenues had been one-fourth of rail revenues in\n1900, by 1970, they had fallen to 3 percent.\n\n Figure 1: Index of Railroad Freight and Passenger Traffic (1 = 1910)\n\n\n\n\nSource: Statistical Abstract of the United States, Various Years\n\n\n\nFreight ton-miles rebounded during World War II and did not fall off as sharply as\npassenger traffic, but traffic growth was weak over much of the postwar period prior to\nthe Staggers Act.\n\nFigure 2 shows that railroad freight traffic largely shifted to trucks and, to some extent,\npipelines. The result was rapid growth of trucking while the railroads struggled.\nRailroads had almost 70 percent of market share for freight transportation in 1945, while\ntrucking accounted for only 6 percent of the market. By 1985, the trucking market share\nhad risen to 25 percent while the railroads\xe2\x80\x99 share plummeted to little more than a third of\nthe freight ton-miles. Since 1985, railroads have regained some market share such that\ntoday, railroads account for about 40 percent of freight ton-miles and trucking\n30 percent.\n\n\n\n\n 8\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n Figure 2: Volume Shares of Freight Traffic by Mode\n (percent of total ton-miles)\n\n 100%\n\n Pipe\n 80%\n\n Water\n 60%\n\n Trucks\n 40%\n\n\n 20% Trains\n\n\n 0%\n 1940\n\n 1945\n\n 1950\n\n 1955\n\n 1960\n\n 1965\n\n 1970\n\n 1975\n\n 1980\n\n 1985\n\n 1990\n\n 1995\n\n 2000\n\n 2005\nSource: National Transportation Statistics, Table 1-46b, various years\n\n\nThe parallel for the Postal Service is the great recession and the development of\nelectronic communication technologies. As in the rail industry, the new competition\naffected the various classes of mail differently. Figure 3 shows the volumes of First-\nClass Mail, Standard Mail (formerly called Third-Class Mail), and total mail.\n\n Figure 3: First-Class Mail, Standard Mail, and Total Mail Volume\n (millions)\n\n 250,000\xc2\xa0\n Total\xc2\xa0 mail\xc2\xa0 volume\xc2\xa0\n peaked in\xc2\xa02006\n\n\n\n 200,000\xc2\xa0\n\n\n\n\n 150,000\xc2\xa0\n First\xe2\x80\x90Class\xc2\xa0 Mail\xc2\xa0\n peaked\xc2\xa0in\xc2\xa02000\xe2\x80\x902001\n\n\n\n 100,000\xc2\xa0\n\n\n\n\n 50,000\xc2\xa0\n Standard\xc2\xa0Mail\xc2\xa0 peaked\xc2\xa0 in\xc2\xa02007,\n rapidly\xc2\xa0declined,\xc2\xa0 and\xc2\xa0 then\xc2\xa0\xc2\xa0\n began\xc2\xa0to\xc2\xa0rise\xc2\xa0again\n\n \xe2\x80\x90\n 1970 1975 1980 1985 1989 1994 1999 2004 2009\n First\xe2\x80\x90Class\xc2\xa0Mail Standard\xc2\xa0Mail Total\xc2\xa0Mail\n\nSource: Docket No. R2006-1, USPS-LR-74, for data from 1970 to 2005 and U.S. Postal Service Revenue, Pieces,\n and Volume (RPW) Reports for data from 2006 to 2011\n\n\n\n\n 9\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nBetween 1970 and 1990, total mail volume approximately doubled; however,\ncomposition of mail volumes changed markedly. First-Class Mail pieces grew by about\n3 percent per year and Third-Class Mail (Standard Mail)\nincreased by 6 percent per year. First-Class Mail The decline in First-Class\nvolume peaked in 2000-2001 and total mail volume Mail volume is significant\npeaked in 2006, while Standard Mail volumes did not because First-Class Mail\nstart to drop until the recent economic downturn in has historically provided\n2008. The change in product mix is significant, as First- most of the contribution to\nClass Mail has historically provided most of the cover institutional costs.\ncontribution to cover institutional costs. On average, it takes approximately three pieces\nof Standard Mail to make up for the lost contribution (profit) of one piece of First-Class\nMail. As First-Class Mail volumes have continued to decline, Standard Mail and other\n mail markups have not been sufficient to make up the\n lost contribution.\n While some of the mail\n volume may return as the While some of the mail volume may return as the\n economy recovers, some economy continues to recover, some of the volume \xe2\x80\x94\n volume, especially First- especially First-Class Mail volume \xe2\x80\x94 is most likely lost\n Class Mail volume, is most permanently. Electronic diversion appears to have\n likely lost permanently. reached a tipping point, fueled by a combination of the\n availability of higher quality Internet services and\nincreased willingness of consumers to conduct business by electronic communications.\nIn 2002, 75 percent of bill payments were made using the mail and only 17 percent\nwere made by electronic payment. By 2010, electronic methods accounted for 48\npercent of bill payments, surpassing the mail share, which had fallen to 47 percent.\nSimilarly, an increasing number of bills and statements are being presented over the\nInternet and less through mail, portending continued First-Class Mail volume losses.32\n\nRegulatory Restrictions Limited Revenue Generation\n\nAs competition began to take market share, both the rail industry and the Postal Service\nwere limited in their ability to generate revenue. For the rail industry, the main problem\nwas that railroads were unable to offer competitive rates. The ICC set maximum and\nminimum rates for rail shipments, which were often unrelated to costs or market\nconditions. For instance, rates for bulk commodity movements with low perceived value\nof service were kept low. Shipments of manufactured goods with high perceived value\nof service, which paid higher rates and markups, provided disproportional contributions\nto institutional costs of the rail network. However, this pricing structure caused the\nhigher-valued freight to be diverted to the highways first, rapidly undermining railroads\xe2\x80\x99\nfinances. In addition, regulation generally kept similar rates for shipments between two\n\n\n\n\n32\n U.S. Postal Service, The Household Diary Study: Mail Uses & Attitudes in FY 2010, Contract No. 102592-02-B-\n15902, April 2011, http://about.usps.com/studying-americans-mail-use/household-diary/2010/fullreport-pdf/usps-hds-\nfy10.pdf, p. 2.\n\n\n 10\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\npoints, even if railroads incurred much higher or lower costs for some shipments.33 In\naddition, rate changes often entailed a long and burdensome process.\n\nThe Postal Service also faces restrictions in its price-setting process. From 1970 to\n2006, the Postal Service was under a break-even requirement, which required it to set\nrates so that revenues covered the cost of operations. While this regulation ensured that\nthe Postal Service would earn significant revenues to cover its costs, it also had\ndrawbacks. Rate cases were long,\xc2\xa0incentives to control costs were weak,\xc2\xa0and mailers\ncomplained that they were often victims of unpredictable rate increases.\n\nIn response to these concerns, the PAEA abolished the PRA\xe2\x80\x99s cost-of-service\nratemaking system, and instead instituted CPI-based price caps for market-dominant\nproducts while largely reducing the regulation of competitive product pricing. Postal\nService rate increases could exceed the CPI caps under exigent circumstances with\nadvance approval by the Postal Regulatory Commission, though to date the Postal\nService has not yet successfully pursued an exigent rate increase.34\n\nPrice caps linked to the CPI may have been regarded as\n CPI deflation following\nallowing the Postal Service sufficient rate flexibility based the 2007-2008 financial\non past experience, given that prices for First-Class Mail crisis left the Postal\nhave generally followed inflation. However, CPI deflation Service unable to raise\nfollowing the 2007-2008 financial crisis left the Postal market-dominant rates\nService unable to raise market-dominant rates under the under the price cap\nprice caps. While the intent of the law was to give the\nPostal Service pricing flexibility, the combination of the class-based price cap and\nregulations on workshare discounts35 hinders the Postal Service\xe2\x80\x99s flexibility to make\nsignificant changes to its rate structure. This not only places some limitation on the\nPostal Service\xe2\x80\x99s ability to offer innovative pricing, such as prices based on the value of\nthe product, it also makes it difficult for the Postal Service to rebalance rates when\nneeded, such as raising the price of products that are not currently covering their costs.\nHowever, some have argued that the Postal Service does not effectively use the pricing\nflexibility it has to rebalance rates within the classes of mail to which the price caps\napply.\n\nThe Postal Service is also limited in its ability to generate revenue from new products\nbecause it can only provide postal products, with the exception of a few grandfathered\nproducts that were offered prior to 2006.\n\n\n33\n For instance, multiple-carload shipments will tend to have lower marginal cost per ton-mile than single-carload\nshipments, other things equal.\n34\n The Postal Service requested an exigent rate increase in Postal Regulatory Commission Docket No. R2010-4. The\nPostal Regulatory Commission found that the Postal Service had shown an exigency, but denied any rate increase\non the grounds that the Postal Service had not shown a sufficient causal nexus between the request and the volume\nlosses due to the recession.\n35\n The PAEA requires that workshare discounts not exceed 100 percent of the cost savings, but allows for several\nexceptions. See Public Law 109-435. December 2006. 120 Stat. 3204. The Postal Regulatory Commission also\nbelieves that when possible, workshare discounts should not be less than 100 percent of the cost savings. See Postal\nRegulatory Commission, Annual Compliance Determination, United States Postal Service Performance FY 2007,\nMarch 27, 2008, pp. 66 and 97, http://www.prc.gov/Docs/59/59460/ACR2007Report.pdf.\n\n\n 11\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nRegulatory Controls Limited Ability to Adapt to Changing Market Conditions\n\nIn 1950, it was obvious that the railroad industry was in a challenging financial situation\nand that the future looked worse. The industry responded through three related actions.\nFirst, the industry consolidated as firms merged, were reclassified, or exited the industry\nbecause of bankruptcy. Second, through consolidation and route abandonment, the\nmileage of the railroad network shrank. Third, the industry aggressively reduced\nemployment. However, it took years for rail to be successful in each of these actions\ndue to regulatory constraints.\n\nThe obligation to provide passenger service was a key factor in the Class I36railroads\xe2\x80\x99\ndeteriorating financial condition through the 1960s. Despite falling demand and\nincreasing operating deficits, railroads found it very difficult to get permission to\nabandon unprofitable passenger services because the ICC only had the authority to\nallow abandonment of the line, not services on the line.37\n\nCommon carrier obligations and regulatory restrictions on abandonment of rail lines\nlimited the industry\xe2\x80\x99s efforts to reduce capacity in line with demand. Abandoning\nunprofitable lines not only was met with political resistance, but was also a lengthy\nprocess. In the 1960s, the ICC took 410 days on average to rule on abandonment\napplications.\n\n The Transportation Act of 1958 somewhat reduced the\n Overall, it took the barriers to route abandonment, but network reduction via\n railroad industry more\n abandonment was modest until the mid-1970s. In 1976,\n than 50 years to\n \xe2\x80\x9crightsize.\xe2\x80\x9d\n the 4R Act greatly reduced the regulatory barriers to route\n abandonment. Consequently, from 1975 to 1990, there\nwas a rapid reduction of the railroad network as over 4,600 miles of road per year were\nshed.38 In the 2000s, the extent of the rail network has been relatively stable; capacity\nneeds on high-traffic routes have led to modest increases in track mileage.39\n\nOverall, it took the railroad industry more than 50 years,\nuntil about 2000, to \xe2\x80\x9crightsize\xe2\x80\x9d itself in response to The Postal Service faces\nchanging market conditions.40 a variety of explicit and\n implicit limitations on\nThe Postal Service also faces a variety of explicit and reducing portions of its\n network.\nimplicit limitations on reducing portions of its network,41\n\n\n36\n Class I railroads are large railroads as defined by operating revenue.\n37\n See Appendix B for a more detailed discussion.\n38\n Association of American Railroads, Railroad Ten-Year Trends, various years.\n39\n Capacity has increased through other means than additional mileage, such as double-stacking. However, there is\nsome evidence that rail is now under-capacity. According to The Economist, due to the success of the rail industry,\ncapacity shortages have become a problem recently and will continue to get worse. The introduction of high-speed\npassenger rail could cause even more problematic capacity issues. See The Economist, \xe2\x80\x9cHigh-speed Railroading,\xe2\x80\x9d\nJuly 22, 2010, http://www.economist.com/node/16636101.\n40\n This sentence is not meant to imply that the railroad industry achieved the optimal size, as it will need to continue\nto adapt to changing market conditions. The sentence is meant to illustrate that rightsizing is a long and arduous\nprocess.\n\n\n 12\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nwhich are often justified by its obligation to provide universal service. The Postal Service\nmay not close Post Offices solely for economic reasons, and is required to maintain 6-\nday residential delivery.42 It also faces resistance to efforts to consolidate its mail\nprocessing network.\n\nHistorically, the Postal Service has engaged in some consolidation of mail processing\nand distribution operations prior to its recent broader effort to consolidate the mail\nprocessing network.43 In particular, the Postal Service\xe2\x80\x99s inventory of automated letter\nand flat processing equipment was scaled for considerably higher volumes than\ncurrently prevail. To some extent, the Postal Service has been able to maintain density\nin some processing operations by using excess capacity to automate the processing of\nsome mail that would otherwise require manual handling. For instance, the number of\nletters sorted to delivery point sequence using automated equipment in mail processing\nplants has significantly increased from 2005 to 2010.44 However, reduced capacity\nutilization leads to upward pressure on product costs as relatively fixed nonlabor costs\nassociated with plants and equipment must be spread over smaller mail volumes.\n\n The Postal Service has Overall, the Postal Service has experienced\n experienced relatively little relatively little network consolidation and indeed\n network consolidation and has has seen considerable growth in its delivery\n seen considerable growth in its network. Consequently, the gains from density\n delivery network. economies in postal services have come primarily\n from increases in mail volumes until recent years.\nThis is in contrast to the railroad experience where density economies (and ultimately\ndensity-driven productivity gains) resulted from both large increases in traffic volume\nand large decreases in network size.\n\nInability to Adapt to Market Conditions Led to Huge Financial Losses\n\nThe financial impact of trucking competition on the railroads was severe. Rail volume\ndeclines directly affected revenues, and railroads could not quickly make adjustments to\ncontrol costs. Because of value-of-service pricing, high-markup goods were particularly\nvulnerable to diversion to highways, further undermining railroads\xe2\x80\x99 revenue sufficiency.\n\nAs shown in Figure 4, between 1947 and 1960, real operating revenue decreased as\nthe result of stagnant rail volumes, and railroad expenses grew faster than revenues.\nFrom 1960 to 1975, after volumes began increasing, the cost-revenue differential\nbecame even greater. Not until after 1975 did the railroads turn the corner and the\n\n41\n For example, a discussion of the hurdles the Postal Service faces when it attempts to cut retail costs is in U.S.\nPostal Service Office of Inspector General, Barriers to Retail Optimization, Report No. RARC-WP-11-005, June 9,\n2011, http://www.uspsoig.gov/foia_files/RARC-WP-11-005.pdf.\n42\n This requirement appears as a rider on annual appropriations bills.\n43\n As of the writing of this paper, the broader mail processing network rationalization and associated service changes\nare the subject of Postal Regulatory Commission Docket No. N2012-1.\n44\n The percent of letters that were in delivery point sequence increased from 77 percent in 2005 to 99 percent in\n2010. See 2005 and 2010 Comprehensive Statement of Postal Operations at, respectively,\nhttp://about.usps.com/strategic-planning/cs05/welcome.htm and http://about.usps.com/strategic-\nplanning/cs10/CSPO__12_2010.pdf.\n\n\n 13\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nfinancial situation began to stabilize. The recovery of the industry occurred largely since\n1985, as revenue growth outpaced expense growth by a full percentage point.\n\n Figure 4: Average Annual Growth in Inflation and Railroad Operating Revenue and Expense\n\n\n\n\nSource: Association of American Railroads, Railroad Facts, 2009 Edition and Railroad Ten-Year Trends 2000-2009\n\n\nFigure 5 compares growth rates in operating revenues to operating expenses for 5-year\nperiods for the Postal Service.45 This figure shows that the greatest financial\nimprovement occurred in the years immediately following the PRA, as break-even rates\nfrom the PRA ratemaking system were implemented and the Postal Service enjoyed an\ninitial productivity boom from restructuring. Under cost-of-service ratemaking, operating\nrevenues and expenses broadly tracked each other over most of the PRA period;\ngrowth rates of both declined in the lower-inflation economy of the later 1980s and\n1990s. The 2005-2010 period shows that the price cap system decoupled revenues\nfrom expenses, and operating revenues decreased on average by 0.9 percent per year,\non sharply lower demand, while expenses increased by 2 percent per year.46 From the\nmid-1980s until 2005, the Postal Service had operating expenses largely in line with\noperating revenues. However, the Postal Service has been experiencing significant\nlosses in recent years as expenses and revenues became unbalanced.47\n\n\n\n\n45\n The data presented in Figure 5 do not include any public service or revenue forgone appropriations. Since 1983,\nthe Postal Service has not received any public service appropriation.\n46\n A substantial amount of the growth in expenses 2005-2010 was from the increase in retiree health benefit\nobligations. The net result of Public Law 109-435 was to add $6.8 billion dollars to this obligation in 2007. The net\nresult of Public Law 111-68 was a reduction of the obligation by $4.0 billion.\n47\n While the retiree health benefit obligation is a significant part of the net loss, the Postal Service financial condition\ndeteriorated otherwise.\n\n\n 14\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n Figure 5: Average Annual Growth Rates in Inflation and\n Postal Operating Revenues and Operating Expenses\n 14.0%\n\n\n 12.0%\n\n\n 10.0%\n\n\n 8.0%\n\n\n 6.0%\n\n\n 4.0%\n\n\n 2.0%\n\n\n 0.0%\n\n 1970-1975 1975-1980 1980-1985 1985-1990 1990-1995 1995-2000 2000-2005 2005-2010\n -2.0%\n\n Operating Revenues Operating Expenses Inflation\n\n\nSource: U.S. Postal Service Annual Reports\n\n\n\nParallel Solutions\nRegulatory reform of the railroad industry was not a quick process; instead, it took over\n50 years. The railroad industry faced an extended period of crisis, and a number of\ninterim reforms, before the more comprehensive reforms in the Staggers Act were\npassed. Ultimately, the Staggers Act recognized the\nindustry as being in crisis and focused on restoring The Staggers Act\nrailroads\xe2\x80\x99 financial health, even through means that may recognized the industry as\n being in crisis, and focused\nhave been unpopular and challenging, such as relieving\n on restoring railroads\xe2\x80\x99\nthe railroads of their obligation to provide passenger financial health.\nservice.\n\nThe post-Staggers Act freight rail industry is often considered a model of success for\ntransportation deregulation because both railroads and shippers were able to benefit\nfrom rapid productivity gains. These gains allowed freight railroads to greatly improve\ntheir financial positions while shippers could enjoy lower real (if not nominal) rail rates at\nthe same time. Railroads also benefited from market changes, such as the increased\ndemand for low-sulfur western coal, which were not anticipated in the regulatory reform.\n\nBut the freight railroad story is not necessarily the perfect blueprint for the Postal\nService. Table 2 lists some of the key elements of rail reform success and how those\nsame elements may apply to the Postal Service.\n\n\n\n\n 15\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n Table 2: Parallel Solutions\n Rail \xe2\x80\x93 After Staggers Potential for the Postal Service\n Increased Railroads are allowed to base their rates While the Postal Service does have the\n Pricing on market demand when sufficient ability to enter into private contracts, it\n Flexibility competition exists. Railroads can enter could benefit from more pricing flexibility \xe2\x80\x93\n into confidential contracts. specifically innovative pricing that better\n captures the value of the mail and the\n network.\n Relaxed The Staggers Act streamlined procedures There is significant and effective resistance\n Restrictions for abandoning or selling unneeded rail to network rationalization efforts.\n on Network lines. The number of miles of road served\n Rationalization by the Class I railroads was cut by more\n than half.\n Industry Rail started with multiple railroads with Postal Service is a monopoly. If anything, it\n Consolidation duplicate service and was able to has created more mail service providers as\n consolidate. Class I railroads decreased growth of workshare volumes has created\n from 126 in 1950 to 7 in 2000. an industry of upstream competition to the\n Postal Service.\n Increased An increase in traffic density was a key Due to the growing delivery network and\n Traffic Density factor in recovery. It was facilitated by unlikely comeback of First-Class Mail, it is\n Facilitated stronger, more efficient locomotives unlikely the Postal Service will be able to\n Productivity pulling heavier cars and longer trains see large gains in density. Network\n Improvements greater distances. Increase in demand for rationalization will improve density and\n low-sulfur coal and long-haul intermodal productivity prior to delivery.\n shipments also resulted in an increase in\n density.\n Reduction in It took until 1980 to see significant labor There is potential for a reduction in labor\n Labor Costs cost reductions. Even though employment costs; however, the reduction would be\n decreased by 87 percent as a result of largely dependent on the Postal Service\xe2\x80\x99s\n industry consolidation, labor-saving ability to rationalize its network and or\n technological change, work rule changes, change the delivery mode (i.e., move from\n and operating efficiencies (including house to curbside delivery). More flexibility\n eliminating the caboose and the in work rules could also lead to a reduction\n introduction of unit trains), wage and in labor costs.\n benefit growth outpaced the rate of\n employment reduction until 1980.\n Relaxation on The Class I railroads were relieved of their It is unlikely that the Postal Service will be\n Universal passenger service obligations when relieved of its USO, but it might benefit\n Service Amtrak began operations in May 1971. from a reevaluation of some of the\n Obligations requirements of USO.\n (USO) and\n Common\n Carrier\n Obligations\n Increased Benefited from the increased demand for Unlikely long-term increase in demand for\n Demand low-sulfur coal. Lower prices from hard-copy high-contribution mail services.\n increase in productivity allowed additional Some of the loss of First-Class Mail is most\n gains in market share. likely permanent and it will be difficult for\n the Postal Service to make up this lost\n revenue through other hard-copy mail.\n\n\n\n\n 16\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nThe recovery of the freight rail industry has been largely a productivity story, with\nrailroads experiencing rates of productivity growth much higher than the productivity\ngrowth rate in the economy overall. Since 1950, Class I railroads\xe2\x80\x99 total factor\nproductivity, a comprehensive measure of productivity that compares an index of output\n production to an index of all input usage, has grown by\n The recovery of the freight\n rail industry has been\n an average of 2.5 percent a year. The strongest\n largely a productivity story, productivity growth for the railroads came after the\n with customers on average regulatory reform of the 4R Act of 1976 and the\n sharing the benefit through Staggers Rail Act of 1980.48 Railroad productivity\n lower prices. growth has come from technological change across all\n aspects of production (engines, cars, rails, track\nmaintenance, communications, etc.); density economies resulting from volume growth,\nconsolidation, and network rationalization; and managerial efficiencies resulting from\noperational innovation, fewer work rules, lessening of other regulatory and political\nconstraints, and market-oriented management.49\n\nA significant increase in traffic density was a strong component of the increase in\nproductivity. The increase in density was facilitated by stronger, more efficient\nlocomotives pulling heavier cars and longer trains greater distances. Compared to 1950,\nthe typical train goes twice as far, is 40 percent longer, and carries 2.5 times the freight\nweight.50 The shifting mix of traffic toward low-sulfur coal and long-haul intermodal\nshipments51 and the introduction of contract terms that promote efficient railroad\noperations are also a large part of the density and productivity story.\n\nAs can be seen in Table 2, other factors also played a role in the recovery of the rail\nindustry, including increased pricing flexibility, the elimination of the obligation to provide\npassenger rail service, and the ability to reduce labor costs. It is important to note that\nall of the elements that led to the successful recovery All of the elements that\nof the freight rail industry are interrelated; none would led to the successful\nhave been successful in isolation. For example, labor recovery of the freight\ncost reductions would have not been as significant rail industry are inter-\nwithout network rationalization and industry related; none could have\nconsolidation. And while pricing flexibility was been successful in\nimportant, it would not have been as successful without isolation.\nproductivity gains that allowed for lower prices and\n\n\n\n\n48\n Philip E. Schoech and Joseph A. Swanson, \xe2\x80\x9cPatterns of Productivity Growth for U.S. Class I Railroads: An\nExamination of the Pre- and Post-Deregulation Determinants,\xe2\x80\x9d Christensen Associates Working Paper, November\n2010, http://www.lrca.com/topics/Schoech_Swanson_Patterns_of_Productivity_Growth_for_US_Class_I_Railroads.pdf.\n49\n B. Kelly Eakin, A. Thomas Bozzo, Mark E. Meitzen, and Philip E. Schoech, \xe2\x80\x9cRailroad Performance Under the\nStaggers Act,\xe2\x80\x9d Regulation, Winter 2010-2011, pp 23-31.\n50\n Association of American Railroads, Railroad Facts, various years.\n51\n Intermodal rail is a subset of freight rail service involving the coordinated use of two or more different modes of\ntransportation. Intermodal rail traffic quadrupled between 1980 and 2007. See Association of American Railroads,\nOverview of America\xe2\x80\x99s Freight Railroads, May 2008,\nhttp://www.aar.org/PubCommon/Documents/AboutTheIndustry/Overview.pdf.\n\n\n 17\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nhelped to increase market share.52\n\nWhile there were many interrelated elements, it was the strength of productivity gains\nthat allowed the freight rail industry to recover successfully with many winners and\nfewer losers.53 The vast majority of productivity gains were passed to shippers through\nlower rates. While regulatory reform may have left some individual shippers worse off,\nshippers as a group were big winners. Likewise, the freight railroad industry was a big\nwinner as it recovered to a healthy financial position. Labor has borne the brunt of\nrailroad restructuring through large decreases in employment levels. However,\ncompensation increases offset the employment decreases. So those workers who kept\ntheir employment and the next generation of workers hired have benefited through more\nskilled, higher-paying jobs.\n\nSimilar to the railroad industry, the Postal Service\xe2\x80\x99s\nrecovery from its financial crisis will need to come from The potential for postal\n productivity gains seems\nthree interrelated sources: productivity improvements,\n limited under the Postal\nrevenue generation, and cost containment. However, Service\xe2\x80\x99s present service\nunlike the railroad industry, the potential for postal obligations and current\nproductivity gains seems limited under the Postal network structure.\nService\xe2\x80\x99s present service obligations and current network\nstructure. Postal Service productivity growth historically has been slightly less than that\nachieved in the private sector. This does not mean that Postal Service performance has\nbeen poor, as technologies and the ability to innovate vary across industries. The Postal\nService may face some inherent limits in achieving high productivity growth.54 A steady\nincrease in its network of delivery points coupled with the universal service obligation\n (USO) limit density economies. In addition, delivery\n Unlike the rail industry, operations are inherently labor intensive and therefore\n Postal Service recovery have little potential for labor-saving technological\n will be to a greater extent changes. Therefore, while productivity will play an\n a story of shared pain, important role, the Postal Service\xe2\x80\x99s recovery will most\n rather than shared gain. likely have to result from revenue generation and cost\n containment.55 As large productivity gains are unlikely,\nPostal Service recovery will be, to a greater extent, a story of shared pain, rather than\nshared gain.\n\nRevenue generation can come from two sources, current products and services and\nnew products and services. Freight rail benefited from both. For existing products, rail\n\n52\n While prices overall declined, this does not mean that there were not some shippers who experienced price\nincreases. In addition, it should be noted that prices for freight rail have been increasing recently; however, after\nadjusting for inflation, prices on average are still lower than they were before 1980.\n53\n In contrast, passenger rail service continues to face losses.\n54\n Opportunities for optimization initiatives have been the subject of several U.S. Postal Service Office of Inspector\nGeneral reports. See, for example, U.S. Postal Service Office of the Inspector General, A Strategy for a Future Mail\nProcessing & Transportation Network, Report No. RARC-WP-11-006, July 6, 2011,\nhttp://www.uspsoig.gov/foia_files/RARC-WP-11-006.pdf; Retail and Delivery: Decoupling Could Improve Service and\nLower Costs, Report No. RARC-WP-11-009, September 22, 2011, http://www.uspsoig.gov/foia_files/RARC-WP-11-\n009.pdf; and Analyzing the Postal Service\xe2\x80\x99s Retail Network Using an Objective Modeling Approach, Report No.\nRARC-WP-10-004, June 14, 2010, http://www.uspsoig.gov/foia_files/RARC-WP-10-004.pdf.\n55\n For the purpose of this paper, cost containment would include actions such as rightsizing/optimizing its networks.\n\n\n 18\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nwas able to gain market share through increased pricing flexibility and the ability to offer\nlower rates due to productivity gains. As mentioned earlier, the rail industry also\nbenefited from the increased demand for low-sulfur coal, something that was\nunforeseen when the Staggers Act was passed.\n\nIt is unlikely that the Postal Service will benefit from something akin to the increased\ndemand for low-sulfur coal. It is difficult to imagine a market disruption that would lead\nto a dramatic long-term increase in demand for hard-copy mail, particularly the First-\nClass Mail that traditionally bore the bulk of the Postal Service\xe2\x80\x99s institutional costs.\nWhile it is possible that in the future, the Postal Service will offer new ancillary and\nnonpostal products with considerable revenues, the Postal Service is unlikely to benefit\nfrom significant new sources of revenue for several years.\n\nAs for existing products, the Postal Service may be able Revenue gains will most\nto generate revenue through increased pricing flexibility likely be dependent on\nand pricing innovations.56 However, unlike the rail moderate, predictable rate\nindustry, revenue gains will most likely be highly increases.\ndependent on price increases, because the Postal\nService appears to have fewer opportunities for productivity gains relative to rail.57\nModerate, predictable rate increases will most likely be more palatable than a\npostponed larger rate increase, which could cause rate shock and could ultimately drive\nmailers out of the postal system.\n\n Even with moderate price increases, there are no\n The first and foremost\n element of postal recovery\n quick fixes for revenue gains for the Postal Service.\n needs to be cost Therefore, the first and foremost element of postal\n containment \xe2\x80\x94 fixing the recovery needs to be cost containment, including fixing\n retiree prefunding issues the retiree prefunding issues. Similar to the rail\n and rightsizing the industry, cost containment for the Postal Service is\n networks. contingent on its ability to rightsize. With the railroads,\n rightsizing meant dramatic reductions in labor costs,\nconsolidation of the industry by mergers, and rationalization of the network by\nabandoning and spinning off unprofitable routes to regional and short lines. The\nparallels for the Postal Service are reducing employment, consolidating processing\nfacilities, and potentially reducing the frequency and speed of service. Cost reductions\nwill fall mostly on labor because the Postal Service is very labor intensive. As with the\nrailroads, postal restructuring will likely lead to fewer workers, but may result in more\nskilled, higher-paying jobs.\n\nPrioritizing rightsizing does not mean that the Postal Service should focus solely on\ncutting costs. Instead, rightsizing should be viewed as the first step to financial stability.\n\n56\n Increased use of contract pricing may help both mailers and the Postal Service, particularly where mailers are\nwilling or able to prepare mailings with lower cost characteristics than mail prepared according to existing standards\nfor tariff rates.\n57\n Currently the Postal Service has some of the lowest postage rates in the world. See U.S. Postal Service Office of\nthe Inspector General, Postal Service Revenue: Structure Facts and Possibilities, Report No. RARC-WP-012-002,\nOctober 6, 2011, http://www.uspsoig.gov/foia_files/RARC-WP-12-002.pdf.\n\n\n 19\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nRightsizing does not necessarily mean cutting service; it means realigning the network\nso that it can match service to current market demands.58 If the Postal Service can find\nthe appropriate balance of reducing its network while providing adequate service to its\ncustomers, it may be able to pass the cost savings on to its customers through smaller\nprice increases. This will allow the Postal Service to possibly regain, or at least\nmaintain, some of its market share.\n\nWhat is imperative is the speed with which cost The quicker cost containment\ncontainment and optimization occurs. While the and optimization are\nPostal Service cost containment and optimization implemented, the quicker\nefforts are just beginning, the quicker they can be stakeholders can begin to share\nimplemented, the sooner the Postal Service will be the benefits of a stronger, more\nable to begin its financial recovery and the sooner viable Postal Service.\nthe resulting cost savings can be used to lessen\nthe negative impacts on stakeholders. Stakeholders could then begin to share the\nbenefits of a stronger, more viable Postal Service.\n\n\nConclusion\nThe Postal Service faces the most significant financial and organizational challenges\nsince the PRA. These challenges fundamentally result from structural changes in\nmarkets for communication and transactions. Permanent market share losses to\nelectronic and other means of communication have severely reduced mail volumes and\nthe corresponding revenues, but costs have not decreased commensurately. To bring\nthe situation into balance, the recovery from this crisis will come from three basic\nsources: productivity improvement, revenue management, and cost management.\n\nWhile there are parallels and lessons to be learned from comparing the rail and postal\nindustries, the railroad experience does not necessarily provide the blueprint for the\nPostal Service recovery. Productivity improvement has been the central story behind\nthe railroad recovery. In postal restructuring, productivity will play an important but\nlesser role. It is not likely that postal productivity gains alone will be sufficient to lead to\na full recovery. Consequently, revenue generation and cost containment will play a\nlarger role in balancing the profitability equation. Therefore, postal recovery will, to a\ngreater extent, involve shared pain rather than shared gain.\n\nWhat is applicable from the railroad experience is the importance of rightsizing. With the\nrailroads, that meant dramatic reductions in employment, consolidation of the industry\nby mergers, and rationalization of the network by abandoning and spinning off\nunprofitable routes to the regional and short lines. The parallels for the Postal Service\nare reducing employment, consolidation of processing facilities, and reducing the\nfrequency and speed of service.\n\n\n\n58\n Rightsizing is a dynamic process. As in the rail industry, the Postal Service will need to continue to adapt as market\nconditions change over time.\n\n\n 20\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\nThe optimal configuration of postal employees, facilities, and service attributes remains\nto be determined. Pursuit of the quantitative answers is imperative, and the direction of\nneeded postal changes is clear. It is important to recognize that making changes sooner\nrather than later will likely reduce the total burden that is to be shared.\n\n\n\n\n 21\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\n\n Appendices\n\n\n\n\n 22\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\n\nAppendix A History of the Railroad Industry\n\nGeneral and Regulatory History Prior to the Staggers Act\n\nSince their genesis in the early 1800s, railroads have been central to America\xe2\x80\x99s social\nand economic development. The development of the railroads marked the beginnings of\nthe modern transportation network in the United States. America\xe2\x80\x99s first railroad, the 13-\nmile Baltimore and Ohio Railroad, was chartered in 1827 and completed in early 1830.59\nBy 1850, more than 9,000 miles of railroad were in operation, representing a fairly\ncomplete railroad network.60 Development of the railroads spurred economic growth and\nterritorial expansion by providing access to previously inaccessible areas and increasing\nthe mineral, timber, and agricultural products brought to market. Furthermore, the\nconstruction of the railroads increased the demand for coal, steel, and iron production.\nRailroads also played a major role in the Civil War.61\n\nBy the 1860s the railroads possessed and exercised monopoly power such that \xe2\x80\x9cthe\nfirst serious manifestations of the monopoly problem thus made their appearance on the\nAmerican scene.\xe2\x80\x9d62 Captive shippers saw higher rates while the railroads provided\ncheaper rates to shippers with transportation alternatives, often by rebating a portion of\nthe charge. This price discrimination was viewed as unfairly favoring large business to\nthe disadvantage of small shippers. Also, railroads charged different rates between\ncertain points regardless of distance. In some cases, higher rates were charged for\nshorter distances along the same route.63\n\nMany shippers, particularly farmers, and the general public resented the railroads\xe2\x80\x99\npricing practices. Agrarian pressures, known as the Granger Movement, resulted in\nMidwestern states passing legislation to regulate the railroads by establishing maximum\nrates and outlawing some forms of price discrimination. Between 1871 and 1874,\nIllinois, Iowa, Wisconsin, and Minnesota enacted legislation regulating the railroads.\nBetween 1875 and 1878, the \xe2\x80\x9cGranger laws\xe2\x80\x9d were repealed or weakened, but these\nstates kept some regulatory legislation and by 1890 34 states had passed some railroad\nregulation laws.64\n\nInitially, the federal government\xe2\x80\x99s role in the regulation of railroads was limited primarily\nto granting land for rights of way. In 1886, an impetus for federal regulation ensued from\na U.S. Supreme Court ruling in Wabash v. Illinois according to which the authority to\n\n59\n Ross M. Robertson, History of the American Economy, p. 148.\n60\n Association of American Railroads, \xe2\x80\x9cA Short History of U.S. Freight Railroads,\xe2\x80\x9d October 2011,\nhttp://www.aar.org/~/media/aar/Background-Papers/A-Short-History-of-US-Freight.ashx.\n61\n The North\xe2\x80\x99s victory was due in large part to its well-organized rail operations and the fact that most of the country\xe2\x80\x99s\nlocomotive and railcar-building plants were in the North. See Association of American Railroads, \xe2\x80\x9cA Short History of\nU.S. Freight Railroads.\xe2\x80\x9d\n62\n Ross M. Robertson, History of the American Economy, p. 281.\n63\n See, e.g., John F. Stover, American Railroads, pp. 116-117, and Ross M. Robertson, History of the American\nEconomy, p. 282.\n64\n Ross M. Robertson, History of the American Economy, pp. 284-285.\n\n\n 23\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\nregulate railroads engaged in interstate commerce rested with the federal government\nrather than the states.65 A legislative compromise between the Senate and the House\nled to the passage of the Interstate Commerce Act of 1887, and consequently, railroads\nbecame the first U.S. major industry to be subject to economic regulation.66 This Act\ncreated the Interstate Commerce Commission (ICC) and imposed various types of\nregulations on railroads including maximum and minimum rail rates, and prohibited\npooling, rebates, and long/short haul rate differentials.67\n\nThe ICC wanted to establish control over the railroads, but for many years did not\npossess the necessary power to do so. In the first decades of its existence, several\nSupreme Court decisions were used by the railroads to prevent the ICC\'s efforts at\nregulation and rate reductions from being implemented successfully. As a result, major\nlegislative efforts were made to increase the ICC\xe2\x80\x99s authority accordingly. The Elkins Act\nof 1903, signed by President Theodore Roosevelt, was the first of such legislations to\npass, which increased the restrictions of rebates railroads received.68 This was followed\nsoon by the Hepburn Act in 1906, which increased the powers of the ICC and allowed it\nto set freight rates.69 Finally, in 1910, the Mann-Elkins Act was passed which further\nexpanded the powers granted to the ICC under the Hepburn Act, and demanded that\nrailroads\xe2\x80\x99 reasons for any rise in freight rates must be warranted.70 Concerns about\nfinancial weakness in the railroad industry also led to the passage of the Transportation\nAct of 1920, which granted powers to the ICC to control entry, regulate construction and\nabandonment, and prescribe minimum and maximum rates.71\n\nIn the 1930s, most railroads faced financial pressures due to two reasons. The Great\nDepression wreaked havoc on the railroads, causing many of them to fall into\nreceivership or be purchased by stronger companies. Thus, there was a decrease in the\noverall level of demand for transportation services provided by railroads. Additionally,\ncompetition from new modes of transportation \xe2\x80\x94 automobiles, buses, trucks and\nairplanes \xe2\x80\x94 prevented the railroads from returning to prosperity. The railroad industry\'s\n"Golden Age" was over.72\n\nWorld War II-related rail demand traffic gave the railroads a temporary boost, but it was\ninsufficient to resolve the railroads\xe2\x80\x99 financial difficulties. More bankruptcies, service\nabandonments, and deferred maintenance plagued the railroads throughout the 1950s.\nRailroad regulation was considered to be a major factor hindering the industry\xe2\x80\x99s ability\nto adapt to changing market conditions. Several of the existing regulations that came\nunder question were:\n\n\n65\n Wabash, St. L. & P. R. Co. v. Illinois, 118 U. S. 557, 7 Sup. Ct. 4, 30 L. ed. 244 (1886).\n66\n Clyde Aitchison, \xe2\x80\x9cThe Evolution of the Interstate Commerce Act: 1887-1937,\xe2\x80\x9d pp. 289, 300 (1936-1937), citing\nWabash, St. L. & P. R. Co. v. Illinois, 118 U. S. 557, 7 Sup. Ct. 4, 30 L. ed. 244 (1886).\n67\n Interstate Commerce Act of 1887, ch. 104, 24 Stat. 379, approved 1887-02-04.\n68\n The Elkins Act, \xc2\xa7 708, 32 Stat. 847 (1903).\n69\n The Hepburn Act, 34 Stat. 584 (1906).\n70\n The Mann-Elkins Act, \xc2\xa7 8, 36 Stat. 539, 547 (1910).\n71\n Transportation Act of 1920, Public Law. 66-152, 41 Stat. 456, 1902. (Also known as the Esch\xe2\x80\x93Cummins Act,)\n72\n Association of American Railroads, \xe2\x80\x9cA Short History of U.S. Freight Railroads.\xe2\x80\x9d\n\n\n 24\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\n (1) The ICC set maximum and minimum rates for rail shipments which were often\n unrelated to costs or demand. For instance, rates for bulk commodities were\n kept low at the expense of higher rates for many kinds of manufactured goods\n that were traded in smaller quantities. As a result, shippers began to divert\n this higher-rated freight to the highways instead.\n\n (2) The concept of \xe2\x80\x9copen routing\xe2\x80\x9d was another issue. Regulation generally kept\n similar rates for routes between two points, even if railroads incurred much\n higher or lower costs to use some routes than others.\n\n (3) Because regulation made it difficult for railroads to adjust individual rates,\n they typically increased all rates as their costs rose. Since rail rates took into\n account lagged cost patterns, subsequent changes in technology and traffic\n flow that may have significantly altered those cost patterns were often\n ignored.\n\n (4) Regulation also delayed the widespread use of \xe2\x80\x9cunit trains,\xe2\x80\x9d which made use\n of highly efficient sets of 50 or more cars to move freight between two points\n (for example, a coal mine and a power plant), because it prevented railroads\n from offering lower rates to shippers who used these trains.73\n\nTo deal with these issues, President Eisenhower appointed the Weeks Committee,\nwhose report in 1955 appeared to set the stage for deregulation. In its preamble, the\nreport promoted concepts such as a \xe2\x80\x9c\xe2\x80\xa6free enterprise system of dynamic\ncompetition\xe2\x80\xa6\xe2\x80\x9d to \xe2\x80\x9cencourage and promote full competition between modes of\ntransportation\xe2\x80\xa6\xe2\x80\x9d and to \xe2\x80\x9creduce economic regulation of the transportation system to the\nminimum consistent with public interest\xe2\x80\xa6\xe2\x80\x9d74 Three years after the release of the Weeks\nCommittee report, the Transportation Act of 1958 was passed. This act incorporated\nonly a few of the recommendations of the Weeks Committee. Although there was a\nseries of court cases and ICC decisions through the mid-1960s, the regulatory practices\nin the transportation industry had not been substantially changed by either the report of\nthe Weeks Committee or the Transportation Act of 1958.75\n\nThe U.S. railroad industry reached its low point in the early 1970s, when it had lost so\nmuch market share to trucking that many companies either were purchased by stronger\nones or simply went bankrupt. The government reacted with the Regional Rail\nReorganization Act (the 3R Act). The purpose of the 3R Act was to reorganize the\nnumerous bankrupt railroads in the Northeast and Midwest regions into an economically\nviable system that could provide adequate and efficient rail service. This led to the\n\n\n\n73\n Ibid.\n74\n Presidential Advisory Committee on Transport Policy and Organization, Revision of Federal Transportation Policy,\np. 8.\n75\n A Study of Competition in the U.S. Freight Railroad Industry and Analysis of Proposals that Might Enhance\nCompetition, Revised Final Report, prepared by Laurits R. Christensen Associates for the Surface Transportation\nBoard, November 2009, vol. 1, pp. 2-5 \xe2\x80\x93 2-6.\n\n\n 25\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\nformation of the Consolidated Rail Corporation (Conrail), and the United States Railroad\nAdministration (USRA) which would fund and oversee Conrail\'s operations.76\n\nDespite these governmental efforts, continuing financial problems plaguing railroads\nbegan to motivate the serious consideration of rate deregulation. Some of the adverse\ndevelopments that formed the main impetus for deregulation were as follows:\n\n (1) Most major railroads in the Northeast, including the giant Penn Central and\n several major Midwestern railroads, went bankrupt. Bankrupt railroads\n accounted for more than 21 percent of the nation\xe2\x80\x99s rail mileage.\n\n (2) Between 1970 and 1979, the rail industry\xe2\x80\x99s return on investment never\n exceeded 2.9 percent and averaged only 2 percent.\n\n (3) By 1978, the railroad share of intercity freight had fallen to 35 percent, down\n from 75 percent in the 1920s.\n\n (4) Railroads lacked the funds to properly maintain their tracks. By 1976, more\n than 47,000 miles of track had to be operated at reduced speeds because of\n unsafe conditions. Deferred maintenance, namely maintenance that needed\n to be done but which railroads could not afford, was in the billions of dollars.77\n\nThe first significant reduction in federal regulation of railroads since the enactment of\nthe Interstate Commerce Act in 1887 was realized in the passage of the Railroad\nRevitalization and Regulatory Reform Act of 1976 (the 4R Act). Congress undertook\nregulatory reform in the 4R Act to stop the wave of bankruptcies in the industry and to\nimprove the railroads\xe2\x80\x99 opportunities to survive as private companies.78\n\nThe next major event that further removed regulatory restraints on the railroad industry\nwas the passage of the Staggers Rail Act of 1980. The main provisions of the Staggers\nAct were as follows:\n\n (1) Railroads were allowed to base their rates on market demand.\n\n (2) Railroads and shippers could enter into confidential contracts.\n\n (3) Procedures for abandoning or selling unneeded rail lines were streamlined.\n\n (4) The need for railroads to earn adequate revenues to support their operations\n was explicitly recognized.79\n\nThe Staggers Act was followed by the abolishment of the Interstate Commerce\nCommission (ICC) effective January 1, 1996. The Surface Transportation Board (STB)\n\n76\n Congressional Budget Office, Economic Viability of Conrail, August 1986, pp. 4-5.\n77\n Association of American Railroads, \xe2\x80\x9cA Short History of U.S. Freight Railroads.\xe2\x80\x9d\n78\n Congressional Budget Office, Economic Viability of Conrail, August 1986, p. 5.\n79\n Association of American Railroads \xe2\x80\x9cA Short History of US Freight Railroads.\xe2\x80\x9d\n\n\n 26\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\nwas established as the ICC\xe2\x80\x99s successor. The STB is an economic regulatory agency\nthat Congress charges with the fundamental missions of resolving railroad rate and\nservice disputes and reviewing proposed railroad mergers. The STB maintains a focus\non promoting a regulatory structure that:\n\n (1) Helps promote revenue adequacy (i.e., that the return on capital invested in\n railroads is at least as great as that earned on capital invested in other\n industries).\n\n (2) Allows flexibility in setting of rail rates in response to differing circumstances.\n\n (3) Protects shippers from the exercise of market power by railroads. 80\n\nAmerica\xe2\x80\x99s Freight Railroads since the Staggers Act\n\nThe U.S. railroad industry has been regaining its financial health since the passage of\nthe Staggers Rail Act of 1980. Large improvements have been made on several fronts\n\xe2\x80\x94 productivity and costs, prices, and railroad financial stability.\n\nThe industry has witnessed a dramatic increase in productivity since the passage of the\nStaggers Act, which was the result of two combining factors namely, high output growth\nand reductions in inputs. These productivity gains have further been translated into cost\ngains for the industry. Productivity growth averaged 3.7 percent over the period 1980 to\n2008 which was almost 3.5 times the productivity growth of the overall private business\nsector during the same period. The period of highest growth was between 1980 and\n1996 (4.8 percent), but the rate of growth thereafter slowed down to about 2.3 percent\nper year. Much of the slowdown in productivity growth was attributed to an increase in\nmaterials input and a slower reduction in labor inputs, along with the diminishing role of\neconomies of density.81\n\nNot only has the industry realized productivity gains, but also after the Staggers Act\ngave the railroads the ability to negotiate prices with shippers, railroad rates have\ndropped significantly. Data depicts that inflation-adjusted rail rates for freight services\nare down by about 40 percent since 1980. Breaking this down by commodity type, coal\nshippers enjoyed the greatest rate reductions from around 1993 to 2004, when this\npattern began to reverse as real rates started to trend upwards.82\n\nThe financial state of the railroad industry has also seen big improvements in the past\n30 years. The return on net investment, which had been falling for decades, rose to 4.4\npercent in the 1980s, 7 percent in the 1990s, and 8.2 percent over the period 2000 to\n\n\n80\n A Study of Competition in the U.S. Freight Railroad Industry and Analysis of Proposals that Might Enhance\nCompetition, Revised Final Report, prepared by Laurits R. Christensen Associates for the Surface Transportation\nBoard, November 2009, vol. 1, pp. 2-5 \xe2\x80\x93 2-6.\n81\n B. Kelly Eakin, A. Thomas Bozzo, Mark E. Meitzen, and Philip E. Schoech, \xe2\x80\x9cRailroad Performance Under the\nStaggers Act.\xe2\x80\x9d\n82\n Ibid.\n\n\n 27\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\n2010. Since 2004, railroads have also been steadily lowering their operating ratios.83\nOverall, as a result of these changes, as well as increases in highway congestion and\nfuel costs, the railroad industry is no longer at a severe competitive disadvantage to\nother transportation modes, as it was when the Staggers Act was passed in 1980.\n\n\n\n\n83\n Association of American Railroads, \xe2\x80\x9cRailroad Ten-Year Trends 2001-2010.\xe2\x80\x9d\n\n\n 28\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\n\nAppendix B Common Carrier and Universal Service Obligations\n\nObligations to serve customers take two basic forms. The first is a common carrier\nobligation (CCO), found in transportation industries, where firms provide service under\ntheir posted terms to all potential customers. The second form is a universal service\nobligation (USO), such as that of the Postal Service, where firms must provide a\nspecified minimal level of service to all customer groups, at similar prices.\n\nCommon carrier and universal service obligations are often used in network regulation\nnetworks to ensure efficiency. Common carrier or universal service obligations ensure\nthat all customers are served. Recipients benefit from receiving service, when they\nmight have not received service absent the USO. Recipients of mail also benefit from\nthe USO as senders finance the USO (senders pay the postage, not the recipients).\nSenders benefit from the existence of a larger network. Universal service and common\ncarrier obligations can also arise from equity considerations, where the availability of\nservice is considered a fairness issue.84\n\nClass I Railroads\xe2\x80\x99 Obligation to Serve\n\nThe U.S. freight railroad industry has a CCO. However, there is a lack of clarity over\nwhat this CCO entails. For example, a critical ongoing debate centers on railroads\xe2\x80\x99\nobligation to carry hazardous materials. Shippers claim that the CCO requires railroads\nto transport such materials at \xe2\x80\x9creasonable\xe2\x80\x9d rates. Railroads contend that the liability of\ntransporting these materials is so high that it places them at extreme risk. The railroads\nbelieve they should be able to charge rates to cover such risks and/or federal law\nshould be changed to indemnify them from these risks.85\n\nPrior to the establishment of Amtrak in 1971, the Class I railroads also provided\npassenger service. While not a USO per se, railroads were obliged to provide\npassenger service to communities they served. This service was not ubiquitous, but\nonce established it was viewed as an obligation of the railroad (particularly at the\nindividual state level) and was difficult to abandon.86\n\nClass I Railroad Passenger Service in the pre-Amtrak Era\n\nThe obligation to provide passenger service was a key factor in the Class I railroads\xe2\x80\x99\ndeteriorating financial condition through the 1960s. Two events led to a relaxation and\nelimination of this obligation to serve: (1) the passage of the Transportation Act of 1958,\n\n84\n A Study of Competition in the U.S. Freight Railroad Industry and Analysis of Proposals that Might Enhance\nCompetition, pp. 3-8.\n85\n For example, see Surface Transportation Board Ex Parte 677, Common Carrier Obligations of Railroads-\nTransportation of Hazardous Materials, June 4, 2008.\n86\n Thomas H. Trimarco and John H. Hines Jr., \xe2\x80\x9cThe Railroad Passenger Problem\xe2\x80\x94At the Crossroads,\xe2\x80\x9d Boston\nCollege Law Review, Volume 6, Issue 2, 1965, p. 306 and Presidential Advisory Committee on Transport Policy and\nOrganization, Revision of Federal Transportation Policy, p. 18.\n\n\n 29\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\nwhich provided a greater ability to drop money-losing passenger services; and (2) the\ntransfer of passenger service to Amtrak in 1971.\n\nIn 1955, a presidential advisory committee (the \xe2\x80\x9cWeeks Committee\xe2\x80\x9d) reported that\nrailroads suffered for many years from unprofitable passenger service operations and\nthat \xe2\x80\x9cthe railroad shippers of the country are being required to subsidize in substantial\nand growing amounts those who benefit from the utilization of passenger train\nservice.\xe2\x80\x9d87 At the time of the Weeks Committee report, Class I railroad passenger\nservice operations had incurred deficits every year since 1930 (with the exception of the\nwar years of 1942-1945) with the largest deficit occurring in 1953 at $750 million.88\nThese deficits were primarily due to declining demand for rail passenger service\nbecause of the increased availability and use of auto and air travel. The growth in these\nalternative modes of travel was substantially due to increasing government funding of\nhighway and airport construction.89\n\nDespite falling demand and increasing operating deficits, railroads found it very difficult\nto get permission to abandon unprofitable passenger services. A major reason for this\ndifficulty was that, prior to the 1958 amendment of the Interstate Commerce Act;\nindividual states had a significant role in granting service abandonments. The Interstate\nCommerce Commission (ICC) could authorize the abandonment of all operations over a\ngiven line, but had no power to authorize the discontinuance of particular trains or\nservices over a given line while leaving the operation of other trains and services on that\nline. This severely limited the ICC\xe2\x80\x99s ability to grant abandonment of unprofitable\nservices. In these instances, \xe2\x80\x9cthe sole forums to which [railroads] could proceed for\nconsideration of their discontinuance requests were the state regulatory commissions\nwhich by and large were unsympathetic to their plight.\xe2\x80\x9d90 The Weeks Committee noted\nthat, despite the decline in demand for rail passenger service and its effect on railroad\nprofitability, there was reluctance by state authorities to abandon service because of\nopposition to service curtailments from local interests and railroad employees.91\n\nThe Weeks Committee recommended that the Interstate Commerce Act be amended to\nprovide the ICC with greater oversight powers over railroad operations, so that the ICC\ncould order the discontinuance of service, irrespective of any state law or power of any\nstate authority, where the ICC \xe2\x80\x9cfinds that continuance of unprofitable facilities or\nservices imposes an undue burden upon interstate commerce, and that adequate\nservice by other forms of transportation are available to meet the public need.\xe2\x80\x9d92\n\nIn 1958, Congress amended the Interstate Commerce Act to give the ICC greater ability\nto grant service abandonments:\n\n87\n Presidential Advisory Committee on Transport Policy and Organization, Revision of Federal Transportation Policy,\np. 18.\n88\n Ibid., p. 18.\n89\n Thomas H. Trimarco and John H. Hines Jr., \xe2\x80\x9cThe Railroad Passenger Problem\xe2\x80\x94At the Crossroads,\xe2\x80\x9d p. 303.\n90\n Ibid., p. 306.\n91\n Presidential Advisory Committee on Transport Policy and Organization, Revision of Federal Transportation Policy,\np. 18.\n92\n Ibid., p. 19.\n\n\n 30\n\x0cU.S. Postal Service Office of Inspector General August 13, 2012\nParallel Tracks? Lessons from the Railroad Industry RARC-WP-12-014\n\n\n\n Under Section 13a, in order for the Commissioner to grant or acquiesce in\n any discontinuance, he must first find that the service in question is not\n required by public convenience and necessity and second, that the\n continuation of the service will unduly burden interstate commerce. \xe2\x80\xa6\n Under paragraph (1), a carrier may discontinue an interstate train or\n service of its own accord, subject only to the possible determination by the\n ICC that such discontinuance is unwarranted, whereas under paragraph\n (2), the Commission may take action concerning discontinuance of an\n intrastate service only after the appropriate state commission has had the\n opportunity to act and has refused to authorize the discontinuance.93\n\nWhile this helped alleviate the drag of passenger service deficits on railroads\xe2\x80\x99 financial\nconditions, the Class I railroads were still obligated to provide passenger service (albeit\non a reduced scale) until the passage of the Rail Passenger Service Act of 1970, which\ncreated Amtrak. The Class I railroads were relieved of their passenger service\nobligations when Amtrak began operations on May 1, 1971.\n\nSummary\n\nIncreasing competition from alternative modes of transportation was at the core of the\nincreasing deficits the Class I railroads incurred from their passenger operations. The\nvery same forces that caused the downfall in passenger service were important for\neventually relaxing/relieving railroads from this obligation: namely the recognition by\npolicymakers that consumers had viable options to rail passenger service. However, it\ntook almost 30 years of passenger service operating deficits (1930-1958) before the\nability to relax passenger service obligations was granted, and 40 years of passenger\nservice operating deficits (1930-1970) before the Class I railroads were relieved of their\nmoney-losing passenger service obligations.\n\n\n\n\n93\n Thomas H. Trimarco and John H. Hines Jr., \xe2\x80\x9cThe Railroad Passenger Problem\xe2\x80\x94At the Crossroads,\xe2\x80\x9d pp. 307-308.\n\n\n 31\n\x0c'