U.S. Postal Service: Postal Reform Law Provides Opportunities to Address Postal Challenges
Published: 2007-04-17T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: When GAO originally placed the U.S. Postal Service's (the Service) transformation efforts and long-term outlook on its high-risk list in early 2001, it was to focus urgent attention on the Service's deteriorating financial situation. Aggressive action was needed, particularly in cutting costs, improving productivity, and enhancing financial transparency. GAO testified several times since 2001 that comprehensive postal reform legislation was needed to address the Service's unsustainable business model, which assumed that increasing mail volume would cover rising costs and mitigate rate increases. This outdated model limited its flexibility and incentives needed to realize sufficient cost savings to offset rising costs, declining First-Class Mail volumes, unfunded obligations, and an expanding delivery network. This limitation threatened the Service's ability to achieve its mission of providing affordable, high-quality universal postal services on a self-financing basis. This testimony will focus on (1) why GAO recently removed the Service's transformation efforts and outlook from GAO's high-risk list, (2) the Service's financial condition in fiscal year 2007, (3) the opportunities and challenges facing the Service, and (4) major issues and areas for congressional oversight. This testimony is based on GAO's past work, review of the postal reform law, and updated information on the Service's financial condition.
section_title: What GAO Found
paragraphs: Key actions by both the Service and Congress have led GAO to remove the Service's transformation efforts and long-term outlook from its high-risk list in January 2007. Specifically, the Service developed a Transformation Plan and achieved billions in cost-savings, improved productivity, downsized its workforce, and improved its financial reporting. Congress enacted a law in 2003 that reduced the Service's annual pension expenses, which enabled it to achieve record net incomes, repay debt, and delay rate increases until January 2006. Finally, the postal reform law enacted in December 2006 provides tools and mechanisms that can be used to address key challenges facing the Service as it moves into a new regulatory and increasingly competitive environment. The two key factors that will affect the Service's financial condition for this fiscal year are the new reform law and new postal rates that go into effect in May. The reform law increases the costs of funding retiree health benefits but provides opportunities to offset some of these cost pressures through efficiency gains and eliminating certain pension payments. For the rest of the year, Service officials do not expect significant changes from its projected expenses and revenues. Other factors, such as costs for fuel or labor resolutions varying from plan, could affect the Service's projected outcome for this fiscal year. Congress's continued oversight of the Service's transformation is critical at this time of significant changes for the Service, Postal Regulatory Commission (PRC), and mailing industry. Also, key to a successful transformation is innovative leadership by the Postmaster General and the PRC Chairman and their ability to work effectively with stakeholders to realize new opportunities provided under the postal reform law. GAO has identified key issues and areas for oversight related to implementing the reform law and new rate-setting structure, as well as other challenges to ensure the Service remains financially sound.

section_title: Letter
paragraphs: I am pleased to be here today to participate in this oversight hearing for  the U.S. Postal Service (the Service). To begin, I want to acknowledge  Congress’s efforts in passing comprehensive postal reform legislation. The  Postal Accountability and Enhancement Act (the act) provides tools and  mechanisms that can be used to establish an efficient, flexible, fair,  transparent, and financially sound Postal Service—a Service that can more  effectively operate in an increasingly competitive environment not  anticipated under the Postal Reorganization Act of 1970. Effective  collaboration among the Service, the newly established Postal Regulatory  Commission (PRC), mailers, and employee organizations can help to  facilitate the successful implementation of the act by achieving a greater  understanding of each other’s changing needs and operations, and how  they correspond to the American public’s need for the continued provision  of affordable, high-quality postal services. My remarks today will focus on  (1) why we recently removed the Service’s transformation efforts and  outlook from GAO’s high-risk list, (2) the Service’s financial condition in  fiscal year 2007, (3) the opportunities and challenges facing the Service,  and (4) major issues and areas for continued congressional oversight.
When we originally placed the Service’s transformation efforts and long- term outlook on our high-risk list in early 2001, we stated that a structural  transformation would be needed to address the growing financial,  operational, and human capital challenges that threatened its mission to  provide affordable, high-quality universal postal services on a self- financing basis. This designation would help raise the urgency of taking  actions to address these challenges before the situation escalated into a  crisis where the options for action could be more limited. Since that time,  key actions by both the Service and Congress have improved the Service’s  financial, operational, and human capital condition and outlook.
Specifically, the Service’s management issued a Transformation Plan in  2002 that outlined steps to guide it in addressing its challenges and has  demonstrated a commitment to implementing the Plan by cutting costs,  improving productivity, downsizing its workforce, and improving its  financial reporting. Further, a statute enacted in 2003 reduced the  Service’s annual pension expenses, which allowed the Service to achieve  record net income, repay debt, and delay rate increases until January  2006. Comprehensive postal reform legislation was enacted in December  2006 that among other factors, provides:    a framework for modernizing the Service’s rate-setting process;    an opportunity to preserve affordable universal service by reassessing the  future needs of postal customers and taking actions to increase value and  efficiencies throughout the postal network—fundamental principles of  functioning in a competitive environment; recognition of the Service’s long-term financial obligations by prefunding  retiree health benefit obligations, which will result in short-term cost  increases for the Service, but over the long-term this action improves the  fairness and balance of cost burdens for current and future ratepayers; for a transfer of the obligation to fund civil service pension payments  attributable to past military service from postal ratepayers to taxpayers;  and   enhanced transparency and accountability by requiring that the Service  collect, track, and report financial and service performance information,  including the creation and reporting of modern service standards.
Based on these actions, we determined that sufficient progress has been  made to warrant the removal of the Service from our high-risk list in  January 2007. We recognize, however, that the Service continues to face  challenges to maintain its viability as it implements significant changes  under the new law and will further discuss these challenges below.
The Service’s financial condition for the current fiscal year has been  affected by the act, which, along with the ensuing rate increase, will  continue to affect its near- and long-term financial outlook. Specifically,  changes to either projected or actual Postal Service payments that result  from this act include:    accelerating funding of the Service’s retiree health benefit obligations,    expensing funds previously set aside in escrow (transferring them to the  Treasury) and eliminating future escrow payments, transferring funding for selected military service benefits back to the  Treasury, and   eliminating certain annual Civil Service Retirement System (CSRS)  pension funding requirements.
Since the law was enacted, the Service has updated its expense  projections for fiscal year 2007. To date, those expenses not directly  impacted by the 2006 Act and its total revenues have tracked closely to  budgeted estimates. For the remainder of the fiscal year, Service officials  do not expect significant changes from projected expenses, and still  expect to meet revenue targets—even though the rate decision approved  by the PRC was different than what the Service requested. These officials  did acknowledge, however, that other factors could have a favorable or  unfavorable impact on the Service’s projected net loss for the year, such as  the effect of rate increases on mail volumes, changes in fuel prices, and  resolution of certain labor agreements. The Service is planning to borrow  $1.8 billion this year, which will push its total outstanding debt to almost  $4 billion to meet short-term cash flow needs that come at year end.
As the Service transitions to its new statutory framework in an  increasingly competitive environment, it will continue to face financial,  operational, and human capital challenges. Table 1 illustrates how the  legislation provides opportunities to address some of these challenges.
Continued oversight will be necessary to help ensure the Service’s future  financial condition remains sound and that the intent of the act is followed  throughout implementation. In particular, we have identified major issues  considered significant by various postal stakeholders, as well as areas for  continued oversight including:  the effect of the upcoming rate increases and statutory changes on the  Postal Service’s financial condition; the impact of the Service’s decision on whether or not to submit a rate  filing later this year under the old rate structure;   actions by the PRC to establish a new price-setting and regulatory  the Service’s ability to operate under an inflationary price cap while some  of its cost segments are increasing above the rate of inflation;   actions by the Service, in consultation with the PRC, to establish modern  service standards, and the Postal Service’s plan for meeting those  standards; the Service’s ability to provide high-quality delivery service as it takes  actions to reduce costs and realign its infrastructure and workforce; and the PRC’s development of appropriate accounting and reporting  requirements aimed at enhancing transparency and accountability of the  Service’s internal data and performance results.
The successful transformation of the Postal Service will require innovative  leadership by the Postmaster General and the Chairman of the PRC, and  their ability to work effectively with their employees, the mailing industry,  and the general public. We are encouraged by the Service’s ongoing efforts  to facilitate workgroups with participants from the mailing industry that  will make recommendations regarding new service standards and  measures. It will be important for all postal stakeholders to take full  advantage of the unique opportunities that are currently available by  providing input and working together, particularly as challenges and  uncertainties will continue to threaten the Service’s financial condition  and outlook.
subsections: section_title: Recent Actions Warranted the Postal Service’s Removal from Our High-Risk List
paragraphs: Several actions—both by the Service and the Congress—led us to remove  the Service’s transformation efforts and long-term outlook from our high- risk list. In 2001, we made this designation because the Service’s financial  outlook had deteriorated significantly. The Service had a projected deficit  of $2 billion to $3 billion, severe cash flow pressures, debt approaching the  statutory borrowing limit, cost growth outpacing revenue increases, and  limited productivity gains. Other challenges the Service faced included  liabilities that exceeded assets by $3 billion at the end of fiscal year 2002  major liabilities and obligations estimated at close to $100 billion, a  restructuring of the workforce due to impending retirements and  operational changes, and long-standing labor-management relations  problems. We raised concerns that the Service had no comprehensive plan  to address its financial, operational, or human capital challenges, including  its plans for reducing debt, and it did not have adequate financial reporting  and transparency that would allow the public to understand changes in its  financial situation. Thus, we recommended that the Service develop a  comprehensive plan, in conjunction with other stakeholders, which would  identify the actions needed to address its challenges and provide publicly  available quarterly financial reports with sufficient information to  understand the Service’s current and projected financial condition. As the  Service’s financial difficulties continued in 2002, we concluded that the  need for a comprehensive transformation of the Service was more urgent  than ever and called for Congress to act on comprehensive postal reform  legislation. The Service’s basic business model, which assumed that rising  mail volume would cover rising costs and mitigate rate increases, was  outmoded as First-Class Mail volumes stagnated or deteriorated in an  increasingly competitive environment.
Since 2001, the Service’s financial condition has improved and it has  reported positive net incomes for each of the last 4 years (see fig. 1).
The Service has made significant progress in addressing some of the  challenges that led to its high-risk designation. For example, the Service’s  management developed a Transformation Plan and has demonstrated a  commitment to implementing this plan. Since our designation in 2001, the  Service has:    Reduced workhours and improved productivity: The Service has reported  productivity gains in each year. According to the Service, its productivity  increased by a cumulative 8.3 percent over that period, which generated  $5.4 billion in cost savings. The Service reported eliminating over 170  million workhours over this period, with a 4.5 million workhour reduction  in fiscal year 2006.
Downsized its workforce: The Service has made progress in addressing  some of the human capital challenges associated with its vast workforce,  by managing retirements, downsizing, and expanding the use of  automation. At the end of fiscal year 2006, the Service reported that it had  696,138 career employees, the lowest count since fiscal year 1993. Attrition  and automation have allowed the Service to downsize its workforce by  more than 95,000, or about 10 percent, since fiscal year 2001.
Enhanced the reporting of its financial condition and outlook: The Service  responded to recommendations we made regarding the lack of sufficient  and timely periodic information on its financial condition and outlook that  is publicly available between publications of its audited year-end financial  statements by enhancing its financial reporting and providing regular  updates to the financial statements on its Web site. The Service instituted  quarterly financial reports, expanded the discussion of financial matters in  its annual report, and upgraded its Web site to include these and other  reports in readily accessible file formats.
The 2003 pension act provided another key reason for why we removed  the high-risk designation. Much of the Service’s recent financial  improvement was due to the change from this law that reduced the  Service’s annual pension expenses. Between fiscal years 2003 and 2005,  the Service had a total of $9 billion in decreased pension expenses when  compared to the annual expenses that would have been paid without the  statutory change. This change enabled the Service to significantly cut its  costs, achieve record net incomes, repay over $11 billion of outstanding  debt, and delay rate increases until January 2006.
The Service’s improved financial performance and condition during this  time was also aided by increased revenue generated from growing  volumes of Standard Mail (primarily advertising) and rate increases in  June 2002 and January 2006. Standard Mail volumes grew by almost 14  percent from fiscal year 2001 to 2006, and Standard Mail revenues, when  adjusted for inflation, increased by over 11 percent during the same time  period. In June 2002, the Service implemented a rate increase (the price of  a First-Class stamp increased from 34 cents to 37 cents) to offset rising  costs. In January 2006, the Service implemented another rate increase (the  price of a First-Class stamp increased from 37 cents to 39 cents) to  generate the additional revenue needed to set aside $3.0 billion in an  escrow account in fiscal year 2006 as required by the 2003 pension law.  Revenues in fiscal year 2006 increased by about 4 percent from the  previous year due largely to the January 2006 rate increase.
The passage of the recent postal reform legislation was another reason  why we removed this high-risk designation. Although noticeable  improvements were being made to the Service’s financial, operational, and  human capital challenges, we had continued to advocate the need for  comprehensive postal reform legislation. After years of thorough  discussion, Congress passed a comprehensive postal reform law in late  December 2006 that provides tools and mechanisms that can be used to  establish an efficient, flexible, fair, transparent, and financially sound  Postal Service. Later in this statement, I will discuss how some specific  tools and mechanisms can be used to address the continuing challenges  facing the Service.
section_title: The Postal Service’s Current Financial Condition
paragraphs: The Service’s financial condition for fiscal year 2007 has been affected by  the reform act, which, along with the May change in postal rates, will  continue to affect its near- and long-term financial outlook. The Service  will benefit financially from an increase in postal rates in May averaging  7.6 percent. Key steps in the rate process are provided in appendix I. The  Service is estimating that it will gain an additional $2.2 billion in net  income in fiscal year 2007 as a result of the new rates. The recent rate  case, in addition to generating additional revenues, took significant strides  in aligning postal rates with the respective mail handling costs. Some rate  increases are particularly large—i.e., some catalog rates may increase by  20 to 40 percent. The new rates structure is aimed at providing the  necessary incentives to encourage efficient mailing practices (e.g., shape,  weight, handling, preparation, and transportation) and thereby encourage  smaller rate increases and steady mail volumes in the longer run.
At the beginning of fiscal year 2007 (before the enactment of the reform  law), the Service expected to earn $1.7 billion in net income, which  reflected the additional revenue the Service estimated it would receive  from the May increase in postal rates. The Service, however, planned to  increase its outstanding debt of $2.1 billion at the end of fiscal year 2006  by an additional $1.2 billion in fiscal year 2007 in order to help fund the  expected $3.3 billion escrow requirement for 2007.
Since enactment of the reform law, the Service has updated its expense  projections. While the Service’s total expenses for fiscal year 2007 have  been affected by passage of the act, those expenses not directly related to  the act and total revenues have tracked closely to plan. The Service  currently is estimating an overall fiscal year 2007 net loss of $5.2 billion,  largely due to changes in either projected or actual Postal Service  payments as a result from the act including:    Accelerating funding of the Service’s retiree health benefit obligations:  Beginning this fiscal year, the Postal Service must make the first of 10  annual payments into a newly created Postal Service Retiree Health  Benefits Fund (PSRHBF) to help fund the Service’s significant unfunded  retiree health obligations. The 2007 payment of $5.4 billion is due to be  paid by September 30. The Service has accrued half of this expense— $2.7  billion—during the first 6 months of the fiscal year and will accrue $1.35  billion in each of the remaining 2 quarters.
One-time expensing of funds previously set aside in escrow and  eliminating future escrow payments: The act requires the Service to  transfer the $3.0 billion it escrowed in fiscal year 2006 to the PSRHBF,  which the Service recognized as a one-time expense in the first quarter of  fiscal year 2007. The reform act also eliminated future escrow payments  required under the 2003 pension law, including the $3.3 billion payment  scheduled for fiscal year 2007.
Transferring funding for selected military service benefits back to the  Treasury: The act significantly reduced the Service’s civil service pension  obligations by transferring responsibility for funding civilian pension  benefits attributable to the military service of the Service’s retirees back to  the Treasury Department, where it had been prior to enactment of the  2003 pension law. The reform act requires that any overfunding  attributable to the military benefits as of September 30, 2006, be  transferred to the PSRHBF by June 30, 2007.
Eliminating certain annual Civil Service Retirement System (CSRS)  pension funding requirements: The act eliminated the requirement that the  Service fund the annual normal cost of its civil service employees and the  amortization of the unfunded pension obligation that existed prior to  transferring the military service obligations to the Treasury Department.  The Service estimates that it will save $1.5 billion in fiscal year 2007 from  eliminating the annual pension funding requirements and amortization  payments.
The result of these payments is a net increase in retirement-related  expenses of $3.9 billion, which is $600 million higher than the expected  $3.3 billion escrow payment for 2007 that was eliminated. Thus, the  Service is planning to borrow $600 million more than initially budgeted to  cover this shortfall. This increase is anticipated to result in the Service’s  borrowing $1.8 billion in fiscal year 2007, which would bring its total  outstanding debt to $3.9 billion by the end of the fiscal year.
The Service has identified other factors and uncertainties that, depending  on how results vary from budgeted estimates, could have a favorable or  unfavorable impact on the Service’s projected net loss for fiscal year 2007.  For example, volumes and revenues may be affected by a continued  slowdown in the U.S. economy or unanticipated consequences of the  recent rate decision. The Service has anticipated economic growth to pick  up in the third and fourth quarters of this year, but a slowdown may  depress volume growth below projected levels for the rest of the year.
Furthermore, the unusual nature of the rate case creates uncertainties for  the Service that may affect its financial results. These uncertainties  include how the Service and its customers will respond to the:  limited implementation times—the 2-month implementation period (the  Postal Service Board of Governors decision on March 19, 2007, stated that  most new rates would become effective on May 14, 2007) leaves little time  for the Service to educate the public and business mailers on the new rate  changes and to allow mailers sufficient time to adjust their mailing  practices and operations accordingly;   delayed implementation times—how mailers and the Service will be  affected by the delay in implementing new Periodical rates until mid-July;   magnitude of certain restructured rates, particularly for those specific  types of mail that will experience rather significant increases, and the  related impact on volumes and revenues; and   unfamiliarity with restructured rates—the prices for many popular  products, such as certain types of First-Class Mail, will experience  significant shifts based on the shape of the mail. For example, figure 2  shows how the cost of First-Class Mail will differ based on its shape.
Moreover, the Service’s expense projections may be susceptible to rising  fuel prices due to the Service’s vulnerability in this area or that the  outstanding contract negotiations for two of its major labor unions would  vary from projected levels. Although the extent to which these factors and  uncertainties will affect the Service’s financial condition for fiscal year  2007 is not known, they may affect its subsequent financial outlook. For  example, if the Service finds that its financial performance and condition  is weakening—either through revenue shortfalls or expense increases—it  may decide to file another rate increase later this year.
section_title: Postal Reform Law Provides Opportunities to Address Challenges
paragraphs: The new postal reform law provides new opportunities to address  challenges facing the Service as it continues its transformation in a more  competitive environment with a variety of electronic alternatives for  communications and payments. Specifically, it provides tools and  mechanisms to address the challenges of generating sufficient revenues,  controlling costs, maintaining service, providing reliable performance  information, and managing its workforce. Effectively using these tools will  be key to successfully implementing the act and addressing these  challenges.
subsections: section_title: Generating Sufficient Revenue as First-Class Mail Volume Is Declining and Mail Mix Is Changing
paragraphs: The Service continues to face challenges in generating sufficient revenues  as First-Class Mail volume continues to decline and the mail mix changes.  First-Class Mail, historically the class of mail with the largest volumes and  revenues, saw volume shrink by almost 6 percent from fiscal year 2001 to  2006. The trends for First-Class Mail and Standard Mail, which currently  combine for about 95 percent of mail volumes and 80 percent of revenues,  experienced a historical shift in fiscal year 2005. For the first time,  Standard Mail volumes exceeded those for First-Class Mail (see fig. 3).
This shift has major revenue implications because:    First-Class Mail generates the most revenue and is used to finance most of  the Service’s institutional (overhead) costs (see fig. 4).
Standard Mail generates less revenue per piece compared to First-Class  Mail and it takes about two pieces of Standard Mail to make the same   contribution to the Service’s overhead costs as one piece of First-Class  Mail.
Standard Mail is a more price-sensitive product compared to First-Class  Mail because it competes with other advertising media. Also, because  advertising, including Standard Mail, tends to be affected by economic  cycles to a greater extent than First-Class Mail, a larger portion of the  Service’s mail volumes is more susceptible to economic fluctuations.
The act provides tools and mechanisms that can help address these  revenue challenges by promoting revenue generation and retention of  revenues. The act established flexible pricing mechanisms for the Service’s  competitive and market-dominant products. For example, it allows the  Service to raise rates for its market-dominant products, such as First-Class  Mail letters, Standard Mail, and Periodicals, up to a defined price cap;  exceed the price cap should extraordinary or exceptional circumstances  arise; and use any unused rate authority within 5 years. For its competitive  products, such as Priority Mail or Expedited Mail, the Service may raise  rates as it sees fit, as long as each competitive products covers its costs  and competitive products as a whole cover their attributable costs and  make a contribution to overhead.
The act also allows for the Service to retain any earnings, which may  promote increased financial stability. First, to the extent the Service can  generate net income to retain earnings, this could enhance its ability to  weather economic downturns. For example, a slow economic cycle or  sudden increase in fuel prices might not necessitate an immediate rate  increase if sufficient retained earnings exist to cover related shortfalls.  Furthermore, to the extent the Service can retain earnings as liquid assets,  it may reduce the Service’s reliance on borrowing to offset cash shortfalls.  The Service has stated that it will take out debt to cover cash shortfalls in  fiscal year 2007 and projects that this increase will result in $3.9 billion of  outstanding debt at the end of the year (see fig. 5). Controlling debt will be  important because the Service needs to operate within its statutorily set  borrowing limits ($3 billion in new debt each year, and $15 billion in total  debt outstanding). Reducing debt was one of the key factors we cited in  removing the Service’s high-risk designation.
Uncertainties related to the recent rate decision and reform law may  impact the extent to which the Service is able to address its revenue  related challenges. The uncertainties include:    How will mailers and volume respond to the new rate decision’s pricing  signals?
What types of innovative pricing methods will be allowed?
How will the Service set rates under the new price cap system, and how  will mailers respond to this additional flexibility? How will the Service and  mailers be able to modify their information systems to accommodate more  frequent rate increases?
How will customer behavior change as prices change under the new  system? To what extent will customers desire for mail be affected by  privacy concerns, environmental concerns, preference for electronic  alternatives, or efforts to establish Do Not Mail lists?
How will the Service be able to enhance the value of its market-dominant  and competitive products (e.g., predictable and consistent service,  tracking and tracing capabilities, etc.)?
What will the Service do with any retained earnings (e.g., improve its  capital program, save to weather downturns in the economy)?
section_title: Controlling Costs and Improving Productivity
paragraphs: The Service faces multiple cost pressures in the near- and long-term  associated with the required multi-billion dollar payments into the  PSRHBF, dealing with key cost categories experiencing above-inflation  growth while operating under an inflationary-based price cap, and other  costs associated with providing universal postal services to a growing  network—one now expanding by about 2 million new addresses each year.  While the reform act takes actions that increase current costs by  improving the balance of retiree health benefit cost burdens between  current and future ratepayers, it also eliminates other payments and  provides opportunities to offset some of these costs pressures through  efficiency gains that could restrain future rate increases. It will be crucial  for the Service, however, to take advantage of this opportunity and  achieve sustainable, realizable cost reductions and productivity  improvements throughout its networks.
Personnel expenses (which include wages, employee and retiree benefits,  and workers’ compensation) have consistently accounted for nearly 80  percent of annual operating expenses, even though the Service has  downsized its workforce by over 95,000 employees since fiscal year 2001.  The Service’s personnel expenses have grown at rates exceeding inflation  since fiscal year 2003 and are expected to continue dominating the  Service’s financial condition. In particular, growth in retiree health benefit  costs have, on average over the last 5 years, exceeded inflation by almost  13 percent each year. This growth is expected to continue due to (1) rising  premiums, growth in the number of covered retirees and survivors, and  increases in the Service’s share of the premiums; and (2) the Service will  continue paying the employer’s share of the health insurance premiums of  its retirees along with the required payments ranging from $5.4 billion to  $5.8 billion into the PSRHBF in each of the following 9 years. While we  recognize the cost pressures that will be placed on the Service as it begins  prefunding its retiree health benefits obligations, we continue to believe  that such action is appropriate to improve the fairness and balance of cost  burdens for current and future ratepayers. Furthermore, beginning in  fiscal year 2017, the Service might enjoy a significant reduction in its  retiree health costs if its obligations are fully funded.
In addition to these personnel expenses, the Service has also experienced  growth in its transportation costs that exceeded the rate of inflation in  fiscal years 2005 and 2006. Transportation costs represent the second  largest cost category behind compensation and benefits. These costs grew  by about 11 percent from fiscal year 2005 to 2006, largely due to rising fuel  costs. In a February 2007 report, we stated that the Service is vulnerable to  fuel price fluctuations and will be challenged to control fuel costs due to  its expanding delivery network and inability to use surcharges.
The Service has made some progress in containing cost growth, and  pledged to cut another $5 billion of costs out of its system between fiscal  years 2006 and 2010 through productivity increases and operational  improvements. The Service has reported productivity increases for the last  7 years, but the reported increase in fiscal year 2006 was its smallest  during this period. The Service has recently had trouble absorbing gains in  mail volumes while achieving targeted workhour reductions. Although the  Service has reduced its workhours in 6 of the last 7 years, in fiscal year  2006, its goal was to reduce workhours by 42 million, but the Service  reported a decrease of only 5 million workhours.
While both the recent rate decision and reform act seek to improve  efficiencies in the postal networks, these developments will pose  challenges to the Service. In terms of the rate case, the Service will be  challenged to modify its mail processing and transportation networks to  respond to changes in mailer behaviors (e.g., in the quantity and types of  mail sent and how mail is prepared) to minimize their rates. Furthermore,  the reform act provides an opportunity to address the Service’s cost  challenges because it requires the Service to develop a plan that, among  other things, includes a strategy for how the Service intends to rationalize  the postal facilities network and remove excess processing capacity and  space from the network, as well as identifying the costs savings and other  benefits associated with network rationalization alternatives discussed in  the plan. This plan provides an opportunity to address some concerns we  have raised in previous work, in which we stated that it was not clear how  the Service intended to realign its processing and distribution network and  workforce, and that its strategy lacked sufficient transparency and  accountability, excluded stakeholder input, and lacked performance  measures for results. We are currently conducting ongoing work on the  Service’s progress in this area over the past 2 years and will be issuing a  report this summer with updated findings.
Taking advantage of the opportunities available will have a direct impact  on the Service’s ability to operate under an inflationary-based rate cap,  achieve positive results, and limit the growth in its debt. If the Service is  unable to achieve significant cost savings, it may have to take other  actions such as borrow an increasing amount each year to make year-end  property and equipment purchases and fund its retiree health obligations.  The following uncertainties may have a significant impact on the Service’s  ability to achieve real cost savings and productivity in the future:    How will operating under a rate cap provide an incentive to control costs?
How will the Service operate under a rate cap, if certain key costs  continue to increase at levels above inflation (e.g., health benefit costs)?
How will the new rate designs/structure lead to efficiency improvements  throughout the mail stream?
Will the Service’s implementation of its network realignment result in  greater cost savings and improved efficiency?
Will the Service achieve its expected return on investment and operational  performance when it deploys the next phase of automated flat sorting  equipment?
How will the Service’s financial situation be impacted when the 10-year  scheduled payments into the PSRHBF are completed?
Will the balance of the PSRHBF—which is a function of the PSRHBF’s  investment returns and the growth in the Service’s retiree health  obligations—be sufficient to cover the Service’s retiree health obligation  by the end of fiscal year 2016?
section_title: Maintaining, Measuring, and Reporting Service
paragraphs: The Service will be challenged to continue carrying out its mission of  providing high-quality delivery and retail services to the American people.  Maintaining these services while establishing reliable mechanisms for  measuring and reporting performance will be critical to the Service’s  ability to effectively function in a competitive market and meet the needs  of various postal stakeholders, including:    The Service—so that it can effectively manage its nationwide service and  respond to changes and/or problems in its network.
The Service’s customers (who may choose other alternatives to the  mail)—so that they are aware of the Service’s expected performance, can  tailor their operations to those expectations, and understand the Service’s  actual performance against those targets.
Oversight bodies—so that they are aware of the Service’s ability to carry  out its mission while effectively balancing costs, service needs, and the  rate cap; can hold the Service accountable for its performance; and  understand service performance (whether reported problems are  widespread or service is getting better or worse).
The Service’s delivery performance standards and results have been a  long-standing concern for mailers and Congress. We found inadequate  information is collected and available to both the Service and others to  understand and address delivery service issues. Specifically, the Service  does not measure and report its delivery performance for most types of  mail (representative measures of delivery performance cover less than  one-fifth of mail volume and do not include key types of mail such as  Standard Mail, bulk First-Class Mail, Periodicals, and most Package  Services), certain performance standards are outdated; and that progress  has been hindered by a lack of management commitment and  collaboration by the Service and mailers. Based on these findings, we  recommended the Service take actions to modernize its delivery service  standards, develop a complete set of delivery service measures, more  effectively collaborate with mailers, and improve transparency by publicly  disclosing delivery performance information.
The Service has recently reported positive delivery results for the limited  segment of mail for which the Service does track performance. It has  reported on-time delivery performance improved in the first quarter of  fiscal year 2007 for some single-piece First-Class Mail. However, issues  such as late deliveries have been reported in places such as Chicago, Los  Angeles, and El Paso; and for different types of mail such as Standard Mail  and Periodicals. Figure 6 shows that delivery performance in Chicago for  this type of mail was worse than the national average at the end of the first  quarter for this fiscal year.
The reform act provides an opportunity for the Service to address this  challenge by establishing requirements for maintaining, measuring, and  reporting on service performance. Specifically, the act identified four key  objectives for modern service standards:    enhance the value of postal services to both senders and recipients;    preserve regular and effective access to postal services in all communities,  including those in rural areas or where post offices are not self-sustaining; reasonably assure Postal Service customers delivery reliability, speed, and  frequency consistent with reasonable rates and best business practices;  and    provide a system of objective external performance measurements for  each market-dominant product as a basis for measurement of Postal  Service performance.
The act also required the Service to implement modern delivery  performance standards, set goals for meeting these standards, and  annually report on its delivery speed and reliability for each market- dominant product. Key steps specified in the act include that within 12  months of enactment (by December 2007) the Service must issue modern  service standards, and within 6 months of issuing service standards the  Service must, in consultation with the PRC, develop and submit to  Congress a plan for meeting those standards. Furthermore, within 90 days  after the end of each fiscal year the Service must report to PRC on the  quality of service for each market-dominant product in terms of speed of  delivery and reliability, as well as the degree of customer satisfaction with  the service provided.
These requirements provide opportunities to resolve long-standing  deficiencies in this area. As the Service transitions to the new law, the  following uncertainties may impact its ability to address challenges in  maintaining, measuring, and reporting service performance in the future:    How will the Service implement representative measures of delivery speed  and reliability within the timeframes of the reform act, while taking cost  and technological limitations into account?
How much transparency will be provided to the PRC, Congress, mailers,  and the American people, including the frequency, detail, and methods of  reporting?
section_title: Financial Performance Reporting
paragraphs: Another challenge facing the Service is to provide reliable data to  management, regulators, and oversight entities to assess financial  performance. Accurate and timely data on Service costs, revenues, and  mail volumes helps provide appropriate transparency and accountability  for all postal stakeholders to have a comprehensive understanding of the  Service’s financial condition and outlook and how postal rates are aligned  with costs. Earlier I discussed the past issues we have raised related to the  Service’s financial reporting and the improvements that the Service has  recently made. We have also reported on the long-standing issues of  ratemaking data quality that continue to persist.
The act establishes new reporting and accounting requirements that  should help to address this challenge. The major change is the  establishment of, and authority provided, to the new PRC to help enhance  the collection and reporting of information on postal rates and financial  performance (see table 2).
Service officials have acknowledged the importance of financial reporting,  but stated that there are cost implications associated with these  improvements. The Service has recognized that it will incur costs in  complying with the Securities and Exchange Commission’s (SEC) internal  control reporting rules and by changes needed to provide separate  information for competitive and market-dominant products. We have  reported that significant costs have been associated with complying with  the SEC’s implementing regulations for section 404 of the Sarbanes-Oxley  Act, but have also reported that costs are expected to decline in  subsequent years given the first-year investment in documenting internal  controls.
As the Service transitions to these new reporting and accounting  requirements, its ability to address future challenges in this area will be  impacted by uncertainties including:    How will the PRC use its discretion to define and implement the new  statutory structure?
What criteria will PRC use for evaluating the quality, completeness, and  accuracy of ratemaking data, including the underlying accounting data and additional data used to attribute costs and revenues to specific types of  mail?
How will PRC balance the need for high-quality ratemaking data with the  time and expense involved in obtaining the data?
How will PRC structure any proceedings to improve the quality of  ratemaking data and enable the Service and others to participate in such  proceedings? What proceedings might PRC initiate to address data quality  deficiencies and issues that PRC has raised in its recent decision on the  rate case?
How will the Service be impacted by the costs associated with complying  with the SEC rules for implementing section 404 of the Sarbanes-Oxley  Act, as well as for the requirement of separate information for competitive  and market-dominant products?
section_title: Managing Its Workforce
paragraphs: The Service will be challenged to manage its workforce as it transitions to  operating in a new postal environment. The Service is one of the nation’s  largest employers, with almost 800,000 full and part-time workers.  Personnel-related costs, which include compensation and benefits, are the  Service’s major cost category and are expected to increase due to the  reform legislation requirements to begin prefunding retirement health  benefit costs. We have reported on the human capital challenges facing the  Service, but have found the Service has made progress in addressing some  of these challenges by managing retirements, downsizing, and expanding  the use of automation.
Provisions in the reform act related to workforce management can build  on these successes. As part of the Postal Service Plan mandated by the act,  the Service must describe its long-term vision for realigning its workforce  and how it intends to implement that vision. This plan is to include a  discussion of what impact any facility changes may have on the postal  workforce and whether the Postal Service has sufficient flexibility to make  needed workforce changes.
The Service, however, faces human capital challenges that will continue to  impact its financial condition and outlook:    Outstanding labor agreements: Labor agreements with the Service’s four  major unions expired late in calendar year 2006. In January 2007, the  Service reached agreements with two of these unions, including semi- annual cost-of-living adjustments (COLA) and scheduled salary increases.  Labor agreements, however, remain outstanding for the other two unions  that cover over 42 percent of its career employees.
Workforce realignment: As the Service continues to make significant  changes to its operations (i.e., rationalize its facilities, increase  automation, improve retail access, and streamline its transportation  network), it will be challenged to realign its workforce based on these  changes. This challenge may become more significant as mailers alter their  behavior in response to the new rate structure. These actions will require a  different mix in the number, skills, and deployment of its employees, and  may involve repositioning, retraining, outsourcing, and/or reducing the  workforce.
Retirements: The Service expects a significant portion of its career  workforce—over 113,000 employees—to retire within the next 5 years. In  particular, it expects nearly half of its executives to retire during this time.  The Service’s decisions regarding these retirements (that is, whether or  not to fill these positions, and if so, when, with whom, and where) may  have significant financial and operational effects.
The following uncertainties will affect the Service’s ability to address  workforce-related challenges in the future:    How will the Service be able to respond to operational changes? How will  the Service balance the varying needs of diverse customers when  realigning its delivery and processing networks?
How will employees and employee organizations be affected and informed  of network changes and how will the Service monitor the workplace  environment?
How will the resolutions to the outstanding labor agreements affect the  Service’s financial condition?
How will the Service take advantage of flexibilities, including allowing  more casual workers to deal with peak operating periods?
section_title: Key Issues and Areas for Continued Oversight
paragraphs: The Postal Service, the PRC, and mailers face a challenging environment  with significant changes to make in the coming months related to  implementing the recent rate decision and the new postal reform law. We  have identified several major issues considered significant by various  postal stakeholders, as well as areas related to implementation of the law  that will warrant continued oversight. Specifically, focusing attention on  these issues during this important transition period will help to ensure that  the new statutory and regulatory requirements are carried out according  to the intent of the reform act and that the Service’s future financial  condition is sound. These key issues and areas for continued oversight  include:  the effect of the upcoming rate increases and statutory changes on the  Postal Service’s financial condition; the decision by the Service whether or not to submit a rate filing under the  old rate structure;   actions by the PRC to establish a new price-setting and regulatory  the Service’s ability to operate under an inflationary price cap while some  of its cost segments are increasing above the rate of inflation;   actions by the Service, in consultation with the PRC, to establish modern  service standards and performance measures, and the Postal Service’s  plan for meeting those standards; the Service’s ability to maintain high-quality delivery service as it takes  actions to reduce costs and realign its infrastructure and workforce; and the PRC’s development of appropriate accounting and reporting  requirements aimed at enhancing transparency and accountability of the  Service’s internal data and performance results.
One of the most important decisions for monitoring in the short term is  whether or not the Service decides to file another rate increase before the  new rate structure takes effect. The trade-offs involved in the Service’s  decision on whether to file under the new or old systems include weighing  the respective costs, benefits, and possible unintended consequences of  the Service’s need for new rates along with the time and resources  required by the Service, the PRC, and the mailing industry to proceed  under either the new or old systems. For example, the Service may benefit  from filing under the old system because it would allow the Service to  further align costs with prices prior to moving into price-cap restrictions.  Under the old rules, the Service would have to satisfy the “break-even”  requirements that postal revenues will equal as nearly as practicable its  total estimated costs. Under the new rules, the Service would have to  ensure that rate increases for its market-dominant products do not exceed  a cap based on the growth in the Consumer Price Index. Filing under the  old system, however, could put additional strain on mailers and the PRC.  In particular, the PRC would be reviewing the Service’s rate submission  while transitioning to its new roles and responsibilities under the  legislation—establishing a new organization structure, a new regulatory  framework with new rules and reporting requirements, which must  include time for public input, and a multitude of additional requirements.
Recognizing these challenges, the Chairman of the PRC has suggested  (and asked for public comments on) that rather than expending resources  on extending the application of the old system, the PRC would work with  the Service and mailers to implement the new regulatory systems even  sooner than the 18 months allotted by the new law. This action could  allow the Service to implement new rates sooner under the new regulatory  system depending upon when the PRC completes its work and the Service  chooses to file new rates. The Service’s decision will not only impact its  financial performance and condition, but also the mailing industry and the  focus of the PRC.
Another key provision of the law that warrants close oversight is the  requirement for the Service to develop modern service standards. We are  encouraged by the Service’s actions to date to establish a workgroup that  includes participants from the mailing industry to review and provide  recommendations on service standards and measures. This workgroup is  expected to complete their work in September of this year, and the Service  is to make its decisions on the new service standards by December 20,  2007. The Service then has 6 months to provide Congress with a plan on  how it intends to meet these standards, as well as its strategy for  realigning and removing excess capacity from the postal network. We  believe this plan is a particularly important opportunity to increase  transparency in these areas, particularly given the changes to the Service’s  plans for network realignment and the limited information available to the  public. We will be reporting this summer on the status and results of the  Service’s efforts to realign its mail processing network.
Finally, the PRC’s role in developing reporting requirements is critical to  enhancing the Service’s transparency regarding its performance results.  Congress was particularly mindful in crafting the reform act to ensure that  the provisions for additional pricing flexibility were balanced with  increased transparency, oversight, and accountability. The new law  provides the regulator with increased authority to establish reporting rules  and monitor the Service’s compliance with service standards on an annual  basis.
The successful transformation of the Postal Service will depend heavily  upon innovative leadership by the Postmaster General and the Chairman  of the PRC, and their ability to work effectively with their employees,  employee organizations, the mailing industry, Congress, and the general  public. It will be important for all postal stakeholders to take full  advantage of the unique opportunities that are currently available by  providing input and working together, particularly as challenges and  uncertainties will continue to threaten the Service’s financial condition  and outlook.
Chairman Davis, this concludes my prepared statement. I would be  pleased to respond to any questions that you or the Members of the  Subcommittee may have.
section_title: Contact and Acknowledgments
paragraphs: For further information regarding this statement, please contact Katherine  Siggerud, Director, Physical Infrastructure Issues, at (202) 512-2834 or at  siggerudk@gao.gov. Individuals making key contributions to this  statement included Teresa Anderson, Joshua Bartzen, Kenneth John, John  Stradling, Jeanette Franzel, Shirley Abel, Scott McNulty, and Kathy  Gilhooly.
section_title: Appendix I: Summary of Recent Rate Developments
paragraphs: Postal Service submits proposal to Postal Rate Commission (PRC)
Requests rate increases effective May 2007.
Establishes pricing structure based on mail weights and shapes:    Revises old structure which was primarily weight-based.
Recognizes that different mail shapes have different processing costs.
Gives mailers an opportunity to minimize their rates by altering shape of mail.  2/26/07  PRC issues recommended decision on Service’s proposal  Issued after detailed administrative proceeding involving mailers, employee  organizations, consumer representatives and competitors.
Recommends revisions to many of the rates and rate designs submitted by the  Increases rates substantially for some types of mail.
Revised  rates  are  intended  to  more  accurately  reflect  costs  and  send  proper    Concurs with shape-based pricing structure and, according to the PRC, the  change in rates will still meet the Service’s revenue needs.
Anticipated that this would have been the last rate case initiated prior to  implementation of the new rate structure established under the reform legislation  and explained that its recommended rates are intended to provide a sound  foundation for the future.  3/19/07  Postal Service’s Board of Governors issues decision to implement PRC- Implements most rates effective May 14, 2007.
Asks PRC to reconsider some rates, most notably those for flat-sized Standard  Mail, which is generally advertising and direct mail solicitations (this could lead to  further changes in these rates).
Delays rate implementation for Periodicals for over 2 months, citing reactions of  magazine mailers and the publishing industry’s need to update software.
The Forever Stamp will sell at the First-Class one-ounce letter rate, and will continue to be worth the  price of a First-Class one-ounce letter even if that price changes.
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