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

Letter

Recent Actions Warranted the Postal Service’s Removal from Our High-Risk List

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.

The Postal Service’s Current Financial Condition

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.

Postal Reform Law Provides Opportunities to Address Challenges

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.

Generating Sufficient Revenue as First-Class Mail Volume Is Declining and Mail Mix Is Changing

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)?

Controlling Costs and Improving Productivity

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?

Maintaining, Measuring, and Reporting Service

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?

Financial Performance Reporting

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?

Managing Its Workforce

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?

Key Issues and Areas for Continued Oversight

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.

Contact and Acknowledgments

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.

Appendix I: Summary of Recent Rate Developments

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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