USPS’s financial condition and outlook continue to be challenging despite recent congressional action that relieved USPS of $4 billion in mandated payments to prefund postal retiree health benefits by September 30, 2009. Preliminary results from the end of fiscal year 2009 and USPS’s outlook include: In fiscal year 2009, mail volume declined about 28 billion pieces, or about 14 percent, from the prior fiscal year, when volume was about 203 billion pieces; revenue declined from about $75 billion to about $68 billion. A looming cash shortfall necessitated last-minute congressional action to reduce USPS’s mandated payments to prefund retiree health benefits from $5.4 billion to $1.4 billion. In the absence of this congressional action, USPS was on track to lose about $7 billion. USPS and its auditors are currently considering whether the $4 billion in relief will be booked in fiscal year 2009 or fiscal year 2010. Regardless of the outcome, USPS will have a large net loss for the third consecutive fiscal year and one of its largest losses in decades (see fig. 1). USPS debt at the end of fiscal year 2009 increased by the annual statutory limit of $3 billion, bringing outstanding debt to $10.2 billion. If debt continues to increase by $3 billion annually, USPS will reach its total statutory debt limit of $15 billion in fiscal year 2011. Looking forward, USPS has projected annual deficits exceeding $7 billion in fiscal years 2010 and 2011, and continuing large cash shortfalls. As we previously reported, USPS’s cost-cutting efforts and rate increases have not fully offset the impact of huge declines in mail volume (a decline of about 28 billion pieces in fiscal year 2009) and other factors—notably semi-annual cost-of-living allowances (COLA) for employees covered by union contracts. Compensation and benefits constitute close to 80 percent of USPS costs—a percentage that has remained similar over the years despite major advances in technology and automating postal operations. These costs declined by 1.3 percent in the first 11 months of fiscal year 2009 (the most recent data available) as compared to the same time period in fiscal year 2008, in contrast to other costs such as transportation, supplies and services, and depreciation, which together declined 8.2 percent. Over this same period, total revenue declined by 8.6 percent, including declines of 9.1 percent for market-dominant products and about 4.0 percent for competitive products. (See app. I for a summary of market- dominant and competitive products.) About 88 percent of USPS revenue was generated from market-dominant products and services, with competitive products and services generating about 12 percent of rcent of revenues (see fig. 2). revenues (see fig. 2). PAEA and implementing Postal Regulatory Commission (PRC) regulations provided USPS with greater flexibility to set prices, test new postal products, and retain earnings so that it can finance needed capital investments and repay its debt. PAEA abolished the former ratemaking structure that involved a lengthy, costly, and litigious process. Under the new structure, USPS has broad latitude to announce rate changes that are implemented in a streamlined process unless PRC determines these rates would violate legal requirements. Key requirements and flexibilities provided in the law include: A price cap based on the Consumer Price Index generally applies to market-dominant classes of mail, such as First-Class Mail and Standard Mail. This means that in general, USPS has the flexibility to increase some individual rates either above or below the rate of inflation as long as the average rate increase for each class of mail does not exceed the cap. USPS can request that PRC approve a rate increase that exceeds the price cap on the basis of extraordinary or unexpected circumstances (postal stakeholders refer to this as an “exigent” rate increase). PRC must determine whether such an increase would be reasonable, equitable, and necessary “to maintain and continue developing postal services of the kind and quality adapted to the needs of the United States.” Worksharing discounts for market-dominant products are generally limited to the costs avoided by USPS as a result of specified mailer activities. Each competitive product must generate sufficient revenues to cover its costs. In addition, competitive products must collectively cover what PRC determines to be an appropriate share of USPS’s overhead costs. PRC has determined this share to be 5.5 percent of USPS’s overhead costs. Within these constraints, USPS was given broad pricing flexibility for its competitive products, which are not subject to a price cap. USPS can also establish volume discounts for competitive products as well as enter into contract rates with individual mailers. PAEA generally restricted USPS to offering postal products and services by prohibiting it from initiating new nonpostal products and services. USPS was required to discontinue existing nonpostal products—such as passport photo services and photocopying services—except for those that PRC determined should be continued. Subsequently, PRC determined that most existing USPS nonpostal products should be continued. In the short time since PAEA was enacted, with the exception of annual rate increases, revenue-generation actions have generally achieved limited results compared to USPS’s deficits. We commend USPS for taking action to use its pricing flexibility to address the pressing need for additional revenue. Although these actions generated some revenues, their positive impacts were overwhelmed by the recession—with its cutbacks in consumer spending and corporate advertising—and ongoing diversion of mail to electronic alternatives. Further, the potential of some actions was limited because they applied to types of mail that generate only a small fraction of USPS revenues. Other actions, such as targeted sales for some types of mail, were implemented this year with little advance notice, which may have limited mailer response. Key USPS revenue-generation actions since PAEA was enacted are summarized below. Rate Increases for Market-Dominant Mail: Under the ratemaking system established by PAEA, USPS annually increased rates in 2008 and 2009 for market-dominant classes of mail at virtually the maximum allowable amount under the price cap. To put this into context, historically, rate increases have been a key action that USPS has taken to remain financially viable. Volume-Based Incentives for Specific Types of Market-Dominant Mail: USPS has recently implemented three targeted rate incentives to stimulate additional mail volume and take advantage of its excess operational capacity. First, a 2009 “summer sale” for Standard Mail offered lower rates for volumes that exceeded specific thresholds, with the goal of increasing mail volume during a typically slow period. Second, an ongoing “fall sale” for First-Class Mail aimed at commercial mailers is providing lower rates for volume over specific thresholds. Third, an ongoing Saturation Mail incentive program also is providing lower rates for volume over specific thresholds. Negotiated Service Agreements (NSA) for Market-Dominant Products: According to USPS data, its seven NSAs for market-dominant products collectively did not generate any net revenue in fiscal years 2007 and 2008 combined. These NSAs generally offered mailers lower rates for volumes that exceeded specific thresholds. Mailers also agreed to actions to reduce some USPS costs, such as the substitution of electronic notices in lieu of USPS returning undeliverable advertising mail. Rate Changes and Contract Rates for Competitive Products: Under the ratemaking system established by PAEA, USPS annually increased rates in 2008 and 2009 for competitive products such as Priority Mail and Express Mail. USPS also made product and pricing changes to enhance their competitiveness, such as a new small flat-rate box for Priority Mail and the introduction of zone-based rates for Express Mail. USPS has introduced volume discounts for Express Mail, Priority Mail, and bulk Parcel Post. USPS has also introduced lower rates for electronic postage used for some competitive products such as Express Mail and Priority Mail. In addition, USPS has entered into close to 90 contracts with mailers of competitive products that included Priority Mail, Express Mail, bulk Parcel Post, Parcel Return Service, and various types of bulk international mail. These contracts are generally volume based and have provisions intended to lower USPS’s mail handling costs. USPS does not publicly report results for its individual contracts because it considers this information to be proprietary. Looking forward, USPS has opportunities to continue pursuing the flexibilities provided by PAEA to help generate additional revenue from postal products and services. For example, USPS is continuing to pursue its “Click-N-Ship” initiative that allows customers to print out mailing labels with postage, as well as flexible pricing for Express Mail, Priority Mail, and bulk Parcel Post. USPS is also promoting voting by mail to stimulate additional First-Class Mail volume. However, results from USPS revenue-generation efforts will continue to be constrained by the economic climate and by changing use of the mail. USPS has asked Congress to change the restrictions established by PAEA so that it could offer new nonpostal products and services such as banking and insurance. However, USPS has not presented a business plan which details what markets it might enter, its prospects for profitability, and what specific legislative changes would be needed. Allowing USPS to compete more broadly with the private sector would raise risks and concerns. As with USPS’s nonpostal ventures before PAEA was enacted, new nonpostal ventures could lose money; and even if they were to make money, issues related to unfair competition would need to be considered. On the other hand, increasing postal rates may provide a short-term revenue boost but would risk depressing mail volume and revenues in the long term, in part by accelerating diversion of payments, communications, and advertising to electronic alternatives.