Opinion ID: 370472
Heading Depth: 1
Heading Rank: 3

Heading: service related costs

Text: 53 It is to the credit of USPS and the PRC that they have departed from their initial approach to postal ratemaking and have sought with reasonable fidelity to apply the legislative intent as delineated by this court. The task that confronted them in this ratemaking proceeding was formidable. Yet at the present juncture the primary dispute over cost allocation revolves about the allocation of only 7.14 percent of the Postal Service's total revenue requirement. 30 That is the percentage the PRC found reasonably assignable to certain classes of mail as service related costs calculated as the fixed delivery costs incurred in maintaining a six-day-a-week, as opposed to a three-day-a-week, delivery schedule. The parties raise numerous challenges to the rationality of this assignment pattern. With the deference we accord the PRC's expert judgment in developing cost allocation methods, we find this method of allocation to be reasoned, nonarbitrary, and congruent with the legislature's objective. 54 Further discussion of the issue requires that we delve in some detail into the mechanics of the cost allocation process. The PRC essentially followed the approach of USPS's initial presentation, although it developed its own figures in many instances. For convenience, we shall refer in our discussion only to the PRC. 55
56 It is useful to start with a brief sketch of the various mail classifications as they are defined in the Domestic Mail Classification Schedule. 31 The four general classifications of mail are probably familiar to most mail users. First-class consists of letters and sealed parcels weighing 12 ounces or less, plus postal cards and post cards. 32 Priority mail is a high priority service akin to first-class for sealed parcels weighing more than 12 ounces. 57 Second-class and Controlled circulation are available for magazines, newspapers and other periodicals. Second-class is divided into several subclasses and subcategories. Second-class regular rate is the one that encompasses the vast majority of second-class mailings. Second-class is essentially for bulk, not single piece, mailing. 58 Third-class is a service for single pieces and bulk mail, consisting of matter that is not mailed or required to be mailed as first-class, is not entered as second-class or controlled circulation, or weighs too little to qualify as fourth-class. Single piece service is used by individuals for small parcels and by organizations for minor distribution of parcels, catalogs and other printed matter. Bulk mail service is used by businesses, institutions or government agencies to send brochures, catalogs, samples or other matter in mailings of 200 pieces or more or with a total weight of 50 pounds or more. 59 Fourth-class includes parcel post (merchandise weighing 16 ounces or more); bound advertising matter; books, films, sound recordings and other matter entitled to a special rate; and library rate mail. 60 USPS also offers Express Mail (an expedited delivery service to and from some cities) and many other special services, such as certification, registration and C.O.D.
61 As its first step, the PRC determined USPS's revenue requirement by projecting its costs for each of 20 cost segments 33 based on estimates of the volume of mail that would be generated at the proposed rates. 34 The PRC determined the revenue requirement to be $17,585 million, 35 modifying USPS's calculation slightly. 62 Within each cost segment, the PRC then determined the percentage of costs that could be said to vary with volume over either the short or long run. This percentage was then available for attribution to the various classes by application of an appropriate distribution key. In the PRC's opinion, cost variability with volume remained the key to attribution. It stated that it could not have reasonable confidence that costs were in fact the consequence of providing the service unless 63 there is at least some showing of volume variability over the long run. If costs do not vary with volume over either the short or long run, there is still the possibility of cost assignment under (NAGCP I ), but we see no basis for attribution, if we are to maintain any distinction between attribution and assignment. 36 64 In view of USPS's improved data on long run variable costs, the Commission found NAGCP I 's requirement of extended attribution satisfied. The PRC called for further improvements in data to lessen the need for reliance on mere inferences of causation. 37 65 The PRC apparently takes the position that mere inferences of causation beyond volume variability are not an appropriate basis for attribution. 38 This is not entirely congruent with that part of the language of the NAGCP I opinion that prescribed Attribution of costs through variability theory as well as through other reasonable inferences of causation. 39 Since no party has challenged the PRC decision on this point, we do not pass on it. 40 We do observe, however, that the PRC was struggling with the NAGCP I court's rather murky distinction between attribution (for reasons other than volume variability) and assignment, both of which were to proceed from inferences of causation. 41 Taking into account the PRC's expansion of the scope of attributable costs based on variability, its relegation of costs derived from inferences of causation to the assignable category alone may well have been an appropriate application of NAGCP I. The context is one in which USPS's enhanced ability to attribute costs on the basis of volume variability resulted in the attribution, after PRC modification, of almost 65 percent of total costs. 42
66 The PRC's assignment of service related costs proceeded from differences in service accorded the various classes of mail. The Postal Service Manual commits the Service to different standards of service for different types of mail, based on USPS's perception of customer needs, and transportation and distribution capabilities. 43 For first-class mail and for newspapers (a service category within the second-class regular rate classification, also known as red tag mail 44 ), the Manual requires delivery on the first delivery trip if the mail is received at a distribution facility prior to the cut-off time. 45 For third- and fourth-class parcels, USPS is required to deliver on the next delivery trip all parcels received prior to the cutoff, 46 but the post offices have more flexibility in determining that cutoff. For all other mail, including third-class mail and second-class publications not entitled to red tag service, the regulations provide for delivery not later than the second day after receipt. 47 67 Two witnesses provided the main evidence before the Commission. Postal Service witness Jellison, the Assistant Postmaster General for Mail Processing, testified on the differences in service standards. Jellison first ranked the priorities of treatment given the various classes of mail, in order of decreasing significance: (1) first-class mail, including priority mail and post or postal cards; (2) newspapers or red tag mail; (3) parcels (both third- and fourth-class); (4) ordinary papers (all second-class not entitled to red tag service and controlled circulation); and (5) circulars (fourth-class bound printed matter and all third-class except single piece parcels). Jel lison then characterized first-class and newspapers as preferential because of the requirement of immediate delivery upon receipt at the distribution facility; parcels as borderline preferential; and the other classes as nonpreferential or deferrable because of the ability to defer delivery of that mail for two days after it reached the distribution facility. The witness differentiated the levels of service afforded preferential and nonpreferential mail at each stage of the mail process between receipt and delivery. He asserted that while preferential and nonpreferential mail were often delivered together, deferrability of some classes permitted workload levelling, and avoidance of the need for overtime or part-time employees, at peak periods, with resultant efficiencies. Jellison concluded that because of the deferrability feature, nonpreferential service standards could be met by delivery every other day, as opposed to the current six-day delivery schedule. In his view, were it not for the existence of preferential mail, a three-day delivery system with recipients receiving mail every other work day would be feasible. 48 68 Based on Jellison's conclusion as to the feasibility of a three-day delivery schedule, USPS witness Hume, a private consultant, sought to calculate the costs resulting from the need to maintain six-day delivery to meet preferential service standards. 49 Although transportation and processing costs would likely be affected by initiation of a three-day schedule, Hume focused only on the delivery function. He found that in the other two functions, service related costs either were volume variable (and therefore would be accounted for in the attribution step), or could not be determined with sufficient accuracy from available data. 50 69 Hume estimated the delivery costs that would be incurred in a three-day delivery system, assuming no variations in total mail volume. By subtracting this figure from the projected delivery costs in the six-day delivery system, he obtained the delivery costs occasioned by maintenance of a six-day schedule. Because variable costs would be attributed under either schedule, he then determined the proportion of delivery costs that would be fixed under each system. The difference in fixed costs he assigned as service related costs to the classes receiving preferential service. 70 The PRC approved the methodology proposed by the USPS witnesses. It found that nonpreferential mail is deferrable under the Postal Service's standards and that, in fact, such mail is frequently deferred. 51 It agreed with the Postal Service that it can reasonably be inferred that the preferred classes cause the differential between 3-day and 6-day delivery costs. 52 Adjusting somewhat USPS's calculations, the PRC made an assignment of $1,256 million in test year costs, or 7.14 percent of the total revenue requirement. 53 71 While asserting that, as a first effort, the use of service-related costs was satisfactory, the Commission urged further refinement in three areas: (1) the analysis used in determining the cost differentials resulting from service priorities at the delivery stage; (2) the development of data and methodology to reflect more accurately the actual hierarchy of delivery standards in the assignment of service related costs; and (3) more complete investigation into the possibility of extending service related costs to functions other than delivery. 54 72
73 In considering the various challenges to the assignment of service related costs, we recall that we judge a particular ratemaking methodology by whether it is reasoned, nonarbitrary and congruent with the statutory mandate. We do not insist on mathematical precision in developing new ratemaking methods; mere articulation of imperfections in a new scheme will not alone defeat it. This is especially true in cost Assignment, where, as NAGCP I recognized, there is a wide scope for the exercise of judgment and discretion by the PRC. With this overview, we conclude that the service related cost method reflects a reasonable inference of causation, and despite the imperfections identified by the parties, represents an acceptable first effort at meeting the strictures of NAGCP I. Our conclusion is supported by PRC's avowed intention to require refinement of the service related cost method in future rate proceedings. 74 The newspaper publishers 55 attack the assignment of service related costs as arbitrary and unreasonable on the ground that nonpreferential mail is rarely, if ever, deferred in the delivery function. According to these parties, the current delivery system is designed to ensure that each carrier can deliver each piece of mail he receives at the delivery unit each working day. To further this design, the Postal Service conducts an annual review of its routes and adjusts them to guarantee delivery of all mail that comes into the delivery unit. 56 On heavy volume days, delivery service managers may use overtime or auxiliary help, but deferral is discouraged. 57 Instead, it is argued, most deferral occurs not at the delivery stage, but in mail processing units before reaching the delivery unit. 58 Based on these facts, the publishers submit that it is arbitrary and unreasonable to apportion costs upon the basis of a theoretical differential between preferential and nonpreferential mail in the delivery function. 59 75 The publishers do not dispute that deferral can and does occur relatively frequently at some point in the mail handling process. The deferrability gives rise to differences between preferential and nonpreferential mail in the overall level of service provided. Accordingly, it was not unreasonable for the PRC to infer that the preferential classes may be called upon to bear the cost of providing the capacity I. e., six-day delivery necessary for this preferential service. The PRC reasoned that if all mail were nonpreferential, then three-day delivery would be feasible, and that the additional fixed costs resulting from maintenance of the six-day schedule could be determined. The primary source of such costs was found in the delivery unit, but the PRC recognized that, with improved data, such costs could be determined for other functions as well. In drawing this inference of causation, the salient feature was overall level of service, not whether, under current practice, the deferral that does take place occurred within any particular function. 76 Recognition that overall service levels, and not deferrability within one function, provide the key to service related costs also forms the basis for distinguishing the PRC's rejection of the citizens' rate. As explained by Judge Tamm in the companion opinion, that special rate was premised on deferrability in the delivery function Only. 60 The PRC concluded that because such deferral was unlikely to occur in practice, there would be no difference in overall service that would justify an unequal allocation of delivery costs as between citizens' rate and regular first-class mail. On the other hand, in the case of preferential versus nonpreferential mail, there are conceded differences in overall service that do justify disparate cost assignments. 77 The newspaper publishers, joined by the first-class mail users, 61 make a further argument. For this purpose they assume, in effect, the reasonableness of the PRC model in determining costs that are caused by the need to maintain a six-day delivery schedule. Although the non-preferential classes may not require six-day delivery, in practice they are often delivered without deferral, and so receive the benefit of six-day delivery capacity. By assigning capacity costs entirely to the preferential classes, they argue, the PRC gives the nonpreferential classes a free ride. These parties contend that such a free ride is contrary to legal precedent and sound economics. They point to Colorado Interstate Gas Co. v. FPC, 324 U.S. 581, 65 S.Ct. 829, 89 L.Ed. 1206 (1945), as prohibiting such a free ride by theoretically interruptible customers who get the benefit of capacity provided to serve peakload customers. While Colorado Interstate does lean against free riders, it does not establish a legal prohibition against assigning all capacity costs to peakload customers. That case rather affirmed the FPC's discretion to require interruptible customers to bear some portion of capacity costs. 78 In general we agree with the first-class users that there is good reason, in economics and common sense, to call upon nonpreferential classes to contribute to the capacity costs used in providing them a benefit. 62 However, as applied to the costs entailed in maintaining a six-day system, the question is not a simple one. There is a question whether and to what extent the users of this nonpreferential mail receive a benefit of value. On the record, we cannot hold that the PRC abused its discretion in choosing as of this ratemaking proceeding not to require the nonpreferential classes to contribute to the differential in capacity costs ascribable to a six-day system. 79 Various parties attack the PRC for failing to justify fully the operational feasibility of its hypothetical three-day delivery schedule. They also assert that the PRC erred in assuming that all other aspects of postal operations would remain relatively constant under a three-day system and in failing to consider the effects on costs of distortions in the postal system that would result from three-day delivery. The PRC did provide a discussion of the feasibility of the three-day system. 63 While some of its assumptions are, to put it mildly, optimistic, we cannot say that the system is so unrealistic a model as to call into question the rationality of the conception underlying ser vice related costs. A model may be useful for purposes of analysis, though it premises a condition that has not been and indeed cannot be exactly duplicated in real life. A familiar instance is the model of Newton's laws of motion with its (unrealistic) premise of a world without friction. 80 More substantial is the contention that the Postal Service had an obligation to consider the effect of a three-day system on other functions of the postal system. However, the PRC did not reject the need to make its model as realistic as feasible. Instead, it found as a fact that the other functions of the Postal Service would remain relatively stable, without significant distortion from the institution of a three-day system. 64 That conclusion finds support in the record. 65 It must be remembered that we deal here with inferences of causation. The PRC may draw reasonable inferences of causation without resolving all subsidiary issues, especially those that would require extensive and disproportionate effort. 81 The magazine publishers 66 challenge the reasonableness of the service related cost concept on the ground that the service standards on which it was based do not reflect any determination as to which classes actually need six-day delivery and which can therefore be said to cause the six-day delivery schedule. They argue that the existing service standards were adopted as the basis for service related costs without investigation into whether the classes receiving preferential service under the standards actually required that preference. Specifically, the magazine publishers contend that magazines require delivery only two days a week; hence, magazines, at least, cannot be said to cause six-day delivery. 82 The issue raised by this contention is substantial, but in the last analysis it does not warrant rejection of the PRC's methodology. While the mail system is bounded by constraints against undue preferences or discrimination, it need not be, and probably could not be, tailored to match perfectly individual customers' perceptions of their own service needs. In mail classification, judgments are properly made that similarities between types of mail or mail users justify their inclusion within a single class, even where there might be differences among them in the service desired. Thus, daily newspapers, which presumably demand prompt delivery, are included in second-class with magazines of various publication frequencies. 67 Their similarities are evident, especially in the context of their joint entitlement to a congressionally mandated preference based on their key characteristics of regularity of publication and type of information conveyed. 68 The Postal Service must be afforded broad discretion to manage its operations efficiently by developing service priorities. In making these decisions, USPS need not restrict itself only to considerations of customer need, but may also take into account such operational factors as transportation availability and distribution capabilities. So long as these service priorities are not manifestly unrealistic, USPS is not obliged to undertake a comprehensive review of its service priorities before those priorities may form the basis of cost allocations. In this case, it was not manifestly unrealistic for USPS to conclude that magazines published weekly or more often (and therefore entitled to red tag service) would, like daily newspapers, require the prompt delivery accorded by a six-day schedule. 83 In a similar vein, the magazine publishers and mailers of third- and fourth-class parcels 69 contend that it was arbitrary to assign costs on an all-or-nothing basis depending on whether a class was designated pref erential or nonpreferential, when the service priorities as described by witness Jellison form not a simple dichotomy but rather a hierarchial array with first-class taking precedence over all other classes. The result, these parties contend, is discrimination the assignment of equal cost responsibility for unequal degrees of service. While there is some merit to this objection, we do not find it fatal in the context of this ratemaking proceeding. USPS and the PRC, in developing the service related cost method, endeavored to meet this court's mandate in NAGCP I. In the initial implementation of a new ratemaking approach, some leeway for approximation and estimation must remain. The courts often uphold regulatory actions on the premise that the approximations will be subject to refinement. 70 The rough categorization of service priorities into preferential and nonpreferential was a reasonable first approximation in tracing the costs of providing the various levels of service. That this dichotomy may not suffice in future proceedings is highlighted by the PRC's exhortation to USPS to develop data and methodologies that will reflect more accurately the hierarchy of service priorities. We prefer to leave such efforts at refinement of methodologies in the hands of the PRC. 84 This approach also serves to dispose of the parcel mailers' further claim of error in the PRC's failure to determine actual operating priorities before assigning costs on the basis of hypothetical service priorities. Such a study, they believe, would prove that borderline classes I. e., parcels are actually afforded nonpreferential treatment. We do not find it unreasonable to draw inferences of causation without detailed studies of actual operating practices, at least in the context of an initial effort. We again note the PRC's request that USPS provide more accurate data on service priorities in future proceedings. 85 Finally, we do find substance to the claim of American Business Press, Inc. (ABP), an association of publishers of specialized business publications. Despite the fact that preferential or red tag second-class mail makes up only 40 percent of all second-class mail, the PRC assigned to all second-class, both preferential and nonpreferential, the service related costs caused by providing preferential service to red tag. We agree with ABP that assignment of service related costs to mail not receiving preferential service raises serious concerns of discrimination. 71 In our preceding discussion, we have accepted, at least for this case, the PRC's adoption of a model based on a dichotomy between preferential and nonpreferential mail, even though that distinction may not entirely reflect actual service priorities. But the failure to distinguish in the assignment of costs between preferential and nonpreferential mail goes contrary to the PRC's own model. 86 Despite our concern, we decline to disturb the PRC's decision at this time. There is some doubt whether the issue was fully ventilated in the proceedings before the PRC. 72 In any event, the Commission has chosen to deal with the issue as a classification matter, rather than in the context of a ratemaking proceeding. In Docket No. MC76-2, the Commission recently rejected a proposed surcharge on red tag mail, as well as a proposal to eliminate the current restriction on the availability of red tag to periodicals with a frequency of once a week or more. 73 The Governors affirmed this aspect of the Commission's recommended decision, but rejected a recommendation that red tag be incorporated into the Domestic Mail Classification Schedule as a separate subclass of second-class. 74 Both decisions indicated that a reexamination of the question would be appropriate in light of the adoption subsequent to the development of the record in that proceeding of the service related cost methodology. 75 The PRC has recently initiated a proceeding, Docket No. MC79-3, to undertake that reexamination. 76 Although, as this discussion reveals, mail classification and postal rate issues are often intertwined, the Act establishes separate, though parallel, procedures for considering each of them. 77 While it is feasible, and perhaps desirable, to consolidate the consideration of classification and rate issues where appropriate, 78 the PRC did not act arbitrarily in choosing to explore this matter in the context of classification proceedings. We therefore defer to the PRC's pending proceeding where the issue will receive further analysis, with this court's concern in mind. 79