Business, Innovation and Skills Committee - Stamp PricesWritten evidence submitted by Ofcom

When Chris Rowsell, Gavin Knott and I appeared before you on 21 February, I promised to write with additional information in a number of areas. I set these out below.

International Benchmarking of the UK’s Stamp Prices

The Committee asked for more evidence on Ofcom’s international benchmarking and details on where the UK’s stamp prices currently stand in comparison to other countries in Europe. Below we have summarised information that we published in our October consultation (and associated documents), and relevant information we received as responses from key stakeholders.

In the consultation document Securing the universal postal service: Proposals for the future framework for economic regulation,1 pages 24–25, we state:

Until recently Royal Mail’s prices compared favourably with those in other EU countries. Due to the more recent price rises, its prices for basic weight stamps are now much more aligned with international comparators, although Figure 3 shows that a like-for-like analysis of prices across First Class services, Royal Mail’s prices for 0–100g services remain low.

Footnote 23: It is important, however, to recognise the caveats that need to apply to international comparisons—in particular the universal service requirements vary considerably between different EU member states, it does not include both a First and Second Class service for most countries, and other countries offer more than one service in the 0–100g range. In addition, costs will vary significantly due to factors such as geography and quality of service standards.

Figure 3

EU-15 AVERAGE FIRST CLASS STAMP PRICES UP TO 100G USING UK VOLUME WEIGHTS, MAY 2011

The two slides below come from Ofcom’s stakeholder briefing presentation of 20 October 2011 on Securing the universal postal service: The future framework for economic regulation.2

In its response to the October consultation, Royal Mail provided the following chart comparing stamp prices in Europe.3

The Definition of “Vulnerable Consumers”

We undertook to clarify the definition of “vulnerable consumers” we have applied in undertaking our work on affordability.

The concept of a vulnerable consumer is not specifically defined in either the Postal Services Act 2011 or the Communications Act 2003. Rather, it is a description we have applied to those groups of consumers to which we are required to have regard and/or whom we consider are in need of special protection.

Section 3 of the Communications Act 2003 sets out the general duties of Ofcom. These also apply (where relevant) to the carrying out of our functions under the Postal Services Act 2011. Subsection (4) of this section says: “OFCOM must also have regard, in performing those duties, to such of the following characteristics as appear to them to be relevant in the circumstances”, Subsection 3(4)(h) identifies “the vulnerability of children and of others whose circumstances appear to OFCOM to put them in need of special protection”, and Subsection 3(4)(i) identifies “the needs of persons with disabilities, the elderly and of those on low incomes”.

This section does also identify other groups to which we are to have regard; in particular, “the different interests of persons in different parts of the United Kingdom, of the different ethnic communities within the United Kingdom and of persons living in rural and in urban areas” (Section 3(4)(l) of the Communications Act 2003). While we have had regard, where relevant, to these groups in making our proposals these groups are not in our view inherently vulnerable.

In assessing affordability in the context of vulnerable consumers we have therefore have attached particular significance to the potential impact of any price changes on “the needs of persons with disabilities, the elderly and of those on low incomes”. As we noted during the discussions with the Committee on 21 February, and as is reflected below, we have also taken account of the impact of changes in prices on consumers overall as well as on business users.

Affordability and Consumer Behaviour Research

The Committee requested further information on our analysis of affordability and consumer behaviour and detail on our assessment of the impact of our proposals on different types of business.

In assessing the impact of our proposals to give Royal Mail commercial flexibility we have considered a range of evidence as to the likely impact of price changes on customers, including business and residential customers. We have used the results from three different pieces of research and Royal Mail’s relevant models:

(a)Research undertaken in 2010 by Postcomm and Consumer Focus of 1,398 residential consumers and 460 businesses;4

(b)Consumer Focus research undertaken in November and December 2011 on 2,020 residential online consumers and 212 vulnerable consumers (over 65 or in the DE social class) who did not access the internet at least once a day;5

(c)Ofcom survey of 3,621 residential consumers in December 2011;6 and

(d)Royal Mail’s relevant models.

We have considered the issues of affordability and the impacts on small business and residential customers separately below.

(1) Affordability of universal service products

Postcomm published a discussion paper on affordability in early 2011.7 This concluded that as the average weekly household expenditure on postal services is £0.40 per week, universal service prices remained affordable for residential customers now and for the foreseeable future. In addition, we set out our assumption in the October consultation document8 that while the issue of affordability is more complicated for small businesses, it was our working hypothesis that if prices are affordable for consumers they will also be affordable for small businesses.9

A number of respondents to this consultation challenged these assumptions, particularly with respect to small businesses. However, no respondent provided specific evidence on affordability in respect of either residential or small business customers.

We recognise that, if implemented, our proposal to deregulate to remove the substantial majority of price controls opens the possibility that some universal service prices will increase and could raise affordability concerns in the future. We are in a position where we have to balance such risks against the wider risk to the maintenance of the Universal Service. Therefore, we intend to monitor universal service price changes, and retain the power to intervene as appropriate. We are also planning to undertake further research and analysis on affordability levels for different universal services and types of universal service customers.

(2) Residential customers

As set out above, the average weekly household expenditure on post is very low (£0.40 per week), particularly in comparison to other forms of communication. Vulnerable customers in general appear to send less mail than other residential customers, however older customers (over 65) appear to send more mail (and in particular more letters).

The different surveys of residential mail usage undertaken over the last couple of years consistently show that residential customers are more likely to use First Class rather than Second Class mail. For example the 2010 Postcomm/Consumer Focus research found that 66% of customers say they use First Class all or most of the time when sending letters. When looking at what class of mail vulnerable customers use, there are some differences in the findings from the different pieces of research. Consumer Focus’ 2011 research suggests that while vulnerable customers use mail less, their overall pattern of usage is similar to other residential customers. However, the 2010 Postcomm/Consumer Focus research suggests that vulnerable customers are more likely to use Second Class mail than other residential customers. All of the different surveys did show that vulnerable customers claim to use First Class more than Second Class mail.

However, not all of this mail needs to be delivered the next day. The 2010 Postcomm/Consumer Focus research found that only 39% of residential customers considered all or most of their mail needed to be delivered the next day. The more recent Consumer Focus research found that 65% of people claimed that all or most of their mail needed to be delivered the next day (see figure 1 below). This may be overstated to an extent as the most common types of mail sent at least once per month were personal communications and general correspondence which may be able to be sent Second Class if this was planned in advance.

Figure 1

PROPORTION OF LETTERS SENT FIRST CLASS THAT HAVE TO ARRIVE AT THEIR DESTINATION THE NEXT WORKING DAY

We are also reviewing the usage of large letter and packet products by residential customers in general and vulnerable customers in particular to determine whether the scope of the safeguard cap should be extended to these products. While the data sets involved different questions and methodologies there are some related themes. Consumers as a whole send significantly less large letters and packets than standard sized letters. Royal Mail’s customer data for Second Class stamps shows that nearly 90% of volumes are standard sized letters and our omnibus research indicates that only 9% of residential consumers stated that they use large letter stamps (of which 40% used them for packets and 23% for parcels).

We are considering these areas in more depth in coming to our decision on the appropriate scope of a safeguard cap for vulnerable consumers.

(3) Small business customers

The main source of data for our analysis of business users is the 2010 business research undertaken by Postcomm and Consumer Focus. This research considered small business usage (spend, use of products) by business size, location (ie rural, suburban, urban) and business sector (although as the survey design was based more around company size not much analysis on the weighted data by industry sector was possible).

As can be seen in figure 2 below, SMEs’ monthly spend on postal services is correlated to the size of the business, ie businesses with fewer employees spend less on postal services and those with more employees spend more. The research also found that businesses in rural areas are more likely to use mail than businesses in urban or suburban areas but that they are also more likely to have a low spend of £1 to £25 per month (47%).

Figure 2

MONTHLY MAIL SPEND BY ESTABLISHMENT SIZE

	Total	1–10	11–50	51–249	250+
	(460)	(153)	(106)	(108)	(93)
	%	%	%	%	%
£1–£25	35	38	18	16	3
£26–£100	36	37	37	13	10
£101–£500	19	17	29	31	24
£501+	10	8	16	39	63
Mean	£344	£294	£390	£806	£4,768
Median	£37.50	£37.50	£75	£350	£2,812
Mode	£7.50	£7.50	£75	£750	£3,500

The research also shows (figure 3 below) that overall businesses were more likely than residential customers to say they use Second Class mail all or most of the time, and smaller businesses were more likely to use Second Class than larger businesses. In addition, we found that businesses in rural areas and production and public services were more likely to say that they use First and Second Class postal services equally.

Figure 3

PERCENTAGE THAT MAINLY USE SECOND CLASS BY ESTABLISHMENT SIZE

	Total	1–10	11–50	51–249	250+
	(460)	(153)	(106)	(108)	(93)
	%	%	%	%	%
Second Class all/most of the time	38	40	31	32	23

We also asked businesses what proportion of the mail sent First Class has to arrive at their destination the next working day. Only 55% of respondents considered that all or most of their First Class mail needs to be delivered the next day suggesting that some businesses will also be able to switch to Second Class services if the price of First Class increases significantly in relation to the Second Class price.

Figures 4 and 5 below show SMEs’ usage of different products split by size of business and sector. Larger businesses are more likely to use all products than smaller businesses.

Figure 4

USE OF ROYAL MAIL SERVICES BY ESTABLISHMENT SIZE

	Total	1—10	11—50	51–249	250+
	(460)	(153)	(106)	(108)	(93)
	%	%	%	%	%
Recorded Delivery	84	84	88	90	91
Standard Parcel	71	72	67	74	80
Special Delivery	71	70	75	84	94
Packetpost	52	54	39	53	66
Business collection service	23	22	24	44	61

Figure 5

USE OF ROYAL MAIL SERVICES BY SECTOR

	Total	Production	Retail leisure services	Financial and business	Public services	Other services
	(460)	(93)	(83)	(96)	(93)	(95)
	%	%	%	%	%	%
Recorded	84	79	85	97	73	71
Standard Parcel	71	78	90	60	73	45
Special Delivery	71	70	83	75	52	64
Packetpost	52	45	61	45	74	35
Business collection service	23	33	8	37	5	14

All businesses have been increasingly using online alternatives to physical mail over the last few years but larger businesses are more likely to have moved some of their communication to these channels.

Most SMEs use post in a very similar way to residential consumers, ie the vast majority of SME mail is stamped (86%) and posted by hand (82% in post boxes). Therefore, while we do not consider small business fall into the definition of vulnerable customers (as discussed above), our proposal to put in place a safeguard cap on Second Class is also likely to benefit these SME customers.

Royal Mail’s modelling

The analysis presented above does not in itself show how these different business customers will respond to price changes particularly if these are not implemented uniformly across Royal Mail’s products. Royal Mail has undertaken extensive statistical modelling of these impacts for all businesses. We have considered Royal Mail’s analysis and built a modelling tool to test the implications of Royal Mail’s models. Our model is based on Royal Mail’s survey evidence and assumptions around the impact of price increases on volumes. This allowed us to understand the potential implications of any changes in price on different customers. The analysis is split by size and type of customer (as different customers use different products), by type of mail used (eg bulk mail customers and universal service customers) and for different uses of mail (eg advertising, transactional, e-fulfilment, magazines or social mail). We have also tested Royal Mail’s analysis by talking to individual customers.

Our overall assessment is that the majority of business customers may be willing to accept price rises to some degree, but that there remains very significant uncertainty over the rate of volume decline resulting from e-substitution in the context of price rises. The analysis indicates that some customers, particularly large transactional mailers (eg banks) could accelerate their moves to electronic alternatives. Other customers, such as magazine publishers and direct mailers, are likely to significantly reduce their use of mail if prices increase materially. Our conclusion is that this all supports the need for Royal Mail to have commercial flexibility as we consider that it is in a better position to understand its different customers than the regulator. However, are very clear that we expect Royal Mail to use that commercial flexibility appropriately and retain the power to intervene in future as appropriate.

The Commercial Cost of a Second Class Stamp

The Committee requested further information on the commercial cost of the Second Class stamp service for standard mail.

As recommended in the Hooper report and as discussed in Postcomm and Ofcom’s consultations, we require Royal Mail to provide extensive evidence to Ofcom on the costing of its different services. While we therefore hold information on the estimated costs of the Second Class stamp service, including Royal Mail’s calculation of what activities drive the cost of the service, Royal Mail does not publish service costing information at this level of detail. We consider that we are prevented by section 56 of the Postal Services Act 2011 from disclosing to the Committee the cost estimates that we have received from Royal Mail, without Royal Mail’s agreement.10 We would of course be happy to seek such consent in the event that the Committee does not obtain the information directly from Royal Mail.

Notwithstanding this, the Committee may find the following information helpful:

Royal Mail’s profitability as a whole has been weak in recent years. In 2010–11, Royal Mail’s business unit for UK Letters & Parcels and International (UKLPI) made a loss of £120 million on turnover of £6.9 billion, compared to a small profit of £20 million on turnover of £7.0 billion in the previous year.11

Reported operating profits on the regulated business have been low or negative in every year since the start of the current regulatory framework in 2006—never exceeding 3% of sales.12

The most recent publicly available data (which is for 2008–09) shows losses of £82 million on Second Class stamps13, and losses of £244 million for First and Second Class stamps combined, which was equivalent to 8.7p per item.14

Since then price increases and some changes to the method of costing for stamps have improved this picture.

Care must also be taken when interpreting the costs and profitability of individual mail services. Mail is a network business where the costs of individual services depend on the scale and type of other services delivered over the same network and on the implications of the universal service obligation. This is particularly the case for Second Class stamps which only account for less than 10% of total letter volumes. Were there to be a significantly lower volume of business and bulk mail, for example, the average cost of all mail services, including Second Class mail services, would be higher than current levels, possibly quite significantly (all other things equal). Sustaining the financial viability of the universal service therefore requires Royal Mail to set prices across its different mail services in a manner that helps maintain mail volumes overall. This in turn should help contain costs and prices for all mail users, but it does also mean that the reported accounting margins and profitability across mail services will vary, again possibly significantly.

Confirmation of how long the Price Ceiling had been in Place in the Netherlands

The Netherlands’ price control with a price cap on postal prices regime was introduced on 1 January 1989. Prior to that date prices were proposed by the company, set by the responsible minister and approved by parliament.

I trust this letter responds fully and satisfactorily to the questions on which the Committee requested further information. We obviously remain very keen and willing to support the Committee’s on-going work on postal services and would be pleased to provide further input or assistance if that would be helpful.

Stuart McIntosh
Group Director, Competition

28 February 2012

APPENDIX

The Dutch parliament decided to put a price cap on PTT Post (later TNT, now PostNL) at the date of corporatisation, ie 1 January 1989. This was to address the concern that as a privatised postal operator PTT Post would raise prices extremely. Before that date prices were proposed by the company, set by the responsible minister and approved by parliament.

From 1989 until 2008 tariff regulation in the Netherlands was based only on affordability. The increase in the weighted average of domestic tariffs was not allowed to exceed the increase in the index of wages. From time to time, when the gap between the tariff index and the wages index became too large, both indices were reset at 100 to avoid large tariff increases at once. According to PostNL its improvements in efficiency and productivity led to good financial results together with very limited price raises.

In 2009 the size of the USO changed drastically and the price cap system was changed as well. CPI became the relevant index for the price cap, whereas a capped letters basket and a separate basket for parcels were introduced. International items are included in both the letter and the parcel baskets.

In addition to affordability-regulation, there is now, also, regulation on Return on Sales. Every four years PostNL has to send the Supervisory body (ie OPTA) a tariff-proposal showing that the calculated RoS does not exceed 10%. In 2011 our first proposal, with all tariffs as of 2012 was duly submitted.