1. Universal Service in a Liberalized Environment* Michael A. Crew CRRI Professor of Regulatory Economics, Director CRRI, Rutgers University * Based on joint work with Paul Kleindorfer

2. Outline 1. What is the USO? 2. What is a Liberalized Environment? 3. How is the USO to be funded? 4. What should be the role of regulators and competition? 5. Summary and Implications

3. What is the USO? Generally: those activities (or social obligations) that a private (profit oriented) firm would not perform Specifically: –Ubiquity and uniformity for letters –Ubiquitous post offices or retail outlets –Limits on quality variability

4. What is a Liberalized Environment? Full Market Opening (FMO) – the culmination of liberalization POs traditional reserved area in letter mail gradually reduced Elimination 2011/13 – Defining event in liberalization process

5. A broader view of liberalization Liberalization is about direct competition and entry into all of the PO’s markets Consequent Transformation of POs New virtual technologies – strong driver of competition Inter modal competition nothing new; PO survived phone and fax Email and the Internet

6. Why is Internet different? Relatively much cheaper than traditional telecom based technologies More ubiquitous than fax Vast range of possibilities beyond email Almost as ubiquitous as telephone Wireless dimension

7. How is the USO to be funded? Traditionally reserved area funded the USO Uniform price enabled cross subsidies from low cost to high cost area Further surpluses used to fund extensive retail outlet network Barricaded entry to reserved area prevented cream skimming

8. Liberalization of the Postal Sector* PO/USP Governance PublicPrivate Market Structure Monopoly Competitive Privatized Investor-Owned Enterprise Commercial Public Enterprise “Planned” Path of Postal Reform *See Crew, Kleindorfer, Campbell, Handbook of Worldwide Postal Reform, Forthcoming, Edward Elgar, 2008.

9. How is the USO to be funded under liberalization? 1.Scale economies: POs derive scale economies from local delivery that may provide some cost advantages and some protection against entry. 2.Scope economies: POs expect to have scope economies between say letters and other products, particularly, parcels and financial services.

10. How is the USO to be funded under liberalization? (Continued) 3. Market dominance: POs may derive market power from e.g. scale economies, ubiquitous coverage and name recognition. 4. Increased X-efficiency 5. Increase in the uniform price of single-piece mail. 6. Reducing the scope and therefore the obligation of the USO 7. Extent of pricing flexibility allowed by regulators.

11. What should be the role of regulators and competition? All 7 items are of varying concern to regulator All interact making regulatory intervention difficult Underlying principle for regulation: - Avoid micromanagement by employing incentives for efficiency

12. Avoiding Micro management Scale and scope economies:- excessive concern for market power and not efficiencies from scale Presumption should be that incremental cost test is deemed sufficient Market dominance may be needed to finance USO. How much? Stay within limits of competition law

13. Increasing X-efficiency Perception that POs as inefficient civil- service type bureaucracies Liberalization an attempt to provide pressure for X-efficiency Change from bureaucracies to commercial of for-profit orientation need Avoid regulatory micro management and excessively high expectations

14. Uniform price and scope of USO Uniform price and scope of USO interrelated Scope of USO multidimensional Regulator concerned with: –Frequency of delivery –Number of PO retail outlets –Quality –Access

15. Design Incentives and provide transparency Incentives for quality important Design can lead to excess or too little quality and affect profits ANACOM approach –Consultation with CTT – attempt to provide information to design incentive –Transparency in reporting –Castro et al (2009)

16. Access and the USO What is the role of access in the USO? PO’s ubiquitous delivery arises from USO –Makes access to its facilities attractive –Provides contribution toward covering the cost of the USO Consensus that upstream access (worksharing) beneficial for the PO and its customers Profitable for worksharing companies

17. Downstream Access more problematical May be efficient for high cost areas to use PO’s delivery resulting from USO USO may make it difficult to compete for access in low cost areas USO may also mean access is priced below cost in high cost area Uniform single piece price place severe limits on PO/Regulator’s flexibility

18. Pitfalls of Micro Management: Worksharing /Access Different Possibilities

19. Regulator’s limited flexibility Upstream entry may promote lower costs in low cost areas PO cannot avoid burden of USO SUSO impossible because business customers cannot be excluded from USO USO has some features of a public good

20. USO and Access under Downstream Entry Added problems PO’s surplus in low cost zones under pressure If access unregulated, PO will charge lower prices in low cost zone for E2E PO still limited in flexibility by uniform single-piece price

21. USO driver under E2E Competition If regulator sets access too low, little or no E2E competition If access price unregulated, can make greater surpluses or reduce losses Uniform single-piece price places lid on benefits of price flexibility on access and USO products Case for regulation of access weak

22. 22 P H – C UE – ρ B (z I ) Unit Delivery Cost Illustrating Business Mail Zones Served By Entrants and by the Incumbent under Entry (C UE < C UI ) 0T t A (M, z I ) C DI (t, z) – ρ B (z I ) Delivery Zone Zones Serviced by Incumbent under Access Zones t < t A Serviced E2E by Entrants (1+M)C DI (t, z I ) – ρ B (z I ) t U (P H, M, z I ) Zones t > t U Serviced by Incumbent E2E at Price P H

23. Pricing Flexibility to fund USO If single-piece price is set too low it may limit the benefits of pricing flexibility Flexible pricing in competitive and access products might offer benefits Concern: PO allowed flexible pricing but the upside truncated by ex post regulation

24. Drivers Market Preparedness of the USP Impact of scope and characteristics of USO Regulatory policies FMO impactsThemes Postal scale, urbanisation, direct mail %, letter mail and bulk mail, postal density,… Labour cost, efficiency,… Counter density, frequency of delivery,… Licensing, pricing, access,… USP Financing needs Benefits of Workable competition achieved Scope & location of entry Employment impact Price and product changes in response to competition Diversity of driver values across countries Variety of impacts across countries … that influence the … PwC Study (2006)*: Model-based Assessment of the impact of FMO on the USO *See http://ec.europa.eu/internal_market/post/studies_en.htm

25. Main Conclusion of EU Studies (further reflected in the 3 rd Directive, 2008): There exist a variety of country specific situations concerning FMO SI BE FR ES PT GB IE LU NL DE DK SE FI EE LV LT PL CZ SK AT IT HU GR MT CY NO BG RO IS Significantly above average Above average Below average Significantly below average 121-145 101-120 80-100 65-80

26. Country-specific Re-Balancing USO Labor Agreements X-inefficiency, Entry PO Restructuring Pricing Flexibility Regulatory Reform

27. Summary and Implications Maintaining USO will be more complicated At least 7 ways of funding the USO POs will need to continue to transform themselves with increased efficiency Challenge of preserving scale and scope economies Setting uniform single-piece major driver

28. Final Thoughts Single-piece price will increase Scope of USO will decrease POs become more efficient Maintaining USO and viable PO Avoid micro management Incentives for efficiency Transparency in regulation Regulatory economics promising insights