Evolution of Postal Services CWU European Conference March 20, 2008 Alex Smith

2 Trends Driving Change at Royal Mail 1.Industry dynamics in Europe 2.Evolving competition in the UK 3.Postal economics that create opportunities for competitors 4.Evolving regulation 5.The Government’s review of the industry

3 Industry Dynamics in Europe Five major trends: 1.Markets declining by 2-4% per annum: competition from other media 2.Liberalisation coming, but delayed to 2011/13 3.Governments responding with protection of national incumbents - Minimum wage in Germany - Pay or play in Finland and France - Reciprocity 4.Despite protection incumbents preparing for volume declines: - New sources of growth Attacking outside home markets: low cost delivery Related diversification: express, logistics, courier fulfillment, value chain extension - Cost reduction and flexibility: outsourcing, flexible working etc 5.And Governments privatising: - To free-up incumbents to compete: access to capital and talent - To resolve pension legacies - To avoid political heat of major change

4 Evolving Competition in the UK Competition is intensifying and changing: 1.E-substitution: internet advertising, transactional ing, social networking, distributed printing? 2.Access – 20% of volume and still growing - >70% of M2 gone - >40% of bulk mail gone - Attacking SMEs: PPI and meter mail 3.Two major players (18 licensed operators): TNT and UK Mail (~50:50) 4.TNT moving into delivery: -7 sorting centres, 10,000 pickups per day, 8 million items per day -Planning last mile networks – North, South West, Scotland, Midlands, London -Claim will have enough mail to breakeven downstream by 2009

5 Postal Economics Creating Opportunities for Competitors Postal competitors take advantage of 2 economic distortions: 1.Pricing constraints on Royal Mail encourage access competition: - Uniform prices: geographic cream-skimming - High business prices (subsidising low stamp prices) - Headroom regulation 2.USO encourages delivery competition: -Delivery costs driven by number of addresses per day -Revenues driven by volume per day -Less frequent delivery (2-3 days per week per walk) reduces costs -USO mandates 6 days per week: high cost (and quality) -TNT can undercut by focusing on 2C and 3C mail -Close to having sufficient accessible volumes to break even

6 Evolving Regulation Pace of change likely to accelerate: 1.Easing of barriers for competitors: -Encourage small deliverers with reduced licence requirements -Encourage delivery competition by removing VAT advantage 2.Deregulation of RM ……? - Narrower price control? -Narrower universal service? -More reliance on competition law? 3.Separation of RM…..? - Upstream /downstream? - Geographically? -Financially? Operationally? Ownership?

7 The Government’s Review of the Industry: Terms of Reference 1.Assess impact to date of liberalisation on Royal Mail, alternative carriers and consumers 2.Explore trends in the market and their impact on Royal Mail, alternative carriers and consumers 3.Consider how to maintain the U.S.O. in light of the above “…be specific – say what you think – be clear about what you think needs to be done...” Richard Hooper (Chair)

8 What will it take to safeguard the USO? 1.Much less regulation of business mail: - Narrower price control on stamps only (currently over 88% of revenue) - Fewer constraints on changes to business product specifications and pricing - Removal of access headroom controls (guaranteed margins for our competitors) - No regulation of access prices – Postcomm threat 2.A narrower U.S.O: - Still high quality (1 st class, every day, everywhere) - But focussed on social and small business customers (stamps) - Giving flexibility to price competitively for business mailings

9 What will it take? (…continued) 3.An integrated business: -Postcomm proposing business separation and wholesale equivalence -Why? Access market is developing rapidly -Separation and equivalence simply reduce quality and/or increase costs for customers -Transformation and innovation would be stifled 4.Investment: -In new technology to improve productivity -In new products and services to win back customers from other media and fulfilment channels -In adjacent markets to grow new sources of revenue as mails revenues decline

10 Summary 1.Mails volumes are declining and the U.S.O is losing money today 2.But there is a solution to financing a high quality U.S.O: -Less regulation so Royal Mail can compete and innovate -A U.S.O focused on stamps that covers its costs -An integrated Royal Mail that innovates on behalf of customers -Investment in new technologies, products and services to drive up productivity and grow new revenues 3.There is a positive future for Royal Mail – but we need these changes now to build that future