In a report issued last April, Christian Wetherbee, an analyst for Citigroup Inc., concluded that the U.S. Postal Service (USPS) would have to raise its artificially low parcel rates by as much as 50 percent in order to break even on its fast-growing parcel offerings. The biggest question, Wetherbee wrote, was who or what would break through the Washington inertia and "trigger" such a change.
Enter the President of the United States.
It is easy to dismiss Donald J. Trump's executive order last night creating a task force to analyze all of USPS' operations as a political vendetta against Jeff Bezos, the owner of The Washington Post—on Trump's toilet list for years—and founder and CEO of Amazon.com Inc., the Seattle-based e-tailing goliath and USPS' biggest parcel customer. For months, Trump has pounded on the idea that USPS virtually gives away its parcel services, citing reports that it loses $1.50 on each Amazon shipment, a claim considered by many to be dubious if not untrue.
It could be quite easily surmised that Trump would have little, if any, interest in USPS' financial condition if not for the Bezos-Amazon-Washington Post connection. In addition, the executive branch has no daily pull over USPS. The president's role is limited to signing bills into law that affect the quasi-governmental agency. The Postal Regulatory Commission (PRC), created by Congress in 1970 to operate as an independent entity, approves all USPS' rate proposals. Changes in postal operations, from the closure of local post offices to modification of USPS' pension obligations, are the province of Congress. The Postmaster General is appointed by USPS' Board of Governors, who are appointed by the President.
Yet the President is a "starting gun," meaning most of what he says or does has consequences. Last night's order, which requires Treasury Secretary Steven T. Mnuchin, who has been appointed to lead the task force, to report back to Trump with its recommendations within 120 days, could hasten what Wetherbee last year called a "day of reckoning" for USPS, when its parcel rates would be forced to reflect the actual cost of service, and shipping would have to pull more of the profit load to offset the secular decline in first-class mail, the traditional cash cow.
Should USPS' parcel rates rise to the levels cited by the analyst, the impact on the shipping marketplace, and on an economy increasingly influenced by e-commerce activity, could be enormous. Millions of online retailers and merchants offer their end customers "free shipping" for purchases as a means of retaining and keeping their business. The shipping is not free, and USPS has been raising parcel rates by mid- to high single-digit amounts for several years. Still, the rates remain so competitive that big-ticket users have been willing to effectively eat the costs. That approach may no longer be viable should rates rise substantially from current levels.
In his analysis, Wetherbee wrote that "many consumers have been conditioned to expect shipping solutions which are not supported by economic reality." A meaningful parcel rate hike from USPS, especially if it is pushed by Congress rather than just by the PRC, could shock the ecosystem into making profound changes in parcel delivery strategy, he said.
Large users could increase their in-house investments in parcel distribution, much the same way Amazon has been doing in building out its own network. However, Amazon's volume is extremely large, and it is growing at a 20-percent-a-quarter clip. Thus, there is no way it could accommodate all its shipping business in house. About three-quarters of Amazon's shipping costs would be impacted in some manner by a meaningful USPS rate hike, according to Wetherbee's projections.
For UPS Inc. and FedEx Corp., companies that compete with USPS and also rely on its "Parcel Select" service to deliver packages to out-of-the-way addresses too costly for the companies to serve, an elevation in postal rates could be a revenue bonanza. Wetherbee estimated a $15 to $19 billion combined annual revenue "opportunity" for the two carriers should the overall rate floor rise and enable them to price ground services more aggressively.
ALLOCABLE COSTS
One of the elephants in the postal room is the issue of allocable costs. Under a 2006 law that further changed how USPS does business, the agency is required to price its product offerings in such a way that they recoup both its variable costs and the appropriate share of the organization's overall costs. Back then, so-called competitive products—the category under which parcel and shipping fall—were assigned a 5.5-percent allocable share. That percentage has remained the same, even though parcel and shipping today account for about a one-quarter of total revenue, the highest ratio in USPS' history.
In 2015, USPS told the PRC that competitive products should account for 24.6 percent of the agency's overall costs. The Post Office has declined to comment on various requests from DC Velocity asking what it considers an appropriate percentage. The implication is that, should parcel costs and revenue be more closely aligned than they are today, costs would rise substantially and, by extension, so should parcel rates, to offset those escalations.
The debate over the proper allocable cost formula is critical in the context of postal operations. Parcel processing brings with it higher labor and equipment costs. By contrast, first-class mail processing is highly automated. Furthermore, a truck that cubes out with letters generates more revenue than a truck full of parcels.
The irony is that significant parcel rate hikes could end up taking business from USPS. The three largest users of Parcel Select, UPS, FedEx, and Amazon, are developing their own infrastructures and rate matrixes to challenge USPS in the local last-mile e-commerce delivery category. USPS has publicly acknowledged that those efforts could undermine its ability to grow the business in the years ahead.
What is even more ironic is that a meaningful postal rate hike could create a scenario where, over the long haul, the one company that ends up benefitting the most is Amazon. Its large-scale logistics investments in recent years have afforded it deeper fulfillment density than ever before, which, in turn, allows it to diversify its delivery options to include local carriers. This would insulate it from any USPS rate hikes, especially if they are imposed over a period of time, according to Wetherbee.
Because Amazon would be better able than its retailer rivals to digest higher shipping costs, a USPS rate hike would further strengthen its cost advantage to consumers and the e-tailer would gain even more market share, Wetherbee predicted. While Amazon might be hurt in the short-term by postal rate hikes, "increased purchase frequency and customer density should benefit (its) margins over time," he wrote.
