Competitive Market Review

2007

COMPETITIVE MARKET REVIEW UK POSTAL MARKET

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CONTENTS

1 EXECUTIVE SUMMARY

2

2 OVERVIEW OF THE POSTAL MARKET

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3 DEVELOPMENT OF COMPETITION

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4 ROYAL MAIL

47

5 MARKET DEVELOPMENTS/OPPORTUNITIES

59

6 ANNEX A

71

CONTENTS

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1 EXECUTIVE SUMMARY

As the regulator of the UK mail market Postcomm needs to have a thorough understanding of the market and how it is evolving. The 2007 Competitive Market Review builds on last year’s document to give an overview of developments in the mail market. It will help to inform Postcomm’s policy decisions and will assist in the continued development of a regulatory framework that facilitates the development of competition in the context of a healthy, stable mail market. Market size and growth The UK addressed mail market was worth around £6.6 billion in 2006/07. Mail volumes amounted to 21.9 billion items, down 2 per cent on the previous year1. This is the third consecutive year of mail volume decline in the UK. While there is evidence to suggest that substitution has caused mail volumes to decline for the last three years, there is also evidence of areas of growth in the market which appears to be offsetting a more significant volume decline. In 2006/07 2.4 billion items were carried under access agreements; this represents 11.8 per cent of total operational mail volumes. This is an increase from 5.6 per cent in 2005/06. Around half of these items were handled by alternative operators. Latest figures (cumulative volumes from August 2007) show that access mail accounts for 19 per cent of Royal Mail’s revenue-derived volumes.

1

2

Based on Royal Mail operational volumes, including access. Includes all regulated and non-regulated mail, excludes door-to-door and international. 2006/07 volumes are based on operational measurement. For the financial year 2007/08 and going forward, Royal Mail volumes will be measured on a revenue-derived basis, as agreed between Postcomm and Royal Mail. 2007 COMPETITIVE MARKET REVIEW

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There was a decrease in the volume carried end-to-end by alternative operators from 39 million in 2005/06 items to 34.8 million items in 2006/07. Table 1.1 Addressed letters’ market by volume2 Total Volumes 2005/06 (millions)

Total Volumes 2006/07 (millions)

Volume Growth (%)

19,705

17,846

-9

Total Alternative Provider Access

539

1,148

113

Customer Direct Access

618

1,292

109

1,157

2,442

111

280

336

33

21,142

20,675

-2

39

35

-2

Royal Mail end-to-end*

Total Access Other letter products Total Other operators’ end-to-end mailings

Source: Postcomm with data from Royal Mail

Market segmentation, sectors and mail applications Businesses generate 87 per cent of all mail; the main uses of mail for business are advertising mail, fulfilment, general business mail and transactional mail. Although direct mail volumes declined slightly in 2006/07, by around 2 per cent, there are indications that direct mail use is a growing and successful medium in some industry sectors. Distinctions between advertising mail and transactional mail are beginning to blur and measuring trends in this area will become increasingly difficult.

2

Postcomm is working with Royal Mail and other licensed operators on a definition of mail volume market shares. This is a complex matter, for example Royal Mail argues that self-delivered mail (such as local authority items) should be included in these figures. To date, Postcomm’s market share figures exclude document exchange mail. There is also difficulty with the treatment of parcels, most of which fell outside Royal Mail’s historic monopoly.

*

Royal Mail inland addressed end-to-end mail comprises price controlled products (excluding downstream access) plus USO non-price controlled products. EXECUTIVE SUMMARY

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Transactional mail is estimated to be declining by around 2-3 per cent per year, due largely to businesses encouraging their customers and other business to move physical bills and statements on-line. However, while businesses are trying to reduce the volume of physical statements they send, they tend also to be committed to offering customers a choice of communications channels. Some of this decline is predicted to be offset by household growth and the increased volume of transactional mail generated by internet sales. The use of blank spaces on transactional mail for advertising messages may also extend the lifecycle of transactional mail. Fulfilment and publications remain potential growth areas in the mail industry and both tend to be customer driven. According to IMRG, e-retail which drives fulfilment mail now accounts for over £4 billion worth of sales a month, which is driving small parcel and packet growth. In the publications sector, customer magazines are exhibiting the strongest growth. In the last 12 months the industry has seen 16 per cent year-onyear growth as companies invest in customer magazines as a marketing tool.

Market developments As of September 2007 there are 18 licensed operators including Royal Mail. Since the last Competitive Market Review two new long-term licences have been granted by Postcomm, and the UK market now has its first franchised operator. End-to-end networks are in evidence in the UK market, however mainly in niche areas, but there is potential for this to grow. The different operators in the postal market do have different customer bases, target markets and business models which are outlined in this report. The role of mail value chain innovation and suppliers to the industry is increasing in importance year on year, and recent developments in hybrid mail are particularly interesting for the future of the market.

Royal Mail’s performance Royal Mail’s financial performance for the year ended 25 March 2007 was weaker than in the previous year, with operating profits from Royal Mail’s Letters’ business falling from £344 million to £194 million, caused by increasing costs, falling mail volumes and constant revenues. In 2006/07, quality of service targets changed to better reflect customer needs. Royal Mail achieved 11 out of 12 of its targets, compared to 10 out of 16 in 2005/06. Royal Mail’s failure to meet the target for the number of postcode areas delivering at least 91.5 per cent of first class mail the day after posting was due to industrial action in two postcode areas.

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International, VAT and the environment Competition is developing at different rates and in different ways across Europe depending in part on the regulatory regime in place from country to country. Liberalised European markets are broadly characterised by relatively stable mail volumes and nationwide competition developing in delivery. Competitive market shares range from 8-12 per cent in Germany, the Netherlands and Spain, which have had elements of mail liberalisation for several years. On VAT, Postcomm continues to support a level playing field for all postal operators, with no significant price rises for customers. It therefore believes that a reduced rate of VAT (of 5 per cent) should be applied to all mail services. However, in light of the European Commission’s (‘the Commission’) ongoing infringement proceedings against the UK, Germany and Sweden on the interpretation of the VAT exemption for postal services, Postcomm has modelled the effect that different VAT exemption scenarios might have on the UK postal services market. The result of this modelling has shown that the imposition of the full rate of VAT on mail services (17.5 per cent) could result in around 5 per cent decline in Royal Mail volumes, while the imposition of the reduced rate would only result in a 1 per cent decline. Given that Postcomm’s preferred option of 5 per cent VAT applied to all services would require unanimous Commission Member State agreement, Postcomm intends to wait for the outcome of the current infringement proceedings before deciding whether to continue to support this option, or whether there is another option available.

The environment is an issue with an increasing impact on the mail industry, and those involved in the industry, from trade bodies to operators, are beginning to develop solutions to minimise the environmental impact of mail production and delivery. This is a relatively new market dynamic in the industry, and Postcomm intends to monitor developments in this area.

EXECUTIVE SUMMARY

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2 OVERVIEW OF THE POSTAL MARKET

This section offers an overview of the mail market in the UK, including market size, growth, structure and competition. It discusses market segmentation, mail flows and applications of mail in detail, looking at trends where appropriate. The chapter also looks at the related markets of unaddressed mail, express deliveries and international outbound mail. Market size and growth The UK addressed mail market was worth around £6.6 billion in 2006/07. Mail volumes amounted to 21.9 billion items, down 2 per cent on the previous year3. This is the third consecutive year of mail volume decline in the UK. As domestic letter volumes have been in decline for the past three years, there is growing industry concern that this may be a structural decline based on a mature mail market subject to impacts such as e-substitution. While there is evidence to suggest that substitution has caused mail volume decline, there is also evidence of areas of growth in the market and significant moves away from mail have not materialised. This appears to be due, in part, to the fact that while email and the internet are a substitute to physical mail, there are areas in which they also drive mail volume growth, where there is, in other words, convergence between electronic and physical mail. Physical delivery of on-line orders is an example of such convergence, as is using multi-channel advertising where a customer acquired by email may then be retained via direct mail. Indeed, according to Pitney Bowes, internet users in the UK receive up to 65 per cent more mail than those who do not use the internet. 3

6

Based on Royal Mail operational volumes, including access. Includes all regulated and non-regulated mail, excludes door-to-door and international. 2007 COMPETITIVE MARKET REVIEW

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Whatever the pace and extent to which mail volumes may be declining, the role of the postal sector is evolving, as it finds itself influenced by communications, advertising and delivery, all of which now use multiple channels to access receivers, and which are sometimes substitutes and sometimes complementary to mail. The extent to which mail has growth potential will be determined, in part, by the behaviour of mail operators. The pricing and commercial policies of operators, particularly Royal Mail, will undoubtedly impact volume trends, as will operators’ ability to add value to mail for customers, and to provide innovative solutions and incentives for businesses to continue to use mail. The chart below illustrates the changing dynamics of the postal market. The fact that the postal market is now driven to some extent by different dynamics has meant the economic and demographic link has weakened and volumes are more difficult to predict.

Figure 2.1 Inland letter traffic compared with economic and demographic growth BREAK POINT

8.0 5 year average year-on-year growth (%)

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6.0

4.0

2.0

0 86/87

88/89

90/91

Inland letters Economic and demographic growth

92/93

94/95

96/97

98/99

00/01

02/03

04/05

Economic growth is weighted by letter demand; demographic growth is measured by growth in number of households Source: Royal Mail

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This trend appears to be consistent with mature mail markets across Europe. Figure 2.2 shows that letter volumes have grown less than the economy in real terms, even in the new member states, illustrating that letter volumes are less related to GDP across most European countries than in the past.

Figure 2.2 Member states domestic letter post per GDP: average annual growth, 2000/02 and 2002/04 5.0 2.5

Average annual growth (%)

0.0

SK AT EE DK FI MT SE DE FR LU IT EU NL PT ES CY UK GR CZ PL HU SI LV

-2.5 -5.0 -7.5 -10.0 -12.5 -15.0

2000/02 2002/04

Notes: BE, IE, LT – confidential Source: WIK

Figure 2.3 shows that, in 2004, the UK was the highest per capita mailer in Europe. If the UK mail market is the most mature in Europe, does this indicate limited room for growth? In the United States in 2005, the average household received 1,800 items of mail, while the average UK household received 850. This could indicate per capita growth potential beyond that seen in Europe, although patterns of mail use differ markedly between Europe and the US due to a variety of differences in culture and infrastructure.

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Figure 2.3 Member states domestic letter post, items per capita 2002 and 2004 350 Domestic letter post, items per capita

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300 250 200 150 100 50 0 LV PL SK GR CY EE HU CZ IT MT PT ES SI EU DE LU AT FI FR DK UK NL SE

2002 2004

Notes: BE, IE, LT – confidential Source: WIK

Because mail trends are impacted by new forces making the market increasingly difficult to predict, it is instructive to examine the different mail sectors to understand their relative size and characteristics in order to understand the underlying factors impacting mail volume trends in the UK. First we look at the overall structure of the market, 18 months after full liberalisation.

Market structure The UK addressed mail market has been fully liberalised since January 2006 and, as of September 2007, there are 18 licensed mail providers including Royal Mail. Competition has so far taken two main forms in the UK, ‘access’ competition and ‘end-to-end’.

Access Most competitors have entered the market by using third party access to Royal Mail’s delivery network. This is known as ‘access’ competition, and it refers to the process by which an alternative operator collects, sorts and trunks its customers’ mail to Royal Mail’s inward mail centres, turning it over to Royal Mail for final delivery. Around a dozen of Royal Mail’s large customers also have ‘customer direct access’ agreements whereby they arrange directly with Royal Mail access to Royal Mail’s inward mail centres. Access customers and operators typically pay Royal Mail around 13p per letter for delivery. OVERVIEW OF THE POSTAL MARKET

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In 2006/07, mail carried via access arrangements (both operator and customer direct access) accounted for 11.8 per cent of total operational mail volumes for the year. This is an increase from 5.6 per cent in 2005/06.

Current access competition As of August 2007, access mail accounted for 19 per cent of addressed revenuederived letter volumes. Just under half of this is carried through access agreements directly with Royal Mail’s customers.

Figure 2.4 Access volumes April 2006 – August 2007 400

(Millions)

300

200

100

Ap r0 M 6 ay 0 Ju 6 n 06 Ju l0 Au 6 g 0 Se 6 p 06 Oc t0 N 6 ov 0 De 6 c 06 Ja n 0 Fe 7 b 0 M 7 ar 07 Ap r0 M 7 ay 0 Ju 7 n 07 Ju l0 Au 7 g 07

0

Total Access volume

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2007 COMPETITIVE MARKET REVIEW

Operator access

CDA

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End-to-end A second type of competition in the mail market is end-to-end competition, where a competitor provides the entire mailing process from collection to delivery. End-to-end competition is much less developed in the UK licensed mail market to date, representing only 0.2 per cent of licensed mail volumes. While a few operators currently offer end-to-end services, they tend to be local or high-value networks. There are a few operators with stated ambitions to establish national end-to-end networks in the UK, and they may achieve this either by ensuring items are of a high enough value or by having adequate drop-density to make lower priced items profitable. End-to-end networks have been established in other European countries with liberalised mail markets; however, these markets have been open to this type of competition much longer than the UK. The development of competition in European markets is discussed further in Chapter 5.

Market segmentation A breakdown of mail flows in the UK domestic market is shown in Figure 2.5. Businesses send around 87 per cent of all mail and their main uses of mail are split between advertising, transactional mail, general business mail, and fulfilment, each explained briefly below.

Figure 2.5 Mail flows, domestic v business Domestic-to-domestic 10% Domestic-to-business 3% Business-to-business 27% Business-to-domestic 60%

Source: Royal Mail

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Mail applications

Advertising According to Royal Mail, 5.03 billion items of direct mail were sent in the UK in 2006, a decline of 2.1 per cent in volume on the previous year. In the past few years, direct mail has shown a slight year-on-year decline, following strong growth from 1996-2003. This growth was driven by large advertisers such as banks and retailers employing national direct mail campaigns to acquire new customers, however, in the past few years, mass direct mailings have tended to give way to smaller, more targeted campaigns which are blended with other media. Direct mail is being used for retention and cross-selling, which amount to lower mailing volumes, although the return on investment of these campaigns may well be higher. Declining volumes have fostered speculation about whether direct mail is approaching market maturity and is destined for long-term decline, as happens in some markets in which products become commoditised, or whether the decline is simply a result of changing posting patterns, with the medium itself presenting further growth opportunities.

It could be argued that the postal industry has the main responsibility for ensuring that direct mail remains a valuable marketing medium, particularly as postage costs can account for up to 60 per cent of a direct mail campaign. As other costs come down (input costs such as print, and the cost of alternative media), mail must be seen to be competitive. The mail industry should be in a position to lead on ensuring that mail is a trusted and valuable direct marketing tool.

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Figure 2.6 illustrates the recent decline in direct mail volumes, which is occurring in both business-to-consumer, and business-to-business mailings. Volumes have been declining in both categories since 2003.

Figure 2.6 Direct mail volumes 6000 5000 4000 Millions

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3000 2000 1000 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Consumer

Business

Total

Source: Direct mail information service

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The chart below shows the percentage of business-to-consumer direct mail sent by industry sector. Financial services and home shopping account for 45 per cent of all business-to-consumer direct mail. Both these sectors have tended to move away from mass mailings toward mailing to more targeted audiences, which may go some way to explaining the recent volume decline. Although overall direct mail volumes have fallen, Royal Mail has pointed to strong growth in certain market sectors. In the last quarter of 2006, for example, direct mail spend from building societies grew by 18.8 per cent on the same period in 2005, while the charity sector was up 9.1 per cent, government by 6 per cent and health by 5.7 per cent4.

Figure 2.7 Consumer direct mail volume share by sector 2006 (%) Financial 31% Home shopping/mail order 14% Retail 9% Charity 10% Utilities 6% Media/publishing 5% Travel/tourism 5% Government 2% Leisure/entertainment 2% Manufacturing 3% Health 1% Car dealers 1% Education 0% Other 8% Not specified 3%

Source: DMIS

4

14

‘‘Royal Mail accentuates positive as mail volumes dip’’, Precision Marketing, 30 August 2007.

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Some industry experts suggest that the direct mail decline is due to the increased use of more integrated, multi-media campaigns rather than a significant whole-scale switch to other media, suggesting that direct mail has become just one of many media used in a typical campaign. Indeed, direct marketing budgets overall are growing. The latest Bellwether Report from the IPA, a quarterly survey of marketing spend, suggests that marketing budgets have increased for the second quarter in a row, to the greatest extent since 2004. The report revealed that business confidence is growing and budgets are being revised upward across all marketing sectors. The strongest growth was in internet advertising, which now accounts for 6 per cent of all advertising spend, however, there seems to be evidence of media integration, combining email, direct mail, DRTV (direct response television marketing), and on-line advertising5. Indeed, email marketing overtook direct mail in terms of volume for the first time in the last quarter of 2006, when 1.6 billion emails were sent, compared to 1.2 billion items of direct mail, according to the DMA’s Email Marketing Council6. A similar trend is shown in the table below. Table 2.1 Advertising expenditure by medium Q1 2007, £m current prices, and Q1 2007 on Q1 2006 percentage changes in current prices Q1 2007 adspend

Current prices (£m)

change year/year (%)

National newspapers (Includes supplements)

492

-1.8

Regional newspapers

705

-3.8

Consumer magazines (Excludes supplements)

188

-1.4

Business magazines

203

-6.6

Total press – of which display – of which classified

1,589 869 720

-3.3 -2.1 -4.8

Television

962

-0.8

Radio

127

-1.8

Outdoor

237

7.7

Cinema

30

9.9

Internet (Internet figure is a WARC estimate)

648

42.0

Direct mail

615

-3.6

4,208

3.0

Total measured adspend (excludes directory advertising)

Source: AA Quarterly Survey of Advertising Expenditure June 2007 5

The Q2 2007 Bellwether Report, IPA, 16 July 2007.

6

Email overtakes print in DMA’s latest report, Print Week, 16 August 2007. OVERVIEW OF THE POSTAL MARKET

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This points to a complex, multi-channel direct marketing environment that has altered the underlying business models of agencies and suppliers. A recent article in Marketing Week explains that whereas direct marketing agencies used to rely on a single channel for most income, they now need to spread their activity across a range of marketing channels. Companies are tending to move away from volume mailings toward servicebased offerings, using customer data to tailor messages and offerings, and direct mail is a strong medium for this type of marketing. Email marketing is also good for tailored messages, however, nine out of ten email messages are spam7, making legitimate email marketing difficult to deliver. Direct mail is a good complement to email here, and helps maintain the integrity of channels to market as a personalised, trusted medium. Often email is used for large acquisition mailings, and direct mail tends to be used for customer retention and brand building. Where large mailers used to use three or four channels to reach their customers, they now spread their marketing budget among up to 15 different media. Although direct mail has declined in overall volume the last two years, there are opportunities for growth, particularly if the medium can add value to customers in a multi-channel environment.

Direct mail continues to grow in the United States, for example, aided by organisations such as the National Postal Forum – a not-for-profit educational corporation that provides education to business mailers and facilitates communication between USPS and its business customers. There is evidence to suggest that the UK postal industry can encourage mail use and add value to mail as a medium, leading growth in mail volumes.

7 16

Quality replaces quantity, Marketing Week, 30 August 2007. 2007 COMPETITIVE MARKET REVIEW

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Case Study BSkyB

Company background BSkyB is a media and broadcasting company with 8.5 million direct customers. Mailing profile BSkyB sends significant amounts of transactional mail pieces each year, including bills, statements and welcome letters to its customers. It moved all its transactional mail to TNT Post in 2004. BSkyB also has a direct mail programme, targeting customers and prospects via both addressed and unaddressed mail, the majority of which is also handled by TNT Post. BSkyB sends monthly magazines to its customers and still uses Royal Mail for all its magazine distribution.

Why did you switch? BSkyB switched because it receives a 95 per cent day-two drop rate with TNT Post compared to Royal Mail, and it finds TNT Post more flexible to work with. What have been the benefits/experiences to date? BSkyB has received very good benefits from gradually moving most of its mail to TNT, driving valuable savings in its overall postal budget. Although BSkyB has had a few issues with late delivery, they are promptly investigated and dealt with.

What would you recommend other mail customers to consider when thinking about switching? You must decide to switch for the right reasons and remember that downstream access is a new product. What are your thoughts on the mail market? BSkyB is concerned about the lack of innovation in the market. It feels that the growth in the internet will have an impact on the mail market, but that mail and the internet can be complementary. “Internet and direct mail work well together. The internet raises awareness, whereas people like to respond to direct mail. Our direct mail budget has not been cut.”

What would you like to see in the mail market in the future? BSkyB would like to see more choice and innovation.

Source BskyB OVERVIEW OF THE POSTAL MARKET

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Unaddressed mail Unlike addressed direct mail, the unaddressed advertising mail market has continued to grow through 2006, although at a decreasing rate8. Although not part of the regulated mail market, it is interesting to look at the door-to-door market as it is a complementary medium to direct mail, and its continued growth suggests there is sustained demand amongst advertisers for physical, through-the-letterbox communication.

Figure 2.8 Size and growth of the door-to-door market 1200

Expenditure (£m)

1000 800 600 400 200 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Distribution expenditure

8 18

DMA door-to-door Council. 2007 COMPETITIVE MARKET REVIEW

Print and production expenditure

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Table 2.2 UK door-to-door market – estimates of size, growth and spend per household

Volume (Items millions)

1997

1998

1999

2000

2001

2002

2003

2004

2005

6,500

7,000

7,950

8,470

9,250

10,170

11,880

12,560

13,045

7.7

13.6

6.5

9.2

9.9

9.2

9.7

3.9

5.6

6.3

6.7

7.3

8.0

9.2

9.7

10.0

6.8

12.5

5.4

9.0

9.2

16.0

5.0

3.1

Year on year increase in volume (%) Average Volume Per GB Household Per Week (items) Year on year increase (%)

5.3

Source: DMA door-to-door Council

Growth is predicted in door-to-door through 2007, although growth rates are considered to have broadly reached a plateau. According to the DMA door-to-door Council, the door-to-door market has sustained growth for a variety of reasons. Firstly, it is considered to be the most cost-effective way to reach mass audiences, particularly considering the fragmentation that has been occurring in other media such as television and press. On the other hand, it can be targeted to specific audiences when postcode details are overlayed with demographic and lifestyle data, and it can be targeted to retail catchment or government authority areas. Finally, the emergence of companies that monitor door-to-door performance means that efficiency levels can be monitored and the reputation of the industry as a whole has improved.

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Transactional mail Transactional mail volume estimates range anywhere from 6 billion to 10 billion items per year in the UK9. The portion of this that constitutes bulk mailings from large firms has been one of the main arenas of the competitive postal market, and constitutes a substantial proportion of the 2.4 billion items in access traffic handled by competitors last year. Transactional mail is estimated to be declining by around 2-3 per cent per year, due largely to businesses encouraging their customers to move physical bills and statements on-line. However, while businesses are trying to reduce the volume of physical statements they send, they tend also to be committed to offering customers a choice of communication channels, so the extent to which this drive in cost savings actually reduces transactional mail volumes will depend on customer willingness to move these items on-line. Most large transactional mailers expect to maintain 90 per cent of their transactional mail volumes in the medium term due to customer choice10.

There is evidence to suggest that the predicted decline in transactional mail will be offset, to some extent, by other factors. Transactional mail experiences organic growth from the continued growth in household numbers, which is estimated to continue at around 1 per cent a year for example. There is also evidence that many large mailers are integrating their transactional and advertising messaging using inserts or printing messages on the white space of bills and statements. This adds value to the bill or statement as a communication medium, and sales generated in this way offset the expense of the transactional delivery. All these factors combined suggest that transactional mail volumes will continue to decline gradually in the short term as observed over the past few years, at a rate of around 2 per cent. UK experience and European data suggest that transactional mail is subject to electronic substitution11; however, it is also true that internet-driven sales do, to some extent, generate physical, transactional mail. The use of advertising on transactional mail pieces is blending the uses of mail. Perhaps it is because of the complementary nature of these media that a more significant decline in physical transactional mail has not occurred.

9

OTM discussion paper, OTM Website – Estimates that in the UK, 20,000 firms issue 6.7 billion statements, and a further 7,500 telecoms, financial services and utilities firms issue 3 billion bills each year. Triangle Management Services, UK Transactional Mail Survey, 2006, estimates 6.4 billion items of transactional mail sent in the UK in 2004.

10 Based on Postcomm interviews with large transactional mailers, 2006/07. 11 Main Developments in the Postal Sector, 2004/06, WIK-Consult, May 2006. 20

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Case Study HBOS

Company background Halifax Bank of Scotland plc provides a range of financial services including savings/current accounts, lending facilities and insurance. The company has 22 million customers and employs 64,000 people. Mailing profile HBOS sends out an average of 450 million items of mail per year ranging from first class specialised mailings to bulk Downstream Access. Downstream Access mailings are typically 550,000 per day but have peaked at 1.5 million. Why did you switch? HBOS has decided to switch its transactional mail to TNT Post for 3 keys reasons: financial benefits; transparency of service up to final mile; and the fact that there will be no impact to customer service. HBOS is in the process of reviewing dual sourcing for its mail with the intention of benchmarking service across access operators. What have been the benefits/experiences to date? So far HBOS has seen the following benefits: financial benefits – mailing services need to be cost effective; transparency of service up to final mile; consistently good service standards; increased flexibility; and the agreements have enabled collaborative supplier interaction. HBOS found that implementation was challenging, however processes are now embedded and the service performance is consistently good.

What would you recommend other mail customers to consider when thinking about switching? Carefully assess the benefits to your organisation, switching to Downstream Access is a major change therefore a feasibility study is recommended. Review as a holistic process including missorts, forecasting requirements, etc to ensure you understand what is required and the implications to your organisation. Ensure the implementation includes a slow ramp-up of volume and you focus on pre-sort mail.

What are your thoughts on the mail market? Year on year HBOS mail volumes are slowly decreasing. “I would like to see more competition in the Downstream Access market. An organisation of HBOS size needs a supplier that has sufficient infrastructure which only a few licence holders can currently offer.” HBOS would also like to see an alternative and feasible E2E solution and, “innovation from all sectors of the market including Royal Mail and the Downstream Access providers. One size does not fit all so solutions need to be tailored to the customer needs.”

Source HBOS

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General business mail General business mail refers to the day-to-day correspondence sent from or between businesses, and tends to be single item, individual correspondence. Mail sent by small and medium sized businesses (SMEs) tends to be general business mail, and it will either be stamped, postage paid impression, or sent through franking machines. General business-to-business mail tends to be vulnerable to e-substitution with the implementation of electronic systems between firms to increase efficiency and cut costs. SMEs however, still appear to be highly reliant on physical mail for most of their transactions. According to a survey by the Federation of Small Businesses, 69 per cent of SMEs still send invoices through the post, 59 per cent use the postal system for the delivery of goods and services, and 88 per cent send post every day12. Competitors have begun to enter this end of the market over the last year, and a few operators offer to take all types of mail with a minimum daily collection of 250 items. Hybrid mail services are also very relevant to this type of mail, as small businesses can send information electronically and pay to have their mail printed, enveloped and handed to Royal Mail for delivery geographically near to its destination.

Publishing

Consumer magazines Consumer magazines are paid-for magazines covering a wide range of interest areas, with around 3,400 titles currently in circulation in the UK. According to the Advertising Association, consumers spent £2.09 billion on magazines in 2006. While the main channel to market is the newsstand, postal subscriptions have been growing, and now account for 14 per cent of magazine sales, up from 3 per cent 10 years ago. Publishers tend to promote subscriptions as they encourage regular readership and, with sustained sales, they offer measurability and predictability. With continuing pressure on newsstand space, subscriptions are expected to continue to grow. Some significant titles are around 50 per cent subscription sales, including Good Housekeeping, Gardeners’ World, and the Economist13.

12 ‘‘Small Business and the UK Postal Market’’, December 2006. 13 InCirculation, Monday, 1 January, 2007. 22

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Business-to-business magazines There are over 5,000 business-to-business (B2B) titles in the UK, and 90 per cent of these are distributed by post. Of those, 70 per cent are controlled (free) circulation. The B2B publishing model is advertiser-driven, with publishers targeting named individuals in specific marketplaces. This is a particularly price-sensitive market, and with its high reliance on postal distribution as a channel to market, it is particularly sensitive to postal price rises. According to Postcomm’s discussions with stakeholders, it is an area of the publishing sector that has been especially sensitive to electronic substitution. Customer magazines Customer magazines are those produced by companies for their customers and they rely heavily on postal distribution. There are around 1,000 customer magazine titles in circulation, and 72 per cent are mailed directly to customers, with a total circulation of over 400 million. The remaining volume is either distributed through the retailers’ own shops or increasingly via newsstands, other retailers or bundling with other media. Mintel, the market research company, estimates that over half of all posted magazines are customer magazines and that, as of 2005, the industry spent over £350 million on postage. Mintel expects continued growth in this market, and predicts that the customer publishing industry will reach a value of £1 billion by 2010. Indeed, in the last 12 months the industry has seen unprecedented growth at 16 per cent year on year with companies including Sony, RBS, Chestertons, ASOS and Virgin Media investing in customer magazines as a marketing tool. Further growth is expected, in particular in the public sector, automotive and retail industries. The particular challenge for the postal industry is the recent trend away from postal distribution toward retail outlets. Publishers are experimenting with various cost-saving measures, including reducing postal costs by increasing retail distribution, especially as postal costs can represent up to half of the entire cost of producing a magazine. Most customer magazines are not highly time sensitive, therefore the industry is more sensitive to cost than time efficiencies.

OVERVIEW OF THE POSTAL MARKET

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Fulfilment Fulfilment mail refers to the delivery of requested goods, from items bought mail-order to brochures and tickets. This is a growth area of the market, driven mainly by internet sales. The IMRG14 recorded e-retail sales in July 2007 to be 80 per cent higher than the previous year, reaching £4.2 billion for the month alone. The on-line sales growth is projected to continue, as demonstrated by the Verdict figures in the table below.

Figure 2.9 e-Retail market size 2001/11

Total on-line spending (£bn)

30

20

10

0 2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source: Verdict Research, UK e-Retails 2007

This market is a combination of items sent within the licensed area and parcel and express traffic which falls outside the licensed area. It is also to some extent a receiverdriven market, demanding alternative delivery services, unlike most other mail applications where services are driven by the sender. Finally, the emergence of on-line generated sales requires operators to enter into co-operative arrangements beyond traditional postal processes, integrating IT platforms and forming partnerships seen with internet based service providers. Canada Post, for example, has an integrated on-line service with eBay allowing customers to buy postage and print shipping labels on-line. USPS has a similar alliance that allows customers to deal with postage directly on the eBay site, and also offers free next-day collection of packages from residential and small business customers15.

14 Internet Media Retail Group E-Retail Sales Index, August 2007. 15 Strategic Transformation Plan, United States Post Office, September 2005. 24

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Case Study LOVEFiLM LOVEFiLM, the on-line DVD rental company, relies heavily on first class post for the success of its business model. It has around 450,000 active subscribers in the UK and is growing at significant rates. Customers subscribe to a package, and depending on their choice of subscription receive 1, 2 or 3 DVDs at a time via Royal Mail. LOVEFiLM uses first class standard tariff PPI for the delivery of DVDs to its customer. The customer returns the DVDs in the same packaging, via Royal Mail first class business response. LOVEFiLM’s rentals make up 23 per cent of the total UK DVD rental market, including high street rentals – this equates to 2 million rentals per month and as such 4 million first class mail transactions a month. As a large mailer LOVEFiLM has been working to improve the machine-ability of its packaging in order to achieve better pricing and service. As yet it has not found a solution with either Royal Mail or an alternative provider. LOVEFiLM believes that a true end-to-end provider, offering first class inbound and outbound services would increase current operators’ flexibility and customer focus. LOVEFiLM has also recently started using direct mail, both addressed and unaddressed, as part of its marketing mix. It hopes that with improved targeting it can continue to use direct mail as a successful customer acquisition tool. LOVEFiLM feels that there is significant potential for growth in the on-line DVD rental. Figures from Screen Digest show that in 2006, the on-line DVD rental business accounted for 27.9 million DVD rental transactions in the UK. Furthermore, it anticipates that the number of on-line DVD rentals in 2007 could exceed 35 million from 700,000 British households and forecasts that this could rise to 67 million transactions from 1.4 million households by 2011. LOVEFiLM will continue to rely on and demand an efficient and reliable postal service.

Sources: LOVEFiLM, October 2007. Screen Digest Video Intelligence, 2007. www.screendigest.com

OVERVIEW OF THE POSTAL MARKET

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Express market Closely related to the postal market, the express market is concerned with the collection and delivery of time-specific items. It is estimated to be worth around £5 billion, or 1.3 billion items. Around 70 per cent of this is thought to be business-to-business, while £1.2 billion comprises the business-to-consumer market. Overall, the express market is demonstrating growth of around 6 per cent per annum16. International postal groups have a strong presence in the UK express market, Deutsche Post Worldwide through DHL, La Poste through Geopost, UPS through Lynx Express and TPG through TNT Post UK. Parcels are the primary service for most players in this market, but mail is a natural extension for some players and is becoming a more significant component. Documents account for around 25 per cent of express shipments in the UK. Next-day deliveries represent about 80 per cent of total revenues17. Table 2.3 UK Express parcels market, market share 2005* Ownership

by Value (%) Domicile

TNT Express

TPG

18

Netherlands

Premium

DHL

Deutsche Post

14

Germany

Low-mid-range

Parcelforce

Royal Mail Group

8

UK

Low-mid-range

Business Post

UK listed company

8

UK

Premium

Parceline

La Poste Group

7

France

Mid-range

Lynx Express

UPS

6

US

Mid-range

Initial City Link

Rentokil Initial Plc

6

UK

Premium

Target Express Parcels

Venture Capital

6

UK

Premium

ANC

Venture Capital

5

UK

Mid-range

Interlink Express Parcels

LaPoste Group

5

France

Mid-range

UPS

US listed company

4

US

Mid-range

Amtrak

Netfold Ltd

3

UK

New focus on B2C

Nightfreight

Venture Capital

3

UK

Irregular dimensions and weight

Tufnells Parcel Express

Venture Capital

2

UK

Irregular dimensions and weight

5

UK

Others

100% *

26

Positioning

Source: Investec Securities

Royal Mail Special Delivery is not included in this analysis as considered to be part of ‘express letters’ rather than parcels market. 2007 COMPETITIVE MARKET REVIEW

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UK express parcel carriers tend to use one of two business models. The first is a franchise model, where each depot is owned and operated by a third-party. The second model is a wholly-owned, or leased, network. Both can be effective, although the franchise model risks the franchisor subsidising losses of the franchisees. The UK express parcels market traditionally has been related to consumer spending, although structural changes such as the growth in internet sales and the liberalisation of the postal market create changing dynamics in the industry. Customer demand for alternative delivery options, growth in internet-driven sales, and opportunities in the liberalised postal market could impact the structure of the express market and the wider mail market.

International outbound International outbound bulk mail from the UK is a market estimated to be worth £300 million annually18. Unlike the domestic, or internal, market operators do not need a licence to offer international outbound mail services. Several of the large incumbent postal operators are competitors in this market in the UK, including Deutsche Post (DHL), TNT, La Poste, De Post (Belgium) and Swiss Post. Postcomm estimates that Royal Mail has around a 33 per cent share of this market. There are also several consolidators specialising in international outbound mail, including BTB Mailflight, Pharos and Mercury (now part of DHL), and many mailing houses offer international mailing services. The Mail Consolidators Association (MCA) has around 20 members and represents the consolidation industry, and there are many more competitors in this market of varying sizes outside the MCA. The consolidators and mailing houses active in this market sector have the experience of handling multiple mail providers in a competitive market which could benefit them in the liberalised domestic market.

16 UK Express Delivery Market Research Report, MBD, 2007. 17 The Economic Impact of Express Carriers for UK Plc, Oxford Economic Forecasting, 2006. 18

International Postal Corporation (IPC) Market Audit Data, 2005. OVERVIEW OF THE POSTAL MARKET

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3 DEVELOPMENT OF COMPETITION

This chapter looks at the development of competition in the postal market. The first part of the chapter in particular looks at alternative licensed operators, the relative market importance of access and end-to-end competition, and the business models used by alternative operators. Part two of this chapter looks at wider issues affecting the mail market such as private equity, mergers and take overs, the mail value chain and the role of external players such as mailing houses. The chapter concludes by looking at some of the important mail related events of 2007. As of September 2007, there are 18 licensed postal operators in addition to Royal Mail. They are: • Royal Mail; • ANC Express (trading name of ANC Limited); • Challenger Security Services (Admin) Ltd; • Citipost AMP Limited; • City Link Post (trading name of Target Express Parcels); • CMS (trading name of Royale Research Limited); • DHL Global Mail (UK) Ltd; • DX Network Services Limited; • Intercity Communications Ltd; • Lynx Mail (trading name of Red Star Parcels Ltd); 28

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• Racer Consultancy Management Services; • Secure Mail Services; • Secured Mail Limited; • Securicor Omega Express; • The Mailing House Group; • TNT Post UK Limited; • UK Mail Limited; • Zip Mail Limited. Last year DHL Global Mail held two licences which have now been combined into DHL Global Mail (UK) Ltd. DHL Global Mail UK, TNT Post UK and CMS are licensees owned by national incumbent operators from other European countries. CMS is owned by La Poste in France, DHL Global Mail is owned by Deutsche Post and TNT Post UK is owned by the Dutch post office, TNT Post. These operators are seeking market opportunities in the UK as well as other liberalised European markets, while operating as incumbent universal service providers in their own domestic markets. This is discussed in more detail in Chapter 4. Securicor Omega Express has been acquired by DHL Express. It holds an interim licence which allows it to provide internal mail services for two clients in the banking sector.

Market share

Access Competition has continued to develop in the downstream access part of the market, where third party operators and large mail customers gain access to and pay for Royal Mail’s final mile delivery network at the inward mail centre stage. Access agreements can cover the whole of the UK or just certain zones. Information from Royal Mail is that there are 13 customers and 9 operators with national access agreements as at September 2007. Four of these operators have Agency agreements meaning they only have to charge VAT on the part of the mail process that they carry out themselves. Three customers have zonal access contracts, as do seven operators, again four of these have Agency agreements as of September 2007. In 2006/07 access mail made up 11.8 per cent of Royal Mail’s operational volumes. For the five months from April to August 2007 access mail represented 19 per cent of Royal Mail’s revenue-derived volumes, compared to 11 per cent for the corresponding period in 2006. Figure 3.1 shows a comparison of Total Access volumes for financial years from 2005 onwards.

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Figure 3.1 Total Access volumes 2005/06 vs 2006/07 vs 2007/08 400

Volume (Millions)

300

200

100

0 Period Period Period Period Period Period Period Period Period Period Period Period 2 1 3 4 5 6 7 8 9 10 11 12 (Apr) (May) (Jun) (Jul) (Aug) (Sep) (Oct) (Nov) (Dec) (Jan) (Feb) (Mar)

Total Access volume 2007/08 Total Access volume 2006/07 Total Access volume 2005/06

Access mail volume is roughly split 50/50 between customer direct access and operator access.

End-to-end In 2006/07 alternative operator end-to-end licensed area volumes declined slightly to 34.8 million items, representing a 12 per cent decline in end-to-end items carried in the licensed area compared to the previous year19. This decline in volume is attributable to a number of licensed operators reporting reduced volumes, combined with Express Dairies exiting the end-to-end market.

19 30

International Postal Corporation (IPC) Market Audit Data, 2005.

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End-to-end developments TNT Post UK

TNT Post UK maintains its ambition to develop an end-to-end service in the UK so as to be able to offer customers a complete postal and delivery solution. As part of its growth strategy, TNT Post is currently looking at a number of potential locations in which it can develop an end-to-end solution. To make its own end-to-end delivery service viable, TNT Post will first need to grow its letters business in these key areas through the acquisition of customers’ mailing volumes. TNT Post will continue to use Royal Mail’s downstream access until it believes it has reached the critical mass for its own distribution. TNT Post hopes to provide further information on some of these locations later in 2007. The company intends to offer this service to local businesses as well as big national mailers. Source: TNT Post, September 2007

DX Network Services and Secure Mail Services

DX Network Services and Secure Mail Services (both now part of the DX Group) also have a foundation on which to extend their end-to-end delivery services. DX already delivers considerable volumes of mail going to business addresses, both within its document exchange network (see note) and to high street and other business dense locations throughout the UK. DX’s sortation systems allow it to segregate mail into different channels, depending on whether final delivery is through the document exchange network, or by hand delivery to postcode addresses within its delivery footprint. The higher value of items carried by SMS means that it is commercially viable for SMS to deliver to virtually all addresses in the UK – both business and residential. Opportunities for the further development of end-to-end deliveries exist by capitalising on the combined strengths of the businesses, including the cross-selling of services to both groups of customers, as well as targeting new areas of business. In the case of DX, new business growth could come by targeting mail going to business districts that can be consolidated with existing volumes. SMS could expand by extending the offer of its services to mailers who might not yet have realised that they have a need for secure delivery. DX and SMS will evaluate any opportunities on their own commercial merits. Source: DX Network Services Ltd/Secure Mail Services Ltd, September 2007

Note 1: Document exchange is not licensed area mail, therefore not regulated by Postcomm.

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Other licensed operators

Market entry/exit In October 2006 Postcomm granted a new long-term licence to Zip Mail Ltd, the first fully franchised operator to enter the UK market. On 1 January 2007 Postcomm granted a long-term licence to DHL (Global Mail). The work undertaken by this new licensee replaces the mail volume previously carried by Deutsche Post Global Mail and Speedmail. In February 2007 MailPlus exited the mail market to concentrate on its next day parcel delivery service, which is the core business focus of Geopost UK, the parent company of MailPlus. In April 2007 Postcomm granted a new long-term licence to The Mailing House Group. Further information about The Mailing House Group is available in the section on Mail Operators.

Operators’ business models As alternative operators are developing their businesses in different areas of the market Postcomm has gathered the information that follows from the licensees in order that the market place better understands their operations and business models. The services offered by Royal Mail are extensive and widely understood by the market place, and therefore this section deals exclusively with alternative providers.

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Table 3.1 summarises the current business focus of the licensees. This section gives more detailed information on each of the licence holders, their current operations and customer base. This information was provided to Postcomm by the licensees and is not an endorsement by Postcomm of any operator in particular or any of the services offered by them. The information is intended to improve customer knowledge of the current licensed operators.

Licensee

End-to-end

Access

(items costing less than £1 or weighing under 350g)

(delivered under C9 or Customer Direct Access Agreement)

Focus/business model

ANC Express (trading name of ANC Ltd)

Pouch services. Not currently operating in the licensed area.

Citipost AMP

Niche B2B markets. Also offers Downstream Access (DSA) services (consolidated, zonal and national).

City Link Post (trading name of Target Express Parcels)

Express, parcels; B2C through DSA.

Challenger Security Services (Admin)

Disguised mail delivered by Royal Mail/couriers.

CMS (trading name of Royale Research Ltd)

B2B (mostly London).

DHL Global Mail (UK) See section on Market entry/exit for licence changes relating to DHL Global Mail (UK)

DSA sorted and unsorted services provided on a national basis. Some E2E (B2B). Delivery in the London area only, though collections can be anywhere in the UK.

DX Network Services (Now part of The DX Group)

National next day B2B through own delivery network (document exchange, business mail and parcels).

Intercity Communications

B2B niche markets, own delivery in London; international courier services.

Lynx Mail (trading name of Red Star Parcels)

National DSA, bulk pre-sorted mail, B2C and B2B.

Racer Consultancy Management Services

UK and international mail and courier services; B2B and B2C mainly through Royal Mail (not Access). Some B2B (not in licensed area) through own network.

Continued

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Licensee

End-to-end

Access

(items costing less than £1 or weighing under 350g)

(delivered under C9 or Customer Direct Access Agreement)

Focus/business model

Secured Mail Ltd

National consolidated and bulk mail through DSA.

Secure Mail Services (Now part of The DX Group)

National B2C and B2B through own secure delivery network (valuable items such as bank cards, passports, event tickets) – not in the licensed area – and through Royal Mail (not Access).

Securicor Omega Express

Acquired by DHL Express. Interim licence to convey mail between offices of HSBC and between the offices of Royal Bank of Scotland. Pouch services.

The Mailing House Group*

Bulk mail through DSA.

TNT Post UK

Pre-sorted and unsorted B2C and B2B letter mail with delivery through DSA. Parcel and packet delivery through own network and DSA.

UK Mail

Pre-sorted (bulk mail), unsorted and international B2C and B2B mail through DSA.

Zip Mail

Fully franchised business in the London/M25 area.

* Note: The volumes are as reported by Licensees for the Financial Year 2006/07. The Mailing House Group only received its licence on 11/4/07.

Is under 100,000 mail items Is between 100,000 and 1,000,000 mail items Is between 1,000,000 and 10,000,000 mail items Is between 10,000,000 and 100,000,000 mail items Is over 1,000,000,000 mail items conveyed

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Citipost www.citipost.com

[email protected]

0208 301 8500

Services: End-to-end in London, Manchester, Birmingham, Bristol, Edinburgh, Glasgow and Liverpool. DSA zonal, national DSA and unsorted DSA. Customer base: Direct mailers, transactional mailers, mailing houses, SMEs, all of these B2B for the hand delivery and B2B B2C for DSA.

City Link Post (trading name of Target Express Parcels) www.city-link.co.uk [email protected] Services: Full basket of express delivery services. Including added value elements such as Post, Sameday, fulfilment services. Quality driven organisation aiming to become largest in UK. Customer base: Mostly made up of direct mailers, transactional clients, mailing houses and large brand names, with some estate agents and travel companies. Innovation: Target Express has successfully merged with City Link to create the 2nd largest express operator in the UK. “In addition, we have broken new ground with our combination of zonal and national pricing solutions, as well as moving into the unsorted market.”

CMS (trading name of Royale Research Ltd) www.cmsnetwork.com [email protected] Services: Research distribution worldwide. Customer base: Mainly financial institutions; however targeting all industries. Innovation: Track and trace bar code with customer interface.

DHL Global Mail (UK) www.dhl-globalmail.com

0208 603 3000

Services: Downstream Access services (both sorted and unsorted products), offering national coverage. Citispeed – A business-to-business end-to-end delivery service within 22 London postcode areas. Citispeed will collect mail from outside these areas. International Mail – Collection from anywhere in the UK, offering global coverage. Customer base: Direct mailers, transactional mailers, and mailing houses covering all sectors. International mailers and publishers make up a major proportion of its customer base. Targeting business mailers of international, pre-sorted and unsorted mail.

DEVELOPMENT OF COMPETITION

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DX Network Services Ltd and Secure Mail Services Ltd20 www.thedx.co.uk www.securemail.co.uk Services: DX Network Services Ltd – Provide nationwide post 5 pm collection/pre 9 am delivery of mail to over 27,000 business customers through a Document Exchange network. In addition next day door-to-door mail delivery services covering every high street and business district every working day is offered. Secure Mail Services Ltd – Provides registered, recorded and disguised postal services for the secure delivery of valuable items (e.g. passports, bank cards, cheque books and event tickets) to virtually all UK addresses. Customer base: DX Network Services Ltd – Organisations of all sizes, from SMEs to large corporates, who have a regular requirement to send next day mail to other businesses. Targeting businesses that operate within the legal, financial services, property, professional services, government, publishing and retail sectors. Secure Mail Services Ltd – Banks, government agencies, ticket agents, voucher printers and others. Targeting organisations sending high volumes of valuable or sensitive items to business and residential addresses nationwide. Innovation: Brought together DX Network Services Ltd and Secure Mail Services Ltd to form an end-to-end alternative to Royal Mail. Combining the strengths of the two organisations, introduction of SecureDX in spring 2007, a guaranteed and ‘signed for’ registered mail service delivering to virtually every address in mainland UK and Northern Ireland.

Intercity Communications Limited www.icityc.co.uk [email protected] Services: Central London hand delivery business-to-business. The remainder of mail goes via Royal Mail. Intercity also has a mailing house function, offering design and printing, data capture, envelope enclosing by both machine and manual, polywrapping, inkjet addresses and all other services relating to the preparation of material for distribution. This fulfils the role of a ‘one-stop-shop’ if required. Customer base: Various customers, mainly in the financial research sector.

LYNX Mail (trading name of Red Star Parcels Ltd, a UPS company) www.ups.com [email protected] 0778 626 2851/ 0247 637 3737 Services: C9 Down Stream Access postings with Royal Mail providing last mile delivery for bulk mail. Typically mail previously sent as Mailsort with volumes in excess of 25,000 posting over all UK or just locally. Collection and delivery spread is nationwide with a fully-integrated national Hub and UPS/LYNX collection and delivery fleet. UPS, the world’s largest parcel company, has a full range of express package delivery products from small items to pallets, air and sea freight, UK and International services. LYNX Mail team can assist in accessing all the UPS products and bring together a complete suite of services. Customer base: Many third sector21 mailers, large marketing and catalogue response mailings, financial service providers. Targeting bulk mailers with average volume in excess of 25,000 items using either downstream access already or Mailsort/Presstream from B2B or B2C lists – transactional and direct mail.

20 DX Network Services Ltd and Secure Mail Services Ltd hold two separate licences. Since their acquisition by Candover in 2006, the companies are working closely together. 21 The third sector comprises of value-driven organisations, including voluntary and community organisations, charities, co-operatives and social enterprises. 36

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Table 3.2 Business Focus of Licensees The Mailing House Group (trading as Northern Mail) www.themailinghouse.co.uk

[email protected]

Services: • Downstream Access (DSA); • Specialist Packet Production and Sortation Services; • Inbound Mail Sortation and Consolidation; • Storage, Mailing and Fulfilment Services; • Track and Trace;

• • • • •

0870 010 2000

Undeliverable/Gone-Away; Bespoke Services; Secure Mail Services; International Services; Business Reply Services.

Geographical Areas: Midlands, North West, North East and Scotland Customer base: Direct Mailers, SMEs and Public Sector. Innovation: The introduction of specialist packet production and sortation systems.

TNT Post www.tntpost.co.uk

[email protected]

0162 889 1644

Fax: 0162 881 6882

Services: TNT Post provide a range of home delivery, addressed and unaddressed postal services to business customers delivering bills, statements, direct mail, packets and parcels to 26 million UK households. Customer base: Top 500 UK bulk mailers both DM and transactional, mid-market mailers, SMEs, mailing houses. TNT Post targets all types of customers from SMEs to Blue Chips. Innovation: Launched: 1) AllSort, a 3 day national service for unsorted, non-machineable mail and a 4-8 day unsorted service for international and BFPO mail. 2) PremierPacket, a nationwide packets delivery service that delivers sizeable savings. 3) Launched variants of pre-sorted and unsorted mail services e.g. EconomySort, a more cost effective version of its unsorted mail service. 4) Established regional businesses in Scotland, the North of England, South West England and South Wales, focused primarily on the SME sector.

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UK Mail www.ukmail.biz

[email protected]

08452 30 50 50

Services: UK Mail offers nationwide collection and daily delivery of mail to all addresses, with a two day service for a range of pre-sorted mail specifications and two or three day service for unsorted mail. Customer base: Transactional mailers; direct marketing; mailing houses; financial services; public sector; SMEs. Targeting business mailers of pre-sorted and unsorted mail. Innovation: UK Mail was the first Down Stream Access mail operator, the first to introduce Customer Direct Access and has established an Agent For Access agreement. UK Mail has made significant investment in sortation capability in various locations around the UK, including high-speed sortation of Large Letters and Packets. The company recently announced the introduction of a next day service for mail printed at one of UK Mail’s national network of sortation centres. This is discussed in the value chain innovation section of this report.

Zip Mail Ltd www.zip-mail.co.uk

[email protected]

Services: Collection from M25 area; consolidated UK Next Day and Economy, and International postal services; whole street delivery. Customer base: SMEs, estate agents, mailing houses, professional bodies. Innovation: Offered alternative postal services to SMEs and smaller volume mailers.

Licensing review In May 2007 Postcomm began the first of a two stage review of its licensing framework, looking to facilitate entry to the market, with the publication of a consultation document considering amendments to the current framework. Postcomm is due to publish its decision in November 2007, and this will be available on the Postcomm website. Consultation about the second stage of the review, considering more fundamental changes to the licensing framework, is due to begin in January 2008.

Private equity investment, mergers and takeovers in the UK and European postal markets A range of companies are responding to the emerging liberalisation of mail markets both in the UK and across Europe. A few universal service providers in member states are expanding their businesses both geographically and functionally. Some are expanding into other countries’ liberalised mail markets, some are moving into upstream and downstream activities, or into express and logistics. Local companies are also setting themselves up in these markets across Europe, leading to mergers and acquisitions as they become established in certain regions or market sectors.

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Private equity companies offer a source of funding for financing developing business models in the postal sector throughout Europe, and they are investing in competitive postal operators who do not have the financial backing of large parent companies such as foreign postal incumbents. They are also investing in the privatisation of universal service providers in Europe. The evidence of private equity backing generally indicates positive prospects for the postal market. Most recently, the UK postal market attracted private equity and investment when Candover Investments plc bought both DX Network Services and Secure Mail Services in September 2006 based on leveraging the complementary delivery services of these two companies. Private equity backing has been instrumental in much of the consolidation that has occurred in the UK mail, express and parcels industry, which are becoming increasingly integrated, as demonstrated by recent acquisitions relating to mail licence holders. Fedex, the American express transportation company acquired ANC Holdings Ltd in December 2006, and in the same month Rentokil Initial plc acquired Target Express. Rentokil Initial also owns City Link Ltd, and as of 1 May 2007 Target Express has been trading as City Link Ltd. (The mail operator licence remains in the name of Target Express, and all access mail is carried via the Target network.)

Privatisation of universal service providers (USPs) has attracted investors across Europe. The German, Dutch and Austrian USPs are listed on the stock exchange, and the majority of Deutsche Post is held by private investors. USPs themselves are increasingly looking to exploit market opportunities and position themselves for future market developments. Post Danmark sold 22 per cent of its shares to CVC Capital partners, and 11,000 employees also hold shares. Preparing for European liberalisation, they have a scheduled exit for CVC, and plan to form other strategic partnerships in preparation for share sales. Post Danmark also holds 49 per cent of the shares in De Post – La Poste, the Belgian national operator. Deutsche Post is among the most active in pursuing a European acquisition strategy. In the mail market, Deutsche Post owns Speedmail and DHL Global Mail in the UK, Unipost (38 per cent) in Spain, and Selekt Mail in the Netherlands. Deutsche Post has acquired several logistics companies, including Exel in the UK, along with companies in the parcels and express industry across Europe, such as Securicor and Danzas. Deutsche Post also owns companies involved in upstream services such as Williams Lea in the UK and Koba in France.

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Most recently, there is speculation that UPS is interested in bidding for a stake in Deutsche Post, backed by private equity from Apax Partners Worldwide. Over the past years there have been rumours that UPS is interested in acquiring the 30 per cent stake currently held by the German government, and UPS has recently been thought to be in talks with Apax about possible funding arrangements. This announcement, helped by a 13 per cent profit increase in Q2 this year, boosted Deutsche Post’s share value by 2.3 per cent22. This share rise and investment speculation signals market confidence about the German mail market ahead of liberalisation in January 2008. The Dutch universal service provider, TNT Post, is expanding its European mail market presence in the UK and Germany. In the UK it is building its mail business through TNT Post UK, while in Germany it has acquired several regional distribution networks to offer a nationwide end-to-end alternative to Deutsche Post. While TNT is expanding in Germany and the UK, Sandd, the 2nd largest postal operator in the Netherlands, has developed its business by buying regional postal companies in the Netherlands, expanding its own network and forming partnerships with regional distribution specialists. Sandd attracted capital from NIB Capital Principal Investments and Fortis Private Equity. Trimortuer Holdings BV, an investment and management company, is the major shareholder. It now has 100 per cent coverage of the Netherlands, distributing direct mail and magazines on set delivery days twice a week23. The scale of private equity investment and acquisition activity in liberalised mail markets points to market opportunity. This extends to business activity in the upstream and downstream ends of the mail industry as well as to geographical expansion, and the business models that emerge may well involve companies that look less like traditional postal operators and more like a new breed of business service providers offering solutions along the mail value chain.

22 Air Cargo News International, 7 September 2007. 23 Trimoteur Holding, B.V. Website. 40

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Mail value chain

Figure 3.2 The mail value chain

SOLUTIONS

DISTRIBUTION

Mail creation

Mail finishing

Mail collection

Mail processing

Mail delivery

Addresses/ databases

Printing/ franking

Pick up/ transport

Sorting

Final mile

Developments in electronic media have not only impacted the demand-side of mail volumes, but along with developments in printing technology, have altered the mail value chain. The mail production industry has evolved to capitalise on the technologies which expanded the scope of mail production to include functions ranging from data management to response handling. Information technology, data services and print technology make it possible to substitute most traditional postal activity up to final delivery. They also offer a variety of opportunities to add value to mail and make it unique from other media. To the extent that innovation has occurred in the industry, it has been driven largely by developments along the ‘back end’ of the mail value chain. Functions traditionally performed by the mailing customer have been increasingly outsourced to specialists, and in turn the provision of these services is being consolidated into ‘one-stop-shop’ providers of mailing services. The third-party provision of specialist data services has improved mail effectiveness in that accuracy of data reduces costs associated with poor addressing, and also makes on-going communication with customers more viable. Ranging from list provision to data cleansing, data services have made targeted direct mail campaigns feasible, and have refined the targeting to an individual, personalised level. It is likely that this targeting is responsible for some of the decline in direct mail volumes in that advertisers are opting away from mass mailings toward smaller, better targeted campaigns. On the other hand, better targeting increases return on investment and enhances the perception of direct mail to the receiver, which should make it a more sustainable medium.

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Related to better targeting, technological advances in the print industry have created new opportunities for printing tailored customer messages on both transactional and advertising mail, and have indeed blurred the distinction between these mail streams. They offer opportunities for mailers to become more personalised in their communication by creating customised up-to-date messages on mail items. This in turn ties into document management and back-end processing that includes functions such as managing returns, digitising and archiving documents. There has also been growth in the use and outsourcing of these functions.

Value chain innovation

Case Study Royal Mail’s Personalised Integrated Media In April 2007 Royal Mail announced an innovation in the advertising market. In partnership with Sony DADC Royal Mail has developed a product which fuses traditional post and digital media. The personalised, interactive CD can be tailored to individuals’ needs and interests, allowing the advertiser to include videos and information which is entirely personal and relevant. The solution, which has been called Personalised Integrated Media, takes the concept of personalisation further than was possible before and allows greater scope to build brand image by including features such as 3D product tours and television advertisements.

Case Study UK Mail launches i-mail UK Mail is to launch a new next day mail delivery service, i-mail, which will see it moving its business further back along the mail value chain. Customers will electronically send their mail to a UK Mail national network of sorting centres, where it will be printed, enveloped and transferred on to Royal Mail for delivery. Customers using the i-mail service will be able to send their mail from any internet enabled computer. UK Mail has secured an agreement with Royal Mail meaning that i-mail arriving with UK Mail as late as 6pm will benefit from a first class next day delivery service. This agreement is the first allowing a private organisation evening access to Royal Mail mail centres around the country. Customers will benefit from reduced administration tasks, a decreased environmental effect and greater flexibility for time sensitive mailings.

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Case Study ViaPost ViaPost is a new market entrant planning to launch an ‘electronic-to-physical’ mail service late in 2007 that will allow businesses and individuals to send letters directly from personal computers to a secure ViaPost print facility where they are automatically printed, folded and put into envelopes for delivery through Royal Mail for the ‘final mile’ of the journey. By downloading the free software, businesses and individuals who register for a ViaPost account, which can be on a pay as you send basis, can send single or double sided mail or colour documents anywhere in the UK without leaving their desks. As the mail is printed at a location close to the Royal Mail inward mail centre near to the destination of the recipient, transportation costs are kept to a minimum, and this also means that the carbon footprint of a ViaPost letter is reduced considerably. ViaPost has no trunking network of its own, relying entirely on distributed print for the upstream element of distribution.

Mailing houses, suppliers, brokers and consultants Mailing houses and other suppliers such as intermediaries, brokers and consultants have all developed the scope of their business in line with the opportunities created by the emerging mail value chain. While traditionally involved in mail production and finishing activities, mailing houses are beginning to offer services along the distribution end of the value chain. Alongside The Mailing House Group, which has been granted a postal operator’s licence, Postcomm notes that Postal Net, a network of mailing houses across the UK, is working in a co-ordinated manner to make it easier for large customers to get the most cost-effective deals on postal services. The knowledge and skills of the mailing houses involved is leveraged in this collaborative network. Mail consolidators also form an important part of the mail market. Although many consolidators have traditionally built their business around international mail, Postcomm has seen evidence of mail consolidators becoming more involved in the UK domestic market. Consolidators are able to use the knowledge and skills regarding mail collection and processing, developed whilst working with different operators in the international market, to benefit and advise their customers in the UK home market.

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Also, there is an increased number of consultancy operations in the market, assisting mainly large blue chip mailers with their postal procurement. The services offered by these consultancies vary but are typically software or audit based. Some consultancies have developed software which they use to match the customer’s mailing profile to the best value mail service. Consultancies are often independent and will suggest different providers for different types of mailing, meaning customers may end up working with multiple mail providers. Other consultancies look at the entire mail process, taking several months to audit the customer’s mail services, recommending efficiency changes depending on the mailing requirement. This would include mail sent and received and relationships and contracts with current suppliers. Consultancy advice could also include management of address databases, and advice on changing the format, size and content of mail in order to optimise cost effectiveness. As the alternative licensed operators are starting to target smaller businesses, these consultants have started to broaden their client base outside of larger mailers and develop cost effective solutions for small and medium sized mailers. Postcomm has details of many postal consultancies on its website. Printers stand to benefit from innovative services such as that of ViaPost which will build up a network of printers located near Royal Mail’s network of mail centres, to print electronically distributed mail, which can then be taken to Royal Mail’s local inward mail centre for sortation and delivery. Distributed print may benefit smaller mailers who do not currently meet the minimum volume requirements of other operators, as it can accommodate small volume down to single items, and it reduces the environmental impact of a mailing by sending it electronically closer to its destination. The customer further benefits from such solutions as members of their staff are no longer required to carry out tasks such as printing the mail items, enveloping, stamping or franking mail and taking it to the Post Office, as these tasks are fulfilled by the operator. Electronic distributed print is currently being trialled by a number of UK operators.

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Mailing houses are increasingly offering to share their expertise in database management and mail targeting with their customers. Better data management and targeting of mail allows organisations to obtain a better return on investment from their direct mail campaigns. Regular database cleansing ensures that organisations always have the most up-to-date contact details for their customers, meaning they can cut down on ‘gone aways’ and return to sender mail. Targeting direct mail more effectively means that customers only receive mail that is specifically relevant to them, therefore increasing their likelihood to respond favourably to the call to action in the mail piece. Mailing houses and printers have also been instrumental in suggesting ways to make mail, especially transactional mail, work harder for customers. Customers are increasingly working with their mailing houses and printers to develop ‘transpromo’ mail, where mailers use white spaces on transactional mail, envelopes and bills as spaces for advertising and other messages. This practice is highly developed in the US and is being used increasingly in the UK. However a recent report by DSI CMM, a leading direct mail and print services provider, shows that companies are failing to exploit around £500 million of advertising space on their bills and statements24. This figure equates to 22 per cent of annual UK direct mail spend and demonstrates an area of opportunity to add value to the transactional mail stream. According to the same report, the banking and credit card sectors combined could be missing out on over £350 million of opportunities. Developing new ways of making mail valuable is one possible way of extending the life cycle of transactional mail in the face of environmental and other concerns which are putting pressure on the medium.

24 Marketers fail to exploit £500m ‘transpromo’ opportunities, www.printweek.com, 6 September 2006. DEVELOPMENT OF COMPETITION

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2007 COMPETITIVE MARKET REVIEW

ANC Holdings Ltd acquired by Fedex.

Target Express acquired by Rentokil Initial plc.

Jan 07

December 2006

Dec 06

Zip Mail licence granted.

Nov 06

October 2006

Oct 06

Postcomm consults on Royal Mail compensation schemes.

Postcomm publishes. its decision on Royal Mail’s future management of PAF.

Postcomm announces its business plan.

May 07

April 2007

Apr 07

MailPlus exits the market.

Mar 07

February 2007

Feb 07

July 07

Aug 07

Sep 07

Postcomm agrees to Royal Mail’s request to suspend until the end of its current financial year the payment of compensation to bulk mail customers, where industrial action has taken place and quality of service figures have dropped.

Postcomm publishes its open letter regarding the exemption from the requirement for a licence of ‘pre-paid’ mail conveyed to a licence holder.

Postcomm publishes its annual report and holds the Postcomm Forum.

Business Customer Survey and Competitive Market Review 2007 launched.

Postcomm responds to BERR’s consultation on consumer redress schemes.

Postcomm publishes Post Office Network report: ‘A sustainable customer focused network’.

October 2007

Oct 07

Postcomm closes its investigation into Business Mail Secure, ruling that there is no evidence that BMS is predatory and insufficient evidence that it is discriminatory or restrictive to customers.

Postcomm agrees to Royal Mail’s application to stop Sunday and Bank Holiday collections.

Postcomm publishes consultations on its enforcement procedures for licence breaches and its statement of policy in relation to financial penalties.

Postcomm announces results of collection and delivery time consultation – Royal Mail agrees to examine customer concerns about earlier final collections.

June 2007

June 07

Postcomm begins its review of the licensing framework.

May 2007

Postcomm consults on Royal Mail’s proposal to charge large mailers by delivery location ‘Zonal Pricing’.

Postcomm publishes updated guidelines on exceptions to the universal postal service.

Royal Mail price increases come into force.

The Mailing House Group licence granted.

DHL Global Mail licence granted.

Business Customer Survey and Competitive Market Review 2006 launched.

Postcomm consults on the issue of what is the most appropriate notification process for trials of new products and product changes by Royal Mail.

April 2007

January 2007

November 2006

Strategy Review emerging themes.

14:31

Postcomm offers guidance on Royal Mail participation in competitive tendering.

Interim Review decision giving Royal Mail more pricing flexibility.

Consultation on proposal to reject Zonal Pricing.

Postcomm responds to the government consultation on the Post Office Network. Postcomm welcomes a new type of access arrangement allowing non VAT exempt organisations to take better advantage of the competitive market.

Postcomm announces:

Postcomm examines Royal Mail’s charges to new operators for access to the ‘final mile’.

Postcomm opens a consultation on collection and delivery times.

29/10/07

Postcomm issues guidelines for customers requesting access to Royal Mail’s postal facilities.

August 2007

March 2007

October 2006

Figure 3.3 A year in the mail industry

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4 ROYAL MAIL

This chapter discusses Royal Mail’s financial position, taking information from its 2006/07 regulatory accounts to examine profitability, volumes, revenues and costs. It examines Royal Mail’s quality of service in relation to its targets, and highlights developments relating to Royal Mail’s business transformation and the Consumers, Estate Agents and Redress Act 2007. Royal Mail

Overview Royal Mail’s financial performance for the year ended 25 March 2007 was weaker than in the previous year with operating profits (before exceptional items) for Royal Mail Letters’ business falling from £344 million to £194 million, caused by increasing costs, falling mail volumes and constant revenues. For the regulated area, Royal Mail recorded operating losses of £29 million in 2006/07 compared with profits of £168 million in 2005/0625. The USO remains profitable overall though less so than the previous year (operating profit was £27 million compared with £54 million in 2005/06) with profits from non-licensed mail weighing over 350g continuing to offset losses on licensed mail weighing 0-350g. The use of access products has grown quickly, with access volumes of 2.4 billion items in 2006/07 compared with around 1.2 billion in 2005/06. Royal Mail agreed a refinancing package in February 2007 with its shareholder, which will enable it to commence investment in its transformation plan and deliver the cost efficiencies it needs to meet the demands of its customers. 25 In March 2007, Royal Mail requested Postcomm to review Royal Mail’s pricing flexibility and the level of access headroom. On August 9, Postcomm published its proposals, ‘Review of Royal Mail’s pricing flexibility and the level of access headroom (the ‘Interim Review’ of the price control)’. ROYAL MAIL

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Financial performance

Profitability Royal Mail recorded an operating loss (before exceptional items) within the regulated area26 of £29 million, compared with an operating profit of £168 million (restated) in 2005/06, a reduction of £197 million over the two years. Revenue in the regulated area fell by £41 million (around 0.7 per cent), but costs increased by £156 million. The main cause of the cost increase is people costs, in particular pensions. Table 4.1 Royal Mail profitability by business area Operating profit/loss before exceptionals 2005/06 (restated)

2006/07

change (%)

54

27

-50

Price controlled area

197

(12)

-106

Regulated area

168

(29)

-117

Royal Mail Letters

344

194

-44

USO

Source: Royal Mail 2006/07 regulatory accounts

Royal Mail’s profits across weight steps, classes of mail and products are not uniform. The following analysis is based on Royal Mail’s regulatory accounts. Overall, within the price controlled area, first and second class mail (stamp, meter and PPI) made losses of £18 million compared with a profit of £41 million in 2005/06 (restated). Though first class mail made a net profit of £121 million (similar to 2005/06), this was offset by losses on second class of £139 million (£58 million worse than 2005/06). On access products, Royal Mail retains around 13p out of a total price of about 17.5p per item but reports that access products are loss making (Royal Mail showed losses of £44 million in its 2006/07 regulatory accounts). However, Postcomm’s analysis for its Interim Review27 consultation published in August 2007 suggests the loss is much smaller, at around £12 million per annum.

26 The regulated area comprises letters weighing up to 350g conveyed in consideration of/and less than £1, this includes the price controlled products (including downstream access) and USO non-price controlled products. 27 See Footnote 25. 48

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The USO remains profitable, although in 2006/07 the operating profit was £27 million compared with £54 million in 2005/06. The most profitable part of the USO is for non-licensed products (items weighing more than 350g), with Royal Mail generating an operating margin of around 18 per cent (based on operating profit before exceptionals). However, the profitability of USO items above 350g has reduced by 18 per cent to £198 million compared with the previous year (see Figure 4.1). Royal Mail reports an operating loss before exceptionals of £171 million on licensed USO items weighing less than 350g. Profit margins vary greatly between the different weight steps and formats because of an historical misalignment between prices and costs, although this has reduced since the introduction of PiP from August 2006. Postcomm’s proposals in the Interim Review28, if confirmed in November 2007, would enable Royal Mail greater price flexibility to address these misalignments more quickly than is the case under the current price control arrangements.

Figure 4.1 USO profit/loss from operations (before exceptional items) by weight step for 2005/06 and 2006/0729 300 200 100 £m

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0-350g 0 350g + -100 -200 2005/06

2006/07

Source: Postcomm with data from Royal Mail

28 See Footnote 25. 29 Figures restated to take account of change to USO scope. Profits/losses are shown in nominal terms after the effect of removing exceptional items. ROYAL MAIL

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Volumes Overall mail volumes in the Royal Mail’s Letters’ business30 have decreased by around 2 per cent to 21.9 billion items in 2006/07 from 22.3 billion items in 2005/06. However, there are variations in terms of rate and direction of growth within this overall figure: • First class stamp, meter and PPI mail volume fell by 7 per cent, while second class fell by 4.9 per cent; • Bulk mail (including Mailsort, Cleanmail and Walksort) volumes within the price controlled area fell by 11.6 per cent, primarily as a result of a more than doubling of access volumes; • Presstream volumes fell by 13.3 per cent; and • Special Delivery volumes remained broadly unchanged. The most recent Royal Mail figures show that mailing volumes continue to decline at around 3 per cent per annum. Meanwhile, access volumes continue to increase with Royal Mail forecasting volumes of around 4 billion for 2007/08, an increase of around 65 per cent on the Total Access volumes for 2006/07.

30 Volumes figures are total operational volumes for the mail’s business, excluding door-to-door. This measure includes all regulated and unregulated mail items of all classes and weights. 50

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Table 4.2 Addressed letters’ market by volume31 Total Volumes 2005/06 (millions)

Total Volumes 2006/07 (millions)

Volume Growth (%)

19,705

17,894

-9

Total Alternative Provider Access

539

1,148

113

Customer Direct Access

618

1,292

109

1,157

2,442

111

280

336

20

21,142

20,672

-2

39

35

-10

Royal Mail end-to-end32

Total Access Other letter products Total Other operators’ end-to-end mailings

Source: Postcomm with data from Royal Mail

Revenue Royal Mail’s total mails revenue has remained flat despite an increase in average prices of around 5 per cent for the price controlled area. This is because of the decline in volumes, which indicate that mail customers are sensitive to the effect of price increases and are increasingly shopping intelligently for lower priced mail items that better suit their needs (e.g. selecting second class or access alternatives to an overnight first class service) or selecting alternative forms of communications media.

31 Postcomm is working with Royal Mail and other licensed operators on a definition of mail volume market shares. This is a complex matter, for example Royal Mail argues that self-delivered mail (such as local authority items) should be included in these figures. To date, Postcomm’s market share figures exclude document exchange mail. There is also difficulty with the treatment of parcels, most of which fell outside Royal Mail’s historic monopoly. 32 Royal Mail inland addressed end-to-end mail comprises price controlled products (excluding downstream access) plus USO non-price controlled products. ROYAL MAIL

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Figure 4.2 Royal Mail revenue for the price control area by type of mail: 2006/07 First class stamp/meter/PPI 28% Second class stamp/meter/PPI 18% Bulk mail* 25% Downstream access 5% Other** 24%

* Bulk Mail includes Mailsort, Walksort and Cleanmail ** Other includes Presstream, Packetpost, Response Services, Special Delivery and some International products

Table 4.3 Royal Mail’s addressed inland letters’ market by revenue Total Revenue 2005/06 (millions)

Total Revenue 2006/07 (millions)

Revenue Growth (%)

5,587

5,316

-5

Total Access

152

327

115

Other letter products

269

300

12

6,008

5,943

-1

Royal Mail end-to-end33

Total inland addressed mailings

Source: Postcomm with data from Royal Mail

33 See footnote 32. 52

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Costs Table 4.5 Royal Mail’s cost of providing addressed inland letters’ market Total Revenue 2005/06 (millions)

Total Revenue 2006/07 (millions)

Cost Growth (%)

5,406

5,315

-2

Total Access

166

371

123

Other letter products

181

188

104

5,753

5,874

2

Royal Mail end-to-end34

Total

Source: Postcomm with data from Royal Mail

Overall costs for inland addressed mailings have increased by around 2 per cent, due mainly to an increase in pension costs. Royal Mail incurred approximately £140 million additional pension costs within the price controlled area for 2006/07. People costs represent around 70 per cent of Royal Mail’s total costs for its Letters’ business.

Royal Mail’s quality of service Royal Mail’s quality of service targets are specified in its licence. Prior to 2006/07, Royal Mail’s quality of service performance was measured only on the basis of end-to-end transit times for various products. In 2006/07, additional targets were added to Royal Mail’s licence, to better reflect customer interests. At the same time, in order to reduce the regulatory burden on Royal Mail, Postcomm condensed some of the end-to-end targets so as to reduce the overall number of targets and to allow Royal Mail more flexibility to manage its business. Figure 4.6 compares the new targets to the old ones. Royal Mail continues to be required to achieve set performance standards for first and second class stamped and meter mail, as it does for the Standard Parcels, Special Delivery and Mailsort 3 services. The four first class bulk services, which previously had individual targets, are now in a grouping which has to achieve a group performance standard. The same is true for second class bulk services.

34 See footnote 32. ROYAL MAIL

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Postcode area performance is now measured according to the performance of first class items delivered next day in the postcode area to which they are addressed, rather than as was previously the case, when performance was measured on the basis of items posted in a postcode area for delivery elsewhere. This is considered to be more effective in identifying poor-performing postcode areas. The ‘Intra’ performance measure, concerning delivery within the same postcode area, has been dropped. Lastly, new targets were introduced to measure the percentage of collections and deliveries completed each day, the percentage of items delivered correctly, and the end-to-end transit times for European International Deliveries. Table 4.6 New and old quality of service targets Targets up to the end of 2005/06

New targets in operation from 2006/07

End-to-end transit times:

End-to-end transit times:

First class stamped and meter mail

First class stamped and meter mail

Second class stamped and meter mail

Second class stamped and meter mail

Mailsort 1 First class Response Services First class PPI Presstream 1

Bulk first class

Mailsort 2 Second class Response Services Second class PPI Presstream 2

Bulk second class

Mailsort 3

Bulk third class

Special Delivery (Next Day)

Special Delivery (Next Day) not posted on account

Standard Parcels

Standard Parcels European International Delivery

Standardised Measures:

Standardised Measures:

Postcode Area Target: Posted

Postcode Area Target: Delivered

Postcode Area Target: Intra % Collection points served each day % Delivery routes completed each day % Items delivered correctly

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Figure 4.7 shows Royal Mail’s performance compared to the targets set out in its licence. In 2006/07, Royal Mail achieved 11 out of 12 of its targets, compared to 10 out of 16 in 2005/06. Table 4.7 Royal Mail’s quality of service in 2006/07 Services

Target (%)

Performance (%)

Difference against target

First class stamped and meter

93.0

94.0

1.0

Second class stamped and meter

98.5

98.9

0.4

Bulk first class

91.0

93.2

2.2

Bulk second class

97.5

98.3

0.8

Bulk third class

97.5

99.5

2.0

Standard Parcels

90.0

94.5

4.5

European International Delivery

85.0

93.2

8.2

Special Delivery (Next Day)

99.0

99.0

–

PCAs delivering 91.5% first class mail next day

118.0

116.0

-2

% collection points served each day

99.90

99.92

0.02

% delivery routes completed each day

99.90

99.95

0.05

% items delivered correctly

99.50

99.66

0.16

The failure to meet the target for the number of Postcode Areas delivering at least 91.5 per cent of first class mail the day after posting was due to industrial action in the Torquay and Exeter Postcode Areas. Royal Mail took action to recover its performance in these areas towards the end of the year, and consequently missed the targets by only 0.1 per cent in Torquay and 0.3 per cent in Exeter. There are no automatic consequences stipulated in Royal Mail’s licence for this degree of failure and there was no suggestion that Royal Mail was not meeting its licence obligation, so Postcomm did not take any enforcement action.

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Table 4.8 and Figures 4.3 and 4.4 illustrate Royal Mail’s performance in first and second class stamped and meter mail over the last four years. Royal Mail once again performed above target levels for these products in 2006/07. Table 4.8 Royal Mail’s first and second class stamped and meter performance Standard

Target Performance Target Performance Target Performance Target Performance 2003/04 2003/04 2004/05 2004/05 2005/06 2005/06 2006/07 2006/07

% first class stamped and meter mail delivered next working day

92.5

90.1

92.5

91.4

93.0

94.1

93.0

94.0

% second class stamped and meter mail delivered within three working days

98.5

97.5

98.5

98.5

98.5

98.8

98.5

98.9

Figure 4.3 Royal Mail’s first class stamped and meter performance

% letters delivered next working day

96

94

92

90

88 2003/04

2004/05

First class stamped and meter performance First class stamped and meter target

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2005/06

2006/07

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Figure 4.4 Royal Mail’s second class stamped and meter performance 99 % letters delivered within three working days

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98

97 2003/04

2004/05

2005/06

2006/07

Second class stamped and meter performance Second class stamped and meter target

2006/07 was the first year in which Royal Mail was required to measure and publish the percentage of deliveries that are made each day by the published latest delivery times, and the percentage of final collections made from postboxes or Post Offices at or after the advertised final collection times. Table 4.9 Collections and deliveries completed to times Collections at or after final advertised times

97.9%

Deliveries by latest times: Rural areas

99.7%

Deliveries by latest times: Urban areas

99.5%

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Quality of service in 2007/08 during business transformation At the end of 2006/07, Postcomm received a request from Royal Mail to suspend, until the end of its current financial year, the payment of compensation to bulk mail customers, and to ensure that the company is not subject to a downward adjustment to its allowed revenues (the ‘C factor’) for the years ahead. These mechanisms are designed to compensate customers when Royal Mail fails to meet its licence obligations on quality of service. Royal Mail’s request was made in view of its desire to transform its business, in order to become more efficient, and the fact that Royal Mail believed that such transformation activities could result in industrial action. Having consulted on and carefully considered Royal Mail’s request, Postcomm sent Royal Mail a ‘letter of comfort’, explaining that it had decided to suspend the Bulk Compensation Scheme and to ensure that Royal Mail is not subject to the C factor in 2007/08, because to do so would be in the long-term interest of customers. Postcomm also explained that the relief only has effect where quality of service failures are caused by industrial action which is a response to Royal Mail’s transformation activities. In Spring 2008, Postcomm will hold an open meeting at which Royal Mail will explain its application for relief from the above mechanisms, and answer questions from stakeholders.

The Consumers, Estate Agents and Redress Act 2007 The Consumers, Estate Agents and Redress Bill became law in July 2007. The Department for Business, Enterprise and Regulatory Reform (previously DTI) introduced the Bill to create a new, stronger and more coherent consumer advocacy body, and to improve redress in the energy, postal services and estate agency sectors. Under the Act, Postcomm must make complaint handling regulations for regulated postal operators and is likely to be required to set criteria for, and approve, redress schemes, of which regulated postal operators must become members. Postcomm recognises the potential for the provisions of the Act to create new barriers to entry to the postal market. In making complaint handling regulations and setting criteria for redress schemes, it will seek to minimise any possible negative effects.

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5 MARKET DEVELOPMENTS/ OPPORTUNITIES

Chapter five discusses relevant international comparisons with the UK mail market, looking at market share, volume growth and the development of competition. This is followed by a review of the current VAT situation outlining Postcomm’s position. The final section in this chapter handles the emerging issue of the environment and its links to the mail market. International comparisons

Mail volume trends In the UK, mail volume trends are increasingly difficult to predict, and this report has attempted to investigate the drivers behind the uses of mail to understand likely mail volume trends in the UK for the future. It is instructive to look at other mail markets, and the analysis below summarises mail volume growth expectations in eleven European member states with similar volumes per capita as the UK. WIK surveyed Universal Service Providers (USPs) and National Regulatory Authorities (NRAs) about their views on future mail volume trends to 2011. It then segmented the respondents according to current mailing volumes. The table overleaf shows member states with relatively high mail volumes, which includes the UK. While letter post is expected to decline, direct mail is expected to continue to increase across virtually all member states.

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Figure 5.1 Expected volume development in high-volume member states until 2011

Number of member states

8 7

7 6

6 4

3

2

2

2

2

2 1

1

0

0 Letter post

1 0

Correspondance

Strong decrease (annual decrease >2%) Slight decrease (annual decrease <2%) No change Slight increase (annual growth <2%) Strong increase (annual growth >2%)

0

0

Direct mail

Notes: The chart refers to 11 member states with volumes above EU average (AT, BE, DE, DK, FI, FR, LU, NL, SE, SI, UK). For each member state, consolidated expectations about future volume development were derived from the assessments provided by USPs and/or NRAs. Source: WIK

According to WIK, both transactional mail and individual correspondence are subject to electronic substitution across Europe, direct mail is much less so. As shown in Figure 5.2, across Europe; direct mail was still growing at an average of six per cent per year, from 2002/04, even in countries where other mail volumes were falling. It is impossible to draw any direct conclusions for potential direct mail growth in the UK due to the number of variables that may be impacting the relative growth in direct mail volumes. However, this does suggest that as mail continues to grow as an advertising medium in neighbouring European countries there may be further opportunities for growth in the UK.

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Figure 5.2 Average annual growth rates of Universal Service Providers’ direct mail (addressed and unaddressed) 2002/04 120 Annual average growth 2002/04 (%)

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DE

DK

EE

ES

FI

GR HU

IE

IT

LU

LV

LT

MT

PL

PT

SI

SK

-20 -40 -60 GDP constant EUR Addressed direct mail Unaddressed direct mail

Sources: WIK survey (EE, ES, FI, GR, HU, IE, IT, LT, PT, SI, SK); UPU (addressed and unaddressed: GR, LU, LT, LV, MT, PL, PT); DE, DK: Annual Reports, Eurostat (GDP at constant EUR); DK, LT, LU, LV, PL: no figures for addressed direct mail

Market shares It is interesting to understand the emerging pattern of liberalisation in those countries with relatively well developed markets in order to assess the potential prospects for competitive development in the UK, understanding that direct comparisons are difficult because the nature and pace of liberalisation differs between countries. Competition has existed in the Netherlands and Germany for several years and has developed gradually through the establishment of local and regional companies delivering to certain areas or providing specialised services. More recently, national end-to-end networks have developed in these countries, through the acquisition of these small, regional companies, to establish national competitive networks. This is in contrast to the UK market, where the large international companies have been drawn to the UK by opportunities offered by access using Royal Mail’s delivery network. Current UK endto-end alternatives are limited to a few companies offering local, high value or document exchange services, and most competition has developed in the upstream end of the mail market.

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Germany In Germany, competitors have been able to offer ‘value-added’ postal services since the late 1990s. Many publishers and unaddressed mailers set up local and regional networks, and TNT Post and PIN AG have since established national networks through partnerships and acquisitions with these local operators. Established in 1999, and based in Berlin, PIN AG plans to develop its network to close to 100 per cent geographical coverage by the end of 2007. Reflecting confidence in PIN’s growth, in June 2007, German media group Axel Springer acquired PIN by increasing its stake to 71.6 per cent. TNT Post is the other main competitor with nearly national coverage. Created from a joint venture between TNT and Hermes Logistics, TNT has acquired several regional German operators and a large consolidator, PostCon Deutschland AG. Competitor market share has grown every year since 1998, although only significantly in the last few years. At the end of 2006, competitor market share in Germany was 10 per cent. UBS predicts that by 2017, competitor market share will have reached 30 per cent, driven mainly by the existence of the two alternative nationwide end-to-end networks. They predict TNT Post and PIN AG will have around 13 per cent of the market each, while a variety of smaller local operators will share the remaining four per cent. The main competitive market is bulk business mail and direct mail. Interestingly, in Germany, overall mail volumes continue to grow, even though Deutsche Post’s volumes appear to have reached a plateau.

Figure 5.3 Germany – Addressed mail market volume, 1998-2006 18000

Volume (million items)

17000 16000 15000 14000 13000 12000 1998

1999

Deutsche Post Competitors

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2001

2002

2003

2004

2005

2006

Source: Deutsche Post, Bundesnetzagentur

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Netherlands In the Netherlands, by the end of 2006, competitors’ share of the addressed mail market was 11.7 per cent. Sandd and Selektmail are the two main competitors and operate low cost end-to-end, nationwide delivery networks focusing on pre-sorted bulk mail with twice-weekly delivery. They have nationwide delivery networks and carry addressed mail, magazines and periodicals. They have continued to increase their share of competitor market volumes, handling over 6% of total addressed mail volumes between them. UBS estimates that competitor market share will increase to 38% in the Netherlands by 2017. In the Netherlands, business letter mail under 50 grams (i.e. transactional mail) is still in the reserved area. Competition has focused on direct mail, and the business models of Sandd and Selektmail are both built around direct mail requirements. UBS predicts they could eventually have a combined 50 per cent share of the direct mail market. Since 2001, addressed mail volumes in the Netherlands have been in slight decline, as in the UK, although the decline has been less severe, amounting to 2.1 per cent over the period, or 0.4 per cent Compound Annual Growth Rate.

Figure 5.4 Netherlands – Addressed mail market volume, 2001-06 5800 5600 Volume (million items)

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2002

TNT

2003

2004

2005

2006

Source: TNT, Sandd, OPTA, UBS estimates

Competitors

MARKET DEVELOPMENTS/OPPORTUNITIES

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Spain In Spain, domestic intra-city mail and direct mail have always been open to competition, and around 200 small local operators provide addressed mail delivery. Unipost was established in 2001 and has built up a network of competing operators that now reaches over 70 per cent national coverage. Unipost (owned by Deutsche Post) is now the main end-to-end competitior to Correos y Telegrafos with an estimated market share of around 8 per cent in 2006, while the other 200 operators share the remaining 1-2 per cent market share35. The pace and type of liberalisation in European countries has differed, therefore it is difficult to draw direct comparisons with the UK, and new entrants’ business models are based on the possibilities offered by the respective regulatory environment in each country. However, market shares of end-to-end competitors in Germany, the Netherlands and Spain are estimated to be between 8-12 per cent in 200636. ECORYS concludes that market conditions for the development of end-to-end competition in the UK are not significantly better or worse than for these European countries generally, and, therefore, in the medium-term, prospects for some end-to-end competition establishing similar market shares are not unlikely. The UK end-to-end market has been slow to develop partly because the access regime encouraged large competitors to enter the market, and potential end-to-end operators now have to compete with both the incumbent and established access operators. The UK enjoys among the lowest prices in Europe, with very high service quality, meaning that emerging competition has to meet a high service expectation and potentially strong price competition. Establishing adequate drop-densities to make delivery profitable will require time for new entrants in the UK. The fact that end-to-end competition has developed, at least to some extent, in the European markets outlined above, is partly a result of the longer amount of time they have had liberalised markets, and of the type of regulatory structure they have each adopted.

35 ECORYS. 36 Prospects for competition in the UK postal market, ECORYS, 16 January 2007. 64

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United States In the United States, the United States Postal Service (USPS) maintains a monopoly on postal services; however, competition exists in the form of workshare agreements similar to access agreements in the UK. USPS works closely with workshare operators and mail preparation companies and considers this to be a key part of its transformation, ensuring the lowest combined costs along the mail value chain to make mail more efficient for customers. Currently, in the United States, three quarters of all domestic mail is pre-sorted and/or barcoded by mailers and mail service providers (presorters, printers and consolidators). USPS promotes worksharing arrangements as the lowest cost option to promote mail growth, and overall mail volumes increased by 2.3 per cent last year (2006/07), while direct mail volumes grew around 5-6 per cent.

“Creating more customer value in core products and services will increase mail volume and revenue to support universal service and the growing delivery network.”37 Another key strand in USPS’s transformation plan has been the development of ‘intelligent mail’, designed to add customer value and reduce costs. Intelligent mail works via a machine-readable barcode that allows the identification of individual items of mail and tracks them through the pipeline. This helps to identify operational bottlenecks, provides mailers with data that assists them in planning and decision making, contributes to more accurate addressing, and serves as the basis for providing actual service measurement data for specific mailings38.

37 Unites States Postal Service, Strategic Transformation Plan, September 2006. 38 Unites States Postal Service, Strategic Transformation Plan, September 2006. MARKET DEVELOPMENTS/OPPORTUNITIES

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VAT

Introduction In April 2006, the European Commission (‘the Commission’) sent letters of formal notice to the UK, Germany and Sweden, which opened infringement proceedings on the interpretation of the VAT exemption for postal services by those countries, as set out in Directive 2006/112/EC – ‘the VAT Directive’. The Commission was not satisfied with replies to its formal notice and so, on 24 July 2007, it opened the second stage of the infringement proceedings, by formally requesting that the UK, Germany and Sweden change their legislation on the VAT exemption which it claimed is not compatible with the VAT Directive. The requests took the form of a reasoned opinion (second step of the infringement procedure provided for in article 226 of the Commission Treaty). If the relevant national legislations are not amended in order to comply with the reasoned opinions, the Commission may decide to refer the matter to the European Court of Justice. Postcomm is not a party in those proceedings. The Commission has said that the VAT postal exemption as applied in the UK hinders competition39. The Commission explained that the UK had exempted from VAT all postal services provided by Royal Mail, on the grounds that Royal Mail had been assigned particular obligations with regards to the provision of the universal postal service. The Commission argued that in the context of competitive postal markets, different tax liabilities were bound to distort competition and could only be justified as regards the strict discharge of the universal service obligation. Where, for commercial reasons – namely to fend off competition from other operators – former monopolies offered to some high volume clients pricing and quality conditions which were not available to the general public, their supplies should be subject to the same tax liability as their competitors.

Postcomm’s position on VAT Postcomm’s position on VAT has consistently been that there should be a level playing field for all postal operators, and that there should be no significant price rises for customers. Postcomm believes that a reduced rate of VAT (of 5 per cent) applied to all mail services and all licensed operators is the best solution to create a level playing field for operators without material price rises for customers. However, a 5 per cent reduced rate of VAT for postal services would require unanimous Commission Member State support – though Postcomm continues to maintain that this is the best solution for the UK postal services market. Postcomm’s analysis of the impact of different VAT exemption scenarios is contained in Annex A of this report.

39 See the Commission’s press release IP/07/1164. 66

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Environmental issues In the last year there has been much publicity about the environmental effects of mail in general and specifically around direct mail. The government has named the direct mail industry as a key stakeholder in reducing the amount of paper waste sent to landfill in the UK. Direct marketing material is estimated to account for approximately 550,000 tonnes of household waste. Addressed mail makes up around 181,500 tonnes, the remainder being unaddressed direct marketing material40. It has been suggested that, in order to reduce waste, direct mail should become an ‘opt in’ communication medium rather than an ‘opt out’ channel. This would mean that consumers would have to indicate that they wanted to receive advertising mail from a company, rather receiving it unless they said that they didn’t want to. This would make direct mail rules similar those used for email marketing. These rules have not yet been changed, and the government and the Direct Marketing Association (DMA) are looking at solutions to the problem that would have less of an effect on direct mailers and consumers. The DMA is working on a number of planned environmental initiatives, including developing a mail opt out system for unaddressed mail, enabling households to register if they no longer want to receive untargeted advertising mail. The first development to be launched by the DMA in response to environmental concerns is a quarterly publication giving advice to direct mailers on green issues, including subjects like environmentally friendly procurement of paper and inks, and recycling. The publication will be available to DMA members and other interested groups. This is the first step in a number of programmes being planned by the DMA, which are partly aimed at helping them meet targets set by Defra in 2007 to ensure that 55 per cent of all direct mail should be recycled by the end of 2009 and 70 per cent by 201341.

40 Source: Waste Strategy for England 2007, May 2007, Defra, www.defra.gov.uk 41 Source: Waste Strategy for England 2007, May 2007, Defra, www.defra.gov.uk MARKET DEVELOPMENTS/OPPORTUNITIES

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Concerns have also been raised about the green credentials of mail operators. Postcomm is monitoring developments to see if there is any evidence that in a competitive market the most efficient and therefore the most energy efficient, ‘green’ operators will be most successful in the market. So far, Postcomm has seen some encouraging signs from many of the licensed operators of green initiatives and products including the following: • Reducing carbon emissions from mail centres, headquarters and other locations; • Procurement of ‘green’ electricity from renewable sources; • Cutting business air travel; • Buying electric or bio-fuel powered vehicles or using cleaner diesel engines; • Developing company wide Corporate Social Responsibility programmes; • Launching carbon neutral mail products (see case study opposite); • In depth analysis of carbon footprints; • Implementing ISO standards on the environment. Recently new and established operators have been working on developing products which are less environmentally damaging. Royal Mail’s Carbon Neutral door-to door product is one example, and will be the first in a series of green products from Royal Mail. The business model used by ViaPost and being explored by other licensed operators (for example i-post by UK Mail, whereby mail is sent electronically to a centre closest to the delivery point) will have the effect of cutting the harmful side effects of mail transportation substantially. TNT NV was, in September 2007, ranked first on the Dow Jones Sustainability Index 2007, improving its overall score from 84 in 2006 to 91 in 2007 and obtaining the top score in the ‘Industrial goods and services sector’ which it has now achieved for three years running. TNT showed consistent improvement in its sustainability reporting and performance. The announcement followed a statement by TNT’s chief executive officer Peter Bakker in August 2007 launching the company’s Planet Me initiative. The programme includes the installation of a certified system to measure, report and manage its CO2 emissions and the reduction of emissions in its 8 most important operational areas. The programme also encourages TNT’s 159,000 employees to extend carbon reduction into their private lives. TNT has the stated ambition to become the first zero emissions express and mail company in the world42.

42 http://group.tnt.com/newsroom/pressreleases/index.asp 68

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An American company Earth Class Mail is taking the idea of hybrid mail one step further, and reducing the physical delivery of mail considerably by scanning customers’ documents at a central hub. The customer is sent a pdf document with scanned pictures of their sealed envelopes via the internet. Customers can then choose from a number of options, for example the item itself could be scanned and emailed to them, sent directly for recycling, archived as a paper or pdf document or physically delivered to their preferred postal address. Statistics from Earth Class Mail show that around 50 per cent of mail is recycled directly and that 44 per cent is scanned into the secure system. An item can have more than one action applied to it, however less than 14 per cent of mail is delivered to a home, office or alternative address43.

Case Study Royal Mail door-to-door In July 2007 Royal Mail launched a ‘Carbon Neutral door-to-door scheme’ to encourage door-to-door mailers to be more environmentally aware. To be able to participate in the scheme, mailers will have to: • Use paper with a minimum of 50 per cent recycled content, and all virgin paper must be Chain of Custody accredited; • Reduce packaging as much as possible and ensure that necessary packaging is made from recycled, recyclable or reusable materials; • Omit windows from campaign envelopes and use cleaner varnishes; • Include the Waste and Resources Action Programme’s ‘Recycle Now’ logo to encourage environmentally friendly disposal. These measures will reduce carbon emissions to a minimum and Royal Mail will then work with carbon offsetting schemes such as the Woodland Trust’s Carbon Plus+ programme to offset the remaining carbon footprint. Once these criteria have been met, mailers are entitled to use the Royal Mail’s carbon neutral logo.

Source: www.printweek.com, 18 July 2007

43 Postal Sustainability, 2007/12: How Delivering Mail On-line Saved Time, Money, our Planet, and (Most of) Our Post Offices, Cameron Powell, Earth Class Mail, 23 May 2007. MARKET DEVELOPMENTS/OPPORTUNITIES

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Postcomm’s stakeholder engagement This report draws on secondary market intelligence sources as well as information Postcomm gathers on its programme of stakeholder engagement. Postcomm conducts a series on on-going meetings and seminars with a variety of stakeholders including various industry groups, large and small mail users, trade associations, industry suppliers, government representatives, influencers and advisors. Postcomm is committed to monitoring market developments through regular updates of this market review in which we seek to understand the development of competition and its impact on the market in order to inform policy decisions and to monitor the subsequent impact of policy decisions on the market. We also monitor the impact of the liberalised market on business customers through our Business Customer Survey, a primary research document, and a sister document to this Market Review, also published this year in October 2007. We welcome the opportunity to extend our reach into the market through our stakeholder programme, or simply through comments or suggestions to the content of this report. If you would like to discuss any aspect of the liberalised postal market, please contact: Ruth Heller or Helen Purser Postcomm Hercules House 6 Hercules Road London SE1 7DB Email: [email protected] [email protected]

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ANNEX A

Postcomm’s analysis of impact of different VAT exemption scenarios Postcomm has modelled the impact on mail volumes of the imposition of both the full rate (17.5%) and the reduced rate (5%) of VAT on all Royal Mail services and published some of its findings in September 200444. Because of developments on VAT, Postcomm has updated its analysis using more recent data. Postcomm has not seen how the European Commission intends to define the services which it describes as being “provided in the strict discharge of the universal service obligation”and which it argues should continue to be VAT exempt. Postcomm therefore has assumed two scenarios. First, services provided in the strict discharge of the universal service obligation could be first class and second class standard tariff stamped mail, Special Delivery, redirection services and the Standard Parcel Service. Secondly, those services could be as above, but also including metered and PPI mail. These two scenarios, together with the full and reduced rate scenarios, give a total of four different VAT scenarios in total. In all scenarios, Postcomm has assumed a price elasticity of 0.58 on Royal Mail services, which we have derived from recent Royal Mail data. Customers appear to be increasingly price conscious: some customers now fold items in order to incur lower charges under Pricing in Proportion (PiP), or have switched from first class to second class services, preferring to pay a lower cost and accept a reduction in delivery time span. To illustrate the impact of this change in price elasticities, Table A1, below, shows how volumes have changed on various Royal Mail services as a result of price changes between 2005/06 and 2006/07.

44 Postcomm’s Competitive Market Review Consultation Document, September 2004. ANNEX A

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Table A1 Price, volume and revenue change % on various Royal Mail services between 2005/06 and 2006/07 Service

Average price change (%)

Volume change (%)

Revenue change (%)

First class stamp, PPI and meter

5.7

(7.0)

(1.7)

Second class stamp, PPI and meter

2.8

(4.9)

(2.3)

(0.3)

(11.4)

(11.6)

2.0

111.1

114.6

Mailsport (All) Access

Postcomm modelled various outcomes based on costs and price information provided by Royal Mail for 2006/07. The tables below set out the result of this modelling. Table A2 shows the volume changes on various Royal Mail services for each of the four VAT scenarios described above. In this table, the ‘Total Royal Mail mails’ figure is based on the volume change for the full range of Royal Mail services (except door-to-door), which have not all been listed here for reasons of space. Table A3 shows the volume change broken down by the VAT status of customers.

Table A2 Volume change % (decline) on Royal Mail services for different VAT scenarios Service % change in volume

17.5% Full

17.5% Partial 1*

17.5% Partial 2**

5% Full

(9.9)

0

0

(2.7)

(10.1)

0

0

(2.9)

PPI first class

(3.7)

(3.7)

0

(0.9)

PPI second class

(3.7)

(3.7)

0

(0.9)

Meter first class

(10.1)

(10.1)

0

(2.9)

(6)

(6)

0

(1.4)

Mailsort (All)

(3.7)

(3.7)

(3.7)

(0.9)

Total Royal Mail mails

(5.1)

(3.7)

(2.4)

(1)

First class stamp Second class stamp

Meter second class

* This assumes VAT of 17.5% is applicable to all Royal Mail services, except first class and second class stamped mail, Special Delivery, redirection services and the Standard Parcel service. ** This assumes VAT of 17.5% is applicable to all Royal Mail services, except first class and second class stamped, metered and PPI mail, Special Delivery, redirection services and the Standard Parcel service.

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Table A3 Volume change % (decline) by the VAT status of customers Customer status % change in volume

17.5% Full

17.5% Partial 1*

17.5% Partial 2**

5% Full

Residential and small business

(8.1)

(7.1)

(6.2)

(2.3)

Non-recovery business

(8.1)

(7.1)

(6.2)

(2.3)

Partial recovery business

(6.8)

(5.8)

(5.1)

(1)

Full recovery business

0

0

0

0

Government departments

0

0

0

0

Discussion on data Current data suggests that the mail market is declining at approximately 2 per cent per year and our future estimates of the trend over the next five years range from 1 per cent growth to 3 per cent decline. The above figures suggest that, in terms of volume decline, an across-the-board 17.5 per cent VAT price increase on all Royal Mail services could result in an additional volume decline of around 5.1 per cent. Postcomm believes that the best outcome would be an across-the-board 5 per cent VAT price increase which would, according to our modelling, only give an additional volume decline of 1 per cent. However, of crucial importance is how any VAT price rise would impact on different categories of customers, depending on their VAT status – and where the volume declines will occur. Table A3 above shows that for fully recovering customers (and government departments), VAT has no significance whatsoever on volumes. These customers account for around half of Royal Mail’s business by value45. That is to say, whatever VAT scenario is chosen, our modelling suggests that there will no change in volumes mailed for these customers. On the other hand, volume decline will be very heavy for customers unable to reclaim VAT, which includes residential users and most small businesses. Overall volumes might decline by 8.1 per cent for these customers if 17.5 per cent VAT was applied to all Royal Mail services.

45 Tackling Barriers To Entry In Postal Services: Postcomm’s Final Decisions And Recommendations, March 2005. ANNEX A

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Given the above, the introduction of 17.5 per cent VAT on all mail services will effectively introduce two different sets of prices into the market: the outcome of this is very difficult to accurately predict as there is no obvious precedent. Although the VAT status of customers applies to all sectors of the market, any sudden change in the application of VAT to postal services may result in confusion and uncertainty. As such, there is a very real danger that 17.5 per cent price increases may lead some customers to move to alternative methods of communication, which could add to the decline in total market volumes and possibly endanger the funding of the universal postal service. Another factor which needs to be considered (and which Postcomm cannot capture in its modelling), is what might happen to PPI and metered mail customers, if the VAT exemption was only applied to first class and second class standard tariff stamps. The full 17.5 per cent VAT could result in a 6p VAT-inclusive price increase (from the current 32p to 38p) on first class PPI and metered services – and a 7p VAT-inclusive increase on second class PPI and metered services (from the current 22p to 29p). The fact that second class service quality is currently very good (exceeding targets) may induce significant switching from first class to second class within PPI and meter, or from PPI and meter to stamps. However, this would be an incorrect price signal, as Royal Mail’s less profitable or loss making services (first class and second class stamps) would be cheaper for a non-VAT recovering customer than its profitable services (first class and second class PPI and meter). Such an incorrect pricing signal could cause damage to the PPI/metered market, if current non-VAT recovering PPI/meter customers switch to buying stamps – despite the fact that the real costs to Royal Mail of supplying PPI and metered services is less than supplying stamped services. Similar distortions between costs and prices and between different types of customers might exist wherever the boundary between VAT and nonVAT products is placed. Hence, in Postcomm’s opinion, the best solution would be a uniform level of VAT on all mail services. These distortions could mean that the real mail volume decline could be far greater than 5.1 per cent. A 17.5 per cent price rise could speed up the decline in mail volumes, resulting in a ‘tipping point’ whereby major mail users unable to recover VAT seek alternative services, such as electronic communications.

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Bulk mail The bulk mail situation has changed significantly since the advent of downstream access (DSA) competition so this area is much more complex. If a DSA operator offers a service at a price of 17.5p per item, it will have to charge VAT on the whole 17.5p and then pay Royal Mail 13p for delivery. Having to charge VAT on the full 17.5p makes it harder for operators to compete with Royal Mail’s VAT-exempt Mailsort services and induce people to switch to their own services. Where a customer holds a Customer Direct Access (CDA) agreement, it would need to also hold a separate agreement with a third party for the ‘upstream’ service required to get the mail to Royal Mail for delivery – which a DSA operator can supply this service. Hence, in this situation, the CDA customer would only pay VAT on the charge for the upstream service and not on the 13p DSA price payable direct to Royal Mail. A recent development in the access market has been ‘Agency Agreements’, which allow the DSA operators to act as agents for mail customers, meaning that customers only suffer VAT on the upstream charge but they do not have to deal separately with Royal Mail and their DSA operator. The impact of applying VAT to bulk mail would vary depending upon which of these situations is in place. It would seem that, under the ‘partial’ VAT exemption scenarios, both Mailsort and DSA would become VAT-able, but the impact would be greater on Mailsort which is currently 100 per cent VAT exempt, while DSA already has VAT applicable to a small portion of the 17.5p. Therefore, the effect is likely to be that those customers who are unable to recover VAT will see Mailsort prices increase more than customers who use DSA. This increase in the difference between Mailsort and DSA might induce more customers to switch to the cheaper DSA service. It may also give a boost to the prospects of end-toend bulk mail competition, which has implications for Royal Mail in terms of declining volumes and revenue and, in turn, the financing of the universal service.

ANNEX A

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2007 COMPETITIVE MARKET REVIEW

© Crown Copyright 2007

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