Focussing Regulation on Bottlenecks: Perspectives on Separation Options

1. Focussing Regulation on Bottlenecks: Perspectives on Separation Options Stephen Gibson Director of Economic Policy, Postcomm Stuart Holder Associate Director, NERA Economic Consulting 17th Conference on Postal and Delivery Economics Bordeaux, 28 May 2009

2. What Does Separation Mean? • Accounting separation • transfer prices between divisions (but just accounting records) • Ringfencing • additional constraints to encourage “separate” behaviour • Structural separation • separate entities under common ownership • Ownership separation • divestment (though not necessarily privatisation)

3. Why Consider Separation? • Main role in UK – allow competition in vertically-integrated industries • applied in telecoms, gas, electricity, water and rail industries • regulator can compare internal transfer prices with external access charges • and can monitor profitability of separate divisions • Other possible reasons for separation • promote greater cost transparency • change organisational focus • change culture

4. Potential Problems with Separation • Operational disruption • loss of economies of scale or scope • loss of flexibility • difficulty co-ordinating planning and investment decisions • Transaction costs • revenue protection and/or volume measurement systems • contracting costs • initial implementation costs • Complexity • difficult to formalise trading arrangements • difficult to regulate complex cost allocation mechanisms

5. Collection Outward sorting Separation for Postal Services? Trunking Inwardsorting DeliveryOffice Outdoordelivery • Important interrelationship between downstream and upstream activities • collections and deliveries • inward and outward sorting • Difficult to separate “network” and “services” • no equivalent of gas and electricity supply companies • Postal networks potentially more flexible • less fixed infrastructure, higher labour input

6. Separation of Bulk Mail Collection Collection ofbulk mail • Transfer prices can be compared with external access charges • allows regulation to switch from “headroom” to access charges • promotes more effective competition • Impact on operations likely to be small • activities already separate from rest of Royal Mail • but revenue protection arrangements required for stronger separation options Outward sorting Sorting /trunking ofbulk mail Trunking Inwardsorting DeliveryOffice Outdoordelivery

7. Separation of Delivery Collection Collection ofbulk mail • Fewer benefits for competition and regulation • internal transfer price covers smaller set of services than external access charge • Risk of higher costs and reduced efficiency, especially with stronger separation options • inward sorting carried out at both mail centres and delivery offices • loss of flexibility if roles of each separate division are formally defined • boundary between divisions not “future proof”, and could restrict future network reconfiguration Outward sorting Sorting /trunking ofbulk mail Trunking Inwardsorting DeliveryOffice Outdoordelivery

8. Separation of Outdoor Delivery Collection Collection ofbulk mail • Little benefit for competition and regulation • internal transfer price covers much smaller set of services than access charges • Possible impact on operations under stronger separation options • some sorting carried out by postmen • workload measurement system required • But longer term opportunities • more efficient delivery workforce (flexible hours, part-time working, etc) • new ways of operating or lines of business Outward sorting Sorting /trunking ofbulk mail Trunking Inwardsorting DeliveryOffice Outdoordelivery

9. Implementation Example: Accounting Separation • How accounting separation might be used to • improve transparency of Royal Mail’s costs • ensure all users face appropriate and non-discriminatory prices / transfer charges for use of delivery network • facilitate monitoring of margin squeeze and other anti-competitive activities • Considers accounting separation between Royal Mail’s • retail bulk (upstream) activities • retail non-bulk (upstream) activities • downstream delivery activities

10. Collection Collection ofbulk mail Retail Non-Bulk Division Outward sorting Example of Divisions Subject to Accounting Separation Sorting /trunking ofbulk mail Trunking Inwardsorting Retail Bulk Division Downstream Delivery Division DeliveryOffice Outdoordelivery

11. Financial Disclosure for Retail Bulk Division

12. Financial Disclosure for Downstream Delivery Division

13. Financial Disclosure for Retail Non-Bulk Division

14. Costing Methodology Principles • Causality • Objectivity and non-discrimination • Equivalence • Consistency • Follows UK GAAP • Third Postal Directive • Transparency

15. Conclusions • Separation proposals need to take account of • structure of postal network and lack of “natural breaks” • measuring systems available • impact on efficiency and future flexibility • Need to be a targeted solution to a specific problem • promoting effective competition • appropriate split between end-to-end and upstream • support anti-competitive investigations • supporting regulation of access and retail prices • promoting cost transparency