Interactions between Regulatory and Antitrust Policies in a Liberalized Postal Sector

1. Interactions between Regulatory and Antitrust Policies in a Liberalized Postal Sector John C. Panzar Northwestern U. and the U. of Auckland CCP Conference: Balancing Regulation and Competition University of East Anglia, July 7-8, 2008

2. Introduction and summary • As with telecommunications, the introduction of competition into the postal sector will create problems for both regulatory and competition authorities. • Areas in which the two policies may be in conflict include: • Downstream Access Policy • Anticompetitive Behavior of State Owned Enterprises • Exclusionary Effects of USO Funding • Two-sided market issues: • PO Box access

4. Collection Mail brought to Local PO from various collection points Short haul transport Mail transported from Local PO to Mail Processing Center Outward Sortation Mail routed to other MPCs using sorting machines Long haul transport Mail transported to destination MPC Inward Sortation Mail directed to destination Local PO Short haul transport Mail transported to destination Local PO Delivery Carriers pick up mail for their routes; sort in route walk order Components of Postal Value Chain(Scale econ. in collection and delivery)

5. Stylized postal network Long Haul Transport: Air, Rail, Truck Sorting Center Sorting Center Outward Inward Inward Outward Volumes Truck transport Truck transport Local PO Local PO Carrier routes Carrier routes

6. Postal Access Issues • Is mandated access required for successful liberalization? • Are there “monopoly bottlenecks” and essential facilities in postal networks? • Pros of mandating access (by analogy to telecommunications): • Reduce sunk costs of entry • Allow entry at small scale • Improve network efficiency • Cons • Little sunk costs in postal networks • May undermine Universal Service Obligation • In any event, how should access be priced?

7. Sunk Costs and Essential Facilities • Relative lack of sunk costs makes it difficult to view postal delivery networks as “essential facilities” • Postal costs over 80% labor costs • Even if Incumbent’s labor costs may be sunk, entrants’ probably are not • Competition Authorities unlikely to compel unbundled access, except for • Address system • Mail forwarding • PO Boxes

8. Regulatory Access Policy • Regulatory authorities may view compelled access as useful policy tool in order to: • Better exploit economies of scale • Allow entrants to provide ubiquitous service quickly • BUT, access pricing may result in exclusion of more efficient upstream competitors • Anticompetitive, even if “refusal to deal” is not?

9. Stamp price = p Work-sharing discount  Access price: a = p -  End-to-end demand = D(p) Fringe supply = S() I’s upstream unit cost = t I’s unit delivery cost = c I’s fixed costs = F Incumbent offers two products: End-to-end service Work-shared mail Incumbent regulated to break-even with ECPR pricing of work-sharing I.e., work-share discount equal to the incumbent’s unit cost savings Example: shift from “cost plus” to “global price cap” regulation

10. Example: shift from “cost plus” to “global price cap” regulation • Freed from “cost plus” regulation, the Incumbent seeks to maximize: (p,) =(p-t-c)[D(p)-S()] + (p--c)S() – F subject to: p(D0- S0) + (p-)S0 <p0(D0- S0)+(p0-0)S0 • (Price cap index weights based upon last period quantities) • Assuming the constraint holds with equality, solving yields:

11. Shift from “cost plus” and ECPR to “global price cap” regulation: discount decreases

12. Exclusion of equally efficient competitors • Thus the shift to global price cap regulation gives the Incumbent the incentive to reduce the work-sharing discount below its unit cost savings. • The result is the “exclusion of equally efficient competitors” in the fringe. • Note: this may be socially efficient • Would this be of concern to competition authorities? • Even if they were not concerned about “essential facilities”?

13. “Unfair” Competition by SOEs? • Likely that most Incumbent Posts will not be privatized during the Liberalization process. • Are Regulatory and Competition authorities able to adequately police their behavior with respect to competitors? • Sappington and Sidak analyze revenue maximizing behavior of SOEs: • Regulatory cross-subsidy constraints and Antitrust predatory pricing rules may not be adequate to prevent predation.

14. Revenue max by SOEs leads to pricing below cost in competitive markets • Incumbent is dominant in market 1 and a price-taking competitor in market 2. • Revenues given by: R1(Q1) + p2Q2 • “Joint and common costs:” K • Attributable costs of service 1: c1(Q1,K) • Attributable costs of service 2: c2(Q2,K) • Example 1: Incumbent assumed to maximize revenues subject to break-even constraint: L = (1+)[R1(Q1)+p2Q2] - [c1(Q1,K)+c2(Q2,K)-K] L2 = 0  p2 =  mc2/(1+) < mc2

15. Inefficient Investment can allow SOE to “pass” the Incremental Cost Test • Example 2: Suppose the regulator imposes the additional constraint that revenues cover “attributable costs” L = (1+)[R1(Q1) + p2Q2] - [c1(Q1,K) + c2(Q2,K) - K] + [p2Q2- c2(Q2,K)] L1 = (1+)MR1- mc1 = 0. L2 =(1+)p2 - mc2 -  [p2- mc2(Q2,K)] = 0 LK = -[c1K + c2K - 1] -  c2K = 0  K > Kcostefficient • Incumbent over invests in common costs to satisfy constraint.

16. Universal Service: Burdensome Obligation or Unfair Competitive Advantage? • Incumbent Posts differ on the profitability of Universal Service (at a uniform price). • Some feel that their ubiquitous coverage is a competitive advantage or necessity • Others argue that the USO makes them vulnerable to cream-skimming and the “Death Spiral” • However, Incumbents typically also provide potentially competitive products in High Cost areas, as well as Letters.

17. What to do about Economies of Scope? • If Universal Service is (somehow) subsidized, whoever receives the USO franchise will likely benefit from economies of scope between services. • Is this an “unfair” advantage? • Is it an “abuse of dominance”? • Is it inefficient? • Economies of Scope between USO services and competitive service has the potential to cause conflict between Regulatory and Competition authorities

18. High Cost area potentially served by three delivery networks: Incumbent Post’s network delivers 1000 Letters and 1000 pieces of X-Mail. NewsCo delivers newspapers and “ready to” deliver X-Mail at any price greater than or equal to 4, its AIC of X-Mail Competitive Carriers “ready to” deliver X-Mail at any price above their unit costs of 5. Before Liberalization: Post delivers 1000 Letters and 1000 X-Mail pieces at marginal costs of 1 and 2. Postal network fixed costs of 6000 for HC area. Revenues less upstream costs: Letters = 4; X-Mail = 4. Area Postal losses are 1000 = 1000(4-1) Letter contribution + 1000(4-2) X-Mail contribution - 6000 HC area fixed costs. No X-Mail competition An Illustrative USO Example:(1) Initial situation

19. An Illustrative USO Example:(2) “Free Exit,” no USO • Letter delivery not provided in HC area • Assume recipients pick up in town, and • X-Mail market profitably captured by NewsCo • X- Mail price = 5, the unit cost of competitive suppliers. • (Eg., Assume Incumbents Stand Alone Cost for X-Mail is 6/unit) • NewsCo earns an incremental profit of 1000 = 1000(5-4) due to economies of scope with its existing network • Local Residents complain to the Regulatory Body about the loss of “free” delivery.

20. An Illustrative USO Example:(3) USO payments fund Letter delivery • Regulator provides Incumbent a USO payment of at least 1000 to resume Letter delivery. • Incumbent resumes Letter delivery service and X-Mail delivery, as initially. • If it did not resume X-Mail delivery, the USF payment would have to be increased by 2000 to replace the X-Mail contribution • NewsCo loses its X-Mail delivery business (and 1000)

21. An Illustrative USO Example:(4) The “Antitrust” Complaint • NewsCo files a complaint with the Competition Authority. • Against whom? • On what grounds? • Nonetheless, several things are clear: • Without the USO payment and Obligation, the Incumbent would not deliver X-Mail. • NewsCo has been damaged by the Regulator’s USO policy • Given, that the Incumbent is induced to deliver Letter mail, it is socially efficient that it deliver X-mail as well. • The Incumbent seems to be guilty of economies of scope!

22. An Illustrative USO Example:(5) “Tendering” the USO? • Give NewsCo a chance to exploit scope economies by tendering the USO. • Assume NewsCo could also obtain Letter and X-Mail delivery costs of 1 and 3 if it upgraded its delivery network at a cost of 7000 • The least it would accept to assume the USO would be:2000 = 7000 – [1000(4-1) + 1000(5-3)] • NewsCo would deservedly lose the USO tender • But, suppose the Incumbent’s network costs are 6000 because of economies of scope with neighboring profitable areas; on a Stand Alone basis they would be 8000.

23. Two-Sided Market Issues: Can Rowland Hill survive Liberalization? • Network externalities are readily internalized under regulated monopoly provision. • Competition brings “two-sided market” anomalies to the fore, as seen in: • Telecommunications interconnection • Payment systems • Regulatory and competition authorities have been perplexed by sustained “cross subsidies” and below cost pricing • Emerging postal example is PO Box Access

24. Post Office Boxes • PO Boxes are facilities rented out to subscribers for the secure reception of mail. • Usually on the premises of the incumbent postal provider. • Mail Boxes, Etc. is a competitive provider of PO Box services in US. • The share of PO Box addresses varies greatly by country, but accounts for a significant proportion of both businesses and individuals. • Delivery entrants in any region find a significant volume of mail addressed to PO Boxes. • Delivering this mail may be their only contact with the incumbent. • Entrants offer to “do it themselves,” but incumbents reluctant to “let them in.”

25. Access to PO Boxes must be mandated • Even those (like me) skeptical of “essential facilities” arguments in postal networks agree that competitors should be granted to incumbent’s PO Box addresses. • But, again, how to price to ensure that there is no leveraging of “dominant position” in PO Box market to delivery market. • Incumbent’s advocate ECPR • retains the incumbent’s full contribution, even though entrant does nearly all of the work! • Entrants (and Postal Regulators) favor cost-based rates • which can be very low. • Notice that this comes up in the presence of delivery competition (bypass), so this is actually an interconnection issue. • suggests “Bill and Keep” as an option

26. But, at what rate? • Natural choices are “cost based” methodologies such as ECPR or Average Incremental Cost. • But, those approaches treat PO Boxes as a fully integrated part of the incumbent’s network. • What if we treat PO Boxes and postal service as inter-related, potentially competitive markets? • 2-sided market effects may make cost based rules inadequate.

27. PO Boxes as a 2-Sided Market • PO Box operator provides services to: • Recipients of mail, who value secure, perhaps anonymous, delivery • Postal operators, who are obligated to deliver mail addressed to PO Box subscribers. • Postal operators “pass through” the demand of senders of mail, who, since Rolland Hill, pay for the volumes sent. • PO Box operator can charge: • Recipients a monthly fee and/or a per piece charge • Postal operators an access fee per piece delivered.

28. Access pricing in “competitive” PO Box markets • Competitive PO Box markets would presumably operate similarly to competitive mobile phone markets: • PO Box providers compete for subscribers, attempting to make money on postal access charges • I.e., by creating “competitive bottlenecks” • Unlikely to subsidize subscription • Receivers cannot guarantee access revenues • Reception subsidies likely • Assume that free entry and exit of PO Box providers ensures zero profit • Following Armstrong and Vickers (2001), assume that this outcome maximizes receivers’ utility • But, this means the access charge is set at the “monopoly” level!

29. What’s the appropriate benchmark for PO Box access policy? • If benchmark is unconstrained welfare max • “Bill and Keep” looks pretty good • If benchmark is outcome in competitive, disintegrated PO Box and postal markets • Access price might even exceed ECPR! • Because of 2-sided market effects, cost based rules don’t seem adequate.

30. Conclusions • Competition and Regulatory authorities will have overlapping responsibilities in liberalized postal markets. • While “optimal policy is optimal policy,” it does not necessarily result from a “level playing field.”