‘Funding universal-service obligation in the postal sector’

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Derek Holt, director at independent economics consultancy Oxera shares his view with EURACTIV on how to finance the universal-service obligation in the context of further liberalisation in the European postal sector.

Derek Holt is the author of a study on 
funding universal service obligations in the postal sector
 commissioned by major postal operators.

As the author of a study commissioned by the postal operators of nine EU countries, including France, Italy, Spain and Belgium, which have been calling for a more cautious approach to market opening, do you agree that the EU should proceed more cautiously on liberalisation? 

Well, the aim of this study was not to analyse the wider benefits of liberalisation or what scope for innovation it might bring. What Oxera has done is to examine the potential implications of liberalisation on the provision of the universal service. 

In the postal sector, there is a requirement for certain universal service obligations (USO), including the need for companies to deliver mail a certain number of times per week and to maintain a minimum standard of service. In some cases, this means having a single postage stamp price for the whole country, so, you can mail a letter in the UK and it can be delivered anywhere within your city or to the far north of Scotland for the same price. 

Those are the sorts of universal services which the European Commission is proposing should be retained – at least some of them, not necessarily all of them. 

There’s a lot of disagreement regarding whether all of these service obligations need to be retained or if only some of them should be kept, have you formed a view on this? 

Well, again that’s more of a policy question for the governments in each member state. 

So, the question that we have been addressing is: What might be the effects of liberalisation on the universal service? And, if there is a financial consequence for the parties providing the universal service, what are the mechanisms to address that? 

For the moment the financing mechanism is this ‘reserved area’. Maybe you can tell us a bit more about the advantages and disadvantages of this system? 

The reserved area essentially works by preserving a monopoly on a certain number of services for the party providing the universal service obligation. If there are profitable activities among these ‘reserved’ services, the universal service provider (USP) can then use the profits accumulated in those sectors to offset the extra cost of having to provide non-profitable universal services. 

Essentially it’s cross-subsidisation. It’s using the profits from one area to help offset the additional costs in another. 

The advantages of that are: it’s in place, it’s easy to implement, we know how it works and there are no major changes required, hence it is less likely that the ongoing provision of the universal service would be put at risk. 

The disadvantage of preserving such a monopoly right is that you risk missing out on some of the benefits that competition might bring, such as efficiency improvements and innovative solutions by new entrants. 

For some member states, the most important consideration might be focusing on stimulating more innovation and efficiency – and in those sorts of cases they might look to different funding mechanisms. 

Whereas in other member states, the importance of preserving a universal service and avoiding a complicated financing mechanism might be the most important criteria – in which case, they are more likely to want to preserve their existing approach. 

In both cases though, you’re talking about the need for some kind of funding mechanism. Would it be impossible to maintain a universal service under full liberalisation without funding mechanisms? 

Well, you might be able to do that if you introduce much more flexibility for the companies providing the universal services. For example, allowing them to change their tariff structures and to have much more cost-reflective prices for stamps and postal services.

Doing this would offset some of the impact of liberalisation and it would provide more scope for the incumbents to respond effectively to competition. 

But, of course, that kind of flexibility might not be consistent with preserving some of the universal service requirements. 

For example, cost-reflective pricing would be inconsistent with preserving a single stamp price for the whole geographic area. 

Concretely, could it lead to people living in remote areas having to pay much more for getting letters delivered? 

Exactly. If you were to say ‘let’s have fully cost-reflective pricing’, concretely, yes, the impact would be that you would have higher prices in rural areas and lower prices possibly in urban areas. 

What are the other options? 

Oxera has considered a number of other funding mechanisms, including compensation funds, pay- or- play mechanisms, state funding or even the introduction of competitive tendering. Each has their specific advantages and disadvantages. 

The idea of a compensation fund is often put forward by the so-called “Southern group” of postal operators as a potential substitute for the reserved area. Could this work? 

Compensation funds are essentially funds that would be made available to the providers of universal services to compensate them for the extra costs I spoke about earlier. 

Although the compensation fund has been used in some other industries, it’s fairly complex. There are a lot of issues about who should pay into the fund and how you define which services should be compensated – should it be all postal services or just a subset of postal services? And what about the providers of related services which are not provided by postal operators? Should they contribute? 

The money could in fact be paid by a number of parties – the government, new entrants… It could even be a direct levy on consumers, who would pay an extra amount for stamps and then some of those funds would be used to compensate for the universal service provision. 

The suggestion that new operators bear the cost is also complicated, because a discussion needs to take place which addresses whether contributions should be based on their revenues or profits, or whether they should pay a one-off ‘entry contribution’ or lump sum. You could also have a system based on, for example, the units of mail processed. 

So there are quite a lot of questions about how exactly this would work and that makes it a little bit more complex to introduce into the postal market. 

New entrants would be likely to oppose such a system? 

Yes, most likely they would. They would rather, of course, not have to pay. However, there is a basis for such a system – a reason why new entrants might agree to pay: they would be able to focus on the more profitable services and they wouldn’t necessarily have the responsibility to provide the less profitable services. 

What is the difference with the ‘pay or play mechanism’? 

It’s actually quite similar. The pay or play mechanism is a sort of version of the compensation approach, but with a bit more flexibility. Rather than assuming that the incumbent will provide the universal service alone and everybody else will contribute to the incumbent’s costs, instead, new entrants have the option to decide whether to only operate profitable services and make a financial contribution – i.e. a bit like the compensation fund – or whether they wish to provide these universal services, which might include delivery to rural areas – and that is, in itself, considered as the contribution that they will make. 

So, new operators don’t need to provide the universal services and a financial contribution – they can choose whichever one makes sense to them as a business. 

The attraction of this approach is that it potentially creates more competition in the provision of the universal service itself, which in turn affects the whole market. 

If this approach is taken, the tricky part will be to define what exactly new entrants will have to do to fulfil their obligations. For example, let’s say that a company decides it wants to ‘play’ and provide universal services, rather than pay into the compensation fund. The question then becomes, ‘are they doing enough?’ Are they really doing as much as they say they are? This then brings to the forefront quite a few issues about how to monitor the situation and define exactly what’s needed to comply with a pay or a play service. 

It sounds rather complicated. How can the Commission resolve all these issues? 

Yes, I think it’s fair to say that it’s complex. Oxera’s analysis examined a number of financing options and we identified a variety of advantages and disadvantages for each of these mechanisms, with a key trade-off being practicality and simplicity versus pure economic efficiency. Each mechanism can broadly fit into one of those two camps. 

You can’t just therefore choose one mechanism that works everywhere. There needs to be an awareness of the considerations of each country – their priorities and the characteristics unique to their postal markets. For instance, different solutions might be necessary for a country that has big differences between urban and rural areas and that has to incur large extra costs to deliver to rural areas and for a different country whose deliveries are mostly urban. 

So the Commission should allow member states to choose the mechanism that suits them best? 

Essentially yes, but, perhaps it could make sure there is a clear process for reaching a decision. The sort of things Oxera would suggest doing would be to first examine what the relevant cost of the universal service is in each case. Then it should assess the relevant country and company characteristics, including the cost structure and the capacity to introduce some of the more complicated regimes – bearing in mind that this may be possible in some, but not all cases. 

These considerations are going to require more studies. Just assuming that it will be possible to fund the universal service is not the answer. Understanding how much to raise and how to do it is also important. 

I don’t think the debate is concluded on this point by any means and I’m sure it will be very challenging to reach a common solution. 

Can this solution be reached by 2009? 

These are some pretty big challenges and member states are going to have to move very quickly if they want to undertake the necessary analysis in time to have a reliable mechanism in time for 2009.

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