Postage rates to rise - when, by how much, and why?

We all know that postage rates rise every year, and that this inevitably has an effect on the cost - and indeed the very continuance of - of our collections.  There has been much written in the mainstream press in recent days about the fact that "second class post will rise to 55p", but the speculation inevitably masks the full story.

The Daily Telegraph wrote:

(Royal Mail) said it is hoping to increase second class stamps by 53 per cent from 36p to 55p, and insisted that the increase was still “affordable” for “vulnerable groups”.

The price of second class stamps would then rise further by inflation every year for seven years. There would be no limit on the price of a first class stamp, which currently costs 46p. 

Ofcom, the new postal regulator, published proposals in October 2011 "designed to ensure that UK consumers continue to benefit from a universally-priced, affordable postal service, six days a week. 

"The central aim of the proposals is to make what is known as the Universal Service Obligation (USO) placed on Royal Mail financially sustainable. Without regulatory changes there is a risk that Royal Mail may not be able to continue to deliver the USO to the same standard.

"Ofcom therefore proposes to give Royal Mail freedom to set its own prices for the majority of its products including:

• First Class deliveries – letters, large letters (A4 in size and up to 750g in weight) and parcels;
• Second Class deliveries – for large letters and parcels up to 1Kg in weight;
• standard parcels;
• business mail – metered or franked mail and pre-printed envelopes; and
• bulk mail – mainly large businesses sending a large volume of post in a single mailing for example, bank statements.

"Ofcom proposes to put a price cap of between 45p and 55p on Second Class stamps for standard letters to protect vulnerable customers from significant price rises. The cap would be indexed in line with inflation."

But why is there a risk that Royal Mail may not be able to continue to deliver the USO to the same standard" ?   The answer lies in the meat of the Consultation Paper. 

"1.21 There is widespread recognition that the approach to regulation adopted in the past, has failed in the face of the particular circumstances affecting this sector. 

1.22 To date, the approach adopted has been based on price controls - similar to those used in most other utility sectors. In normal circumstances this approach is an effective means of preventing private operators from earning excessive profits, thereby providing incentives for firms to reduce costs, while at the same time protecting consumers from excessive prices. It is an approach that is widely used by regulators, including Ofcom, to regulate private operators with significant market power. 

1.23 The recent experience of postal regulation, however, has demonstrated all the weaknesses of price controls with none of the benefits. In a highly uncertain market, price controls have removed the flexibility that would allow Royal Mail to adjust to changes in demand, while at the same time Royal Mail has been unable to improve efficiency, either at the rate expected by the regulator when the price control was set, or at the rate set by its own internal targets at the time. 

1.24 Furthermore, price controls on Royal Mail have served less and less to protect customers from price rises. Since 2006 Royal Mail's financial position has led it to apply to the regulator for price rises over and above those consistent with the regulatory formula. In November 2010 Royal Mail applied to Postcomm for additional flexibility to increase prices, resulting in price rises averaging 12% for 2011-12. In the light of its primary duty towards the universal service, Postcomm granted these applications. 

1.25 We therefore consider that price controls in this sector have failed in recent years. The reasons for this are clear. First, in a highly uncertain market environment, where the level and pattern of demand is so unclear, it is not feasible to expect to predict accurately whether a given price trajectory is sufficient to allow the universal service to be financed. If the price control that is set turns out to be to be too tight, it will not allow for the universal service to be financed. If, on the other hand, it is set too loosely, it will provide little protection and inadequate efficiency incentives."

Both Ofcom papers are very interesting reads.  They demonstrate that the competition faced by Royal Mail is not, as is common in some European countries, end-to-end competition.  Competition in the UK is based on access by other operators to Royal Mail's delivery network.  Ofcom therefore proposes

• imposing an access condition on Royal Mail to oblige it to grant access at inward mail centres;
• not to regulate the price of access, to enable Royal Mail to set prices in a way that covers the costs of the network; and
• ensuring, by means of a 'margin squeeze test', that the difference between the access price and retail price is kept at a level that allows efficient access competitors to compete effectively.

Royal Mail has repeatedly indicated that downstream access costs money because of controls on the price they can charge.  Removal of this control should help restore the letters and packets postal service to profitability.

We'll be interested to see how things develop and at what level the new prices will be set.  As the Ofcom report will not be published until early February it is quite likely that this year's price rise will not take place at the end of March as usual, and early May seems more likely.

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