Wednesday, January 4, 2012

No Such Thing as a Free Ounce: Does 'Second Ounce Free' Make Sense for USPS or for Mailers?

For the most part, mailers cheered when the U.S. Postal Service announced “Second Ounce Free” for bulk-mailed First Class letters. But guest columnist Robert W. Mitchell points out below that the pricing strategy is unlikely to be profitable for the Postal Service, is seemingly unfair to some mailers, and does not follow good pricing practices.

The average Jan. 22 increase in rates for all of First Class adheres to the inflation-based rate cap of just over 2%. That means the lower rates for presorted letters weighing between 1 and 2 ounces are being balanced out by higher-than-inflation increases for other types of First Class Mail.

Mitchell’s analysis makes the simplifying assumption that other bulk mailers are bearing the entire cost of Second Ounce Free. But it’s also possible that the high increases for parcels (10.9%), international (4.7%) and Forever Stamps (2.3%) are helping to bear the load.

Second Ounce Free also means that a 2.1-ounce letter costing 60 cents to mail would only be 35 cents if somehow its weight could be reduced below 2 ounces. Mitchell instead proposes a “piece-pound structure” – already used in such classes as Standard and Periodicals -- where the prices change gradually as weight increases or decreases.

Mitchell, a former employee of both USPS and the Postal Rate Commission, is one of the leading U.S. authorities on postal rates. His previous guest column for Dead Tree Edition was A Bad Move for Small Mailers: Postal Expert Questions Move Update Surcharge.

Beginning January 22, the first weight tier for Bulk First-Class letters will be zero to 2 ounces. That means that letters weighing from 1 to 2 ounces each will pay no more than letters weighing less than 1 ounce. But letters weighing from 2 to 3 ounces will pay (as now) two additional charges: an extra 12.5¢ for being over 1 ounce (a rate element unchanged from the current rates), and another 12.5¢ for being over 2 ounces. And 3-to-3.5-ounce letters will pay (as now) three of these charges. Is all this a good idea?

The new rates are designed to use the entire price cap, as would rates under the current tiers, so the no-free-lunch axiom is enforced by the math. Currently, 1-to-2-ounce letters pay an extra $209 million (beyond what they would pay if they weighed 0-to-1 ounces). That revenue will be lost with the new rates, so it is being made up by increasing other rates.

Someone has to pay
If it is made up by Bulk letters, then each pays an extra 0.51 cents (on average), so that a few can send 1-to-2-ounce letters at no additional charge. If it is made up by all First-Class pieces, then each pays an extra 0.28 cents. There is no way to tell exactly who is paying how much more (because we don’t know what the rates would have been without Second Ounce Free), but someone is. For present purposes, I assume that the burden is spread to Bulk letters only.

In rates, emphasis on fairness, signals, and value is now commonplace. Fairness is in the eye of the beholder. Signals have to do with how mailers respond. Value is difficult, mainly because it varies among pieces. It is fundamental that if the Postal Service charges above value, the pieces disappear. If it charges below value, revenue is anemic and the Postal Service goes broke. In other words, it must charge for value that is there, and avoid charging for value that is not there. Nothing else will work.

How mailers respond is critical. When rates are governed by a price cap, revenues are assumed to be the same regardless of the rate structure -- until mailers change how they mail in response to the new rates. Revenues and costs then adjust, leading to changes in net income. Of course, the Postal Service needs its net income to increase.

Some win, some lose
Look at the effects of Second Ounce Free:

1) Mailers of about 1.7 billion 1-to-2-ounce letters will see a big rate decrease. They will increase their volume somewhat. But the Postal Service will no longer be tapping the value that these mailers see that led them to find it profitable to send 1-to-2-ounce pieces even when their postage bill was higher.

2) Mailers of 2-to-3-ounce letters will have an incentive of 25¢ per piece (instead of the current 12.5¢) to figure out a way to get their pieces into the 0-to-2-ounce tier. For each piece that shifts, Postal Service revenues will decrease 25¢ and costs will decline just a little.

3) A Subset of mailers of 0-to-1-ounce pieces will increase their weight to something over 1 oz. They may increase their volume. They will realize more value. The Postal Service will not tap any of that increased value. Postal Service costs will increase just a little.

4) Because of the presumed increase of 0.51 cents for bulk letters, volumes will decline for mailers not in the Subset and not already sending 1-to-2-ounce pieces.

5) Mailers not in the Subset and not already sending 1-to-2-ounce pieces will ask if it is fair for them to have to pay higher rates, just so the 1-to-2-ounce mailers can get a big rate decrease and the Subset mailers can avail themselves of a “free” option to go over 1 ounce.

The Postal Service is banking on: a) overcoming the lost contribution from effect #1 mailers, b) the lost contribution from effect #2 mailers being small, c) the volume in the effect #3 Subset being large, d) that a sizable portion of the effect #3 Subset would have gone electronic but decides not to do so, e) an increase in contribution from effect #4 mailers, and f) effect #5 mailers remaining quiet.

Whether all this will pan out for the Postal Service is open to question. First, the alignment between rates and value does not look too good. Second, the number of mailers who are near 1 ounce now, who might stuff their mailings further, is not large. The average weight of 0-to-1-ounce letters is about 0.7 ounces. This means that most of them are well below 1 ounce. If they are not stuffing their pieces to 1 ounce already, why would they stuff them to something over 1 ounce under the new tiers? Third, there is no reason to believe that the effect #3 Subset mailers are closer to going electronic than the effect #4 mailers, which means that giving the latter a rate increase may not be a good idea.

If a change in structure is on the table, I would expect the utility mailers to ask for a lower rate for pieces under one-half ounce. There is nothing magical about one-ounce increments. In fact, if these weight breaks are important as signals, and are interfering with attempts by all parties to act on value, why not simply put in a piece-pound structure? The weight breaks would be gone. The signals would be smooth instead of abrupt. Value would be tapped systematically. Costs could be recognized appropriately. Fairness would increase. The rates would be more efficient. Mailers would be served more effectively. And the Postal Service would have a better chance at survival.


Anonymous said...

Why doesn't anyone ever consider the toll that the weight of the mail takes on a letter carrier's body through-out his/her career? Try strapping 35# to your should er and lug it around for 5-6 days a week for 6-8 hours per day. Mailers want reduced cost but the added weight is destroying the health of our carriers.

David M Wysong said...

As a mail service provider, I do not disagree with the concept of piece and pound providing the best of all solutions.

However I do feel that one set of mail shifting as not been noted that I think will happen.

Standard Mail over 1 oz being moved to the 1st cls mail stream.

Many of the "invitation" enveloped mail that does come in to us for processing is over the 1 oz level. More of this mail may be moved to 1st cls rates with the "flat" 1-2 oz rate in place.

When network optimization begins to delay 1 cls mail by a day or more the effect on standard mail delivery will also be effected by at least that many days as well.

Mail owners will see the advantage of moving to the 1st cls rate level without the over 1 oz "penalty".

This decision to move this mail from the standard mail stream to the 1st cls mail stream will become a "no brainer" to get the mail delivered in a more timely and assured time frame, that just is not part of the current standard mail service level and will, under network optimization, will slow even further, in my opinion.

Anonymous said...

It is interesting to ponder the "winners and losers" in this new pricing scheme, but I think some perspective might be had by thinking about what postal customers this new scheme would be aiming for. And if there's any first-class presort letter I regularly get that flirts with the 2 oz threshold, it's the newly verbose credit card statements, complying with new federal law.

Robert Mitchell said...

The matter of Standard being more likely to shift to First-Class is an important one. To my knowledge, it has not been part of the justification for "Second-Ounce Free." Generally, the Standard and First-Class structures have evolved over time, as the postal world has changed. It is scary to think about two classes competing with each other when their structures are so different. The relation we have now fails every test. It deserves attention.

Anonymous said...

First of all in 30+years I've never seen a letter carrier carry 35# in a mail bag. Most carriers as soon as they are out of sight of the PO don't even use the bag. So that certainly has no bearing on your health.

Anonymous said...

"First of all in 30+years I've never seen a letter carrier carry 35# in a mail bag. Most carriers as soon as they are out of sight of the PO don't even use the bag. So that certainly has no bearing on your health."

Just because you don't see it, doesn't mean it is not true. I don't see you, and apparently you exist.

Anonymous said...

When is a postal carrier ever out of the site of the PO, OIG or Postal Inspectors?

Anonymous said...

Try carrying all that mail in florida in the summer months. I guarantee you will die.. and many do carry it because people are too damn stupid, inconsiderate and lazy to put their box nex to the street. dunno how they do it, the humidity n heat along with the absolute boredom makes it tough AND they expect ya to be fast.