Annual monitoring update on the postal market: financial year 2012-13

22 November 2013

1.1 This is our second annual monitoring update on the postal sector and the first covering the period since we introduced the new regulatory framework in our 27 March 2012 statement - Securing the Universal Postal Service, Decision on the new regulatory framework ('the March 2012 statement'). That decision gave Royal Mail greater pricing freedom so it could return the universal service to financial sustainability, subject to certain safeguards. One such safeguard was an effective and ongoing monitoring regime to track Royal Mail's performance. As part of this safeguard we committed to publishing an annual report summarising the results of our monitoring programme.

1.2 This report covers the four key areas that we set out in the March 2012 statement that our monitoring regime would focus on and sets out the key data and trends for the 2012-13 financial year. These are:

  • The financial performance of the universal service;
  • Royal Mail's rate of efficiency improvement;
  • Customers and consumers; and
  • Business customers and competition

1.3 The metrics in this report are also consistent with those in our first report published in November 2012 (enabling yearly comparisons), although we present some additional data in this document. This includes the findings from our assessment of the affordability of universal services and our market research on the views of residential and business postal service customers.

1.4 In summary, with respect to financial performance, profit margins for Royal Mail's Reported Business increased to 2.6%. This is a significant improvement on the previous year (-0.5%) and closer to the indicative 5% to 10% range we consider is consistent with a reasonable commercial rate of return for a financially sustainable universal service in the longer term. The main reason for the improved EBIT margin was a 5.8% increase in revenue, largely as a result of increased prices, but also aided by higher parcel volumes;

1.5 In terms of customers and consumers, most universal service prices rose (in some cases significantly) in 2012, with some prices also increasing in April 2013; but our research indicates these products remain affordable for almost all consumers. However, First and Second Class stamp letter and large letter prices did not increase in 2013 and the safeguard cap on Second Class stamps will continue to protect vulnerable consumers in the future. While Royal Mail met some quality of service targets including its obligation for Second Class, it failed to meet a number of other targets (including the obligation for 93% of First Class mail to arrive next day). We consider that Royal Mail's requirement to provide universal services to a high standard is an essential part of the regulatory framework. We have told Royal Mail to improve its compliance with its quality of service obligations. We will continue to monitor Royal Mail's progress on quality of service performance closely and will consider investigating and potentially taking enforcement action if it fails to meet quality of service targets in the future.

1.6 In relation to business customers and competition, while business mail volumes (retail bulk mail and access) continued to decline overall, access volumes increased by 2.1% (0.6% adjusted for working days) and now represent over 47% of total market volumes. There was also a significant increase in end-to-end letter volumes delivered by other operators due to the trial of London delivery operations by TNT Post UK. However, end-to-end competition still only accounts for less than one percent of total market volumes. In March 2013, Ofcom published guidance on its intended approach should end-to-end competition become a potential threat to the provision of the universal service.

1.7 With regard to efficiency, Royal Mail's physical productivity is gradually improving. As letter volumes are continuing to decline and parcels are increasing it is important to consider the level of effort or "workload" required to process the mail. For example, Royal Mail's workload in 2012-13 (adjusted for working days) only reduced by 0.6% compared to an overall addressed volume decline of 7.3%. In this period Royal Mail reported an improvement in productivity of 1.7% in its mail centres and delivery offices (accounting for changes in volume and product mix). We have also been working to further understand how to assess what would constitute a reasonable rate of efficiency improvement. We will shortly publish two consultancy reports on approaches to measuring the efficiency of postal operators and efficiency programmes in some comparator European countries.

1.8 Overall there was a positive but mixed picture in relation to the key metrics that we are monitoring in 2012-13. There have been some signs of progress around financial performance and productivity is increasing, albeit slowly. However, Royal Mail failed to meet some of its quality of service targets.

1.9 We note that it has only been a year and a half since we introduced the new regulatory framework, and this report focuses on the first year of that framework. In this time the postal landscape has witnessed further change with the partial privatisation of Royal Mail in October 2013. Therefore, it is important that we continue to monitor the market and Royal Mail's metrics closely. This will allow us to better understand the market trends (including the financial sustainability of the universal service) and help us to assess the effectiveness of the regulatory framework.