Royal Mail’s Response to Ofcom’s May 2016 Fundamental Review of the Regulation of Royal Mail - August 2016 Royal Mail plc Response to Ofcom’s May 2016 Fundamental Review of the Regulation of Royal Mail Royal Mail Submission August 2016 Public version Confidential information which has been redacted from this document is indicated by: [] © Copyright Royal Mail Group Ltd 2016. Royal Mail and the Cruciform are registered trademarks of Royal Mail Group Ltd. All rights reserved. Royal Mail Group Ltd, registered in England and Wales, number 4138203, registered office: 100 Victoria Embankment, London, EC4Y 0HQ. Royal Mail’s Response to Ofcom’s May 2016 Fundamental Review of the Regulation of Royal Mail - August 2016 Table of Contents Executive Summary ................................................................................................................................................................. 2 Chapter 1 – Letters pricing. .................................................................................................................................................... 5 Chapter 2 – Efficiency. ........................................................................................................................................................... 16 Chapter 3 - The UK parcels sector. ..................................................................................................................................... 29 Chapter 4 – Cross-subsidy and cost allocation. .................................................................................................................. 39 Chapter 5 – Access. ................................................................................................................................................................ 44 Chapter 6 – USO for the 21st Century. ................................................................................................................................ 57 Chapter 7 – Appropriate regulatory consumer protections in parcels. ............................................................................ 65 Chapter 8 – Appropriate regulatory consumer protections in letters. ............................................................................. 77 Chapter 9 – A new sustainability framework for the Universal Service. .......................................................................... 89 Annex 1 ................................................................................................................................................................................ 104 Annex 2 ................................................................................................................................................................................ 108 Annex 3 ................................................................................................................................................................................ 122 Annex 4 ................................................................................................................................................................................ 138 1 Royal Mail’s Response to Ofcom’s May 2016 Fundamental Review of the Regulation of Royal Mail - August 2016 Executive Summary We are the proud provider of the Universal Service. It plays a key part in the growth of the digital economy. We have made great strides in efficiency and innovation. We welcome Ofcom’s decisions not to reintroduce efficiency targets or price controls . However, we continue to operate in a fragile ecosystem. There is a pressing need for a pro-active sustainability framework to help sustain the Universal Service. Pricing, efficiency and our markets. i. We have a track record of fair, reasonable and prudent pricing in letters and parcels. We welcome Ofcom’s decision not to re-introduce price controls. Ofcom found that postal delivery is the only sector it monitors which has seen an increase in consumer perception of value for money. Market forces are doing their job. The existing safeguard Second Class (2C) Universal Service Obligation (USO) price caps should be removed. (Chapter 1.) ii. We welcome Ofcom’s recognition of our progress in efficiency and its decision not to introduce binding efficiency targets. We are implementing – at the same time and in a much shorter timeframe – changes that other major posts took years to introduce. We have stretching plans to deliver more efficiency improvements, including continuing to target avoiding c.£500 million in annualised cost, cumulative over the three financial years to 2017-18. In doing so, we continually judge the absorbable rate of change. (Chapter 2.) iii. The UK parcels sector is one of the most competitive in Europe. Competition is intense and growing. There are a number of disruptive models. Ofcom has not given sufficient weight to these market forces. Nor do we agree with the regulator’s use of the Postcomm 2010 market segmentation, or its overreliance on market share estimates. We note Ofcom is not proposing to extend the mandated Access regime to parcels. But, it remains open to requests to do so subject to sufficient evidence. Mandated Access is unwarranted given the range of alternative providers available. It could undermine the financial sustainability of the Universal Service especially given the critical centrality of parcels revenue. (Chapters 3 and 4.) iv. We welcome the regulator’s positive comments on our Access consultation process. We will amend our notification periods subject to changes to the proposed wording. We do not agree with the proposal to more than halve the timeframe to process applications for new Access services. It is neither appropriate nor feasible. We do not agree either, in substance or in the form of guidance, with the proposal to introduce the main Access Pricing Review (APR) principles. They are a materially retrogressive change from the 2012 framework. Their proposed application now – despite the absence of direct delivery competition – would restrict Royal Mail’s commercial freedom in an unnecessary and disproportionate way. In order to be able to recover its costs overall, Royal Mail would be effectively required to tie zonal prices to fully allocated zonal costs. But we would not be able to price in a way which any normal, rational business may wish to and which is recognised as competitive market pricing. There is also a need to update and clarify the large letter definition. It has remained unchanged since 2006. (Chapter 5.) A pressing need for a sustainability framework. v. We operate in a fragile ecosystem. The unique circumstances pertaining to post remain in place: structural decline in letters, and intense competition in parcels. There are significant risks to the USO. The sustainability duty to secure the Universal Service enshrined in the Postal Service Act (PSA) 2011 has few precedents elsewhere. Ofcom should quickly progress this duty. It should implement the framework 2 Royal Mail’s Response to Ofcom’s May 2016 Fundamental Review of the Regulation of Royal Mail - August 2016 that is featured throughout this submission and set out in detail in Chapter 9. Alongside the existing high levels of parcel competition, it provides the best approach to securing the Universal Service. After-the- event solutions – like compensation funds – are typically too small to be of value and come too late. (Chapter 9.) vi. The Universal Service plays a vital economic role. It is a key part of the digital economy which is strategically important to the UK’s economic future. The current Universal Service specification gives optimal access to the revenue streams that are available from the market and essential to fund it. Any reduction in the scope of the Universal Service would adversely affect the market based funding model Parliament provided. A market funded Universal Service, like post, needs to be contemporary and market facing. Ofcom should enable the Universal Service to evolve, e.g., by permitting end-to-end tracking of standard Universal Service parcels. If the regulator does not update the Universal Service, over time, it will remove Royal Mail’s ability to access the new or existing revenue pools essential to fund it. The next User Needs Review should include the critical centrality of parcels and letters revenues as a main feature. (Chapter 6.) vii. Sustainability also requires that a minimum set of consumer protection standards are applied in parcels and letters across the whole delivery industry. The growth of e-commerce relies on a good delivery experience. Royal Mail adheres to a highly developed set of regulatory standards. Other major parcel operators have no regulatory standards applied to them or a light touch complaints handling requirement. In letters, we are concerned about the proposed removal of the modest protections that apply to a small number of operators. Royal Mail has a highly developed range of protections and we often operate over and above them. We are concerned too about Ofcom’s proposals relating to outcomes based regulation and untracked letters. They would place an unnecessary and disproportionate burden on Royal Mail with no substantive evidence to warrant their introduction. (Chapters 7 and 8.) viii. In summary, although we welcome Ofcom’s decision not to implement price controls or efficiency targets we are concerned that its current set of proposals – APR guidance, focus on promoting access competition, output based regulation for mails integrity, declining to