A First-Class Crisis In The Making?

As mail and commerce move to the Net, the U.S. Postal Service is facing a slump

Ask a 12-year-old when she last mailed a letter to Aunt Minnie and you're likely to get a blank stare. These days even her aunt is more likely to have sent her an e-mail than a birthday card.

That's a problem for the U.S. Postal Service (USPS). In addition to Net-savvy kids, businesses, which account for 95% of the U.S. mail stream, are cutting back on first-class. The trend isn't new -- it began with fax machines and gained speed with the Internet and the success of couriers such as FedEx Corp. But last year the post office passed a worrisome milestone: For the first time, first-class mail shrank in both volume and revenues. The latter fell by $617 million, to $36.4 billion.

And since first-class mail has long made up over half of USPS' revenues, which hit $69 billion last year, fears are growing that it's only a matter of time before total revenues start to shrink. If so, the ever-growing tide of discounted junk mail won't be sufficient to buoy USPS. Unable to cut costs fast enough to stay afloat, the post office would have to accelerate rate increases. That might cause big mailers to move to alternatives even faster, triggering a spiral of falling revenues, rising debt, and declining service.

Insiders agree that Congress is likely to head off a crisis before the threat of shuttered post offices causes any political pain. But because of its "universal service" obligation -- it must serve 1.8 million new addresses every year -- USPS has limited room to maneuver. "It has very few options but to scale its operations down and be a cost-cutter," says Rick Merritt, executive director of PostalWatch, a nonprofit group for consumers and small businesses. "Unfortunately, it can't -- unless it's forced to by law or by competition."


Losing Aunt Minnie's business is just one of USPS' woes. These days just 5% of mail goes from consumer to consumer; increasingly, everything else originates and/or ends at a business. In recent years, for example, Internal Revenue Service tax returns have gone from all paper to mostly digital, and the conversion is accelerating. With the same shift occurring simultaneously for all the nation's paychecks and credit-card statements, USPS has been shedding 1 billion to 2 billion pieces of first-class mail per year since 2000. "It's a prescription for disaster," says William H. Young, president of the 210,000-strong National Association of Letter Carriers union.

So far the post office has kept its head above water by improving efficiency, cutting costs, and concentrating on growth in advertising mail. So-called standard mail -- advertisements, catalogs, and circulars -- is approaching the volume of first-class mail. Trouble is, on average, each piece of standard mail earns the post office about half as much as a similar piece of first-class mail. And advertisers agree that too many offers in a mailbox blunts their effect. The Postal Service has been "quickly evolving into a commercial advertising medium that also carries some first-class mail," says Merritt.

Despite its many resource restraints, USPS has won kudos for its smart use of information technology and logistics to save money. Aunt Minnie can now purchase services, print and sign forms, and track her mail via USPS.com, as well as arrange front-door pickup. Internet sales are on track to hit $258 million this year, with demand especially strong among small-business owners.

Behind the scenes, the post office is also relying on smarter sorters. Siemens Logistics & Assembly Systems of Grand Rapids, Mich., for example, supplies a device that speeds up forwarded mail. While it sorts mail, the system checks envelopes against a database of forward requests, and applies labels redirecting letters to their new destinations. In the past such a letter would have been forwarded only after arriving at the post office serving the old address.


Steps like these have helped USPS shrink its workforce through attrition, from a peak of 804,000 in 1999 to 701,000 today. Since 2001 head count reductions and supply-chain improvements have produced combined savings of $8.8 billion. USPS has also slashed its debt from $11 billion to around $200 million in three years.

Despite long-term uncertainties, cost cuts have helped bolster USPS's operating finances so that it has the leeway to postpone a request for a rate increase until 2007, according to Postmaster General John E. Potter. But in the background, Congress is forcing him to accelerate a rate hike by insisting that USPS stash $3.1 billion from its overfunded pension pool in an escrow account. Insiders contend that, strapped for cash, the White House is eyeing this money to help cushion the ballooning deficit. So, in mid-March, Potter announced a 2 cents increase for first-class postage, to 39 cents, and a similar 5% to 6% markup for other forms of postage that would take effect in 2006.

Some in Congress would like to grant the post office more autonomy. A set of bills in the House and Senate would, among other things, grant USPS greater flexibility to hitch its rate increases to inflation. Potter would also like more case-by-case freedom, so the post office could compete with private entities by offering discounts to volume mailers, for example. Despite support for the bills, however, the complex political calculus of the deficit makes passage uncertain. "Things may just continue as they are," says Gene A. Del Polito, president of the Association for Postal Commerce, an industry group, "till a real crisis starts."

Such a crisis may be just what some critics of USPS are hoping for. It would provide ammunition to those who want to break up USPS' mail monopoly, on the model of Germany, Britain, and the Netherlands. If revenues start to plummet, they reason, more competition may be the only way to save billions of dollars.

In the U.S., "demonopolizing" is politically explosive. If mail is left to market forces, rural, sparsely populated -- and mostly Republican -- areas are the least likely to be served. Still, if USPS starts racking up big deficits, expect to see a piling over who will deliver Aunt Minnie's next birthday wishes.

By Adam Aston in New York

    Before it's here, it's on the Bloomberg Terminal.