Fake News, Flawed Analysis, and Bogus Tweets

From time to time, Angry Bear has featured Steve Hutkins, (Save The Post Office Blog) and Mark Jamison’s (retired NC Postmaster) commentary on the efforts of various political and commercial interests to close down the United States Postal Service and give it over to the likes of UPS, FedX, and other commercial enterprises. Most recently, President Trump’s inane Twitter comments have again gained undeserving national coverage about Amazon having a hypothetical cost advantage over the USPS by using the USPS to deliver Amazon orders 7 days a week. Steve takes issue with the President Twitter comments and a CitiGroup analysis of the Amazon – USPS relationship. Read on . . .

“Steve Hutkins; Talk about Fake News. How a flawed Citigroup analysis led to Trump’s bogus tweets about Amazon and the Postal Service.” President Trump is continuing his Twitter attack on Amazon over its deal with the Postal Service. Yesterday Trump tweeted,

“Only fools, or worse, are saying that our money losing Post Office makes money with Amazon. THEY LOSE A FORTUNE, and this will be changed. Also, our fully tax paying retailers are closing stores all over the country… not a level playing field!”

A couple of days ago, his tweets were more specific:

“While we are on the subject, it is reported that the U.S. Post Office will lose $1.50 on average for each package it delivers for Amazon. That amounts to Billions of Dollars…. If the P.O. ‘increased its parcel rates, Amazon’s shipping costs would rise by $2.6 Billion.’ This Post Office scam must stop.”

The attacks were in the same vein as his earlier tweets back in December. They are apparently based on an op-ed in the Wall Street Journal by Josh Sandbulte and published last July. Sandbulte claimed each Amazon parcel was getting a $1.46 subsidy;

“It’s like a gift card from Uncle Sam.”

As Jen Kirby at Vox noted, Sandbulte is a money manager who works for a firm owning FedEx stock, but it may or not be relevant, as anyone invested in mutual funds probably owns some FedEx. In any case, he didn’t invent the subsidy idea. It came from an analysis done by Citigroup in April 2017.

The thesis of the Citigroup report is that taxpayers are essentially paying for the free shipping offered by Amazon. As the Citi analysts write, “In this note, we examine the true profitability of the Post Office and show that by charging below market rates on parcel volume (mainly eCommerce) the Post Office has essentially turned free shipping into a future tax payers’ burden.”

It should be noted, the Citigroup report is intended to give advice to investors in the stock market. It claims, “a day of reckoning” is coming when the Postal Service will have to implement a significant increase in shipping rates, and this will provide a large “revenue opportunity” for the Postal Service’s competitors, FedEx and UPS — something on the order of $15 to $19 billion a year in additional revenue. This, they say, “supports upside for both stocks.”

The Citigroup report is somewhat less bullish on Amazon because it will have to bear the brunt of rate increases by the Postal Service and also FedEx and UPS, who will be in a better position to raise rates themselves. According to the analysts’ “worst case scenario,” Amazon will have to pay $2.6 billion a year in additional shipping costs.

As a closer look at the Citigroup report reveals, the case for a huge Postal Service rate hike on parcels is seriously flawed, and the report provides no evidence for Trump’s tweets that the Post Office is losing a fortune on the Amazon deal.

Before we get to the Citigroup report, it will be helpful to lay out a few basic facts about the types of U.S. mail, the way postal accounting works, and the particular service Amazon is using. If you’re familiar with all this, you can cut to the chase and go to the section (Part 2) on the Citigroup analysis.

A Postal Primer

In 2006, the Postal Accountability and Enhancement Act (PAEA) divided postal products and services into two categories, Market Dominant and Competitive.

Market Dominant products and services are those in which the Postal Service “dominates the marketplace” as a result of its two monopolies — the letter monopoly, which gives the Postal Service a monopoly on non-urgent First Class mail, and the mailbox monopoly, which gives the Postal Service exclusive right to put mail in mailboxes. Market Dominant includes First Class, Standard (mostly ad mail), and Periodicals, as well as certain types of international mail. According to the USPS 2017 10-K report, Market Dominant accounts for about 70 percent ($50 billion) of total revenues ($70 billion) and about 95 percent of total volumes (150 billion pieces)

Competitive mail includes shipping services like Priority Mail, parcels, and some other types of international mail. Its name derives from the fact that there are competitors in the private sector for these types of products. Competitive products account for 29 percent ($20 billion) of total USPS revenues and about 5 percent of volumes.

The rates for Market Dominant mail are constrained by “price cap” regulation, which limits rate increases in a class of mail to the Consumer Price Index. The rates on Competitive products are essentially constrained by the marketplace, but the Postal Service is free to set prices as it sees fit, subject to approval by the Postal Regulatory Commission, so long as the products cover their costs, aren’t cross-subsidized by Market Dominant products, and make an appropriate contribution to institutional costs. In other words, the rates can’t be too low.

The phrases “covering their costs” and “contribution to institutional costs” refer to the way the Postal Service analyzes the costs of each product and service. As in every business, for every product there are two types of costs, variable and fixed.

The variable costs are those associated directly and indirectly with a specific product or service, and they change relative to volume. The Postal Service calls these attributable costs.

The fixed costs include wages, rent on leased post offices, and all the other overhead expenses that stay the same regardless of how much volume the Postal Service is handling. The Postal Service calls these institutional costs.

For each product and service, the Postal Service figures out the variable costs that can be attributed to that product; whatever revenue is brought in beyond that is considered contribution to the institutional costs.

The cost coverage for a product or service is determined by dividing the unit’s revenue by the attributable cost. A cost coverage of 100 percent means that the product has covered of all its attributable costs but contributed nothing to institutional costs. Ideally, a product will therefore have a cost coverage greater than 100 percent, so it can contribute something to the Postal Service’s fixed overhead costs.

Finally, there are the Negotiated Service Agreements, i.e., contracts between the Postal Service and individual mailers that provide customized pricing and other arrangements. For business reasons, the details of these deals are withheld from the public, but each NSA must be approved by the PRC before it goes into effect, and then again annually as part of a review to ensure that the deal is still in compliance with the law.

There are several hundred NSAs in effect right now, including 846 Competitive domestic agreements, ranging widely in size and scope. At least one, perhaps several of them, cover the deals between Amazon and the Postal Service.

The PRC’s Annual Compliance Review

The PRC conducts an Annual Compliance Determination Review (ACDR) to ensure sure all the products and services provided by the Postal Service are in compliance with the laws governing postal matters. Generally speaking, the review determines if the costs incurred by each product and service are covered by the revenue generated by that product or service.

The compliance review thus looks at how each type of mail — including each NSA — is doing with respect to cost coverage, i.e., the extent to which it is covering attributable costs and how much it is contributing (or failing to contribute) to institutional costs.

The Commission also examines how much Competitive mail as a whole is contributing to institutional costs to ensure that the Postal Service isn’t using the products which it has a monopoly to unfairly subsidize products for which there’s competition from the private sector.

As it happens, last week the PRC issued the 2017 Annual Compliance Determination Report. The law requires “each Competitive domestic NSA product to cover its attributable cost. The Commission noted “all but four Competitive domestic NSAs covered their attributable costs and complied with this statutory requirement” (p. 84). Three of these NSAs expired or were terminated, and the fourth (a Priority Mail Contract that is almost definitely not the Amazon NSA) is being monitored pending reevaluation.

The PRC’s compliance report means that the PRC has reviewed the Amazon contract or contracts and determined that they are indeed covering their attributable costs. They are not losing money for the Postal Service.

The Amazon NSAs and Parcel Select

While we know very little about the details of Amazon’s contract or contracts with the Postal Service, we do know that most of the parcels delivered by the Postal Service for Amazon fall under the category called Parcel Select.

Back in 2013, when the Postal Service announced that it was doing Sunday delivery for Amazon Prime, we were able to locate the NSA in PRC docket CP2014-1 and confirm that it was a Parcel Select product. You can see the agreement here, but it’s almost entirely redacted.

According to the USPS description, “Parcel Select ser¬vice provides very competitive pricing. It is often used by other private parcel companies to complete delivery of the ‘last mile’ for their shipments — particularly for deliveries in non-metropolitan or rural areas because the Postal Service is the only carrier that offers delivery to every door 6 days a week.”

The biggest users of Parcel Select are Amazon, FedEx, and UPS. They’ve determined that using the Postal Service for the “last mile” (from the post office to the home or business) is much more cost-effective than trying to deliver to millions of addresses themselves.

In fiscal year 2016, according to an article in DC Velocity, about 2.5 billion packages moved under Parcel Select. Amazon was responsible for about 1 billion packages; FedEx (through its “SmartPost” product) used USPS for 600 million pieces, and UPS (through “SurePost”) had USPS deliver about 275 million pieces of Parcel Select. The balance came from several parcel consolidators that aggregate packages from multiple smaller shippers.

Parcel Select generally takes two to nine days, but the big mailers, consolidators, and private shippers prepare and presort the parcels and deliver them to the Destination Delivery Unit (DDU) — usually your local post office — or a regional processing facility, thus saving a lot of time and expense.

If the shippers get the parcels to the DDU by a certain time — Early Bird DDU — the Postal Service can often provide same-day delivery. Regular DDU — dropping off the parcels after the carriers have left the facility — usually means next working day delivery.

The Postal Service’s ability to deliver packages in two days or less has been an important factor in growing its parcel business, and it points to the synergy between the Postal Service and its larger customers who help shuffle packages to the right place in the network, labeled and sorted in the right way.

Because the users of Parcel Select do some of the work themselves, they’re entitled to “workshare” discounts based on the costs the Postal Service is avoiding. These discounts are arranged through the nonpublic NSAs, so we don’t know how much Amazon is paying, but the public pricing for Parcel Select is shown here. As you can see, the prices start at $2.85 for a parcel weighing a pound or less, dropped off at a DDU. Prices go up from there, depending on the weight and how close to the destination it’s dropped off.

Due to its volume discount, Amazon is paying much less than that, however. According to a Bloomberg article, David Vernon, an analyst at Bernstein Research who tracks the shipping industry, estimates that Amazon is probably paying, on average, about $2 per parcel. That estimate can also be derived from this USPS financial report. It shows that in 2017 Parcel Select brought in $5.66 billion on 2.8 billion pieces, an average of $2 per piece. Amazon’s deal is probably comparable to the agreement the Postal Service has with UPS and FedEx to deliver the last mile for them.

As the chart for Parcel Select prices shows, there’s a big range in pricing, and the pricing on Amazon packages probably varies significantly, depending on geography, time of year (holidays), and who’s doing the delivery (e.g., union workers or lesser-paid non-union workers like City Carrier Assistants).

If Amazon is now sending about a billion parcels through the Postal Service, and if the average is about $2 per piece, the relationship is bringing the Postal Service about $2 billion a year. That strictly a ballpark guess — the Citigroup report puts the estimate at $3 billion a year — but it shows that Amazon has become a big part of the Postal Service’s business.

By the way, to put the numbers in context, Amazon reportedly shipped about 5 billion parcels via Prime worldwide in 2017, and it spends about $20 billion a year on shipping.

Talk about Fake News: How a flawed Citigroup analysis led to Trump’s bogus tweets about Amazon and the Postal Service, Save The Post Offic blog, Steve Hutkins, April 7, 2018

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