The Citigroup Analysis of the Amazon – USPS Relationship
Steve Hutkins of Save the Post Office blog also reviewed the WSJ/Citigroup analysis of the Amazon – USPS agreement in the second half of his article, “Fake News, Flawed Analysis, and Bogus Tweets,” April 8 on Angry Bear. As noted in the first half on Steve’s article presented at Angry Bear; Trump’s tweet about the Postal Service undercharging Amazon by $1.50 per parcel is based on a July 2017 Wall Street Journal article undercharging Amazon was based on an April 2017 report by Citigroup.
Citigroup is bullish on UPS and FedEx because, it says, they will enjoy “a better pricing environment in the future” since the Postal Service is soon going to need “to raise rates meaningfully to capture its true costs.” (Of course, if USPS shipping rates were to go up, UPS and FedEx would need to pay more for “last mile” deliveries by the Postal Service, but with higher rates or a bigger market share for their own deliveries, the net result would be to their advantage.)
If these “true costs” are not eventually covered by higher rates, says Citigroup, the taxpayer is going to be on hook for the Postal Service’s financial problems and, by extension, for the “free shipping” Amazon is offering.
In order to identify these “true costs,” the Citi analysts outline two scenarios that illustrate how the Postal Service is charging below market prices for shipping services.
Scenario #1: Paying off the prefunding
In the first scenario, Citigroup focuses on the so-called “prefunding mandate” established in 2006 by Congress with the Postal Accountability and Enhancement Act. Under PAEA, the Postal Service was required to pay $5.5 billion a year, for ten years, into a fund to cover the costs of retiree health care for decades down the road.
How this Retiree Healthcare Benefit Fund (RHBF) came to be is a long story, as discussed in this previous post. Much of the story remains shrouded in mystery, though, because the U.S. Senate decided to withhold publication of the Committee report that described its rationales for the Act’s provisions. But the long and short of it is that the decision to mandate annual contributions of $5.5 billion turned out to be a disaster.
In 2006, the Postal Service was doing great and coming up with over $5 billion a year didn’t seem like a big problem, but then the Great Recession hit, postal revenues took a dive, and it wasn’t long before the Postal Service had to start borrowing from the Treasury to make the payments. When it reached the borrowing limit, the Postal Service just started defaulting on the payments.
This prefunding mandate is responsible for almost all the deficits you read about in the news every time a USPS fiscal report is published. Were it not for the prefunding requirement, the Postal Service would be doing just fine over the past few years, usually breaking even or showing a relatively small profit or loss. According to the FY 2017 10-K report (p. 17), if one looks solely at “controllable” costs and income (i.e., excluding the RHBF payments and other actuarial issues), the Postal Service lost $814 million in 2017 and made a profit of $610 million in 2016 and $1.188 billion in 2015.
In any case, for their first scenario, the Citigroup analysis assumes that “a day of reckoning is approaching” when the Postal Service “must resume making annual prefunding payments to the PSRHBF as well as meeting the amortization schedule on the accumulated $33.9B it owes, as laid out in its FY16 annual report to Congress.”
In addition, says Citi, the Postal Service will need to contend with rising operating costs and declining Market Dominant revenues. According to Citigroup, in fiscal year 2017 the Postal Service will therefore need to bring in an additional $8.3 billion, growing to $9.6 billion in 2019.
For some reason, the Citi analysts then assume that parcel mail would need to cover all of this additional revenue. This, they estimate, would require a 50 percent hike in the price of an average parcel, an increase from $3.50 to $5.25 — or about $1.75 per piece.
The problems with Scenario #1
This scenario is seriously flawed for several reasons. First of all, there’s no reason to believe that such “a day of reckoning” is coming. If anything, we’re heading for a day when Congress recognizes the mess it created with the prefunding mandate and does something to fix it.
As reported by Government Executive, there’s currently a bill in Congress (the text isn’t available yet) under which “Outstanding payments [to the PSRHBF] would be wiped clean and USPS would make actuarial payments toward the remaining liabilities over the next 40 years.”
A 40-year amortization schedule was actually being recommended back in 2006, but the Bush administration pushed for the 10-year schedule that caused all the problems. Such a relaxed schedule would mean annual payments on the order of $1 billion rather than $6 billion, and essentially eliminate the premise on which Citi’s Scenario #1 is based.
A second problem with this scenario is that it assumes the entire $8 billion in increased revenue would have to come from shipping services. But if the Postal Service had to bring in an additional $8.3 billion, it would surely spread the hurt out over all types of mail and not put it all on parcel shippers.
Annual revenues in 2017 were about $70 billion. To bring in another $8.3 billion would require an across-the-board rate increase of about 12 percent. Since such an increase exceeds the price cap on Market Dominant products, the Postal Service would need to request what’s called an exigent rate increase from the PRC due to the “extraordinary” circumstances of being required to pay off the prefunding mandate. That’s happened once before. In 2013, the PRC granted a 4.3 percent increase for about two years to help the Postal Service make up losses due to the Great Recession.
An across-the-board increase of 12 percent would be a serious matter, and mailers, large and small, would go ballistic. One of the effects would be that the rates Citigroup pays to send credit card bills and solicitations would also go up, which would cost the corporation millions of dollars. Maybe that’s why the Citi analysts assume that parcels would need to bear the entire burden of producing the additional revenue.
Anyway, a 12 percent increase on an average piece of Parcel Select ($2) might mean about 24 cents more on a typical Amazon package — not the kind of thing to generate headlines or presidential tweets.
Citigroup actually acknowledges the problems with this scenario later in its report. It notes that the Postal Service could increase postage on other types of mail, Congress might permit the partial reinstatement of the exigent surcharges previously approved by the PRC, and Congress could also provide relief from statutory obligations to prefund certain benefits obligations. Plus, if the Postal Service were to increase parcel pricing significantly, it would do so gradually.
Citigroup calls these “caveats” but they are really much more. Each of these possibilities is much more likely to happen than a 50 percent increase on parcel rates just to cover the costs of retiree health care. Scenario #1 is never going to happen.
Scenario #2: Changing the contribution to institutional costs
In the second scenario, Citigroup notes that when PAEA became law in 2006, Competitive products were assigned a 5.5% share of institutional costs. At the time, parcels represented a relatively small part of the Postal Service’s business, but with the boom in e-Commerce, parcels have become a much larger part. Competitive products now account for about a third of the Postal Service’s revenues.
Over the past few years, UPS has filed several analytic studies and legal briefs with the PRC arguing that Competitive products are not paying their “appropriate share” of institutional costs. According to UPS, the appropriate share would be 24.6% (or even more), as opposed to the 5.5% determined over a decade ago. UPS’ motives are not ambiguous. An increase in contribution to institutional costs would mean an increase in the Postal Service’s parcel prices, which would improve UPS’ position in the market — it could raise its own rates and/or grab a larger piece of the pie.
For its Scenario #2, the Citigroup analysts “work through the impact if the UPS’s suggested 24.6% estimate is instituted.” To do this, they “calculate competitive products’ share at both the current understated 5.5% rate and the updated 24.6% rate proposed by UPS. The difference between the two rates represents the incremental institutional costs that need to be allocated to competitive products.” Here’s how that works out.
For 2017, total USPS operating expenses (i.e., not including the retiree health care expense) were about $70 billion, about half of which were categorized as variable (attributable) costs and half were fixed (institutional) costs. Figured at the 5.5 percent set by PAEA and Citigroup’s estimate of institutional costs (52 percent of total costs), the appropriate share for Competitive products would come to about $2 billion (that’s $70 billion x 52% x 5.5%).
Citi then looks at what would happen if Competitive products had to cover their appropriate share of the fixed costs by using the 24.5 percent figure. The result would be that Competitive products would have to contribute about $9 billion (i.e., $70 billion x 52% x 24.3%).
According to Scenario #2, Competitive products would therefore need to pay $7 billion more for Institutional costs. That would require a rate increase on shipping services comparable to the one determined by Scenario #1 — almost 50 percent. Average parcel rates would go from $3.51 to $4.97, an increase of $1.46. That is the origin of the claim made in the WSJ article, and it’s the basis of Trump’s tweets.
The fatal flaw in Scenario #2
The fatal flaw in Scenario #2 is the assumption that competitive products are currently contributing only 5.5 percent to institutional costs. This 5.5 percent share is actually just the floor set after PAEA was enacted back in 2006, when the PRC determined (as stated in the ACDR) “that if Competitive products contribute at least 5.5 percent toward the Postal Service’s total institutional costs, then, as a whole, they will cover an appropriate share of the Postal Service’s total institutional costs” (p.92).
But competitive products contribute much more than 5.5 percent. According to the 2017 Compliance report, “In FY 2017, the total institutional costs of the Postal Service were $29.700 billion. To comply with 39 U.S.C. § 3633(a)(3) for FY 2017, Competitive products must have contributed at least $1.634 billion toward the Postal Service’s institutional costs. In FY 2017, the total Competitive products contribution was $6.806 billion (approximately 23 percent), which exceeds the minimum contribution requirement.” (italics added, p. 92).
While the numbers differ slightly from Citigroup’s estimates for 2017, the point is clear enough. Competitive products are not contributing 5.5 percent to institutional costs; they are contributing more than four times that amount, and they are contributing almost exactly what Citigroup and UPS say they should be contributing, about 23 or 24 percent.
The Citigroup report observes in a footnote that UPS has subsequently argued that competitive products’ appropriate share should be even higher, like 29 percent. Even at that level, the impact on the prices of Competitive products would be modest compared to what Scenario #2 envisions.
For the past couple of years, there’s been a lively debate at the PRC about how much Competitive products should contribute to institutional costs. (See, for example, PRC Docket No. RM2017-1 on “Institutional Cost Contribution Requirement for Competitive Products.”) While UPS has argued for a higher minimum floor, others have argued that there doesn’t need to be a minimum at all. In its comments on the issue (January 23, 2017), for example, Amazon states this:
“Competitive products are covering almost are four times the share of the Postal Service’s institutional costs that the Commission mandated five years ago. The contribution and cost coverage of competitive products are now far too high to support any credible allegation that a binding minimum contribution requirement is needed to preserve a ‘level playing field’ for the Postal Service’s competitors, let alone to avoid cross-subsidy, predatory pricing, or any other alleged form of unfair price competition, or provide a margin of safety.”
Whatever the Commission ultimately decides to do about the minimum contribution level, the key point here is that Citigroup’s Scenario #2 is based on the mistaken assumption that Competitive products are currently covering only 5.5 percent of the Postal Service’s institutional costs, when in fact they are contributing more than four times that amount. There’s no shortfall of $7 billion that needs to be made up by a big increase in parcel prices.
Considering how sophisticated the Citigroup analysts are when it comes to making projections, it’s perplexing that they missed this basic fact.
The $2.6 billion in additional costs for Amazon
The other number that Trump has tweeted also comes from the Citigroup report. In this tweet, Trump says, “If the P.O. ‘increased its parcel rates, Amazon’s shipping costs would rise by $2.6 Billion.’ This Post Office scam must stop. Amazon must pay real costs (and taxes) now!”
Here’s where that number $2.6 billion comes from.
The Citi analysts outline a “worst case scenario” in which Amazon must bear a 50 percent increase in its costs with the Postal Service, plus a 20 percent price jump with FedEx and UPS, which will be able to raise their prices thanks to the price hike by their competitor.
The analysis gets pretty complicated, but the bottom line, says Citigroup, is that Amazon would incur an additional $2.6 billion in shipping costs.
Trump’s tweet makes it sound as if the Postal Service itself is missing out on $2.6 billion a year in revenue from Amazon, but that’s not the case, and it’s really misleading, to say the least, to make such a claim.
Cost coverage on the Amazon deal
If you want to get even deeper into the weeds on all this, let’s take a look at the cost coverage for the type of mail Amazon is using.
While the Amazon NSAs are nonpublic, one can get a good sense of just how successfully the products are covering costs by looking at a couple of USPS financial reports.
This USPS report shows that in 2017 Parcel Select brought in $5.67 billion on 2.8 billion pieces. This second USPS report shows the cost coverage for each type of mail. It doesn’t mention Parcel Select, but it provides data for Total Ground mail, which includes Parcel Select, Standard Post, and Parcel Return Service. It shows that in 2017, Ground brought in about $6.2 billion in revenue on about 2.88 billion pieces. Parcel Select thus accounts for almost all Ground mail, so the data on cost coverage for Ground can give us a ballpark view of the cost coverage for Parcel Select and, by extension, the Amazon NSAs.
The second report shows that the average Ground piece brought in $2.148 in revenue. The variable cost was $1.221; the rest — $0.927 — was contribution to institutional costs. The cost coverage was 175.86 percent.
If you compare this to the cost coverage for other types of mail, you’ll see it’s typical. First Class letters, for example, have a cost coverage of 164 percent, and First-Class mail overall has a cost overage of 210 percent.
A few types of mail have a cost coverage below 100 percent. Standard Mail flats, for example, have a cost coverage of about 74 percent, and Periodicals, about 70 percent. While these types of mail do not cover their attributable costs, there are legal and policy reasons why some of that failure may be considered excusable. In any case, the issue is regularly discussed in the PRC’s compliance reviews, and all the stakeholders are well aware of the issues.
If the cost coverage on Amazon’s Parcel Select is anything like 175 percent, there’s clearly no cause for concern that the Postal Service or the taxpayer is somehow subsidizing Amazon delivery.
Perhaps an upside
There are many reasons to criticize Amazon — its success is hurting brick-and-mortar businesses, it exploits its workers with low pay and poor working conditions, and it’s “no fan of labor unions” — and there are plenty of reasons for criticizing the Postal Service as well, like the way it underpays its non-union employees and abuses the emergency suspension provision to close post offices without due process.
There are also reasons to raise questions about the relationship between Amazon and the Postal Service, as we’ve done on this website since the deal to deliver for Amazon on Sundays was first announced in 2013. STPO contributor Mark Jamison’s posts on Amazon and the lack of transparency in the NSAs are still worth reading. (Our Amazon posts are archived here.)
Criticisms aside, there’s little reason to believe that the Postal Service is significantly undercharging Amazon for delivering its parcels. The cost coverage data show that parcels are more than covering both their attributable and institutional costs, the PRC has reviewed the NSAs and found them in compliance with the relevant statutes, and there are serious flaws with the Citi analysis on which the claims for underpaying are based. There’s absolutely no evidence that the Postal Service is losing a fortune on the Amazon deal.
While Trump’s tweets on the post office are bogus, perhaps we should at least be thankful to the President for raising some important questions about the Postal Service. Perhaps his tweets will lead to some thoughtful Congressional hearings on postal topics. Perhaps the pension and health care cost issues will finally get clarified. Perhaps the Postal Service will address public concerns by providing more transparency about the deals it strikes with companies like Amazon. Perhaps, perhaps.
Run, I’m some what confused over the Pre-fund issue for UPS retirees medical insurance. Is this pool being used today? If so, does the use rate exceed the pre-funding rate? Since the pre-funding has admittedly stopped due to USPS revenue stream reductions, are the current retirees having their health insurance paid? By whom? How much liability is there for tax payers?
How does ACA and other health laws effect the USP health plans for its current employees and retirees?
A personal point of reference: I am enrolled in the NALC (Nat Assoc of Letter Carriers) health plan, but my subsidized portion is paid out of annual General Fund revenues. IIRC USPS employees and retirees have access to most (some Fed Plans are restricted often due to location) of the other Federal health Plans, as I, a Federal retiree, have access to the USPS specific plans that are open or partially restricted. I do pay an annual premium because I am not a member of the Letter Carrier Union, that partial restriction.
The Retirement and healthcare fund is being funded at an accelerated rate. You could ask Steve Hutkins or Mark Jamison if you like. The main reason the USPS shows itself as being unprofitable is the $billions going to the funding of Retirement and Healthcare even before it is needed. God forbid Congress would put the same requirements on themselves; but wait, they have us to tax for their funding.
This is Steve’s article and he will take questions and Mark is a retired Postmaster. Both are good guys.
Your links provide a lot of insight into what is a difficult issue. One made the important point that Amazon is covering the variable cost with the issue being how much extra they should be billed to cover the USPS’s fixed or institutional costs. I find the following amazing:
‘UPS has filed several analytic studies and legal briefs with the PRC arguing that Competitive products are not paying their “appropriate share” of institutional costs. According to UPS, the appropriate share would be 24.6% (or even more), as opposed to the 5.5% determined over a decade ago. UPS’ motives are not ambiguous.’
UPS just hates it that the USPS is a competitor in this business. a 24.6% markup is just obscene. Of course I suspect that Trump is trying to help out the shareholders of UPS and FEDEX to the rest our detriment. Crony capitalism rules!
“Trump is trying to help out the shareholders of UPS and FEDEX to the rest our detriment.”
Next post this week.
Just a side note: this article made me realize that I’d really like to see Post Office personnel get paid more on a par with UPS and FedX employees. Maybe an overall price hike of 12% could enable that — “not the kind of thing to generate headlines or presidential tweets.” 🙂
Is this wrongness by Citi just the result of business school education being flat wrong about government efficiency?
You reading something special over at WM?
Run, Steve Hutkins or Mark Jamison, I am sympathetic to the amortization period argument. It also appears from this GAO Report
that the various pension funds are also underfunded: https://www.gao.gov/assets/680/674728.pdf
In the long term these underfunded pension funds will become more problematic and disastrous to the USPS work force and retirees.
All these funds’ issues will potentially the US tax payer on the hook.
The bottom line appears to be it sucks to be a quasi-private firm with Congressional oversight/management help. There’s just too big a difference in decision making paces to be effective.
Lost amidst all this controversy is that in 2017 Amazon paid zero federal income tax on over $5 billion of income.
Could we maybe have another 3,000 word article on why corporations gaming the tax code to contribute nothing to funding the Federal government is comfortably in everyone’s blind spot?
Welcome to Angry Bear. First time commenters go to moderation to weed out spammers and moderation. Since neither Steve, Mark, or myself are paid to write and we all work other jobs, the likelihood of writing another post of this length (it was really 6,000 words- split in two). There is nothing lost in these words. What you are asking for is a different topic.
Thanks to everyone for their comments on my article. Here are a few replies.
First, as to the retiree health care fund, this fund is for future retirees, decades down the road, and I don’t believe health care costs for current retirees are drawing from it. For a detailed explanation of how the retiree health care fund came to be and why it was supposed to be funded at an accelerated rate, see my previous post, https://savethepostoffice.com/how-postal-service-began-prefunding-retiree-health-care-and-fell-deep-hole/.
The two USPS pension funds are very well funded and the outstanding obligation is relatively small (some years, there has even been overfunding); the retiree health care fund is currently funded at about 50 percent of the total obligation, but before 2006 there wasn’t even such a fund at all (it was pay as you go), so that’s actually a pretty good percentage. Overall, the three funds are currently funded at over 82 percent of the obligation, and due to accounting methodologies unfavorable to the USPS, even the 82 percent may be lowballing it. Claims that the taxpayer will one day be on the hook for postal worker pension and health care costs are way overblown. For more, see https://www.uspsoig.gov/sites/default/files/document-library-files/2017/FT-AR-17-007.pdf
UPS has been trying since 2003 to get the Postal Service to raise rates on parcels by arguing that parcels should contribute more to fixed (institutional) costs. As my article explains, they were arguing that competitive products overall should contribute about 24 percent; in fact, that’s just about how much they contributed in 2017. More recently, UPS has raised the number to 29 percent, but that won’t be happening. The PRC is looking at raising the floor to about 12 percent, but the floor is essentially meaningless, since competitive products contribute way more than that anyway.
Thanks again for the comments!
Thank you Steve!
Steve Haskins, thanks for the response. I think history fails to support you contention: “Claims that the taxpayer will one day be on the hook for postal worker pension and health care costs are way overblown.” During time of financial distress it is quite common to see Pension/Health funds fail. Typically this is because they have either raided to pay for operating expenses, and even more often they were under funded and unable to weather extended times of financial duress or business change.
I appears USPS is experiencing both. Fully funding these accounts is meant to allow for weathering all but the Depression but even the Great Recession, if they occur.
Again i am sympathetic to changing the amortization, but not so sanguine that the threat to tax payers is “over blown”. History show otherwise. I will not show examples as they are too man.
man = many.
A reply by a friend Mark Jamison, former Postmaster in North Carolina.
First of all the largest portion of the unfunded amounts are the retiree health benefit amounts.
That figure is based on the idea of funding out about 75 years with the primary pre-funding supposed to have occurred over a ten year period (USPS didn’t make most of those payments). Besides questions of methodology and funding windows GAO tends to ignore one very easy fix. All Federal employees pay into Medicare yet the Federal Employee Benefit Health Plan does not require Federal employees to use Medicare as primary payer when employees reach 65. FEHB doesn’t offer any supplemental plans. Even GAO calculated at one point that if postal employees were required to sign up for Part B (Part A is automatic) and if FEHB offered wrap around plans that the retiree health liability essentially evaporates.
I’ll grant that this fix is somewhat controversial, no one likes to give up a free ride and combined Part B premiums and supplemental premiums would be slightly higher than current (although this doesn’t take into account reduced out of pocket due to fuller coverage with two plans) so Postal employee representatives have argued against this fix as have other Federal employee representative organizations. The fact remains that the employees paid into Medicare and the presumption was that they would be covered by the program. Some like Ron Johnson – the Republican Senator from Wisconsin who has given a whole new meaning to the word obtuse – have argued that this would increase Medicare’s overall liabilities. Even under the most critical assumptions this is minuscule and it belies the fact that CMS actually has to account for all potential enrollees in its liability estimates.
The liability for workman’s comp was added a few years ago as a way of making the picture look even worse (one should note that GAO has had something of a hard on for the Postal Service going back 25 years). The Postal Service self-funds worker’s comp but the assumptions that underlie GAO’s estimates have been widely questioned. Also, here again a slight change in the law would cause this liability to evaporate. There’s no mechanism for moving people off worker’s comp into retirement programs so there are actually people who are 90 years old still receiving WC.
The 2016 report shows large deficits for FERS which is interesting because previous reports showed FERS as being heavily overfunded. GAO isn’t very transparent on the underlying assumptions it uses and tends to change them to suit the purpose of the moment. For example there has been significant discussion about using postal-centric demographic information in calculating postal liabilities. Using demographic information that more closely matches the postal population tends to reduce the retirement fund liabilities quite a bit while increasing elements of the health liability. On balance postal specific analysis tends to yield slightly lower total liabilities.
Then we have the whole issue of what assets and liabilities were attributed to the Postal Service in 1972 when it was spun off. There have been credible arguments (Siegel report) that the Postal Service was short changed and given heavier responsibility for future benefits than would have occurred under normal accounting assumptions. The comment that it sucks to be a quasi-private firm with Congressional oversight/management does have a lot of truth to it. Let’s remember how the whole retiree health benefit liability issue started. The Postal Service was being charged with funding the military portion of employee retirements (military time counts towards retirement under CSRS and FERs). The accounting showed that the Postal Service had been overcharged at least $27 billion. In 2006 when PAEA was passed, at least partly to address this issue, the Bush Administration insisted that any changes be budget neutral – hence the invention of the retiree health benefit prefunding.
I haven’t followed this closely for a couple of years but in 2014 the Postal Service had about $325 billion stashed in T-Bills for retirement funding. The Postal Service’s funding far exceeded any expectations regarding safe funding for private entities – e.g. GAAP generally assumes retirement plan funding at 80% to sufficient while the expectation for the Postal Service was 100%. Health funding is typically at a lower level and again the a Postal Service was expected to fund at a 100% level.
This liability issue has always been a sleight of hand distraction not entirely dissimilar to the dissembling that surrounds the Social Security trust funds. It’s a sort of “hey look over here at these really big scary numbers” while the goal is to pick the public’s pocket at the other end. One doesn’t have to look far to find reams of evidence that certain political elements would a) love to undermine the postal unions; b) privatize the Postal Service generally. I’m not suggesting retiree health and pension obligations should be ignored but the focus and scrutiny on these areas has been greatly overblown in the service of other agendas. Unfortunately those who are determined to place primary focus on the pension and health liabilities and that includes some progressives and neo-liberal DLC types, are doing so to the exclusion of issues that, I think, are far more important like the public infrastructure aspect of the postal network and the anti-trust and monopoly problems in package delivery markets.
Unfortunately we could argue about this for the next fifty years and those who are dug in on the liability issues to the exclusion of everything else are going to remain rock solid. We see the same thing with Social Security, Medicare and the general safety net. It’s a way of focusing on a narrow rather slanted utilitarian economic case while denying quality of life issues, the danger of too broad a separation in economic inequality, and the importance of public goods to sustaining democratic institutions.
And now I’m going to go plow pumpkin and potato fields – or maybe I’ll watch the hummingbirds which seemed to have returned over the last couple of days.