Avoiding Financial Armageddon at the Post Office

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The USPS is an analog business being rapidly consumed by digitization. Here's a plan to update and rescue it.

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Reuters

"Now it seems strange
How we used to wait for letters to arrive
But what's stranger still
Is how something so small can keep you alive"
--Arcade Fire, We Used to Wait

It's election season. And since Candy Crowley didn't use my question in the second debate, I thought I'd ask it here: "President Obama and Governor Romney, the United States Postal Service is forecasted to lose $5.5 billion in 2012, and also has defaulted on scheduled payments of $11 billion. What would you do to fix it?"

Since the debates are now over, let me take a shot at answering it.

We have a thesis at Andreessen Horowitz that "software is eating the world," such that analog businesses in a wide variety of sectors are being crushed by rapid digitization. In a recent piece, I discussed how this was playing out in retail, where market share gains by online retailers at the expense of offline retailers are threatening the long-term viability of many offline merchants due to their high operating leverage. This same dynamic is playing out in communications. The USPS is an analog business being rapidly consumed by digitization.

According to the Postmaster General, "The core function of the Postal Service is the physical delivery of mail and packages...to every address in America." Physical = analog. Here is the USPS product mix in 2008 just four years ago:

Screen Shot 2012-10-29 at 9.49.04 AM.png

It was an analog cornucopia. Half of their revenue (and even more of their profits) came from first class mail, but this personal and business correspondence is being rapidly replaced by digital email, texts, social networks, and online statements and bill-pay. Similarly, catalogs, magazines and newspapers are being replaced by commerce and content websites, supported by email marketing. I had a front row seat at eBay as money orders started getting replaced by PayPal. The only growth business that USPS has is packages due to the explosion of e-commerce. But unfortunately, this business has been relatively small for them (representing only about 14% of 2008 revenue) and highly competitive vis-a-vis UPS and FedEx.

So what has happened to the volume of USPS deliveries? It's been decimated:

Screen Shot 2012-10-29 at 9.49.53 AM.png

I have to give the USPS management credit--they saw pretty early on that a freight train was coming right at them. When I was managing eBay in the early 2000's, the USPS management team organized a session with select Valley executives on what they could do to mitigate potential disruptions to their business due to digitization (I was likely invited because the eBay community in aggregate was one of their largest customers).

Any business that encounters disruption on this scale needs to respond decisively to remain viable. And the Postal Service is essentially a business: They are "an independent establishment of the executive branch that does not receive tax dollars for its operations." But unlike privately owned businesses, "...the Postal Service is nevertheless restricted by laws that limit its ability to control costs and grow revenue in the way a business would." (2011 Annual Report)

What are some of these restrictions? The USPS...

• Has a "universal service" obligation that mandates the delivery six days per week to a national footprint of 151 million homes and businesses

• Has labor agreements that specify cost-of-living wage increases and contractual benefit plans for employees and retirees

• Faces limits in raising prices

• Is "restricted by law from taking certain steps, such as entering new lines of business that might generate additional revenue..."

USPS management has attempted to navigate these restrictions to mitigate the financial impacts of digitization. They have been trying to control the costs they can, rapidly consolidating mail-processing facilities and adjusting their employee counts down in line with falling mail volumes. And they have raised prices. Unfortunately, the biggest price increases have been in packages and shipping, their most competitive market:

Screen Shot 2012-10-29 at 9.50.05 AM.png

So what's the net outcome of these actions? Massive and growing losses. Revenue is eroding rapidly as the price increases have only partially compensated for plummeting volume. And they've made very modest progress on lowering expenses:

Screen Shot 2012-10-29 at 9.50.17 AM.png

And unfortunately, their situation is even worse than this. The USPS historically has not accrued for the cost of retiree health benefits; they've booked them on an as-spent basis (governmental entities are allowed to do this, unlike the private sector). And the costs they were spending paled compared to the costs they should have been accruing. Congress in 2006 mandated that USPS catch up on these obligations over a 10-year period, a process called "RHB Pre-Funding" (RHB stands for Retiree Health Benefits). They were able to make these Pre-Funding payments between 2007 and 2010, but their economic meltdown has caused them default on their recent obligations (Josh Barro of Bloomberg provides an excellent explanation of this issue here). The $11 billion in defaults, combined with their operating loss of $5.5 billion, is resulting in the disastrous $16.5 billion 2012 deficit.

USPS management has presented a plan for how they potentially can navigate their way out of this mess (USPS "Plan to Profitability"). It involves significant savings from changes in benefit plans, decreased service levels (e.g., moving from six to five-day delivery), some post office closures, and continued headcount reductions. It also involves continued price increases and identifies some revenue-boosting initiatives. It's an ambitious plan, but it has a few big issues:

• About half of the financial improvements require require "significant legislative change", and Washington hasn't been very good lately on that front.

• It ignores the issue of the under-funded retiree health benefit costs.

• Most importantly, it assumes that their revenue erosion moderates significantly going forward. This just won't happen; that digital "genie" is out of the bottle.

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Presented by

Jeff Jordan

Jeff Jordan is a partner at Andreessen Horowitz and is on the boards of AirBnB, Belly, Fab.com, Circle, Lookout and Pinterest, as well as OpenTable, Wealthfront and Zoosk. More

Jeff Jordan is a partner at Andreessen Horowitz and is on the boards of AirBnB, Belly, Fab.com, Circle, Lookout and Pinterest, as well as OpenTable, Wealthfront and Zoosk. Previously, Jeff was president and CEO of OpenTable, which he took public in 2009. Before OpenTable, Jeff was president of PayPal, and he was previously the SVP and general manager of eBay North America. He blogs at http://jeff.a16z.com/.

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