Postal Services: Public or Private? Competition or Monopoly?
Terry Black and Susan Black

The National Competition Council (NCC) has recently undertaken a review into the performance of Australia Post, specifically concentrating on the possible effects of introducing competition. This article considers some competition issues subject to the NCC inquiry, such as community service obligations and the legislative standard letter monopoly. However, we also look at issues outside the NCC terms of reference: in particular, public ownership versus private ownership, and the abolition of the requirement for uniform pricing of letters.

The terms of reference issued by the Federal Treasurer, Peter Costello, for the review of the Australian Postal Corporation Act 1989 require advice on ‘practical courses of action to improve competition, efficiency and consumer welfare’ (National Competition Council 1997a: 14). This raises the issue of whether or not Australia Post is a natural monopoly and therefore whether a competitive market is a feasible goal.

Natural Monopoly?

A natural monopoly is characterised by decreasing average cost resulting from extensive economies of scale. This means that a single firm is able to supply the whole industry output most efficiently. However, there is a lack of evidence in support of Australia Post being a natural monopoly. Postal services are labour intensive rather than capital intensive and hence decreasing average costs are unlikely (Senior 1983). Albon (1985: 27) concludes that ‘the consensus of the overseas literature is that there are no substantial economies of a single firm operation in the postal industry.’ Also the Bradley Committee’s report (1982: 41) judged that the ‘relatively low capital intensity of the commission’s postal network suggests limited economies of scope or scale for the broad range of postal services.’

Rather than Australia Post being a natural monopoly, legislation has artificially granted it a monopoly over the letter market. Section 85 of the Postal Services Act prohibits anyone other than Australia Post from delivering standard letters, effectively creating a postal monopoly. In the absence of economies of scale or scope, removing the legislative barriers to entry would further the efficiency of the postal system through competition.

Regardless of the existence of natural monopoly conditions, the theory of contestability asserts that the provision of postal services can be opened to competition (Baumol 1982). The contestability of a market increases with the lowering of the costs of entry and exit. This results in ‘hit and run’ firms entering an industry whenever excess profits exist. It is likely that existing courier service firms could do this in the letter delivery market. The low sunk costs in postal delivery would also enable other firms to enter and exit the market readily. The Industry Commission (1997: 37) concludes that ‘in the absence of restrictions on competition, mail delivery is likely to be highly contestable due to low barriers to entry and set-up costs …’

In contestable markets, the threat of entry of other firms results in the incumbent behaving as if competition existed. Positive economic profit would induce firms to enter the market and undercut the incumbent’s price until there is zero economic profit. This means that irrespective of whether or not a natural monopoly exists, it is likely that removal of the legal barriers to entry would force Australia Post to price competitively due to contestability.

There is no economic justification for the legal barriers to entry to the postal market. Repealing Australia Post’s legislative monopoly would improve economic efficiency, with competition and the threat of entry in contestable markets inducing firms to provide and price their services at minimum cost.

Privatisation

The terms of reference for the NCC review indicate the Government’s commitment to maintaining Australia Post in full public ownership. Whilst it is possible to improve competition, efficiency and consumer welfare under public ownership, the improvements may fall short of their full potential.

The incentives to maximise profits by operating efficiently are lower under public ownership than they are under private ownership. This is known as the problem of the commons, and was pointed out by Aristotle over two thousand years ago: ‘What is common to many is taken least care of, for all men have greater regard for what is their own than for what they possess in common with others’ (quoted in Nahan 1992: 11).

Privatisation increases productive efficiency because it provides incentives for the owners to monitor the performance of management. Although management is the agent of the owners and managers are employed to act on behalf of their principals, self-interest may result in their actions being contrary to the interest of the owners. To reduce this conflict of interest, principals engage in monitoring and ‘bonding’ activities to curtail the agent’s divergent behaviour. However, since monitoring and bonding are costly, not all of the agent’s divergent behaviour is eliminated. On cost-benefit grounds it is best for the owners to tolerate the residual loss when the costs of reducing it are greater. (For a further discussion of agency theory, refer to Jensen and Meckling 1976.)

Agency theory provides a strong basis for predicting that while Australia Post remains publicly owned it will fall short of achieving its efficiency potential. This appears to be the view of the National Competition Council (1997a: 95):

The market for corporate control arising from private ownership also provides strong support for the greater efficiency of privatised businesses over those that are publicly owned. Dodd and Officer (1986: 2) explain:

Takeovers and the threat of bankruptcy reinforce agency theory by acting as a disciplinary force if management pursue their own goals and not those of the owners. Although it is often argued that the separation of ownership and control that exists in privately owned corporations enables management to act contrary to the interests of shareholders by not pursuing efficiency, this is denied by the existence of an active takeover market. As Dodd and Officer put it (1986: 3), ‘A market for corporate control contributes to the general economic welfare by providing the opportunity for firms to combine to form more efficient and more profitable entities.’

The Federal Government’s insistence that Australia Post remain in public ownership is a major impediment to its becoming efficient and consequently (assuming lower costs achieved are passed on to consumers through an appropriately competitive environment) improving consumer welfare – in accordance with the government’s own terms of reference for the NCC inquiry.

A Uniform Price for Standard Letters

The terms of reference require that Australia Post ‘provide a standard letter service to all Australians at a uniform price’ (National Competition Council 1997: 14).

This requirement conflicts with the major request for the Council ‘to improve … consumer welfare …’ since it entrenches the present system whereby the welfare of city consumers is reduced. The uniform price results in costly deliveries to rural residents being cross subsidised by lower cost city deliveries, benefiting rural users at the expense of the majority of users (Albon 1985). The NCC (1997b: 8) points out that deregulation would result in country areas facing ‘a combination of increases in prices and reductions in service. … the impact in remote areas is likely to be greater than is socially acceptable.’

Whilst citizens resident in remote areas no doubt would object to the loss of subsidised deliveries, this does not indicate that society would find this outcome objectionable. It is doubtful that the NCC is capable of determining the social will. Mechanisms such as voting or referendum, or at least random sampling, are the usual vehicle for determining social acceptance. Rather than having the NCC decide on behalf of Australian society whether the majority is willing to subsidise the rural minority, questions of wealth redistribution are more appropriately the role of government and are more efficiently processed through the taxation system.

The generally accepted aim of wealth redistribution is to assist low-income households. However, the uniform postage rate benefits individuals mailing letters to or from low density locations, only some of whom are low income earners. Even if it is thought necessary to subsidise people simply for living in rural areas, there is no obvious reason for tying a subsidy to use of the postal service. The removal of the so-called community service uniform price would enable Australians as part of the election process to periodically re-assess such subsidies. Changes in community sentiment would then be reflected at the ballot box.

The NCC (1997b: 11) indicates ‘that in 1995/96 the cost of provision of CSOs [Community Service Obligations] involved in delivery to rural and remote areas is less than $25 million. … It is estimated that the loss per rural or remote person is less than $4.80 per year.’ Given the trivial per person cost there is little justification for the maintenance of the uniform pricing of standard letters.

However, the NCC (1997b: 12) states that ‘Australia Post’s letter delivery CSO is likely to be justifiable on communication grounds, and possibly also to allow the transport of things, such as education material to people in remote areas.’ Since education material is already heavily subsidised by taxpayers, the additional cost from repealing the uniform price could be also incurred through the education budget. If letter communication is highly valued by rural dwellers they will be willing to pay prices which reflect the cost of delivery

The Industry Commission (1997: 16) points out that the cross-subsidy ‘results in greater usage of the service than if those consumers had to face the full costs of the service.’ Consequently some of these communications are valued at less then their cost. ‘The reserved service stifles the demand of other consumers and results in less usage of the services by those consumers than if the price were allowed to fall closer to the cost of the service. These effects involve a welfare or efficiency loss’ (Industry Commission, 1997: 16). This is a misallocation of society’s scarce resources.

If the government’s uniform price requirement was removed, and Australia Post’s letter reservation opened to competition, it is unlikely that Australia Post would
voluntarily cross-subsidise rural deliveries. To do so would expose it to competitors undercutting its prices for city deliveries. Competition would drive down city delivery prices until they were equal to the cost of providing these services. With prices for city delivery no longer inflated by the cost of subsidising rural deliveries, prices for country services would increase. The National Competition Council options paper (1997b: 7) states that ‘Customers whose mail goes mainly to remote areas … would have little choice but to use Australia Post.’

However, whilst competitors would initially enter the highly profitable city delivery market, prices would adjust for both city and country deliveries until they reflected cost. Although prices would rise for country deliveries to equal their cost, it would be Australia Post’s costs that would initially determine price. Consequently it is possible that competitors might enter the country delivery market if they judged that they could operate more efficiently than Australia Post.

The present system of cross-subsidisation results in resource misallocation due to excess investment in country areas and under investment in the cities. The uniform price requirement, under the guise of a community service obligation, in fact results in a disservice to the Australian community.

Parcel CSO

Currently no Community Service Obligation exists for parcel deliveries. However, the NCC considers it has merit, providing ‘there was a significant need for parcel services in rural and remote areas that would not be provided on a commercial basis’ (NCC 1997b: 14).

The NCC acknowledges that the parcel market is subject to full competition. Consequently, price reflects the cost of deliveries. If parcel services are not being provided to some rural areas on a commercial basis then it is because consumers are unwilling to pay prices which cover the cost of such deliveries. Since the value placed on these deliveries is less than the cost of resources consumed, then it is optimal for society that such deliveries do not occur.

The NCC (1997b: 14) considers that if a parcel CSO was adopted, ‘the price should be set at a maximum affordable charge at or above the current rates for delivery from urban to remote areas.’ Social welfare notions of ‘affordability’ are more appropriately handled via the taxation system. They are then more transparent, providing society with the opportunity to periodically review the subsidies being paid.

Setting a maximum price at or above the current price will have no effect whilst the competitive price remains below the price ceiling. However, as costs or demand change it is possible that the commercial price could rise above the CSO maximum price. The NCC sees no problem with this price cap and argues that it will not affect competition. However, when the CSO price is below the competitive price it will result in a significant shift in demand from commercial firms to Australia Post. The greater the difference between the CSO price and the commercial price and the longer the CSO price is ‘capped,’ the greater the effect on commercial firms. In the limit, commercial firms would cease to provide the service at all. Consequently, a CSO price cap for parcels would be contrary to the terms of reference ‘to improve
competition.’

Legislative Monopoly

The Treasurer’s terms of reference asked the NCC to ‘examine the need for a statutory reservation to Australia Post of the exclusive right to carry letters … and whether it is consistent with the government’s commitment to provision of a uniform letter service.’

The Industry Commission (1997: viii) points out that ‘There is evidence that the uniform price of 45 cents for standard letters could be higher than needed to fund the universal service.’ With Australia Post currently operating under monopoly conditions, indications are that it is earning large profits: ‘As a commercial business Australia Post generates strong profits and a high return on assets and the shareholder’s investment’ (NCC 1997b: 92). If Australia Post’s monopoly was removed and the uniform price abolished, these large profits would induce other firms to enter the industry until all economic profit is competed away.

If Australia Post’s letter monopoly was lifted but the uniform price was maintained, then competition would be likely to enter the profitable city delivery market. Since price competition would not be permitted, firms could compete using non-price methods. Possible examples include a door-to-door collection service and several pickups per day. It is likely that competition would result in delivery firms earning only normal profits with firms incurring significant costs from providing the additional services. Whilst some customers would welcome these services, other customers may prefer lower prices and a ‘no frills’ service.

Regulation maintaining a uniform price would be contrary to the social interest to the extent that it would result in customers receiving services which they value less than the cost of providing them. If the uniform price requirement was abolished, then customers could trade off additional services and price reductions. Those customers who value price reductions more than the additional services would gain as competition reduced prices. Customers who are willing to forgo price reductions, perhaps even paying higher prices, in order to receive additional service would also benefit from competition. The removal of both Australia Post’s monopoly and the uniform price regulation would be consistent with the Treasurer’s major term of reference to ‘improve consumer welfare,’ whilst maintenance of either or both would be contrary to the social interest.

Universal Service

Under the Postal Corporation Act, Australia Post is obliged to deliver standard-sized letters to all parts of Australia at a uniform price. If the uniform price requirement were removed, then Australia Post’s delivery obligation would be fulfilled by charging prices which reflect cost. Customers would then avail themselves of the service only if they judged that the benefits exceeded the cost. Some customers would consider alternatives such as fax, phone, the Internet and electronic mail in preference to the postal service.

If a competitive market existed then consumer choices would be consistent with the social interest. Hence, if the uniform pricing legislation was removed, the regulatory requirement for Australia Post to provide an Australia-wide delivery service would be redundant. Australia Post would willingly provide services Australia-wide if it were able to charge prices which reflected cost.

Hilmer Competition Principles

Under the Commonwealth-State competition agreements arising from the Hilmer Report, barriers to competition are permitted only if there is a net public benefit and if the community’s objective can only be achieved by restricting competition. The justification for Australia Post’s barriers to competition is to fund CSOs. However, these CSOs benefit a relatively small part of the public and impose costs on a relatively large part of the public.

If the CSO legislation was repealed and replaced by a subsidy to fulfill its aims then the democratic process would be allowed to determine whether or not a net public benefit exists. If the community decides to continue with CSOs, then it can tax itself to fund them. Consequently the community’s objective can be achieved without the need to restrict competition.

Removal of Australia Post’s monopoly in the market for standard letters may have only a limited benefit on competition, if the requirement for uniform pricing is maintained. If consumers were faced with a choice of Australia Post or its competitors, but with both pricing the same, then there may be a limited incentive for consumers to choose. This is the view of the NCC (1997b: 20): ‘Evidence from potential competitors and international experience suggest that there is little scope for increased competition while prices remain above the standard letter rate.’ In this case, maintaining the uniform price requirement would be incompatible with competition. ‘However, if Australia Post were compensated for its delivery of CSOs by some method other than cross-subsidies then it would be able to compete effectively on price’ (NCC 1997b: 161.).

Conclusion

Retaining Australia Post’s CSOs by maintaining uniform pricing instead of user-pays pricing is contrary to consumer welfare. The requirement of a universal service provided at a uniform price leads to an inefficient allocation of resources. Of further concern is the legislative standard letter monopoly, which allows Australia Post to cross-subsidise. Instead, CSO wealth redistributions in accordance with social preferences are more appropriately achieved through direct funding out of the taxation system.

There is no economic justification for retaining the legislated postal monopoly. The introduction of competition and the removal of CSOs would result in efficient pricing with consumers paying the true cost of those services that they value. In contrast to public ownership, the privatisation of Australia Post, which entails greater discipline by its shareholders through the capital markets, would promote greater operating efficiency. If this greater efficiency is passed on in the form of lower prices in the more competitive environment facilitated by deregulation, consumer welfare in general would benefit.

References

Albon, R. 1985, Private Correspondence: Competition or Monopoly in Australia’s Public Services?, Centre for Independent Studies, Sydney.

Baumol, W. 1982, ‘Contestable Markets: An uprising in the theory of industry structure’, American Economic Review, March.

Committee of Inquiry into the Monopoly Position of the Australian Postal Commission (Bradley Committee) 1982, Report, AGPS, Canberra.

Dodd, P. and R.Officer 1986, Corporate Control, Economic Efficiency and Shareholder Justice, Centre for Independent Studies, Sydney.

Industry Commission 1997, Submission to the National Competition Council review of the Australian Postal Corporation Act 1989, AGPS, Melbourne.

Jensen, M.C. and W.H. Meckling 1976, ‘Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure,’ Journal of Financial Economics, 3: 305-360.

Nahan, M. 1992, ‘How to save our native birds,’ IPA Review, 45(1): 10-12.

National Competition Council 1997a, Review of the Australian Postal Corporation Act Issues Paper, June.

National Competition Council 1997b, Review of the Australian Postal Corporation Act Options Paper, September..

Senior, I. 1983, Liberating the Letter: A proposal to privatise the post office, Research Monograph 38, Institute of  Economic Affairs, London.

Terry Black is a senior lecturer at the Queensland University of Technology and author of the CIS monograph 'Buy Australian: Myths and Realities.' Susan Black is completing Economics and Commerce degrees at the University of Queensland. 

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