USPS Future Business Model March 2, 2010 Contents Recent context Base case – minimal management actions Addressing the challenge Short term requirements McKinsey & Company | 1 Recent Context USPS is experiencing unprecedented losses Net profit/loss Key drivers $ billions No rate increase 2003-2006 3.9 3.1 -1.7 – -0.7 -2.8 -3.8 02 03 04 05 06 Class Mail Down-trading from First-Class to Standard Mail Losses of advertising mail due to the recession RHB pre-funding -7.82 01 – E-diversion of First- 0.9 -5.1 2000 Revenue declines due to: – 1.4 -0.2 Postal Act 2006 signed into law 07 08 09 2010 8.4 5.6 1.41 5.5 RHB pre-funding, $ billions requirement introduced by the PAEA Cost savings, while substantial, have been less than revenue declines due to high fixed costs of the network Note: All years in this document refer to Fiscal Years ending on Sept 30 1 Includes one-time $4 billion deferral 2 Per 2010 Integrated Financial Plan (January Year-to-Date results are favorable to Plan) SOURCE: USPS; P.L. 109-435 (PAEA) McKinsey & Company | 2 Recent Context Losses have been driven by volume declines, RHB pre-funding requirements and limitations on cost savings Drivers of change in net income 2006 vs. 2009 $ billions 0.9 15.8 4.0 -3.8 RHB deferral FY2009 Net income 12.6 5.5 FY2006 Net income Revenue decline1 RHB prefunding requirement Volume declines of 17%, driven by Cost savings Savings driven by – E-substitution – Ad spend shift to other channels – Deep recession – Reduction of overtime – Extreme slow-down in hiring – Route consolidation – Volume reduction 1 Revenue declines calculating by applying 2009 prices against 2006-09 volume declines SOURCE: USPS 2006 Annual Report; USPS 2010 Budget McKinsey & Company | 3 Recent Context Volume declines have been worse than expected when the current legal and regulatory framework was established PAEA implications1 Volume forecasts and actuals Billions of pieces 240 Upside forecast 230 Base case 2005 forecasts2 forecast 220 210 200 Downside forecast 190 180 When PAEA was passed, volume projections did not anticipate the current scale of declines PAEA introduced some additional product flexibility, but also two crucial restrictions: – Price increases capped 170 Actual at CPI by class 160 – Significant pre-funding 0 2003 04 05 06 07 08 09 2010 requirements for Retiree Health Benefits (RHB) 1 Postal Accountability and Enhancement Act, 2006 2 Forecasts from “USPS Strategic Transformation Plan”, 2005 SOURCE: USPS McKinsey & Company | 4 Recent Context The recession has exacerbated volume declines, but mail has reached an inflection point, with e-diversion now driving long term decline First-Class Mail, Standard Mail and GDP growth Cumulative increase from 1973, percent 400 350 300 Standard Mail volume 250 200 Real GDP 150 100 First-Class Mail volume 50 0 1975 SOURCE: USPS 1980 1985 1990 1995 2000 2005 2009 McKinsey & Company | 5 Recent Context Retiree Health Benefit funding requirements are a significant burden, equal to 12% of total revenue in 2010 RHB payments, 2006 – 2010 $ billion Drivers of RHB requirements PAEA scheduled pre-funding requirement Pre-funding is unique to USPS within the public sector, and rare (and not required) within the private sector Employer premiums 10.1 7.7 7.4 is accelerated in the first 10 years of the 50 year liability 8.4 5.6 Schedule of pre-funding requirements 3.4 1.4 5.5 Actuarial estimates of total RHB liability 1.6 1.7 1.8 2.0 2.2 2006 20071 2008 20092 2010 vary widely based on differences in discount rates, future health care costs, the size of the workforce, and period of pre-funding 1 $8.4B scheduled payment includes $3B legacy payment from CSRS 2 $1.4B scheduled payment includes $4B deferral from Congress SOURCE: USPS 2009 10-K; USPS 2010 Budget McKinsey & Company | 6 Recent Context Recent reductions in workforce usage have been significant, but pieces per FTE still declined in 2009 USPS workforce FTEs1, Thousands 1,000 950 917 900 850 800 711 750 700 0 2000 01 02 03 04 05 06 07 08 258 261 265 262 05 06 07 08 2009 Pieces per FTE Pieces per year, thousands 227 231 234 243 251 2000 01 02 03 04 249 2009 1 Full Time Equivalent, based on work hours (includes overtime) SOURCE: USPS McKinsey & Company | 7 Recent Context The USPS has been responsive to declining volume, but recent work hour reductions will become increasingly difficult to replicate Millions of hours Work hours reduction Non-career Overtime 1,423 102 146 Sources of work hours reduction Non Career 1,258 90 67 -12% 12M (7%) Career Career 1,175 1,101 74M (45%) 79M (48%) Overtime 2007 2009 55% of reductions have come from non-career and overtime SOURCE: FY 2009 10-K; 2007 and 2009 National Payroll Hour Summary Report McKinsey & Company | 8 Contents Recent context Base case – minimal management actions Addressing the challenge Short term requirements McKinsey & Company | 9 Base Case Four trends will affect postal economics going forward REVENUE TRENDS Volume Transactional volume declining due to e-diversion Advertising mail is subject to increased substitution options Price Increases capped by inflation class Price elasticities are in flux due to growing alternatives Declining steadily COST TRENDS USO Obligation Fixed cost base These trends will continue to put pressure on USPS ability to provide affordable universal service Rising but capped Rising cost per hour Delivery points Retail locations Sortation facilities Preferred prices for some products (e.g., non-profit mail) Workforce costs RHB pre-funding driven by law Legacy costs beyond USPS control Wages subject to collective bargaining McKinsey & Company | 10 Base Case: Volume Declines Volume will decline significantly over the next decade driven by a steady decline in First-Class Mail, the most profitable segment BCG volume forecast Billions of pieces 200 177 Change in volume 2009-2020 (1.5%) per year Portion of margin available to cover fixed costs, 2009 160 150 120 First Class -31 billion 71% Standard +4 billion 21% Other (e.g., <-1 billion packages, 2020 periodicals) 8% 80 40 0 2009 SOURCE: BCG; USPS Financial Forecasting Model McKinsey & Company | 11 Base Case: Revenue Projection Overall revenue will slightly increase, as inflation-driven price increases will offset the volume decline and shift to Standard Mail USPS Revenue $ Billions $68.1 B An An additional additional 27 27 Billion Billion pieces are forecast pieces are forecast to to be be lost lost (15% (15% of of total). total). Assumes Assumes no no loss loss due due to to elasticity elasticity $11.8 $69.3 B $16.8 $3.8 2009 Revenue Volume decline The The loss loss in in First-Class First-Class will will be be even even higher higher (37% (37% of total), lowering the of total), lowering the average average price price Mix shift from Price impact First-Class to Standard1 2020 Revenue Prices Prices forecast forecast to to rise rise with inflation with inflation 1 Calculated by applying the 2009 First-Class/Standard mix to 2020 prices. Excludes mix shift in any other categories SOURCE: BCG; Global Insights; USPS Financial Forecast Model McKinsey & Company | 12 Base Case: Fixed Cost of USO Costs, from a workforce standpoint, are largely fixed to fulfill the universal service obligation and other service requirements Post Offices (36,500 Post Offices, Stations and Branches1) Delivery network (~150 million delivery points2) Built so that Americans have nearby access Continued urban sprawl and growth puts Required to deliver to almost pressure to increase retail outlets Significant resistancee and a administrative burden to closing existing Post Offices Prohibited by law from closing Post Offices asons for economic reasons every address in America 6-day delivery to every delivery point Network historically built to provide high service levels to citizens, on the basis of growing volumes Sortation plants (600 processing facilities) Transportation (220,000 vehicles) Built to ensure overnight delivery of Large vehicle fleet $2.6 billion in air local mail Network largely fixed unless service standards change Significant political resistance and administrative burden to closing plants transportation expenses 1 Includes CPUs 2 Includes approximately 20 million PO Boxes SOURCE: USPS FY 2009 10-K McKinsey & Company | 13 Base Case: Impact of Volume and USO/Service Levels on Workforce Costs Without aggressive management cost-cutting, work hours will remain flat with volume decline countered by more delivery points Millions of work hours 1,258 4 64 2009 Mail volume reduction 1.5% 1.5% per per year year drop drop in in volume volume (27B (27B fewer fewer mail mail pieces) pieces) SOURCE: USPS 1 1,245 56 Reduction in Increase in delivery points PO locations Increase Increase by by 0.8% 0.8% per per year year (~12 (~12 million million new new delivery delivery points) points) Reduction in overhead 2020 Reduction Reduction of of ~800 ~800 PO’s PO’s (2% (2% of of base) base) McKinsey & Company | 14 Base Case: Workforce cost projection Workforce costs continue to rise faster than inflation through 2020 Workforce annual rate increase projections through 2020 Percent 4.7-5.2 2.0-4.0 Inflation (CPI at 1.9%) 1.3-2.5 Wages Workers’ Comp SOURCE: Global Insights; USPS Financial Forecast Model Health benefits McKinsey & Company | 15 Base Case: Workforce cost projection While payments in 2017-2020 drop, RHB funding will continue to be greater than 10% of gross revenues through 2020 PAEA scheduled pre-funding Additional prefunding Retiree Health Benefit payments1 $ Billions Premiums Normal costs PAEA pre-funding schedule + current premiums 7.7 3.4 1.4 5.5 8.2 5.5 8.6 5.6 9.0 9.5 9.9 Additional pre-funding payment + normal cost for current employees2 Percent of total revenue 10.5 5.8 7.4 7.7 8.0 7.1 2.6 2.7 2.7 2.6 5.6 5.7 5.7 4.2 4.7 4.5 4.8 5.0 5.3 2.0 2.2 2.7 3.0 3.4 3.8 2009 10 11 12 13 14 15 16 17 18 19 2020 5% 12% 12% 13% 14% 14% 15% 16% 11% 11% 11% 12% 1 Based on OPM estimates of future liability, including RHB pre-funding and annual premiums 2 Current retiree health premiums in 2017-2020 are paid directly out of the fund, resulting in no operating expense SOURCE: OPM estimates; P.L. 109-435 McKinsey & Company | 16 Base Case The combination of the trends will put extreme pressure on USPS given it is a largely fixed-cost network business Revenue and cost per piece $ 2009-2020 growth 0.70 Cost per piece 0.65 0.60 ~ 4% per year 0.55 0.50 Revenue per piece 0.45 ~ 2% per year 0.40 0.35 0.30 2000 2005 2010 2015 2020 McKinsey & Company | 17 Base Case The “Base Case” leads to a loss of $33 billion and cumulative losses of $238 billion by 2020 $ Billions Revenue and cost Actual Forecast 96 94 92 90 88 86 84 82 80 78 76 74 72 70 68 66 Annual net loss forecast Cost Cumulative losses 238 0 -2 -3 205 -4 -6 +2.2% p.a.1 RHB reset -8 175 -10 Statutory Statutory debt debt ceiling ceiling of of $15 $15 B B will will be be reached reached in Oct 2010 in Oct 2010 -12 -14 -16 -18 Revenue +0.5% p.a.1 149 125 99 -20 -22 77 -24 58 -26 42 -28 27 -30 -32 -33 17 4 7 7 15 -34 0 07 08 09 10 11 12 13 14 15 16 17 18 20 20 07 08 09 10 11 12 13 14 15 16 17 18 19 20 07 08 09 10 11 12 13 14 15 16 17 18 19 20 Even if volumes remained flat instead of declining by 1.5% annually, the loss in 2020 would still be $21 billion 1 Per Annum: Compound annual growth rate, 2010 to 2020 McKinsey & Company | 18 Base Case The financial outlook for the Postal Service is highly dependent on trends in the general economy Potential upside Potential downside risks Rapid economic recovery Greater than expected volume Greater than expected rebound in Advertising Mail Flattening of e-diversion Government-led decrease in health care cost inflation Non-career employee increase declines due to: – Accelerated e-diversion – Further (“double-dip”) recession Health care uncertainty – Greater than expected health care cost inflation – Legislation to require provision of full medical benefits to noncareer employees Input cost inflation outpacing prices, especially in fuel costs McKinsey & Company | 19 Contents Recent context Base case – minimal management actions Addressing the challenge Short term requirements McKinsey & Company | 20 USPS can pursue two sets of actions to address the challenge Description Actions Within Postal Service Control Actions being taken or planned by USPS to grow and improve productivity May be challenging to achieve Fundamental Change Nonlegislative Actions within USPS authority No legislation required, although stakeholder support/approval needed Most options require PRC approval, collective bargaining, or political support Legislative Actions requiring legislative change McKinsey & Company | 21 Actions within Postal Service control USPS can pursue actions within its control to reduce the FY2020 gap Net income $ Billions Actual Forecast 5 Breakeven $115B cumulative gap remains -5 -10 ($15B) Actions within Postal Service FY2020 control reduce the 2020 annual loss to $15 billion, and the cumulative loss to $115 billion -15 -20 -25 Base Case with no additional ($33 ($33B) FY2020 efficiency or revenue initiatives -30 -35 2005 2009 2020 will lead to a $33B shortfall in 2020, and cumulative losses of $238 billion McKinsey & Company | 22 Actions within Postal Service control USPS will continue to take aggressive action to drive revenue and control costs Net annual income benefit (2020) 1 Product and service actions ~$2B 2 Productivity improvements ~$10B 3 Workforce flexibility improvements ~$0.5B 4 Purchasing savings ~$0.5B Avoided interest due to reduced debt ~$5B Total ~$18B Cumulative impact 2010-2020 ~$123B McKinsey & Company | 23 Actions within Postal Service control: Product initiatives 1 The “Actions within Postal Service control” case includes product and service initiatives above the baseline to grow volume Postal Service product and service initiatives Key actions Mail services Grow under-penetrated segments and access latent Package services Leverage network to grow aggressively through: – Priority Mail Flat Rate Box expansion – Commercial contracts – Parcel Select and Returns, including recycling – Product samples Retail services Maximize profitability by store segment within a plan demand through: – Increasing Small Business direct mail – First Class/Standard mail promotions to reduce costs and increase access though: – PO Boxes – Consumer products – Passport growth Total 2020 income impact SOURCE: USPS ~ $2 billion McKinsey & Company | 24 Actions within Postal Service control: Productivity 2 Aggressive productivity improvements in the “Actions within Postal Service control” case are worth ~ $10 billion Postal Service productivity initiatives Key actions Processing plant operations Continuous improvement/ Lean Six Sigma Incremental network consolidation Increasing world-class productivity Delivery Flats Sequencing System Route restructuring Customer service Continuous improvement/ Lean Six Sigma Transactions moving to alternative access points Admin Restructuring and consolidating administration, USPS already processes 91% of mail through automation, the best in the world. Further improvements will be highly challenging through customer demand supported by technology enablers Total 2020 ~ $10 billion income impact McKinsey & Company | 25 Actions within Postal Service control: Workforce/Procurement 3/4 Increasing workforce flexibility and improving procurement add ~ $1B in the “Actions within Postal Service control” case Postal Service workforce flexibility and procurement improvements Key actions Workforce flexibility As career employees leave, replace with non-career employees up to bargaining limits Takes advantage of natural attrition Total 2020 income impact Procurement ~ $0.5 billion Increase transportation efficiency Improve vendor management for supplies, services and other costs (e.g., IT) Total 2020 income impact SOURCE: USPS National On-roll Complement ~ $0.5 billion McKinsey & Company | 26 Actions within Postal Service control The “Actions within Postal Service control” case leads to a loss of $15 Billion and cumulative losses of $115 Billion by 2020 $ Billions Revenue and cost Net annual loss forecast Actual Forecast 85 RHB reset 0 -2 -4 Actions within management control -6 80 Cumulative losses -8 -10 Cost +1.5% p.a.1 75 -15 -16 -18 -20 100 88 76 Statutory Statutory debt debt ceiling of $15 ceiling of $15 B B still still reached reached in in Oct Oct 2010 2010 -12 -14 115 Cumulative Cumulative losses losses are are reduced reduced to to $115B from $115B from $238B $238B 66 53 42 -22 70 -24 Revenue +1.2% p.a.1 Base Case 33 25 -26 18 -28 14 -30 65 -32 -33 4 15 7 7 -34 0 07 08 09 10 11 12 13 14 15 16 17 18 19 20 07 08 09 10 11 12 13 14 15 16 17 18 19 20 07 08 09 10 11 12 13 14 15 16 17 18 19 20 1 Per Annum: Compound annual growth rate, 2010 to 2020 McKinsey & Company | 27 Fundamental Change “Fundamental Change” that increases USPS flexibility will be required to close the remaining gap Net income $ Billions Fundamental Change is required to secure future sustainability Non-legislative changes Legislative changes Actual Forecast 5 Breakeven -5 ($15B) FY2020 -10 -15 Actions within Postal Service control reduce the 2020 annual loss to $15 billion, and the cumulative loss to $115 billion -20 -25 ($33B) FY2020 -30 -35 2005 2009 Base Case with no additional efficiency or revenue initiatives will lead to a $33B shortfall in 2020, and cumulative losses of $238 billion 2020 McKinsey & Company | 28 Fundamental Change Definition of non-legislative and legislative change Description Non-legislative Examples Actions within USPS authority New product innovations such as hybrid mail No legislative changes required, but will impact some Exigent price increases stakeholders and is challenging to implement Many options require PRC approval All labor changes subject to collective bargaining Legislative Actions requiring Significant change in the retail legislative change Includes changes to the base legislation as well as issues that have historically been attached as annual riders (e.g. additional restrictions on closing Post Offices) network through a combination of increased access with partners and eventual franchising and/or closure of existing locations Eliminating/reducing subsidies nonprofits McKinsey & Company | 29 Fundamental Change Non-legislative USPS will need to pursue multiple “Fundamental Change” options to close the remaining gap Products and services Hybrid mail R1 R2 Advertising product Products and services flexibility R3 Pricing Exigent price increase P1 Cover costs of unprofitable products P2 Price cap modification Service levels Changes to Service standards S1 Workforce Changes to: Workforce flexibility Delivery location Delivery frequency Public policy considerations RHB G1 W1 S2 S3 Legislative Benefits requirements W2 USO subsidies G2 Streamlined oversight G3 P3 S4 Access Options for USPS consideration McKinsey & Company | 30 Fundamental Change: Products and Services Products and services opportunities were identified through a screen for potential feasibility and impact in the near term Fundamental Change: Products and services opportunities Source of ideas ~30+ revenue initiatives Examples include… Existing USPS ideas Foreign post examples from Accenture Financial services (e.g., Banking, Insurance) Transportation services (e.g., 3PL, warehousing) Business and government services Asset commercialization (e.g., Other ideas from McKinsey Options not fully within USPS control truck advertising) R1 Hybrid mail including E2E, E2P and P2E digital solutions R2 Simplified advertising products New mail products (e.g., hybrid mail) Retail products (e.g., vending) Ideas with low profit impact or low feasibility High barriers to entry Significant upfront capital investment required Current labor cost structure unsuitable Low U.S. market feasibility Extremely low industry margins McKinsey & Company | 31 Fundamental Change: Products and Services Products and services opportunities for USPS Non-legislative Legislative Fundamental Change: Products and services opportunities R1 Hybrid Mail Products Advertising R2 products Products and R3 Services Flexibility Create a suite of hybrid mail products the integrate electronic and physical mail – E2E and electronic postmark – E2P and P2E mail and print solutions Simplify advertising product for direct marketers looking to reach households Develop new products and services consistent with USPS mission McKinsey & Company | 32 Fundamental Change: Pricing Pricing opportunities for USPS Non-legislative Legislative Fundamental Change: Pricing opportunities P1 Exigent rate increase P2 Cover costs Price cap P3 modification Apply for exigent price increase Increase prices on select products to cover costs: – Periodicals – Nonprofit mail – Media and Library mail Set a global cap across all market dominant products, rather than by class Automatically adjust cap based on volume triggers McKinsey & Company | 33 Fundamental Change: Service Levels Service level opportunities for USPS Non-legislative Legislative Fundamental Change: Service level opportunities S1 S2 S3 Service standards Delivery location Delivery frequency S4 Access Change service levels from 1-3 day to 2-5 days for FirstClass Mail enabling simplified and standardized mail flows with minimal impact on consumers/businesses Change delivery location to curbside or cluster mailboxes Reduce delivery frequency to 3 or 5 days per week Expand access through alternative channels – Private sector partnerships – Kiosks – Direct (e.g., online, mobile) McKinsey & Company | 34 Fundamental Change: Workforce Workforce opportunities for USPS Non-legislative Legislative Fundamental Change: Workforce opportunities W1 W2 Workforce flexibility Benefits requirements Implement initiatives to – Improve workforce flexibility and leverage natural shift in employee mix due to 5% annual attrition rate – Align workforce costs with overall market trends Bring federally-mandated benefits payments more in line with private sector McKinsey & Company | 35 Fundamental Change: Public policy considerations Public policy considerations Non-legislative Legislative Fundamental Change: Public policy considerations G1 RHB Defer payments Shift to a “pay as you go” system comparable to other federal agencies and private sector companies Receive Universal Service Obligation subsidies through G2 USO subsidies G3 Streamlined oversight federal appropriations Increase flexibility and speed to market by – More clearly defining roles of oversight bodies – Moving toward after-the-fact review – Defining time limits for all reviews McKinsey & Company | 36 Contents Recent context Base case – minimal management actions Addressing the challenge Short term requirements McKinsey & Company | 37 In the short run, USPS will violate its statutory financing requirements in October 2010 Only a limited subset of options will take effect quickly enough to address the short term financing requirement Options available to maintain solvency in October 2010: – RHB restructuring by Congress (deferral or relief) – Receive an increased debt limit (does not resolve core issues) Options available to maintain solvency in September 2011: – RHB restructuring – Receive an increased debt limit – Exigent price increase – 6 to 5 day delivery McKinsey & Company | 38
