Postal Sector Reform Market Entry and Pricing Simulation EPFL, February 4, 2010 Christian Jaag, Ph.D. Managing Partner Swiss Economics.

swiss economicsswiss economicsswiss economicsswiss economics

Postal Sector Reform Market Entry and Pricing Simulation

EPFL, February 4, 2010

Christian Jaag, Ph.D.Managing PartnerSwiss Economics

swiss economicsswiss economics

Christian JaagPage 2

Agenda

0900-1015 Postal Sector Reform:Competition and Regulation

1015-1045 Break

1045-1230 Market Entry and Pricing Simulation


IntroductionRecent Developments in the Market for Mail

swiss economicsswiss economicsOverall mail volumes in different countriesWho is who?

90%

100%

110%

120%

130%

2005200320011999199719951993

Sweden (fully liberalized) vs. Switzerland (partially liberalized) vs. US (not liberalized / worksharing)


swiss economicsswiss economicsOverall mail volumes – a puzzle?

90%

100%

110%

120%

130%

2005200320011999199719951993

SwitzerlandSwedenUSA

Sweden: Complete Market Opening in 1993

Switzerland: Market opening >100g in 2006, >50g in 2009

United States: Rigid monopoly, highest volumes per capita


swiss economicsswiss economicsThe Postal Value ChainExample: Switzerland

Collection

Processing

15m letters per day, 85% of which business originated2‘500 Post offices 1‘000 other access points20‘000 letter boxes

3+6 sorting centers6’000 employees20‘000 vehicles and 470 train carriers

15‘000 mailmen (employees) delivering to3m households per day

„We build our network every day from scratch”

„The postal infrastructure focuses mainly on the 15% private customers “

“The main difference between posts and telecoms is probably that carbon wires are not unionized”

Delivery



RegulationMarket Opening and Universal Service Provision

• Market Opening: EU vs. U.S.• Economic Market Characterization• Why Liberalize?• Universal Service Obligations

swiss economicsswiss economicsModes of Liberalization

Collection

Delivery

Processing

10

0

g 5

0

gLiberalization EU/CHby Weight

Liberalization USAby Processing Step

Protected USPS Monopoly in Delivery

Collection

Processing


swiss economicsswiss economicsNatural Monopoly? Need for Regulation?

With Sunk Costs Without Sunk Costs

Natural Monopoly Monopolistic Bottleneck

Contestable Monopoly

No Natural Monopol

Competition Competition

Natural Monopoly Sunk Costs

Collection ? No

Sorting ? No

Transport No No

Delivery Yes No


No need for regulation due to structural market power

swiss economicsswiss economicsThe Role of the USO

USO narrowly defined:- Area Coverage (Access Points, Delivery)- Uniform Prices- Delivery Frequency- Product Range

USO broadly defined- Working Conditions- Infrastructure Mandate

Regulation due to underprovision or for distributinal reasons?


swiss economicsswiss economicsWhy a Monopoly is Good

Incremental Cost

0% Market Coverage 100%

Incremental Revenue

q

Incumbent

CompetitorCost

per

Item

M

P

C

Regional Balance Economies of Scale

– Consumer Choice

– Innovation

– Pricing

or Bad


After full market opening:

Are competition and USO compatible?

swiss economicsswiss economicsThe Net Cost of USO I

Third Postal Directive, Annex I, Part B:“The net cost of universal service obligations is to be calculated, as the difference between the net cost for a designated universal service provider of operating with the universal service obligations and the same postal service provider operating without the universal service obligations.“


Third Postal Directive Article 7:“Where a Member State determines that the universal service obligations, as provided for in this Directive, entail a net cost, calculated taking into account Annex I, and represent an unfair financial burden on the universal service provider(s), it may introduce:(a) a mechanism to compensate the undertaking(s) concerned frompublic funds; or(b) a mechanism for the sharing of the net cost of the universal serviceobligations between providers of services and/or users.”

swiss economicsswiss economicsThe Net Cost of USO I


Incremental Cost

0% 100%

Incremental Revenue(Several Operators)

Incremental revenue(Single Operator)

Competitive Market Segment

Monopolistic Market Segment

Unserved Market Segment

Market Coverage


Competition IIIncumbents vs. Entrants

• Market Entry• Delivery Network• Post Office Network• Pricing


Market Shares in Liberalized Countries


1999 2000 2001 2002 2003 2004 2005 2006 20070.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%Alternative Operators in Germany

Selektmail and Sandd in the Nether-lands

swiss economicsswiss economicsDeterminants for Market Development

– Legal aspects

– Legal monopoly

– Regulatory aspects

– USO and their financing

– VAT

– Minimum wages

– Network access

– Pricing flexibility

– Economic aspects

– Cost structure (proportion of fixed costs, geography)

– Volume development


Uncertainty


Statutory Market Opening vs. Actual Liberalization

Country State of liberalization Entry barriers

Germany Full liberalizationsince Jan. 2008

Working conditions

VAT exemptionsSweden Full liberalization

since March 1994Working conditions

France Market > 50g liberalized VAT exemptions for USO products

Finland Full liberalizationsince July 1991

Licensing fee(„pay or play“)


swiss economicsswiss economicsDirect Competition: Market Shares

Source: UBS Investment Research 2006

swiss economicsswiss economicsDutch Sandd in Figures

Key Figures:

15% market share in liberalized market segments

Average Price: 0.2 €

EBIT 8%; Turnover per Employee: 5500€

2001

2002

2003

2004 2005 2006 2007 2008

Turnover (mio €) 4 7 14 32 50 68 80 80Volumes (mio #) 15 30 72 130 230 320 390 400

# Clients 25 100 269 400 1000 1500 2000 2200# Fulltime Employees

60 120 180 650 900 1000 1100 1150

# Distributors ? ? ? ? 9000 12000

12500

13000

# Distribution bases

45 80 90 95 95 80 80 80

Coverage 45% 80% 95% 100%

100%

100% 100% 100%Source: Sandd


swiss economicsswiss economicsDutch Mail MarketServices Offered in 2006

Source: Sandd 2008


swiss economicsswiss economicsDutch Mail MarketServices Offered in 2008

Source: Sandd 2008


swiss economicsswiss economicsSwedish Mail MarketCityMail

Regulation

- Full market opening in 1993

- Labor market strongly regulated

Strategy CityMail

- Delivery of electronically sorted economy bulk mail

- Delivery only twice per week in metropolitan areas

- Approx. 1100 Employees, paid on a per-piece basis

- Many full-time jobs, similar wages as Posten AB

Reaction Posten AB

- Aggressive Pricing, price increase for small customers

- Dramatic reduction in post offices




Post Office Network


Post offices are not really needed for mail and parcels® „second best optimization problem“

Conflict between universal service provision and competition

Should the post office network be part of universal services?

Alternative networks?

Alternative use: P.O. box delivery?

Post Office Network DevelopmentConclusion


swiss economicsswiss economicsPricing IssuesWho should pay for postal services? How much?

Felisberto et al. (2006), Friedli et al. (2007)

„Pricing the last mile could contribute to finance universal service“

Jaag (2007), Jaag and Trinkner (2008)

Yes, but…


swiss economicsswiss economicsPricing IssuesWelfare Aspects of Pricing Mail

Source: Jaag (2007)

Issues• If sender pay, they may choose to

send too little mail• If receivers pay they may choose

inefficient P.O. box delivery


swiss economicsswiss economicsPricing IssuesTwo-Sided Market

Sender

Rece

iver

Operator 1

Upstream Downstream (delivery)

Operator 2

Upstream (collection, processing) Downstream (delivery)

Symmetric access to other platforms exclusive addresses (P.O. boxes)

Private redistribution of postage between sender and receiver

Source: Jaag, and Trinkner (2008)Christian JaagPage 31


Observation – pricing structure• Optimal pricing strategy:

- Senders pay stamp price- Receivers pay subscriber fee and get money for every letter received(These results replicate partially observations from New Zealand)

• In such a setting, net profits on end-to-end services are about break even, whereas upstream services incur a loss and downstream business is profitable (i.e. running P.O. boxes and collecting access fees)

The results indicate that competition in two-sided postal markets

forces operators to strongly cross-subsidize large receivers

Pricing IssuesOptimal Pricing Structure


swiss economicsswiss economicsHow to Enter the market

– Focus on high volume customers.

– Distribute only on a few days per week to reach economies of scale.

– Limit distribution to dense regions (in the beginning).

– If available, use access to incumbent networks selectively.– Let subcontractors hire flexible, non-unionized staff on a

part-time / per piece / per address base, let them walk-sequence on their own (e.g. at home)

– Take advantage of having no stranded costs, no universal service obligation, no historically determined network, no pension funds deficits nor poorly negotiated collective agreements

– Charge 20% lower prices


swiss economicsswiss economicsConclusionsIncumbent ‘s Point of View

- There are plenty of possible market entry strategies

- Liberalization means multiple, parallel and competing distribution channels. A significant loss of market power is inevitable.

- Know your weaknesses and tackle them both in business strategy and regulatory strategy (USO, working conditions, access, etc.)

- Pricing is key, but: Market share comes at the cost of margins (SE, NZ, UK), profits at the cost of market entries (see NL, GE).



Break Time.


Market SimulationPricing and Market Entry

swiss economicsswiss economicsObjective and Initial Situation

- Objective of the simulation: Convey an idea about…

- …possible market entry strategies

- …possible market developments

- …the importance of regulation

- Initial situation

- Starting date is February 4th 2010.

- The simulation covers the markets for addressed business originated mail above 50g and newspapers.

- Competitors consider market entry, incumbent defends.


swiss economicsswiss economicsSimulation

Rules Input Participants

3 Groups (stay in the room), no collusion

Timing: 3 Rounds. Groups hand in their

decisions on paper. Market simulation short feedback If no decisions are handed in on

time, the values from the previous round are applied.

Timing

15 Min.

Introduction

30 Min.

Simulation

10 Min.

Conclusion

Pricing for business customers Prio / Eco / News Metro/Urban

under competition

Assignment:

20 Min. 15 Min.


swiss economicsswiss economicsMarket Characteristics I

- There are four products (partial markets):

- Priority Single Piece Mail (PRIO S) requires daily delivery and investment in modern processing technology. Delivery in rural areas causes high transportation costs.

- Economy Single Piece Mail (ECO S) requires delivery twice per week and investment in modern sorting technology.

- Economy Bulk Mail (ECO B) requires delivery twice per week. As these mails are sequenced electronically, they do not require investment in sorting technology.

- Newspapers (NEWS) require daily delivery and investment in modern processing technology. Private operators need early-morning delivery in order to be competitive in this market.


swiss economicsswiss economicsMarket Characteristics II

- Incumbent plus two entrants: Publishers and foreign postal operator

- 70% of the Swiss population live in metropolitan areas

- Entrants must underprice the incumbent


swiss economicsswiss economicsSimulation Tool: Market Equilibrium


swiss economicsswiss economicsSimulation Tool: Inputs Input parameters:

1) Price per region and product2) Remarks: opportunities, challenges (optional)

Switching behavior

Cost structure:

1) Variable cost

2) Fixed cost

Current price for mail > 50 g (business customers)


swiss economicsswiss economicsConclusion

- Possible market developments?

- How to attack / how to defend?

- What is the role of regulation?

- Strategic alternatives?



Game-Theoretic AnalysisThe Market for Early-Morning Delivery

swiss economicsswiss economicsStatus Quo 2008

In the 1970s, the first publishing company in Switzerland established its own early morning delivery network (5 to 6:30 am).

Markets for early morning delivery are dominated by big publishers.

From 2008 on: reduced subsidies for newspapers Daytime delivery becomes less attractive.

Increasingly, magazines are being delivered in the early morning (market opening!).

What can be done by Swiss Post?

Would entry into the market for early-morning delivery be profitable?

What would competitors do?Christian JaagPage 45


-2

-2

-1

+1

+1

-1

0

0

Early-morning delivery (Post)

Expansion(Competitor)

yes

no

yes no

There are no dominant strategies!

Strategic Game I



-2

-2

-1

+1

+1

-1

0

0

There are two nash equilibria in pure strategies which one can be reached?

Strategic Game II

Early-morning delivery (Post)

Expansion(Competitor)

yes

no

yes no



NZZ, 19.1.2008Christian JaagPage 48

„Swiss Post establishes ist ownearly-morning delivery network.“


Basler Zeitung, 19.6.2008Christian JaagPage 49

„‘Basler Zeitung‘ sells ist delivery organization to Swiss Post.“


Berner Zeitung, 3.10.2008Christian JaagPage 50

„Swiss Post becomes number one.“


www.kepmail.ch, 2.10.2008Christian JaagPage 51

„Swiss Post establishes a new monopoly in the market for early-morning delivery.“


Sonntag MZ, 11.1.2009

„Competition commission investigates Swiss Post‘s newspaper-deal.“


Natural monopoly Market consolidation is inevitableBUT: Currently, there are parallel delivery organizations!

Contestability Potential competition

Efficiency gains by neutrality of delivery platform

Independence of early mornig delivery and daytime delivery (time slot)

Core Arguments



NZZ, 26.9.2009Christian JaagPage 54

„Early-morning newspaper delivery is Swiss Post‘s business.“


Christian Jaag, Ph.D. Swiss EconomicsManaging Partner

Abeggweg [email protected] 8057 Zürichwww.swiss-economics.ch Switzerland

Thank you for your attention!

Postal Sector Reform Market Entry and Pricing Simulation EPFL, February 4, 2010 Christian Jaag, Ph.D. Managing Partner Swiss Economics.

Documents

bad christian jaag page

uncertainty slide

email slide

structural market power

regulation market opening

pricing simulation slide

statutory market opening

complete market opening