Why (and How) the Postal Service Must Bring Costs Under Control

Issue Brief

The Postal Service’s quarterly financial reports over the last three years show a consistent storyline: A steady decline in the volume of first class mail, accompanied by a steady increase in productivity.

Much credit is due to Postmaster General John Potter for improving Total Factor Productivity – a measure of output per unit of input thus reducing USPS costs.

Now, though, there is a new subplot to this story. While First Class Mail volume has continued to fall, the growth we have seen in postal productivity has come to a halt and even reversed.

Productivity gains had already been shrinking quarter-by-quarter for the last few years. Now, for the first quarter of 2006, productivity fell by 0.6 percent over the first quarter of 2005.

In the past, the cost pressure put on the USPS by the fall in First Class Mail volume was offset in part by the cushion of growing productivity. (A growing volume of Standard Mail also lessened the impact.) With productivity increases at the USPS more difficult to achieve, and First Class Mail volume still falling, the Postal Service will now face additional pressure to control costs.

So the question is, what is USPS management doing to reduce costs and resolve this bottleneck to future productivity growth?

Recent productivity increases were based largely on labor attrition. That is, while union contracts bar the USPS from laying off employees, the Postmaster General was able to shrink the workforce by encouraging voluntary retirement and not to replace departing workers. With that tactic already maximized, future productivity increases may be much harder to achieve.

That means the USPS must consider new ways of reining in costs. To do so, it will first have to make its case to labor unions (and also the public). The Postal Service faces a clear dilemma : If it continues to increase wages in its traditional fashion, it will have no choice but to continue to raise postal rates. In all probability, these rate hikes will eventually outpace inflation by a substantial margin.

Such increases will, in turn, exacerbate the decline in First Class Mail volume – traditionally the most lucrative segment of the postal market. Ultimately, this will require the USPS to further shrink the workforce.

Having made this case, Postal Service managers should lay out alternatives that could ensure a stable financial future.

One obvious strategy is to try to achieve – either by settlement with labor unions or through arbitration – a reduction in the rate of wage increases and a removal of no-layoff provisions. The ability to eliminate some jobs would allow postal managers to fully take advantage of productivity-boosting technology.

Another option would be to implement a regional wage system that takes cost-of-living differences into account when determining postal pay. This strategy, standard practice at private companies and many government agencies, holds out the possibility of enormous savings for the USPS.

Finally, the USPS ought to look upon increasing oversight of its operations as an opportunity. The Postal Service recently withdrew its support for postal reform legislation – now passed the U.S. House and Senate – because the bill granted increased supervisory powers to the Postal Rate Commission. Enhanced financial oversight, though, could help the USPS with the all-important task of cost control.

To be sure, the Postal Service has taken an important savings measure recently. By redesigning its distribution network, it plans to eliminate as many as 250 mail processing centers, consolidating their operations into fewer, larger facilities. At least 10 consolidations are expected to take place by June of this year.

Yet while this kind of streamlining is important, the Postal Service is still not taking advantage of its best current options. The USPS should view its ongoing labor negotiations as a chance to make a strong case for cost reduction.

In the 1980s, the Postal Service missed a major opportunity, failing to increase productivity even as mail volume was growing rapidly. It would be a shame – and an expensive mistake – to miss that opportunity again.

Charles Guy, Ph.D., is Adjunct Fellow with the Lexington Institute and former Director, Office of Economics, Strategic Planning, U.S. Postal Service.