The Impact of Increasing Competition for Non-Contract Parcels on Postal Prices and Efficiency Decisions

Abstract

The increase in e-commerce and demand for parcels has provided universal postal operators (USPs) with an opportunity to counter-balance, to some extent, declining letter volumes. However, as parcel markets have expanded this has exposed some USPs to increasing competition in the single-piece parcel traffic segment in which historically they have tended to dominate. This chapter develops and calibrates a theoretical model to assess postal USPs’ finances resulting from the trade-offs they face between efficiency gains and pricing, when operating in such an environment within a regulatory framework. Our results indicate that increasing competition in the parcel market can create added uncertainty and may require higher letter price caps to allow the USP to break even. Sensitivity analysis shows that external shocks can have a substantial impact on the USP’s financial position and fixed pre-determined price caps can impose a significant constraint on the USP’s ability to achieve a normal rate of return.

The views expressed in this chapter are those of the authors and do not necessarily reflect those of the organizations to which they are affiliated. We are grateful for comments on an earlier version of this chapter by Victor Glass and also to Amanda Terroni for practical insights into the different options open to frequent senders of single-piece parcels.

Appendix: Calibration for Simulations

(A) Demand. For SPL, BL, SPP and CP markets, when the retail price of the good considered is the same in both zones, the urban zone represents 80% of total volumes, and the rural zone 20%.

SPL market: at a price of p = 0.667€, total volume of 1.8bn items, and direct price elasticity of demand of −0.2.

SPP market: hypothetical monopoly setting: at a price of ${p}_{SP}^I=4$, demand price elasticity of −0.2 (in both zones), and total volume of 0.2 billion items. With competition, displacement ratio $-\left[\partial {x}_{SP,i}^I\left({p}_{SP}^I,{p}_{SP}^E+ cu\right)/\partial {p}_{SP}^E\right]/\left[\partial {x}_{SP,i}^E\left({p}_{SP}^I,{p}_{SP}^E+ cu\right)/\partial {p}_{SP}^E\right]=0.75.$ USP market share of 70% when ${p}_{SP}^I={p}_{SP}^E=6$ and cu = 0.6 and of 90% when ${p}_{SP}^I=6,{p}_{SP}^E=6.6$ and cu = 0.6.

BL market: hypothetical monopoly setting: at a price of 0.4, demand price elasticity of −0.4 (in both zones), and total volume of 7.5 billion items. With competition, displacement ratio $-\left[\partial {y}_i^I\left({q}_i^I,{q}_I^E\right)/\partial {q}_i^E\right]/\left[\partial {y}_i^E\left({q}_i^I,{q}_I^E\right)/\partial {q}_i^E\right]$ of 0.9. Market share of 25% for competitors when ${q}_i^I={q}_i^E=0.4$ and of 50% when ${q}_i^I=0.4$ and ${q}_i^E=0.36$ _.

CP market: assuming that the USP price in the urban (resp., rural) area is 1.9 (resp., 2.4) and that competitors are 10% more expensive than the USP, demands are calibrated so that (i) the displacement ratio is 0.75, (ii) the demand price elasticity is −0.2, (iii) the USP volume is 0.4 (resp., 0.1), (iv) the USP’s market share is 35%. For equal USP and competitors’ prices, the USP’s market share is 10%.

• (B) Costs (in P ₁ ).

SPL market: unit variable cost c _i of 0.38 in urban area (i = U) and 0.48 in rural area (i = R).

SPP market: unit variable costs: ${c}_{SP,U}^I=2.28$, ${c}_{SP,R}^I=2.88$, ${c}_{SP,U}^E={c}_{SP,R}^E=5.83.$

BL market: same upstream variable cost in both zones for both operators: ${b}_U^I={b}_U^E={b}_R^I={b}_R^E=0.02$. Upstream preparation cost of the USP’s BL final customers: b ^p = 0.15. USP’s downstream cost: ${d}_U^I=0.19$ and ${d}_R^I=0.34$. Competitors’ downstream cost: ${d}_U^E=0.28$ and ${d}_R^E=0.74$.

CP market: unit variable costs: ${f}_U^I=1.14$, ${f}_R^I=1.44$, ${f}_U^E=2$, ${f}_R^E=2.6$.

USP: fixed cost of F = 2.4. All (variable and fixed) USP costs decrease by 5e% between P₁ and P₂.

(C) Mark-ups. USP mark-up for access charge set by the regulator: ${m}_L^I=0.1$ and ϕ = 2/3. Competitors’ mark-up in BL market: ${m}_L^E=0.02$; in SPP market: m _SP = 0.03; and in CP market: ${m}_P^E=0.03$.

(D) Exogenous variations in volumes . Exogenous volume trend between P₁ and P₂ for letters are λ ^L =  − 0.2 and for parcels λ ^P = 0.2.

If a strike occurs in P₂ (see sensitivities 4a and 4b in Table 2), USP volumes are assumed to decrease by a fraction γ ^L(e) in the SPL and BL markets, and by γ ^P(e) in the SPP and CP markets. The functions γ ^L and γ ^P are both increasing in e, as the announcement of a larger decrease in costs is likely to result in more severe industrial action. In particular, the volume loss by the USP in the case of a strike in P₂ as a proportion of the USP’s pre-strike volume is equal to γ ^L(e) = 0.04+4e and γ ^P(e) = 0.08+8e, where e is expressed as a proportion (for example, e = 2% as e = 0.02). Competitors’ volumes are similarly affected in the BL market (since the USP delivers these volumes on the competitors’ behalf, at equilibrium). As for the SPP and CP markets, a fraction β = 0.8 of the volumes assumed to be lost by the USP due to the strike is diverted towards the competitors. So, for instance, in the CP market, USP demand when a strike occurs in P₂ becomes $\left(1+{\lambda}^P\right)\left(1-{\gamma}^P(e)\right){z}_i^I\left({s}_i^I,{s}_i^E\right)$ while the competitors’ demand becomes $\left(1+{\lambda}^P\right)\left({z}_i^E\left({s}_i^I,{s}_i^E\right)+{\beta \gamma}^P(e){z}_i^I\left({s}_i^I,{s}_i^E\right)\right)$.