Abstract
Quality of postal service is of concern around the world, and was a subject of proceedings in the US to assess the performance of price-cap regulation (PCR) of “market-dominant” services. Although PCR does not imply minimizing quality, work by Sappington implies that quality will be below the optimal level at the regulated price. Mechanisms to get regulated firms to internalize this quality externality, consistent with information limitations justifying PCR, provide no benefits to postal customers. Negotiated arrangements between a postal operator and its regulator to set and incentivize quality of service are likely the best available option.
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Notes
- 1.
Pub. L. 109-435 (2006).
- 2.
39 U.S. Code §3622(d)(1)(A).
- 3.
If demand increases, the regulated firm’s profits will typically increase, as price for regulated firms generally exceeds marginal cost. If increases in demand are expected, the X adjustment could be a way to share those profits with buyers. Brennan and Crew (2016) explored how a regulator could increase a price cap to prevent declining demand from reducing profits; the same adjustment would reduce prices when demand increases, sharing accompanying higher profits with customers.
- 4.
39 U.S. Code §3622(d)(3).
- 5.
39 U.S. Code §3622(b)(3). The §3691 reference is to a part of the statute requiring USPS, with PRC consultation, to institute service standards that “enhance value,” “preserve access,” and “reasonably assure Postal Service customers delivery reliability, speed and frequency.” 39 U.S. Code §3691(b)(1)(A)-(C).
- 6.
Postal Regulatory Commission, Advance Notice of Proposed Rulemaking on the Statutory Review of the System for Regulating Rates and Classes for Market Dominant Products, Order No. 3673, Docket No. RM2017-3 (Dec. 20, 2016) at 5. This is the proceeding in which I filed declarations for the PRC Public Representative on adjusting prices when demand declines, mentioned in the above disclaimer. Prof. John Kwoka of Northeastern University filed declarations for the PRC Public Representative that discussed service quality.
- 7.
Postal Regulatory Commission, Order on the Findings and Determination of the 39 U.S.C. § 3622 Review, Order No. 4257, Docket No. RM2017-3 (Dec. 1, 2017) at 250.
- 8.
Id.
- 9.
Postal Regulatory Commission, Notice of Proposed Rulemaking for the System for Regulating Rates and Classes for Market Dominant Services, Order No. 4258, Docket No. RM2017-3 (Dec. 1, 2017) at 53-56. The PRC did not say how it would ascertain “adherence”.
- 10.
This model presumes that each PCR service has only one quality level. There may be a menu of PCR services each with a different quality level, e.g., first-class mail and second-class or standard mail.
- 11.
Fixed costs, having no effect on decisions, are ignored to simplify the notation. Assume fixed costs are large enough to generate significant natural monopoly conditions to warrant monopoly regulation, but not so high to make provision under PCR unprofitable. A potentially more restrictive assumption is that fixed costs are independent of quality, but I assume that to minimize notation and do not think it materially affects the results.
- 12.
Calculating optimal levels of quality neglects receiver welfare, other than to the extent it would be captured by the sender who pays the postage. I also do not discuss changes in optimal quality over time as demand changes because of the overall economy or continuing diversion to Internet-based communication. For more on this, see Okholm, Basalisco, Boivie, and Gårdebrink (2018).
- 13.
This is not an optimum for quality either globally or subject to a profit or revenue constraint, but optimally only given a price that is set by a regulator.
- 14.
In the simplified models above, this would entail knowing h(q) (=c x) and h′(q)x (=c q).
- 15.
These costs would include time-varying costs, e.g., weather effects on meeting delivery speed targets.
- 16.
“[T[he return to the equity owner should be commensurate with returns on investments in other enterprises having corresponding risks. That return, moreover, should be sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital.” FPC v. Hope Nat. Gas Co., 320 U.S. 591, 603 (1944).
- 17.
The US approach to postal service quality has this flavor, where USPS proposes standards subject to PRC approval, and with USPS getting a small reward in terms of a higher price if it meets those standards—or, conversely, a penalty for failing to meet those standards. See n. 8 and 9 supra and accompanying text. Ovaere (2017) provides a theoretical examination of such mechanisms.
- 18.
The PRC’s reward of 0.25% of revenues on USPS for meeting its quality standard seems unlikely to equal the consumer surplus at stake. If the negotiated quality level is reasonably close to optimal and if this small penalty succeeds in getting USPS to reach that level, however, the PRC’s policy may be reasonable.
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Brennan, T.J. (2018). Inducing Optimal Quality Under Price Caps: Why, How, and Whether. In: Parcu, P., Brennan, T., Glass, V. (eds) New Business and Regulatory Strategies in the Postal Sector. Topics in Regulatory Economics and Policy. Springer, Cham. https://doi.org/10.1007/978-3-030-02937-1_2
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