Thinking outside the box

None of us wants to see a universal service that becomes an ever greater burden on the taxpayer

ON THE morning of December 3, 1984, British Telecom shares were issued on the London Stock Exchange in a move that marked the beginning of a new era in the British economy. Buyers, who included a vast new army of individual investors, made an instant profit of 30% and the Tory Government heralded the arrival of the shareholder democracy.

Other state-owned enterprises such as British Gas and British Airways followed BT's conversion into private hands though, arguably, the programme's biggest convert was New Labour, which dropped the party's commitment to clause four nationalisation and jumped aboard the privatisation bandwagon. It was a means of raising capital to finance its social programme and, crucially, it had proved popular with the electorate.

But as the energy, transport and utility sectors all moved into private ownership, a few notable institutions, partly for political reasons, partly because of structural complexities, were left behind.

Now, amid revelations of £100m losses, thousands of post office closures and a market increasingly moving online, regulators and analysts are openly discussing the process by which the Government can privatise one of Britain's last remaining publicly owned groups: the Royal Mail.

In a strongly worded report insisting on "bold actions" to halt Royal Mail's "unsustainable" business model, regulator Postcomm said the group should be able to raise capital from the private sector to gain access to the "funding and expertise it needs to enable it to restructure and become more profitable".

Among the proposals, Postcomm argues for "partnerships with the private sector" and "competition to replace regulation as the catalyst to protect customer interests". Not since the heady days of the Thatcher Government has the language of a public agency so strongly recommended privatisation.

"There is increasingly a growing impatience from the Government, MPs and others that some of the problems the Royal Mail has experienced simply cannot continue," says Nigel Hawkins, an analyst and fellow of the Adam Smith Institute. "They are now openly asking, 'How can we reconcile that?'"

Royal Mail is no stranger to upheaval. Throughout the Nineties it struggled under the weight of atrocious industrial relations, poor management and outmoded working practices and sorting equipment. But amid all the difficulties it was still a viable concern. Its main problem was that while successive governments failed to invest, they quite happily helped themselves to the £2.5bn worth of profits the postal group generated between 1990 and 1999.

"In the past, Royal Mail has always struggled under public ownership," says Tom Miers, executive director of Scottish think tank The Policy Institute. "When it makes a profit the Government snaffles it all and when it makes a loss the Government is left with having to cover it.

"The situation is unsatisfactory because the citizens that theoretically own it cannot exit and take their investment anywhere else. So Royal Mail is not really responsible to shareholders, and is not forced to compete in the capital markets by showing a return on investment."

By the end of the Nineties, proposals from Brussels for the standardisation of competition in Europe's postal market were threatening the protected monopoly the state-owned group had enjoyed since Charles I established it in 1635. In an attempt to precede the changes the Government set up Postcomm, with a view to deregulating the market by 2007.

But things got worse. Industrial relations hit an all-time low in 2001. Beset by strikes it was revealed that the now renamed Consignia group was losing £1.2m a day and missing all of its performance targets. Allan Leighton was appointed chairman and Adam Crozier, the Royal Mail's Falkirk-born chief executive, was parachuted in after a proven track record at the Football Association. Their remit was to turn around the business.

Crozier and Leighton pushed through a "renewal" programme stripping out more than 33,000 jobs and implementing a series of cost savings and efficiency gains notably with greater use of machinery in sorting offices.

The duo have since been credited with having pulled off one of the most dramatic turnarounds in UK corporate history by pushing the business into profit.

But while the Crozier and Leighton show sorted out efficiencies, significant capital expenditure, notably the need for new machinery in the group's sorting offices, was still needed. In 2006/07, capital expenditure was £244m but the Royal Mail has already admitted that its rivals are 40% more efficient, a failing it blames on a lack of modernisation and a lack of technology.

To compound matters the exposure to competition wasn't working out exactly as planned as the newcomers to the market targeted the most profitable segments of the business, while steering clear of the company's loss-making operations.

Operators such as Deutsche Post and TNT 'cherry-picked' the best – or most lucrative – parts of Royal Mail's business, particularly the bulk mailing business used by large financial houses, utility companies and Government departments. Royal Mail has four main businesses: Royal Mail, which operates letters and packages and has a profit of £194m; General Logistics Services, an EU-wide parcels business, profit of £115m; Parcelforce Worldwide, profit of £10m; and the 14,219 Post Office branches which for the year 2006/07 made a loss of £99m. The group also has a pension fund deficit of just below £5bn.

It is against this background that Postcomm's chairman, Sir Nigel Stapleton, concluded that the EU-inspired reforms, in particular the introduction of competition, have not helped the public or small businesses.

Even worse, for the first time, Royal Mail's flagship service, its one-price-goes-everywhere delivery, a service which for 36p (first class) helps bind the country together, delivering letters from Truro to Torness, is under threat.

Stapleton said: "Royal Mail can only provide an internally funded universal service if it has the funding to restructure and become the best-in-class operator that it aspires to be and if it is no longer saddled with having to pay down an enormous pensions deficit.

"None of us wants to see either of the two other possible outcomes: a universal service that becomes an ever greater burden on the taxpayer or one where there is a substantial threat to its specification."

Analysts say the time is ripe for reassessing the role of Royal Mail and how its performance can be materially improved. "Despite various efforts the finances aren't stacking up properly," says Hawkins. "This comes at a time when the actual volume of mail is falling as people are finding alternative ways to send information. In addition there is a need for considerable capital expenditure – how do you raise that?"

"The exposure to competition hasn't worked at all. I have always been very suspicious of competition where you have a long-standing embedded monopoly. We saw that in the Eighties with British Telecom which, in theory, was exposed to competition but that only really came when mobile telephony appeared from virtually nowhere."

The main difficulty with privatisation is that the Royal Mail is a network industry like the utilities and some telecom industries. Delivery networks are notoriously difficult to expose to competition. On a practical level it is very difficult to imagine having to choose between several different post boxes to pick up and deliver mail.

Analysts say that 'the last hundred yards in postal delivery' would still have to operate as a monopoly, probably by Royal Mail. The rest can be opened up to competition.

"It is a huge market and there is major scope for cost savings," says Miers. "Companies like Deutsche Post and TNT would be very eager to enter the British postal market and get access to 27 million addresses."

Hawkins argues that the proposed financial restructuring should enable Royal Mail to become more suitable for public flotation. Last year the Government agreed a £4bn refinancing programme for Royal Mail, £1.2bn for an uplift in investment and £1.7bn for modernisation of the Post Office network which will also see about 2,500 branches closed.

"A public flotation of Royal Mail would not only allow it to be far better funded than at present, it would also enable it to expand," says Hawkins. "But it is unlikely to happen in a British Gas and British Telecom type of way. Having said that, if somebody came along and took a 10% or 15% stake in the Royal Mail group it is difficult to see the Government saying no. But the chances of a high-profile, fully fledged public flotation like the 'Tell Sid' campaign of British Gas still looks very unlikely."

Pushing the envelope since 1635

1635: Charles I opened the Royal Mail to the public. All postmasters had to have enough horses to deliver the mail.

1840: The world's first adhesive stamp, the Penny Black, is introduced for postage on any letter weighing up to half an ounce anywhere in the UK.

1881: Henry Fawcett, the Postmaster-General, introduced the postal order, originally for people without bank accounts.

1919: First airmail service begins as the RAF delivers mail between London and Paris.

1969: The General Post Office (GPO), a government department, becomes a nationalised industry.

1974: Postcodes are introduced across the UK.

1981: All telecommunications services transferred to British Telecom. GPO is renamed the Post Office.

2000: Post Office renamed Consignia.

2001: Postcomm, the postal regulator, is created by the Government with the remit of deregulating the market between 2003 and 2007. Postwatch is created for consumers to express concerns.

2002: The Group declares a £1.1bn loss for the financial year to March 2002 with the worst strike record in the UK. Recently appointed chairman Allan Leighton drops the Consignia brand, renaming it the Royal Mail Group plc and announcing 30,000 job cuts.

2003: Adam Crozier succeeds John Roberts as chief executive.

2004: Deliveries are cut to once daily. The iconic mail trains come to an end. They are re-introduced on some lines a year later.

2006: Postcomm liberalises the market as Royal Mail loses its 350-year-old monopoly three years ahead of other European postal markets.

2007: Royal Mail announces plans to privatise up to 85 Crown post offices by relocating them into branches of WH Smith.

2008: Royal Mail posts its first-ever loss of £100m on its Universal Service, deliveries of mail to all parts of the country for a single price. Postcomm recommends partial privatisation of Royal Mail.