Jaag/Koller/Trinkner - page 1 Calculating the Cost of the USO: The Need for a Global Approach Christian Jaag, University of St. Gallen, Swiss Post Martin Koller, Swiss Federal Institute of Technology, Swiss Post Urs Trinkner, University of Zurich, Swiss Post

Jaag/Koller/Trinkner - page 2 Background: Designation requires compensation (Universal Service) Obligation for allfor onefor no one Designated operator (USP) should not be worse off because of Universal Service Obligations (USO) How to compensate the USP for the USO?

Jaag/Koller/Trinkner - page 3 Calculating the Cost of the USO USO Monopoly No monopoly (fully opened market) No USO Difference π 2 - π 1 ? Net Avoided Cost Approach Source: On the basis of Nicolas Curien, ARCEP (2001) Profit π 1 Profit π 2 Profit π 4 Profit π 3 Compensation that ensures that the USP is not worse off = Cost of the USO World of EC Directive Difference π 1 - π 3 ? Entry Pricing Approach Difference π 4 - π 3 ? Profitability Cost Approach

Jaag/Koller/Trinkner - page 4 New EC Directive 2008/6/EC Compensate for Net Costs as of Annex I: Net Costs = Cost of US Net Costs = Net Costs (USO) – Net Costs (No USO) Net Costs = NC (USO) – NC (No USO) + all other elements Somewhat unclear, in principle allows for profitability cost approach Guidelines as for how to calculate the Net Costs: … net cost of specific aspects of universal service obligations is to be made separately and… … so as to avoid the double counting … … overall net cost of universal service obligations …is to be calculated as the sum of the net costs arising from the specific components … EC recommends Separate Approach

Jaag/Koller/Trinkner - page 5 Main Research Questions How to implement a separate approach as proposed by the EC? How to avoid double counting? How to take into account indirect/2nd order effects of USO in competitive markets

Jaag/Koller/Trinkner - page 6 Outline 1.Stylized Example 2.Illustration with Swiss Case 3.Illustration of indirect effects 4.Conclusions

Jaag/Koller/Trinkner - page 7 Stylized example: Sequence matters Binding restricitions 2 1 P USO P* S* 1 S* S USO Non-binding USO restricitions 2 P USO S Example: Assume USO consists of two dimensions only: Obligations to provide a Service (S) Obligations in pricing (P) Cost attribution to individual USO elements is somewhat arbitrary!

Jaag/Koller/Trinkner - page 8 Issue of double counting P USO P* S* S* S USO double counting C(S USO ) based on P USO C(P USO ) based on S USO C(S USO ) based onP* P USO S no counting C(P USO ) based on S* Double counting / overestimation if keeping the remaining USO elements constant Underestimation when considering only one USO element at a time assuming otherwise no USO obligations

Jaag/Koller/Trinkner - page 9 Findings of stylized example There are two approaches compliant with the EC directive to get a correct measure of the net costs based on separate approach: 1. Sequential approach: Well defined sequence (cf. PWC Study for EC) Involves the estimation of the profit situation with all obligations (first sequence) as well as with no obligations at all (last sequence) Global profitability cost approach is embedded. The cost attribution to individual USO elements remains arbitrary and depends on the chosen sequence. 2. Adjusted separate approach: Individual elements can be calculated separately but results in under- or overestimation of the cost of the USO Correction necessary with global profitability cost approach Separate approaches involve implicitly a global approach

Jaag/Koller/Trinkner - page 10 Case Study Switzerland Considering two Swiss USO obligations only: (a) A nationwide collection network and (b) the provision of financial transactions Obligations individually involve almost no net costs: a)A nationwide collection network of 2450 access points: Agencies run by 3rd parties not very costly b)Providing financial transaction in 600 collection points a profitable business However, both obligations combined raise costs significantly: Providing financial transactions in agencies not possible (counter concept, anti- money-laundering measures) Hence, accessibility has to be ensured with (more expensive) post offices. How much money could be saved by converting post offices? Application of cross-section model to Swiss Posts post office network of 2006 Costs = Cost (Output, Opening Hours, Price of Capital, Business Model, Region) Quadratic specification, normalization of values to median

Jaag/Koller/Trinkner - page 11 VariableCoeff.Coeff. Squaredt Mail Output (Q 1 )-13.65/-6.75 Parcel Output (Q 2 )-27.43/ Payments Output (Q 3 )35.54/9.15 Account Output (Q 4 )8.57/22.22 Optional Products (Q 5 )7.66/0.46 Price Capital (P C ) 7.63 Opening Hours (OH) Agency (A 1 ) Agency (A 2 ) Agency (A 3 ) Region (R 1 )-3.05 Region (R 2 )1.49 Region (R 3 )6.35 Constant n=2470, R2 = 0.97 Swiss Example – Results Preliminary, values provided in paper Agency dummies highly significant Associated foregone savings amount to a considerable percentage of total costs

Jaag/Koller/Trinkner - page 12 Effects on market equilibrium? (1) Example shows significant foregone savings. But: Direct effect only. Indirect effects (2nd order) of USO resulting in competition? E.g., if USO increases the USPs variable costs and is not correctly compensated for, this will affect the USPs pricing (with 2nd order effects) Illustration: Two-part USO compensation Bottom up lump sum compensation Global lumpsum Compensation ProfitiBase Case Profit i with USO q i Total Compensation Price Level Direct Effect on USP Indirect Effect on USP State Financing USP Net Burden Burden to the consumer Total Burden Variable Costs +0.1

Jaag/Koller/Trinkner - page 13 Effects on market equilibrium? (2) Effects depend on Specific USO requirements (cost burden) and associated revenues effects Compensation scheme Two-part compensation of net costs might restore the unconstrained equilibrium if no revenue effects are present (no change in customer loyalty). (Ex post) lump sum compensation leads to a change in pricing and hence involves indirect effects. Similarly, a global approach does not prevent a change in pricing but ensures a compensation that considers indirect effects too. If USO consists of pricing restrictions too and has effects on customer loyalty, a global compensation is the way to go.

Jaag/Koller/Trinkner - page 14 Summary and Conclusions How to compensate for USO? Only profitability cost approach considers all elements of the cost and benefits of the USO as prescribed by the EC in Annex I. Accounting for various dimensions separately ignores interdependencies between dimensions. A separate calculation of the net costs of the USO as foreseen by the EC involves implicitly a global approach or needs to be corrected by a global approach.