1. National Postal Policy Council Regulatory Update Postal Regulatory Commission Mark Acton, Vice-Chairman Alex Cooper, Special Assistant September 11, 2014

2. Contents Compliance Annual Compliance Determination Financial Analysis Ratemaking CP2014-55: Priority Mail Pricing MC2014-21/R2014-6 NSA: PHI International Latest CPI-U Price Cap Authority R2013-11: Exigent Rate Case RM2014-5: Price Elasticities Petition 2017 Ratemaking Study Advisory Opinion N2014-1: Load Leveling RM2012-4: Expedited Advisory Opinion Rulemaking Market Tests MC2014-26: Gift Cards Permanent Product RM2013-5: Market Test Rulemaking Requests for Proposal (RFPs) Parcel Market Data Study Institutional Costs Study Terminal Dues Study Other Commission Status Legislative Update Questions and Comments 2

3. Compliance: FY 2013 Annual Compliance Determination Completed on March 27, 2014 Majority of postal products found to be in compliance Financial Analysis for FY 2013 was broken out into a separate document for the first time 3

4. Compliance: FY 2013 Annual Compliance Determination The Postal Service has made improvements in the areas of customized service agreements and increased cost coverage and contribution from competitive products The Commission identified several compliance issues the Postal Service must address in FY 2014: 4

5. Compliance: FY 2013 Annual Compliance Determination 18 workshare discounts did not comply with section 3622(e), which requires the Commission to ensure that workshare discounts do not exceed the costs avoided by the Postal Service as a result of mailers preparing the mail Rates for Parcel Return Service Contract 4, International Priority Mail, International Air Parcel Post, and International Money Transfer Service-Outbound were not in compliance because they did not cover attributable costs 5

6. Compliance: FY 2013 Annual Compliance Determination Despite overall improvements, the Commission found that a majority of market dominant mail products did not reach their annual service performance targets In the FY 2014 ACR, the Postal Service must provide a detailed analysis of the progress made in improving Periodicals cost coverage that includes the impact of leveraging its pricing flexibility and implementing operational strategies 6

7. Compliance: Financial Analysis Separated from the ACD this year for greater clarity and transparency The Financial Analysis includes a more in-depth discussion of the cost savings the Postal Service has generated, the fiscal impact of the various classes of mail, and a review of its assets and liabilities USPS suffered its seventh consecutive financial loss, amassing a total net deficit of $46.2 billion since FY 2007 The total net loss for the year was $10.9 billion less than the total net loss in FY 2012 and $1 billion better than expected under the Financial Plan This significant improvement was due almost entirely to higher than expected volumes, but USPS also reduced expenses 7

8. Compliance: Financial Analysis 8

9. Compliance: Latest Financial Information, Q3 9 Comparing between Q3 FY2013 and Q3 FY2014, the Postal Service’s revenue has increased by $1 billion, from $50.2 billion to $51.2 billion About 85%, or $850 million, was due to the Exigent increase The Postal Service lost about 2.2 billion pieces of mail compared with Q3 2013, but the volume loss is slower than it has been in previous quarters Overall liquidity has improved to 19 days of operating cash

10. Ratemaking: CP2014-55: Priority Mail Pricing On August 15, the Commission approved the Postal Service’s proposed changes in rates for the Priority Mail product The Postal Service’s stated goal with this new rate structure is to attract more Priority Mail ground volume in the 6-20 pound weight range The overall rate for the Priority Mail product is unchanged, and satisfies the legal requirements under Title 39, section 3633, which prohibit the subsidization of competitive products by market dominant products 10

11. Ratemaking: CP2014-55: Priority Mail Pricing Both FedEx and UPS raised questions about intra- product subsidies between retail and commercial customers, but did not suggest that this precludes the Postal Service using its pricing flexibility in setting rates for competitive products Neither FedEx or UPS asserted that the USPS proposal did not comply with the law As always, if parties believe costing methodologies are inaccurate, they may submit petitions to the Commission to initiate a proceeding to review them 11

12. Ratemaking: MC2014-21/R2014-6 NSA: PHI International On June 19, the Commission approved of a new Market Dominant NSA with PHI Acquisitions (known commonly as the Potpourri Group) There is some risk that this NSA could not provide a net financial benefit to USPS, but based on Commission-approved methodology it appears it will In order to ensure this, the Commission will monitor this NSA in future Annual Compliance Determination reports 12

13. Ratemaking: MC2014-21/R2014-6 NSA: PHI International The Postal Service emphasized the importance of an expeditious PRC approval of this NSA. This was complicated by several incomplete filings from the Postal Service. Regardless, the NSA request was filed by USPS on March 5, and PRC approved on June 19 As the catalog mailers (ACMA) wish to do more of these NSAs but found the process to be burdensome, the PRC organized a meeting in July of interested stakeholders including ACMA, USPS and PRC staff to address issues and make the process smoother 13

14. Latest CPI Price Cap Authority As you can see on the following graphs, the Commission has determined that the 12 month average change in CPI-U is currently 1.565% The Postal Service received their last CPI based price increase in August 2013 Although USPS could in theory request a price increase at any time based upon what they have available in the bank, it takes 12 months to build up authority to match the annualized percentage change in CPI The bank is a rolling timeframe of the previous 5 years. That means that any banked authority, positive or negative, expires after 5 years Regardless of how much banked authority the Postal Service has from previous years, it can only use up to 2% of that bank. In other words, if they banked 4% from the previous year, even though they have 4% in the bank, they can only increase rates by 2%. That is on top of any authority granted to them by the current year’s CPI. The Postal Service has not requested a CPI based rate increase this year, however, the exigent increase of 4.3% was implemented in January of this year An exigent rate request being granted eradicates any “banked” authority from previous years 14

15. Latest CPI Price Cap Authority 15

16. Ratemaking: R2013-11: Exigent Rate Case 16 On September 26, 2013, the Postal Service filed a request for an average 4.3% increase above the CPI- cap for market dominant products “Exigent” circumstances are defined as “Due to extraordinary or exceptional circumstances” The Postal Service justified the need for an exigent rate increase as being the result of the Great Recession

17. Ratemaking: R2013-11: Exigent Rate Case 17 The Exigent rate increase is functionally a surcharge This means any CPI-based rate change in the future (the next opportunity would be 2015) would be based on the current CPI rates, not CPI rate + exigent surcharge

18. Ratemaking: R2013-11: Exigent Rate Case 18 The decision by the PRC to grant in part the Postal Service’s request is being appealed by both mailers and the Postal Service Oral arguments in DC Circuit Court of Appeals occurred two days ago on September 9 This case is pending in a court of law, therefore we are unable to discuss details or opinions on the case. I have provided my opinion from our decision.

19. Ratemaking: RM2014-5: Price Elasticities 19 On May 2nd of this year, NPPC (along with seven other organizations) filed a petition for a rulemaking to “review and improve the econometric volume demand model and the associated factors relating to price elasticity estimates and Internet diversion used by the Commission and Postal Service”

20. Ratemaking: RM2014-5: Price Elasticities 20 It has long been asserted by many mailers that the price elasticity estimates for major postal products are not accurate, and that the methodology seems incapable of measuring internet diversion The PRC held a technical conference on August 13th, which highlighted an econometric model produced by senior analysts within the PRC (although the PRC has not taken a position on the study) which attempts to better quantify elasticities The study, titled “Branching AIDS model for Estimating U.S. Postal Pricing Elasticities” is available at www.prc.gov under docket number RM2014-5www.prc.gov Comments are due on this study by September 19

21. Ratemaking: 2017 Ratemaking Study 21 As per the 2006 Postal Accountability and Enhancement Act, the PRC is required to review the system for regulating rates and classes for market- dominant products ten years after the date of enactment of that legislation (which would be December 20, 2016) Title 39, Sec. 3622(d)(3): Ten years after the date of enactment of the Postal Accountability and Enhancement Act and as appropriate thereafter, the Commission shall review the system for regulating rates and classes for market-dominant products established under this section to determine if the system is achieving the objectives in subsection (b), taking into account the factors in subsection (c). If the Commission determines, after notice and opportunity for public comment, that the system is not achieving the objectives in subsection (b), taking into account the factors in subsection (c), the Commission may, by regulation, make such modification or adopt such alternative system for regulating rates and classes for market-dominant products as necessary to achieve the objectives.

22. Ratemaking: 2017 Ratemaking Study 22 The Commission is required by law to consider 9 objectives, while taking into account 14 factors, as described in the previous slide (see handout for factors and objectives) These multiple considerations would suggest a balanced approach, and that no one factor or objective will necessarily result in a change There is currently a legislative proposal in the Senate (S. 1486) which would give the Postal Board of Governors this responsibility instead of the PRC

23. Advisory Opinions: N2014-1 Advisory Opinion: Load Leveling 23 On December 27, 2013, the United States Postal Service filed an Advisory Opinion request with the Postal Regulatory Commission indicating its intent to change the manner by which it processes and dispatches Standard Mail dropped off at Destination Sectional Center Facilities (DSCFs) on Fridays and Saturdays

24. Advisory Opinions: N2014-1 Advisory Opinion: Load Leveling 24 The Postal Service identifies potential benefits of the Load Leveling Plan as: a reduction in mail processing work hours and carrier overtime hours earlier completion of carrier routes and return of mail collected on carrier routes an improvement in downstream operations and service for mail collected on carrier routes

25. Advisory Opinions: N2014-1 Advisory Opinion: Load Leveling 25 The Postal Service has the authority to move ahead with a Change in the Nature of Service such as this, regardless of the PRC’s opinion. However, the PRC found the Postal Service: should perform a cost-benefit analysis at the national level to ensure that the Load Leveling Plan is cost effective, while providing the anticipated benefits; should assess the Plan’s impact on volume and co-mailing/co-palletization activities; should perform additional field testing, since the results of the limited testing may not be representative at the national level should conduct more extensive customer outreach to obtain a clearer understanding of mailer’s questions and concerns

26. Advisory Opinions: N2014-1 Advisory Opinion: Load Leveling 26 The PRC felt it was important to provide this Advisory Opinion in a timely way, as in the March 5 Federal Register, the Postal Service in its Final Rule posting stated its intent to implement the proposed changes starting on April 10. This was the first Advisory Opinion issued by the PRC in less than 90 days The Commission found that the plan has the potential to ameliorate this problem, or at least merit further studies. However, the Postal Service must also be mindful that from the mailers’ perspective, the Load Leveling Plan may cause concerns that detract from the value of the mail

27. Advisory Opinions: RM2012-4 Rulemaking: Advisory Opinion Process 27 On May 20, the Commission issued a Final Order to revise procedures for Nature of Service (Advisory Opinion) cases New 90 day schedule which both affords due process and significantly improves timeliness of our Advisory Opinions moving forward This timeliness of our Advisory Opinions has been the subject of recent Congressional interest Timeliness is critical as the Postal Service can move ahead regardless of whether our opinion has been issued This schedule is subject to change for “good cause only”

28. Market Tests: MC2014-26 Gift Cards 28 On August 8, the Commission unanimously approved a new competitive product which allows the Postal Service to sell gift cards at retail outlets This product was created after the Postal Service conducted a Market Test (MT2011-2) for two years, and found the program to be successful Although a Market Test does not need to meet any requirement to cover its costs by virtue of its experimental nature, the permanent competitive product must The basis for the Commission approving this new product is that gift cards are within the current Greeting Cards and Stationery product, as they are likely to be mailed just as a greeting card purchased at a post office is likely to be mailed

29. Market Tests: MC2014-26 Gift Cards 29 The approval of this new permanent product should not be interpreted to mean the PRC is permitting the Postal Service to provide banking services

30. Market Tests: R2013-5: Market Test Rulemaking 30 On August 9, 2013, the PRC initiated a rulemaking with the goal of providing the Postal Service additional flexibility to conduct market tests while still conforming with applicable regulations. These rules provide increased clarity for the Postal Service, mailers, and the public regarding how such market tests are to be conducted and evaluated under the law. A Market Test may only run for 24 months, but the PRC has the authority to grant an additional 12 months’ extension if necessary to determine the feasibility or desirability of the tested product The Postal Service may only collect up to $10 million per annum in total revenue from a market test, but the PRC may exempt a market test from the limit provided revenue does not exceed $50 million per annum Both limits are subject to inflation

31. Market Tests: R2013-5: Market Test Rulemaking 31 This rulemaking was finalized August 28, 2014 Postal Service has stated its intent to file more Market Tests in the near future, so timeliness of this rulemaking was important

32. Current Requests for Proposal 32 The Commission currently has executed three Requests for Proposal (RFPs) on several areas of interest to our staff: Parcel Market Data, Institutional Costs, and Terminal Dues Although in these three instances, all Commissioners were given an opportunity to review the RFPs, only the Chairman can approve of an RFP and any resulting contract and cost

33. Current Requests for Proposal: Parcel Market Data 33 The Parcel Market Data Study, which was awarded to SJ Consulting, is designed to provide the Commission with greater awareness of market share and on-time performance data to determine the appropriate share of institutional costs to be contributed by competitive products, as well as evaluate the Postal Service’s market power, among others

34. Current Requests for Proposal: Institutional Costs 34 The Institutional Costs study, which was awarded to CMPW Partnership. This is designed to study and estimate what we refer to as “infra-marginal costs.” It is easiest to think about it like this: As volume increases in a given product, the institutional costs decline, not simply because of greater volume, but also due to greater specialization of the workforce, more efficient equipment, et cetera. However, we don’t currently have the means of measuring that infra- marginal cost and how it behaves. It is our hope that this study will produce better information about how those costs vary

35. Current Requests for Proposal: Terminal Dues 35 The Terminal Dues study, which was awarded to Copenhagen Economics, was initiated due to the contention by some that the Universal Postal Union (UPU) terminal dues system distorts the market for letter postage as some national postal operators pay a lower rate for delivery than a private company. Moreover, our agency is unable to determine if anyone has ever applied the theory of international economics to the terminal dues system. This RFP will ideally provide a methodology for measuring any market distortion and evaluate the current terminal dues system

36. Other: Commission Status 36 Currently, the Commission has three Commissioners serving on the panel, and two vacancies Both positions have been vacant since last fall The Chairman’s term expires on November 22 The Chairman can continue to serve in “holdover” status for one year, although is not required to do so Commissioner-designate Tony Hammond, whose term expired October 14, 2012, and Commissioner- designate Nanci Langley, whose term expired November 22, 2012, both await Senate confirmation

37. Other: Legislative Update 37 The House Oversight and Government Reform Committee and the Senate Homeland Security and Governmental Affairs Committee approved legislation aimed at large scale reform to the Postal Service (H.R. 2748 and S. 1486). Both currently await floor action. While the language of the bills is different, both have provisions eliminating Saturday delivery. The Senate bill delays any transition to 5 (or fewer) days of delivery for 12 months. The Senate bill would make permanent the exigent rate increase approved by the PRC in December 2013 Both bills face challenges to passage this year because of the lack of remaining days in the legislative calendar and the upcoming elections. It may be possible to enact more basic reform as part of a lame duck omnibus package

38. Other: Legislative Update 38 A letter signed by 50 Senators was sent on August 14 to the Senate Appropriations Committee requesting that there be no mail processing facility closures in FY 2015. Only Senator Carper (D-DE) has stated any opposition to that request at this point The House has 10 Members of Congress signed onto their letter to the House Appropriations Committee The Senate letter was signed by 44 Democrats and 6 Republicans, while the House letter was signed by 5 Democrats and 5 Republicans Based upon Committee term limits in the Republican party and Senator Tom Coburn’s retirement, there will likely be new Republican leadership in both Committees of legislative purview

39. QUESTIONS? 39

40. www.prc.gov 40