A Critical Examination of the USPS Study of Postal Price Elasticities

There are problems with the U.S. Postal Service's analysis of postal price elasticities. The study lumps all types of mail together and concludes that raising postal rates will result in a net increase in revenue. The study downplays the nearly 10 to one difference in price elasticity between First Class mail and Carrier Route mail.
The study defines price elasticity to mean that a cost increase will result in a short-term net increase in revenue because the revenue increase will be more than the lost mail volume.

No analysis is given to the long-term implications of rate increases or whether an increase in revenue is the sole criteria for judging the merits of a postal rate increase. The study also doesn't address the decrease in volume or the effect on profitability from a cost increase.

The study buries a startling conclusion in a footnote: That raising the cost for carrier route mail will result in a loss in net revenue. This means it would be irrational to raise the cost of carrier route mail. No work is done to consider which subparts of mail categories are actually elastic, as well as what should be done to price those categories of mail so volume doesn't decrease.

The study, Analysis of Postal Price Elasticities, shows that carrier route mail is the most elastic in terms of price sensitivity. Hidden in the analysis is a very important piece of information: "A case can be made for the proposition that Standard Enhanced Carrier Route (ECR) Mail has a price elasticity of one. A price elasticity equal to one means that raising ECR's price would leave gross revenue unchanged." In other words, if you raise the postage on carrier route mail, the drop off in volume would offset the postal rate increase and overall revenue would not increase!

Why is the price elasticity of Standard mail important? There's the threat that the USPS will ask for another exigent rate increase. The last exigent increase was overturned by the Postal Regulatory Commission and Appeals Court review process. The legal review of the statute held that an exigent increase required extraordinary circumstances and that the USPS needs to have studied the economics of a price increase and the impact on all classes of mail.

The legal ruling was that the USPS had failed to meet the statutory requirements of extraordinary circumstances and needed to do economic analysis of postal price increases. This study, Analysis of Postal Price Elasticities was commissioned after the 2010 ruling. It addresses some of the economic issues of price elasticity when raising postal rates.

The study conclusions are suspect because they're exactly the broad conclusion the USPS feels is needed to support an exigent increase. The conclusion that postal products are inelastic has a significant bias. Why the bias? The business study was commissioned by the USPS. It concluded that price is inelastic, which is the conclusion it needed to pave the way for an exigent price increase.

What's missing from its analysis? The study should dive deep in the data of the relative price elasticity of First Class mail, Standard mail and periodicals. The study lays out the vastly different elasticity depending on the class of mail. Elasticity ranges in 2012 are very significant (the higher the number, the more a postage increase affects volume):

• First Class letters: .09
• Work-shared First Class: .39
• Parcels: .21
• Periodicals: .12
• Standard Mail (ECR): .70
• Nonprofit: .30
• Nonprofit ECR: .56

You should not add all these classes of mail together and make the blanket conclusion that all mail is inelastic. Over the past several years, carrier route mail has been the one class of mail that's proven to be elastic - i.e., changes in postal costs have resulted in net decreases in revenue. Standard ECR mail has a price history showing that it's been elastic or very close to elastic (in stark contrast to the other subclasses of mail):

• 2005 1.09
• 2006 1.07
• 2007 .77
• 2008 .91
• 2009 .83
• 2010 .72
• 2011 .78
• 2012 .70

What the USPS doesn't examine is the revenue and profitability implications of price increases on the most elastic portion of Standard mail. Overall Standard mail is the most elastic in terms of price increases resulting in decreases in volume. If Standard ECR mail has a history of price increases actually resulting in revenue decreases or only tiny revenue increases, what's the loss in profitability from the loss in volume? It appears that the price increases result in a loss of top-line revenue and inevitably a loss in bottom-line profitability for carrier route sub mail.

Some other critical parts are left out of this economic analysis, including the following:

• While overall revenue may still increase with a price increase, the carrier route portion of the mail is a proven profitable piece of business for the post office. A reduction in volume cuts out some potential profitability. Does the reduction in volume offset the increase in revenue and does a rate increase result in more profits, not just more top-line revenue? The Christensen study only addresses the narrow issue of whether there's a short-term net increase in revenue and not the critical issue of whether the increase in revenue results in more profits.

• While some portions of Standard mail/catalog mailings are inelastic, some marginal circulation for catalogs is very elastic when it comes to postage costs. Catalogers' basic business rule is to mail only at or above breakeven. Catalogers' base circulation decisions are based on the historical results of prospecting lists and whether those lists responded above breakeven in the past. Catalogers are sophisticated gatherers of historical response data and will cut that portion of circulation that's not above breakeven when the break-even costs of printing and mailing a catalog increase. When break-even costs go up, the marginal circulation of segments that are responding right at breakeven will be cut and volume will go down. It's a lockstep process; when postage rates go up, the break-even point for catalog circulation increases and circulation inevitably goes down.

Therefore, carrier route mail is both relatively elastic based on the cost of postage and is also profitable volume for the post office. The USPS should be planning how to increase the volume of carrier route mail. So what could be done to increase the volume and revenue of carrier route catalogs? Consider the following:

• Simply lowering the postage for carrier route mail will increase volume, according to the data in the study. This study indicates the rational pricing policy should be to lower postage for carrier route (ECR) mail.

• Dropping the postage for catalogers when they increase their volume of mail so that the post office is discounting the incremental circulation from a catalog compared to last year's circulation would be a way to incentivize mailers to increase their circulation and add more profitable volume of carrier route mail.

• Changing the carrier route requirement from a bundle of 10 to a bundle of six or seven would increase the amount of bulk mail that's profitably handled as carrier route mail. This change in the number of pieces in a carrier route bundle would represent a significant shift in mail being handled by co-mailing, the work-sharing solution that moves the mail handling away from the USPS and into the private transportation networks managed by printers.

• Directing the regular promotions coming from the USPS to where they will have the most impact - i.e., using the promotions to promote incremental volume by lowering the postage cost for incremental carrier circulation. Going after the marginally profitable circulation that's most elastic and lowering the postage cost will result in increased volume and revenue.

• Work on increasing the quantity of lower postage formats like tabbed slim-jims by loosening the requirements for mail to qualify as tabbed letters.

There are a lot of ways that the USPS should leverage the data-driven insight that carrier route mail is sensitive to price increases, and that increasing the cost for carrier route mail may actually result in less revenue and lower profits (and will certainly result in lower volume).

There's a lot that's simply wrong in the Analysis of Postal Price Elasticities report. The USPS wants to use the study to frame the case for an across-the-board postage increase. The logic breaks down however when it attempts to use the data to frame a conclusion that's not supported by the data. Where does their logic break down?

• The USPS has data showing that various kinds of mail (First Class, Standard Mail and Periodicals) have widely varying changes in volume from a price increase perspective. But it leaps from this wide-ranging set of elasticities to the conclusion that all mail volume is inelastic. The data points to a different set of conclusions, namely that First Class mail is the least elastic and that carrier route mail is the most elastic type of mail. Furthermore, that within some broad groups of mail that are relatively inelastic there are portions of that mail that are very elastic in terms of volume when costs are increased. The post office needs to slow the decline in mail volume; to do that it needs to be aware of the types of mail that are price sensitive and protect that profitable mail volume by pricing to maximize volume for those price-sensitive classes of mail.

• The data shows that carrier route mail is at a tipping point where cost increases will result in revenue decreases. This should lead to the conclusion that it would be irrational to increase carrier route postage.

• All the price elasticity data shows that some volume is lost across all the categories of mail when costs increase. The point the study makes is that the cost increases result in higher revenue even though volume is inevitably lower. What the study fails to address is that the reason for the need to raise postal costs is because volume is decreasing! The study identifies two reasons for volume decline (the growth of the internet and the Great Recession), but fails to mention, let alone quantify, what portion of the decline in volume is the straightforward result of increasing costs. The data clearly shows the huge decline in bulk mail volume that was triggered by the 2007 postal cost increases, but never addresses that postal cost increases cause volume to decline. The report glosses over that by making the case that the increased revenue offsets the increase in costs.

• If you follow its data to a logical conclusion, then the USPS should raise prices almost exclusively on First Class mail and other subclasses of mail that are most inelastic. Why would the USPS even consider raising costs on mail volume that's price sensitive when it's identified that the existential threat to the post office is an ever-declining volume of mail? The answer in the past was it's politically easier to raise the cost of all subclasses of mail a little bit rather than raise the cost of First Class mail a lot and leave the cost of bulk mail alone. The U.S. Postal Service's study on price elasticity shows clearly that a pricing formula based on raising all mail costs is wrong. If you accept its price elasticity argument, then it follows that the price increases should be imposed on First Class mail and the other inelastic subclasses of mail.

• The post office's argument revolves around the narrow issue of whether price increases will result in incremental revenue. There's no discussion of whether the greater revenue translates into greater profit. Carrier route mail is profitable volume for the post office. Does cutting out profitable volume result in higher profits or just simply higher top-line revenue?

The conclusions the USPS draws from this report simply don't follow the data. The conclusions seem to be exactly what the USPS thinks it needs in terms of economics to back up its economic analysis requirement to ask for an exigent price increase. This study attempts to address the statutory requirement of "extraordinary circumstances" and provide an underlying economic analysis to back up the case for a postal cost increase. The study doesn't provide justification for an exigent increase and is ultimately not a supportable economic argument when it comes to justifying an increase in postage for Standard mail and ECR mail.

Jim Coogan is the founder and president of Catalog Marketing Economics, a consulting firm focused on catalog circualtion planning. Jim can be reached at jcoogan@earthlink.com.