Featuring Lutts’ Logic:
Ending the Post Office Monopoly
Competing with USPS
A Digital Contender
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Odds are you’re reading these words on a computer screen, but not so long ago, the dominant medium of our industry was paper. In fact, in my early years in this business, our big expenses were always the “The Four Ps,” paper, printing, postage and people.
The people are still around (and better than ever) but thanks to the Internet, the other three big expenses have shrunk dramatically ... which is good for those of us trying to cut expenses, but bad for those who see their revenue shrink.
Newspapers are at the top of this list today, as advertising dollars have fled to the Internet. Also suffering from the long-term trend are paper companies, ink companies and advertising companies, to name a few. And the current economic crisis has compounded the damage.
In fact, just last week, one of our local printers (we’ve historically used two, mainly to foster competition) dropped off a job and then stopped by my desk to chat ... or more specifically, to grumble. He says he’s reduced staff to the absolute minimum, and now he’s working “just to keep the lights on.”
I sympathized. And then I saw the story about the United States Postal Service, which lost $2.8 billion last year, and is on track to lose even more this year, in part because the volume of first class mail, which has been declining since 2002 thanks to the Internet, has now fallen off a cliff. Says Postmaster General John Potter, “We are facing losses of historic proportion. Our situation is critical.”
This affects us all, because we’re all accustomed to receiving mail deliveries six days a week. And while we complain about the rising cost of stamps, the fact is the postal service has done a great job. But if there’s anything that last year’s giant domino tumble should have taught us, it’s that when a big institution starts losing money, things can go from bad to worse in a hurry.
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Note: The phrase, “Neither snow, nor rain, nor heat, nor gloom of night stays these courageous couriers from the swift completion of their appointed rounds” has long been identified with the USPS but it is not, in fact, the organization’s official motto. It has none. The phrase originated with the Greek historian Herodotus during the war between the Greeks and Persians about 500 B.C. and it was in reference to the Persian horsemen who carried messages.
But it’s become identified with the USPS because back in 1896-97, when the New York City General Post Office was being designed, Mitchell Kendal, an employee for the architectural firm McKim, Mead and White, came up with the idea of engraving Herodotus’ saying all around the outside of the building. And it’s still there today.
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So what’s the solution for the United States Postal Service? Or more precisely, since disruptive technologies have eroded the core letter-carrying business of the USPS, what’s the most cost-effective way for Americans to send and receive mail in the years and decades ahead?
Let’s start with a little history.
The United States Postal Service was created in Philadelphia in 1775 under the direction of Benjamin Franklin. Its Railway Mail Service was inaugurated in 1869, making great use of rail cars as on-the-move sorting stations. In 1896, Rural Free Delivery was instituted. In 1912, delivery was reduced to six days a week at the behest of religious leaders. 1913 brought the beginning of parcel post. And 1918 saw the debut of the Air Mail Service.
Then in 1970, Richard Nixon signed the order that turned the institution into an independent agency of the U.S. government, which means basically that it’s supposed to be self-sustaining ... and when it’s not, we learn about the losses.
Today, the USPS is the third-largest employer in the United States, after the Department of Defense and Wal-Mart. It’s also the largest civilian operator of motor vehicles. Considering its great size, it’s done a very good job of adapting to changing times. But the growing operating losses (just as at GM) warn us that if bigger changes are not made, the USPS will be next in line for a government bailout. And I think Americans have had enough of bailouts.
Now, it’s easy to say that USPS pensions are too cushy or that political patronage is the problem, and while those may be true, I think the two big issues in the institution’s business equation are these:
One: The Universal Service Obligation mandates that the USPS provide delivery to every address in the U.S., six days a week, at the same rate.
Two: The Postal Monopoly provides funding for the obligation by mandating that only the USPS can deliver letters in this country and only the USPS can access your mailbox.
Long-accepted logic says that rural delivery is expensive, and is thus subsidized by urban deliveries, and removing the monopoly would enable competitors to target profitable urban locations, leaving the USPS with the more expensive rural routes.
However, an analysis of the quality of delivery proves otherwise. The rural customer often provides the “last mile” of delivery service by picking up his or her mail from a cluster box, or from the end of a driveway, while urban customers often receive mail directly at their doors, and the result is that urban mail does not subsidize rural mail.
Thus the monopoly serves not to protect “profits” but only to prevent competition. And what happens without competition? There’s no incentive to compete by pushing costs down!
Yes, the USPS has worked diligently to keep costs under control, and I applaud them for their achievements. I shudder to think what the institution would look like if Richard Nixon hadn’t signed the order making it stand alone.
Nevertheless, it is still a monopoly, and independent economists have concluded that the costs of the monopoly exceed its benefits. In short, the USPS is still overpaying its work force, and those workers account for roughly 80% of the institution’s costs.
Again, the institution is working to address the issue. Just 10 days ago, the USPS announced that it would slash more than 3,000 jobs, and would offer more than 150,000 employees--nearly half its workforce--early retirement.
And now it’s talking about reducing mail delivery to five days a week from six. Sure, that saves money, but it’s certainly not what the customers want!
So, after analyzing the facts, I can only conclude that the best course is to open up the business to competition ... slowly.
The USPS has already proven it can compete in the priority mail business, where it has a 15% share.
And since the end of 2006, when it was first allowed to offer volume-related price discounts on some of its shipping services, it has gained market share there, too. In 2008, the USPS generated 11% of its $75 billion in revenue from shipping services.
Its main competitors, of course, are United Parcel Service and FedEx. (German carrier DHL dropped out of the market last year after a six-year effort.) And United Parcel Service and FedEx would no doubt be among the top competitors should Washington allow true competition for letter delivery as well.
But the real opportunities for growth would lie in the digital realm ... should true competition be allowed, and I’ll get to that below,
In any case, gearing up to serve this huge market will take time, so winding down the monopoly should be done slowly. I have no doubt it will be a very difficult job. But I have even less doubt that the longer it is delayed, the greater the eventual pain, for all of us.
Bottom line: Postal reform appears to be one of the last things on President Barack Obama’s list ... it may not even be on his list. But it should be.
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So, putting on our investment hat, let’s look at United Parcel Service and FedEx and then at a potential competitor from the digital universe.
United Parcel Service (UPS), headquartered in Atlanta, is the big dog. With annual revenues of $51 billion, it’s already two-thirds the size of the USPS. Its bread-and-butter is packages, representing 62% of revenues. International packages account for 21%, and supply chain logistics and freight make the rest.
Revenues have grown in each of the past 10 years (5% and 4% in the past two years), but earnings have shrunk in each of the past four quarters, as revenue growth has slowed faster than expenses.
In the past four years, the stock has fallen from 89 to 38, and it recently rebounded to 50. This rebound might become a new uptrend, but there’s no big power behind the move, so I’m skeptical.
FedEx (FDX), headquartered in Memphis, has a lot of similar traits. With annual revenues of $38 billion, it’s two-thirds the size of UPS ... or half the size of the USPS. But FedEx gets two-thirds of its revenue from express mail, 18% from ground and 13% from freight. International business accounts for 28% of its revenues.
FedEx, too, has seen revenues grow every year of the past decade (9% and 8% in the past two years), but its earnings began shrinking early in 2007.
In the past two years, the stock has fallen from 121 to 35, and it recently rebounded to 45. Technically, it looks worse than UPS.
Admittedly, both stocks might be considered cheap today; they’re well below their old highs, and the market values them at less than one year’s revenues.
But on a price/earnings basis, they’re no bargains ... unless earnings can rebound in the quarters ahead. And the market appears not to expect that. Certainly analysts don’t; they’re reduced their projections for both companies for both 2009 and 2010.
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So who’s the digital contender? Which successful digital company of today might be happy to compete for a piece of the USPS business, and to bring it into the 21st century?
I suggest Amazon.com (AMZN). Clearly, the company is skilled logistically; it’s become successful not only by selling books from retailers to individuals but by selling everything from everybody to everybody else, and getting them delivered correctly, too.
But I’m not suggesting Amazon get into the delivery business. I’m suggesting that Amazon’s Kindle, the electronic book-reader, might just be the revolutionary piece of technology that could deliver personalized paper-like content to your house, eliminating the need for so much of that paper that fills your mailbox.
And I assume the brains at Amazon are working on it.
Even without that, business is very good at Amazon. Revenues, which totaled $19 billion last year, have grown every year of the past decade (39% and 29% in the past two years), though earnings growth has been less linear. But analysts recently raised their estimates for 2009 and 2010.
Technically, the stock looks great; it’s obviously under heavy accumulation. Back on March 2, it earned a spot in Cabot Top Ten Report, where editor Mike Cintolo wrote:
“So why is AMZN so strong? In part, we think it’s because the stock is still not over-owned; fewer than 500 mutual funds own the stock. In part we think it’s because the company is truly international; 47% of revenues come from outside the U.S. In part we think it’s because the company is still achieving double-digit annual revenue growth. And in part we think it’s because the company’s Kindle, the electronic book platform, has been well received. While the company refuses to divulge sales figures, reviews of the original Kindle, and now the Kindle 2, have been quite positive. Furthermore, the ongoing implosion of the paper-based newspaper industry has created an opportunity for an electronic newsreader, and Kindle is the leading contender in the early phase of the race. In short, the stability of revenue flows from its budget-priced merchandise combined with the promise of what the Kindle might achieve make an attractive package.”
When that was written, AMZN was trading at 62. Since then it’s climbed to 75, and in the past week it’s pulled back normally to 70. So you could buy it here. But even smarter would be buying a no-risk subscription to Cabot Top Ten Report, so you’d be kept up to date on Mike’s latest recommendations.
Yours in pursuit of wisdom and wealth,
Timothy Lutts
Publisher
Cabot Wealth Advisory
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