AN ERA OF INNOVATION

S. David Fineman

Chairman, Board of Governors, US Postal Service

& Managing Partner, Fineman & Bach, PC

11th Conference on Postal and Delivery Economics

Toledo, Spain

6 June 2003

Good evening, ladies and gentlemen. I am honored to serve as this evening's featured speaker, and thank you Drs. Crew and Kleindorfer for your kind invitation to address this distinguished audience. I would also like to thank our Spanish hosts for their kind hospitality. Since I know you are all eager to catch up with colleagues and friends from abroad, I will try to be brief.

First, I want to emphasize how much I appreciate the importance of the issues that have been presented and debated at this conference. This conference brings together a vast array of talented individuals with expertise in multiple disciplines, including economists, business managers, and legal professionals from all walks of the postal and logistics industry. I am grateful to be a part of this multilateral exchange of ideas, in the hope that our discussions here will open the door to a wealth of innovative proposals that could prove to be successful in our market.

Second, while it is evident that we may not always agree on outcomes, it is clear that a common theme has emerged in postal markets throughout the world--we are all confronting an increasingly competitive and dynamically changing market. I believe that posts are undergoing a transformation that will forever change their corporate and political culture-and their financial futures. This fundamental change in our business climate is precipitating what I believe is an unparalleled era of innovation.

The postal industry's response to the pressures of competition, electronic diversion, and rising labor costs, and other challenges has been in large measure to innovate. Posts are diversifying, not only their product array, but also the geographic scope of their markets.

Each of our organizations is undertaking innovation in different contexts, and at a different pace. The variety of our experience enables each of us to learn and benefit from the successes of our neighbors, our partners, and our competitors.

The era of innovation appears to me to have manifested itself in many ways. Five recent examples illustrate that innovation in postal markets is not just a passing fad, but rather evolving into routine practices in the new, highly competitive environment.

First, postal operators are moving beyond cooperating and competing with their fellow posts and are now thinking of merging. In the past few months, the trade press has reported possible strategic investments that are being considered in connection with the sale of equity in postal companies in Denmark, Austria, and Singapore. While it is unclear whether any strategic acquisitions will occur, it seems evident that we are now moving beyond the model where a national company alone provides domestic services. We appear to be at the crest of an era where multinational corporations might serve as universal postal service suppliers in several countries. I think this might be less revolutionary for Europe, as integration of posts might be seen as a natural consequence of the integration of the European market. Nevertheless, this possibility represents a significant change from several years ago, when posts were basically confined to their domestic markets.

Second, posts are now looking for expansion opportunities in each others' territories, with posts setting up exchange offices abroad in the form of `extraterritorial offices of exchange'. The genesis of the rapid rise in extraterritorial offices might be a byproduct of the planned reduction and eventual elimination of the monopoly throughout Europe after 2009. In the US, many European posts and even some developing country posts have set up exchange offices to export outbound international mail. Similar efforts have taken hold in other markets, including Canada, Australia, and Europe. These new forms of business structure are unquestionably commercial, profitmaking enterprises, and as such they are forcing all posts to consider the extent to which a post should be geared primarily toward the promotion of universal service.

Third, we are seeing a greater degree of cross-over between the private and public spheres. For example, as part of an agreement with the US Postal Service, FedEx has now placed its Drop Boxes outside U.S. Post Offices nationwide. FedEx Express has also agreed to provide air transportation for certain Postal Service products. These types of arrangements show that previously unimaginable cooperation between former rivals in the postal and private spheres is not only possible, but leads to mutually beneficial relationships.

Fourth, and similar to the last point, the line between the postal sphere and the private delivery sphere is blurring, and we are seeing posts and private operators innovating in each other's markets. For some time now, posts have been expanding their presence in parcel, express, and logistics businesses, with varied degrees of success. Similarly, private operators now are exploring opportunities in the retail market, which traditionally has been dominated by incumbent postal operators. For instance, in the US market, United Parcel Service is in the process of establishing a significant retail presence by converting 3300 Mail Boxes Etc. (MBE) franchisees to UPSbranded stores. Efforts such as these pose significant challenges to the posts' business models, where, until recently, competition for the retail market was to a large degree non-existent.

Fifth, posts are now innovating with specially tailored, customer-focused product solutions. Also hoping to report that the PRL has approval, a recent filing in some markets, particularly in Europe, negotiated service agreements, or NSAs, have become fairly routine. By contrast, the US Postal Service is only now introducing its first NSA. I am pleased to announce that the Governors of the US Postal Service just last week [approved] experimental rate and service changes to implement a three- year NSA with one of our major First-Class customers, Capital One, Inc., a financial company and major mailer of First-Class and advertising mail. The decision is important because it represents our first attempt to develop a customized solution in our domestic market. I am confident that the NSAs will give the US Postal Service a valuable tool to meet our customers' needs in an increasingly complex marketplace.

Even though oceans might divide us, we have much to learn from innovation we have all undertaken. All of us, whether private or public, or partially privatized, are now engaged in countless new endeavors and innovative efforts. While for many of us innovation has been self-initiated, in other cases, innovation has had been instigated by parliaments, regulators, or even international bodies like the World Trade Organization.

Let us consider, for example, the issue of access. In preparation for the expected total liberalization of the European postal market, some countries in Europe are now establishing policies for downstream access into the incumbent operator's network. For instance, recent media reports have highlighted a decision by Postcomm, the UK Regulator, to allow competitors of Royal Mail to enter Royal Mail's 1,400 delivery offices for just 12 pence per letter. The media is reporting that our friends at Royal Mail will be seeking some redress on the access price. However this issue is resolved, the issue of access represents an important step for the UK market.

My Royal Mail colleagues might understandably be concerned about the financial impact of this change, and its possible consequences on universal service. As they enter into an access regime, I hope they will be able to benefit from the U.S. experience with downstream access. Our formulation and application of worksharing discounts, which has been accomplished in collaboration with the Postal Service and its customers, as well as our regulator, the Postal Rate Commission, may ultimately prove to be instructive to the UK's new access regime.

Access in the US postal market is but one of several worksharing initiatives that have evolved in our ratemaking and business practice. Worksharing is one of the major success stories of the Postal Service during the past 30 years. It has helped usher in the age of automation by encouraging customers to prepare machine-readable mail and has remained an important tool for aligning the mail with the operating environment.

Since worksharing was introduced, it has become a key means of keeping mail affordable by lowering rates and leveraging the ability of our customers to assist in the efficient processing of the mail stream. The program has served to propel what we call the de facto liberalization of the Postal Service-a liberalization unparalleled elsewhere. An innovative approach when it was introduced, worksharing effectively shares a significant portion of the Postal Service's business with the private sector. Many of the "unbundling" debates going on within European posts echo the worksharing debates that the United States postal industry resolved more than a decade ago. In my view, postal operators and regulators abroad can benefit from the US experience with worksharing.

Those of us in the US also can stand to benefit from Europe's innovation as well. Our counterparts in Europe have made substantial progress with an ambitious program that combines demon opolization and commercialization of postal operators. This process has evolved over time, and has manifested itself in many ways: such as, for example: (1) the elimination of the letter monopoly in Sweden and Finland, (2) the adoption of commercial structures and practices for European posts, (3) the privatization of ownership of some posts, including most notably TPG and Deutsche Post, and outside Europe with Singapore Post, and (4) the adoption of two successive European Commission Directives that have created a uniform and gradual standardization of regulation and reduction of the monopoly in Europe. The European experience with these revolutionary changes provides an important backdrop for current debates about structural changes to the US postal market. Commercialized post models could prove to be instructive to the US Postal Service, since its business model, which was adopted more than 30 years ago, is now under review.

In April of last year, the US Postal Service adopted a detailed Transformation Plan. The Transformation Plan was developed to address both the near-term and long-term efforts that will result in a continued ability to fulfill the mission of the Postal Service - to deliver business and personal mail affordably nationwide. In the Plan, Postal Service leadership commits to managing immediate challenges facing the Postal Service.

Implementation of the Transformation Plan is also complemented by the ongoing work of a nine-member Commission appointed by the President, which is now undertaking a thorough review of the US Postal Service. This Presidential Commission will make recommendations designed to enhance the organization and Transformation Plan. The Transformation Plan was developed to address both the near-term and long-term efforts that will result in a continued ability to fulfill the mission of the Postal Service - to deliver business and personal mail affordably nationwide. In the Plan, Postal Service leadership commits to managing immediate challenges facing the Postal Service.

Implementation of the Transformation Plan is also complemented by the ongoing work of a nine-member Commission appointed by the President, which is now undertaking a thorough review of the US Postal Service. This Presidential Commission will make recommendations designed to enhance the organization and strengths of the current structure and suggested opportunities for improvement. I trust that the Commissioners, many of whom serve as members or leaders of boards and CEOs of prominent organizations, will bring the benefit of their experience to make sound recommendations for effective governance of the US Postal Service.

As Jack Potter, our Postmaster General, told the Commission, "The basic economic assumption of Postal Service's current business model-that continuing growth in mail volume and revenue would support continued infrastructure growth-is no longer valid." I share this view. Volume growth in the United States is at risk from competition and diversion, while the number of delivery points that we must serve is constantly increasing. Without some significant change, it is evident that the widening divergence of volume growth and delivery point expansion will make it impossible to continue the Postal Service in its current structure as a going concern. The President's Commission accordingly has an historic opportunity to offer recommendations guaranteeing a postal system as effective and dependable as today's.

The Commission's reforms will likely require commitment by Congress, the President, the Governors, and Postal Service management to usher in new changes. As Chairman of the Board of Governors, I am committed to providing the leadership on the Board that will enable the Postal Service to implement Commission recommendations that can be executed under current law. I also intend to help other stakeholders and institutions of the United States government understand the implications of the recommendations and continue to work to change our current antiquated legislation.

An ongoing interest in the U.S. Postal Service among many of you here is much appreciated. I hope each of you returns to your home country with the wisdom you acquire here and come back to this conference again next year to share the results of your own innovations. Such cross-fertilization of postal information will help the US Postal Service and all posts around the world.

Thank your for your attention, and once again, thank you Drs. Crew and Kleindorfer for this opportunity to address such an esteemed audience.