MAXIMIZING THE U.S. POSTAL SERVICE'S PROFITS FROM COMPETITIVE PRODUCTS

Abstract

The Postal Regulatory Commission (PRC) regulates the pricing of the U.S. Postal Service's products, including products not protected by the Postal Service's statutory monopolies that the enterprise sells in competition with the products of private firms. The Postal Accountability and Enhancement Act (PAEA) of 2006 created new requirements for the PRC's pricing regulation of competitive products. I evaluate the economic implications of the PAEA's three primary requirements with respect to the Postal Service's pricing of competitive products: preventing cross subsidy of competitive products by monopoly products, ensuring that competitive products cover their “attributable” costs, and allocating to competitive products an appropriate share of the Postal Service's common costs (known as “institutional” costs in postal regulatory jargon). The first has a relatively straightforward economic interpretation: the PRC can use either the incremental cost test or the standalone cost test to detect cross subsidy, subject to some nuances when the Postal Service does not break even. To ensure that the Postal Service's competitive products meet the PAEA's attributable-cost requirement, the PRC can apply an incremental cost test using Shapley values. Given the evolution of the Postal Service's network to support competitive products, the PRC should use incremental costs that are neutral with respect to the order in which the Postal Service has introduced its product lines. Next, I explain that the appropriate share of institutional costs for the Postal Service to recover from competitive products depends on understanding in precise economic terms the alternative rationales for empowering the PRC to regulate the Postal Service's competitive products. I identify and analyze the implications of three possible rationales: (1) ensuring that the Postal Service fulfills its essential mandate to deliver monopoly (“market-dominant”) mail services, (2) ensuring that the Postal Service fulfills its fiduciary duty to taxpayers as a state-owned enterprise, and (3) preserving competitive parity in markets in which the Postal Service competes with private firms. I find that those goals indicate that the optimal allocation of institutional costs to competitive products would maximize the Postal Service's profit from its sale of competitive products—thereby enabling revenues from competitive products to cover as much of the Postal Service's overhead as possible. I review how a multiproduct firm maximizes profits using Ramsey prices. I then propose a simple shortcut by which the PRC could approximate those prices for its competitive products with limited information and at relatively low administrative cost. By gradually increasing the share of institutional costs that competitive products must bear, the PRC can identify the profit-maximizing price for competitive products and thus iterate toward the precise allocation of institutional costs that maximizes the profits that the Postal Service earns from its offerings of competitive products. Finally, I show how the Postal Service's Board of Governors could obviate the PRC's intervention by independently implementing profit-maximizing prices for competitive products and why, in the absence of other remedies, Congress should enact legislation to ensure that the Postal Service maximizes the profits that it earns from its competitive products.