Boxed in: Royal Mail may need to be freed from its universal service obligation to deliver a turnaround
Royal Mail, the UK’s oldest postal service, has received plenty of bad news in recent weeks. It has been fined for failing to achieve its delivery targets, lost an exclusivity deal with the Post Office and recorded operating losses of £319 million – £100 million higher than for the same period last year.
There are understandable explanations for these problems, not least the long-running dispute over workers’ pay and conditions, and the continuing decline in the volume of letters people send.
But the dispute was settled in July, there have been no strikes since December 2022 and the reduced level of letter posting is nothing new.
Yet Royal Mail, which has been a subsidiary of International Distributions Services since it was controversially privatised in 2013, still finds itself in a difficult position. And this is largely down to a Government imposed obligation that requires it to deliver to more than 30 million UK premises six days a week.
This requirement, known as the 'universal service obligation', and regulated by Ofcom, has long been a major and expensive thorn in Royal Mail’s side. The company has consistently failed to meet delivery targets which state that 93 per cent of first-class mail should be delivered within one working day, and 98.5 per cent of second-class mail should be delivered within three working days.
From 2022 to 2023, the regulator Ofcom reported that the company achieved levels of 73.7 per cent and 90.7 per cent respectively, and only 89 per cent of delivery routes were completed each day. So it was decided that (even taking the strikes into account) Royal Mail had breached its obligations and was fined £5.6 million. It was fined £1.5 million for a similar breach in 2018 to 2019.
But some analysis suggests that the universal service obligation is an anachronism. It was valid in the days before email and smartphones, and made sense while people relied on receiving everything by post – from birthday cards and tax demands, to hospital appointments and letters. Now, in the digital age, that is no longer the case.
Some claim that the official requirement should be for less frequent deliveries, say two or three days per week, meaning letters would be only delivered a day or two later.
The UK Government clearly has a different view. Earlier this year it refused Royal Mail’s far less radical proposal to end Saturday deliveries (although Ofcom has begun a review).
But as letter volumes continue to drop – the half-year results show a nine per cent reduction following several years of similar falls – without significant increases in productivity, the efficiency of Royal Mail will also fall, and the losses will increase.
How can Royal Mail deliver a turnaround?
When it was privatised in 2013, Royal Mail’s future profitability was predicated on continuing to achieve productivity gains and higher parcel delivery levels to offset the continuing decline in letters volumes. And in broad terms, its performance in the early years was reasonable.
More recently, COVID-19 boosted the number of parcels Royal Mail delivered, but now those number have fallen back, laying bare the lamentable performance of the letters business. This is despite significant increases in the price of stamps.
A first class stamp now costs £1.25 (up 108 per cent since privatisation) and a second class stamp costs 75p (up 50 per cent). Overall inflation between 2013 and 2023 was 34 per cent. (Anecdotally, the public seem less and less concerned by such large increases in price which probably reflects their declining reliance on – and use – of the post.)
The International Distributions Services has appointed a new (very experienced) CEO who will be tasked with driving the much needed turnaround together with a yet to be appointed replacement for Royal Mail’s boss.
The new leadership team has some significant problems to tackle – and quickly. Relations with its workforce remain strained. The deal agreed should see some productivity gains, not least through a reduction in the workforce. But they’ll need to be significant to offset the higher pay rates agreed.
Parcels, so long a strong part of the business, will also need some attention as competition increases. Until 2020, Royal Mail had an exclusive parcels contract with the Post Office but while the contract was renewed, exclusivity wasn’t. The Post Office has now signed deals with Evri and DPD. Some customers will be able to use them instead of Royal Mail.
Those customers will no doubt compare reliability, but prices will also play a part. The spectre of price competition is now very real, potentially adding further pressure on Royal Mail to improve efficiency.
But the biggest issue is managing the decline in the letters business, and it simply cannot do that without help from the regulator. The roadblock to achieving major change is undoubtedly the universal service obligation, which is a millstone around Royal Mail’s neck, but which the Government seems to view as sacrosanct.
Ofcom is now reviewing the situation and will report back in 2024. Royal Mail will be hoping the Government and its regulator see the writing on the wall – and make their delivery targets significantly less onerous.
Paul Simmonds is a Teaching Associate in Strategy and International Business at Warwick Business School.
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