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market segment.

While the Postal Service has lost market share

in these smaller markets, its First- and third-class markets have

grown, protected by what has been a monopoly position.

However,

since 1984, the rate of growth for third-class mail has declined to its lowest level since the mid-1970s. Rising postal rates

have encouraged competition and diversion to other forms of

communication, causing part of the decline.

Because of the substantial rate increases since 1988, some postal

customers are actively seeking alternative means of communication. This competitive situation may create further decreases in Postal Service volume, reduce revenues lower than required to break even, and generate the need for more frequent

rate increases to cover revenue shortfalls.? This in turn could

further erode the Postal Service's market share and create a

vicious cycle of volume and revenue shortfalls leading to still

more frequent rate increases.

Given this possibility, the

question arises as to whether the criteria set forth in the

Postal Reorganization Act of 1970 that guide postal ratemaking are still adequate in light of the competitive and changing

environment the Postal Service faces.

2The Postal Service has reported net operating losses from 1987 through 1991 totaling about $1.1 billion. About half of these losses were due in large part to legislative actions requiring the Postal Service to make unplanned payments for retirees' costof-living allowances and health benefit expenses.

The Postal Service recognizes from its lost market share in parcel post and overnight delivery that to be competitive it must control the growth in operating costs; offer its customers a full range of services that are prompt, reliable, and courteously delivered; and price its services to reflect changing demands for

its products. Although it has begun to address the first two

issues through its strategic plan, the Postal Service is

constrained--by legislative design--in its ability to set rates.

Since the late 1970s, the Postal Service and the Postal Rate

Commission have disagreed over the extent to which the ratemaking criteria allow the use of demand factors to be used in allocating the Postal Service's huge overhead burden among the various mail

classes.

This disagreement is the basic reason why the Postal

Service's request in 1990 for a 30-cent First-class stamp was

reduced to 29 cents by the Commission and third-class rates were

raised, on average, 8 percentage points higher than the Postal

Service requested.

The Commission also rejected volume discounts

as a discriminatory pricing strategy when the Postal Service proposed such a discount for its Express Mail service.

The ratemaking criteria set forth in the Postal Reorganization

Act were established during a period when the Postal Service had

less competition than it does now.

Because the Postal Service is

facing a changing and increasingly competitive environment that requires greater flexibility in pricing postal services, we

believe that Congress should reexamine the nine criteria that the

Postal Rate Commission considers in the ratemaking process to

determine if the criteria are still valid in light of changing

marketplace realities.

We believe that demand pricing, which

considers the "value-of-service" to the sender, should be given

greater weight in the criteria used as a guide for allocating overhead costs and setting postal rates. Further, we believe

that Congress should reexamine the question of whether volume

discounts to large business users is in fact undue discrimination

or preference given this practice's wide use by private carriers

in competition with the Service.

In the long run, if demand

based pricing is not given more weight in the criteria as one of several factors to be considered in ratemaking, the Postal

Service could experience serious losses in its price sensitive

third-class market as well as its second-class market and thus

drive up the cost of First-class postage to cover these losses.

Congress could then be faced with demands to further open postal

markets to competition or to subsidize the national delivery

network through appropriations.

POSTAL AUTOMATION

Increased ratemaking flexibility will not, in itself, guarantee survival of the Postal Service in the competitive marketplace. Control of operational costs is also essential. Historically,

mail volume growth every year has helped keep rate increases to

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percent in 1991) will generate the need for larger or more frequent rate increases. The major contributor to postal costs

and their growth is employee pay and benefits. As a percentage of total operating expenses, employee pay and benefits have

exceeded 80 percent for the past 20 years.

Faced with the

reality of not having complete control over employee pay and

benefits, the Postal Service tries to make its workers more

productive by making operational changes and capital investments in equipment and facilities. The latest and perhaps the most

intensive effort to improve productivity is the automation

program.

This program, with optical character and bar code readers as

core

equipment, became operational in 1982. It received renewed emphasis in 1988 when the postmaster General announced a goal of

bar coding nearly all mail by the end of 1995.

In response to congressional interest in automation, we have

issued six reports on various aspects of this program since

January 1983.

The report being released today, prepared at the

request of this Committee and its Postal Operations and Services

Subcommittee, provides an assessment of the program's impact on

productivity and labor costs during 1991.'

The Postal Service recognizes that automation provides one of the

best and most effective ways to control costs if it is to stay

competitive in the marketplace. However, although the Postal Service's automation program is producing savings in certain functional areas, it is unlikely to be a panacea that will

reverse the persistent tendency for costs to outpace inflation.

Given that the Postal Service has spent $2 billion on automated

equipment and had a 9-digit bar code on 40 percent of the mail by

the end of 1991, it is somewhat surprising that its measurement

of savings remains ad hoc and inconsistent.

Publicly, former

Postmaster General Frank has cited the decline in the number of

career employees as savings made possible by automation and related cost control initiatives in mail processing and delivery. This gross measure ignores the fact that workhours--the work

actually put in by employees and paid for by the Service--have

not fallen commensurately.

When career employment was down

34,000 during 1991, overtime was higher by an amount equivalent to 15,000 full-time employees and work by non-career employees

had increased the equivalent of another 3,000 full-time

employees.

'Postal Service: Automation Is Restraining But Not Reducing Costs (GAO/GGD-92-58, May 12, 1992).

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