Speech: ‘Australia Post in the Digital Age’

June 24, 2014
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Speeches

CEDA National Annual Conference – State of the Nation
‘Australia Post in the Digital Age’
Canberra, 24 June 2014

## Check Against Delivery ##

Good morning and thank you for the opportunity to take part in CEDA’s 35th   State of the Nation dialogue.

The Committee for the Economic Development of Australia (CEDA) was established more than half a century ago as an apolitical forum focused on major policy questions facing the nation. Over the years it has participated in several of our most contentious debates over changes that challenged prevailing economic or social orthodoxies. So it isn’t news to anyone at CEDA that structural economic reform is profoundly politically challenging.

Economic reform is always challenging, it disturbs the established order and while there should always be many more winners (rarely vocal in their appreciation) than losers (invariably highly vocal in their dissatisfaction), there are always losers.

Of course when we think of the forces disrupting the globe at present – the spread of ever more powerful digital technologies into every aspect of our lives, and the return of Asia to the centre of the world economy – the limits to the power of Governments to stand in the way of change becomes clear.

That doesn’t mean they won’t come under pressure to try. Business owners and employees alike can rage against the Internet or the rise of China as they see their incomes eroded, but there is nothing they can do about it – other than compete, faster and smarter, or demand a bail out from Canberra.

It’s hard enough for Governments to resist those pressures.  When difficult circumstances for firms or their workers arise from the conscious policy choices of a Government pursuing structural reform, those pressures are even greater. The losers can lobby their elected representatives, they can gee up  the media to rally public opinion, they can campaign against the reform, and they can vote out the reformers.

So while Governments can be an important agent of change and economic progress – and in Australia were emphatically that under most Prime Ministers over the past thirty years – democratic accountability and the propensity of some politicians to cave in under pressure make it a fragile and inconsistent one.

So it is always critical that when we contemplate significant economic or social changes, we carefully and methodically prepare the ground for it.

● That means explaining the problem to the electorate. The first step in any reform process must be to repeatedly explain the facts and tell the truth about the situation.
● It means providing authoritative third party verification of the problem – as Gary Banks has pointed out, an independent Productivity Commission dedicated to evidence-based policy was a powerful tool helping Governments during the reform era.
● It means making the case, persuasively and repeatedly, for what needs to be done.
● And it means pursuing consistent, coherent reforms – treating varying interests equivalently encourages a sense of fairness, while successful reforms tend to build on each other.

Put another way, nobody will accept the bitter pill unless they are convinced they are ill. You cannot sell a solution until you have established there is a problem.

So the first step in the reform process must be to tell the truth about the current state of affairs and then make the case for what needs to be done.

In my own portfolio two government business enterprises provide classic case studies for the reform process.

The NBN and Australia Post

Both NBN Co (of which I have spoken elsewhere and at length) and Australia Post, which I will discuss at length today, face very serious challenges and in each case their capacity to respond is constrained by Government.

So immediately after the election, having appointed a substantially new board for NBN Co composed of people with relevant industry experience I asked the Directors to conduct a strategic review of the project which would tell the truth about the current status of the project, its business as usual trajectory and what our options were to complete it sooner, cheaper and more affordably for consumers.

The Strategic Review told a sorry tale of mismanagement, missed targets, blown budgets and a likely completion cost of $32 billion more than Labor had forecast. The best of the alternatives was the “Multi technology” strategy which simply meant focussing on the customers, delivering them the service levels they need and will value and using the most cost effective technology to do so in any particular area.

Since then we have ensured that the NBN Co continues to be thoroughly open. Rollout and connection figures are no longer released on a Minister’s whim to suit political convenience but posted on the NBN Co website every week. The NBN Co reports quarterly as though it were a listed company and holds a full results presentation every six months with industry analysts and journalists invited to quiz the senior executives. This in addition to frequent appearances before Senate Committees.

But the important thing is that while our changes at NBN Co have not been without controversy, Australians understand the nature of the mess we inherited, why we have made the change in strategy, and how the business is responding.

Australia Post - the case for reform

Unlike the NBN Co whose problems are the consequence of poor policy and management decisions by Government, Australia Post is facing up to a technology tsunami which threatens its fundamental business model.

But unlike its private sector competitors, Australia Post’s ability to respond to digital disruption - to digital substitution - is limited under regulations that compel the company to provide a five day a week delivery service to 98 per cent of all homes and businesses.

Australia Post is one of our oldest businesses, indeed it is the oldest Commonwealth Government owned business with roots that go all the way back to the colonies and Cobb & Co.

Today the Government is releasing an important study by the Boston Consulting Group (BCG) into Australia Post’s regulated letters business, its future prospects and how it compares to its  international counterparts.

Australia Post had revenues of more than $5.8 billion in FY2012-13, employs more than 32,000 Australians and has returned a dividend to government every year since corporatisation in 1989. In the last five financial years alone, Australia Post has paid nearly $966 million in dividends to Government and has not missed a dividend since it was corporatised.

A nice, rather big, earner.

But those halcyon days are quickly coming to an end.

And the reason is very clear.

It’s the internet. Australia Post is a high fixed cost business and year after year letter volumes have been declining. Over 80 cents of every dollar lost in letter revenues goes straight to the bottom line.

Big changes are needed. Without them there is only the prospect of a sea of red ink and ultimately ruin.

So the most important first step, here as with the NBN, is to tell the truth. And since I became the Minister I have asked the management of Australia Post to be more transparent and open about the challenges to their business, and you have seen Mr Fahour doing just that in recent months.

Once again, if you want to persuade people that the price of stamps must increase or the frequencies of letter deliveries change, then you have first to show them why that change is needed.

Tell the truth, disclose the problem, present the solution.

In 2009/10 a typical household spent between $8 and $19 a year sending letters – much, much less than on phones ($1,750), TVs ($670), computers ($384) and the Internet ($404).

Between 2008 and 2013, letter volumes in Australia declined at an average of 5.3 per cent per annum – or put another way, about one billion fewer letters have been sent over the past five years.  It’s important to recognise that the Australian experience is not a unique one – letter volumes have declined at a similar rate in comparable OECD countries. In New Zealand, letters volumes have declined by 5.8 per cent between 2008 and 2012, with average declines of 7.4 per cent in the United Kingdom over a similar period (2007-2012).



And while this has resulted in letters losses totalling hundreds of millions of dollars – more than $710 million alone in the regulated letters business in the last four financial years – until now, profits from Australia Post’s parcels business have offset or subsidised losses in the regulated letters business. 

This means that despite extreme structural pressure, Australia Post has continued to deliver strong commercial returns to successive governments.

Those happy days are over. The profits of parcels are not big enough to offset the growing losses in letters.

In a business as usual case BCG forecasts that Australia Post will return no future dividends to government and will deliver a total enterprise loss – the first since the company was corporatised in 1989 – as early as next financial year.
BCG predicts that letter volumes will decline by an average of 8-11 per cent per annum to FY2019-20, with no floor in the rate of decline – meaning that volumes will continue to decline until there are few letters passing through the network.

Why are letter volume declines accelerating?

Digital disruption is the most significant factor to explain the rate of letter decline but other important factors are at play.

Businesses are increasingly turning to digital alternatives both to save money and improve the quality and convenience of their engagement with customers. The banking sector is an obvious example.  And even those businesses that have a regulatory requirement to physically send a financial statement are doing so less frequently, with many cutting back from hard copy statements sent monthly to the end of the financial year only.

This is significant because business and government account for over 90 per cent of total letter volumes, meaning that the more business and government turn to digital channels, the more the rate of letter decline will accelerate. 

And our own e-government policy sets a goal of making all engagement with the Federal Government capable of being conducted online by 2017!

High fixed costs and declining letter volumes

As I noted, about 80 per cent of the costs of Australia Post’s letters business are fixed.  The postie has to go up and down your street every day whether his bag of letters is full or nearly empty. And because the company has a regulatory obligation to provide five day a week letter delivery to 98 per cent of homes and businesses, letter sorters must work through the night to ensure uniform delivery times are met for all letters, regardless of their urgency or importance.  So there aren’t a lot of easy cost savings measures available.

And at the same time as the post bag is emptying there are about 150,000 new premises being added to the delivery network each year, meaning the cost to service homes and businesses continues to increase despite a rapid decline in letter volumes.

Losses

Without reform, letter losses will soon overwhelm parcel profits, with overall losses for Australia Post as early as FY2014-15. BCG estimates that there will be total cumulative deficits of $12.1 billion for the letters business and $6.6 billion for the company over 10 years from FY2013-14 to FY2022-23.
At an enterprise level, the impact of declining letter volumes has, until now, been offset by business improvement initiatives centred on efficiency, such as improved sorting and processing automation, as well as profit growth in parcels and retail, ensuring the company’s short term viability.



But it’s worth noting that the parcels and retail businesses are also facing challenges.

Not only is growth in the e-commerce market slowing - year on year growth last year was 14 per cent, down from 26 per cent  in 2012 - the parcels market is also becoming increasingly competitive, with new entrants eating into Post’s market share.  Australia Post’s parcels business will grow by about 1.5 per cent this financial year, down from about 9 per cent in FY2012-13.

Digital substitution is having a similar impact on the retail business – that while profitable, foot traffic into retail premises is falling because more and more of the services on offer can be accessed more conveniently online.


Service levels

BCG believes service levels under the current model of letter delivery exceed the demand of most customers, with survey data suggesting that two thirds of people rely on their mail only one or two days per week.

Even though the overwhelming majority of mail is sent by business and government - more than 90 per cent - service requirements are determined by the needs of receivers, how they use, and how much they value postal services.

BCG believes that service levels under the current model of letter delivery exceed the demands of most customers.

BCG’s analysis of the results of a 2014 survey of 8000 customers conducted by Australia Post showed approximately half of survey respondents were willing  to accept a move to three day a week letter delivery.

But the results are more interesting once the true costs of service levels are made transparent to end-users. There is a corollary here with broadband - it is one thing to promise gigabit line speeds but experience shows few customers are prepared to pay any significant premium for those speeds. Among the respondents to the Australia Post survey, an average of five per cent said they would be willing to pay $25 a year to retain current standards.

What’s more, it’s the age groups most likely to reject the idea of three day delivery who are the least likely to willingly pay a premium for the service. Of those aged above 60 years, 37 per cent said they would oppose three day delivery but only five per cent said they would pay the $25 a year premium.



What is to be done?

The conventional response for businesses faced with existential challenges of this kind has all too often been a form of Micawberism - muddling through and hoping something turns up. Sometimes this includes the added folly of refusing to participate in the cannibalisation of your own legacy business, meaning of course that other people do it!

To its credit Australia Post has established a digital mailbox business. They recognise that it will never have the scale in revenues or traffic, let alone profitability of the monopoly letters business of old, but at least they are trying to be part of the solution. Instead of getting washed away by the new wave they are trying to catch it.

It’s clear from the work that  Australia Post and BCG has done, and from the experience of postal operators around the world, that a key to reform is to ensure the stamp price reflects the actual cost of delivery - something that is not currently the case in Australia. Another is to introduce a two-speed letters service - a priority service delivered on five days a week and a regular service delivered on three.


Australia Post’s retail network consists of 4400 outlets, mostly shops, of which 2500 are licensed post offices. 1500 of those LPOs are in rural and regional areas. They have been doing it tough as letter volumes and traffic through the post offices decline as people not only send fewer letters but pay their bills online.

Australia Post has responded to this by increasing the annual payments to LPOs and of course increases in the basic postage rate are also helpful.  But if we want to keep post offices open, and we do wherever possible , then Australia Post needs to replace declining products and services - such as basic payments - with new ones like more trusted services such as licences and potentially representing Centrelink and Medicare and other government agencies.  24/7 parcel lockers and Saturday trading, parcel and Express Post delivery also support the viability of Australia Post’s retail network.

Some people have suggested that the answer is privatisation. There is plenty of precedent for this in other countries, but if the profitable parcels business were to be spun off who is left to pick up the tab for the retail network and the declining letters business? Getting a privatisation cheque in one hand and a continuing and growing claim on government subsidies in the other is not very appealing.

The first thing to do is ensure that there is transformation of Australia Post to ensure the company’s survival in an increasingly digital world. That will take some time. That is why we have made it clear we are not contemplating any privatisation of Australia Post.

Another option, of course, is just to leave things as they are and subsidise the growing losses. Every dollar taken away from a profitable business and given to an unprofitable business is a bad use of taxpayer’s money.  While it may involve holding on to some jobs in incumbent sectors in the short term, the cost of retaining those jobs will increase in the long term - and by overtaxing growth sectors, people don’t think about the jobs that weren’t created. That is not an option, at least not for this Government.

Conclusion

Reforming Australia Post is not an easy job. Without regulatory change we are placing the company’s viability and long term sustainability at risk.

Reform of this kind requires political and public consensus.

On the political side, I am pleased that there has been, so far, bipartisan agreement on the urgent need to reform the regulated letters business.

At the heart of the reform process is explaining to Australians why reform is needed and how it will ensure the company’s long term sustainability - that without reform, we are jeopardising the future of Australia Post.

It is important to explain the hard facts - clearly and in a manner that supports informed debate.

The regulated letters business is losing hundreds of millions of dollars each year. That Australians are sending fewer letters today than they did five or 10 years ago is hardly a revelation.

And while the parcels business will continue to grow - albeit more slowly than it has in recent years - the rate of letters decline is now so large that it will overwhelm all profitable areas of the company as soon as next financial year.

As we have done with the NBN, we will tell the  public the truth about  Australia Post, the challenges it faces and the changes that will enable it to survive and prosper.

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