UK: Privatizing Royal Mail: Will It Lead To Further Efficiency Improvements?

Last Updated: 31 October 2013
Article by Stuart Holder and Helen Smith

Background

The postal industry is changing. Many national postal operators face falling demand as consumers switch to electronic communications and as competition within the industry grows (often from firms serving only part of the market, e.g., bulk mail). These challenges threaten the sustainability of the universal postal service, as well as the financial viability of existing postal businesses.

In the UK, the Postal Services Act was passed in 2011 with the aims of securing the long-term future of Royal Mail and the Post Office, and preserving the universal service. In response to the perceived failure of the previous regulatory regime and the unsustainable financial position of Royal Mail, the Act allowed the sale of up to 90 percent of Royal Mail, and passed responsibility for economic regulation from Postcomm to Ofcom, which has put in place a new regulatory framework (see box below). The UK government launched an Initial Public Offering in October 2013, including creating an employee share scheme placing 10 percent of the company in employee ownership.

Will privatization help secure the future of the universal service? Holder and Smith (2012) examined the potential benefits from privatization, drawing on evidence from a range of other regulated industries. This paper revisits this evidence in the light of recent developments. We present reasons why a privately owned firm might perform better than a publicly owned firm, and assess the available evidence across a wide range of regulated industries. We consider how these insights can be applied to the UK postal industry.

Box 1. New Regulatory Framework for UK Postal Market

The seven-year regulatory framework that Ofcom introduced in 2012 gave Royal Mail greater pricing flexibility and commercial freedom. It eliminated most price controls, though a "safeguard cap" on second class products remains, and gave Royal Mail more operational freedom (including the ability to change the terms and conditions of its products more easily). These changes came alongside the replacement of licensing with a general authorization regime.

Alongside deregulation, Ofcom put in place a number of safeguards. These include measures to ensure that universal services remain available and affordable to all and, where appropriate, to promote effective competition. Ofcom is monitoring Royal Mail's financial performance (particularly with respect to the universal service), operational performance (i.e., efficiency), customer and consumer metrics such as quality of service and affordability of universal services, and competition. It may consider re-regulation if the incentives to deliver greater efficiency are demonstrably failing.

Differences between Publicly and Privately Owned Firms

One reason why some privatizations might lead to efficiency improvements is that governments may not have exercised control over firms as effectively as private sector shareholders. Whereas private shareholders have clear objectives (to maximize the returns they make from holding the shares), some governments may let political objectives affect their decisions, for example in relation to industrial relations issues or the number and timing of job losses. And government departments may lack the necessary expertise to oversee the management and operation of large and strategically important firms.

To try to avoid such problems, governments can set clear commercial objectives for state-owned firms and control them on an arm's length basis. The UK government, for example, established the Shareholder Executive to exercise its role as owner of Royal Mail and other publicly owned firms. Even where governments attempt to mimic the behavior of private sector shareholders, however, firms may face additional constraints as a result of public ownership. For example, there may be restrictions on their ability to access debt finance (as this would add to government debt). And there may be formal or informal constraints on the remuneration packages that they can offer to senior managers.

A public sector firm with clear commercial objectives, managed on an arm's length basis, willing to implement politically unpopular policies, and able to raise finance and decide its own remuneration policy would still face some potential disadvantages compared with an equivalent private sector firm. Both public and private sector owners face the challenge of ensuring that the firm's managers act in the owners' interests, monitoring their effort and effectiveness in pursuing these objectives, and taking remedial action if they identify significant shortcomings. Economists refer to this as the "principal-agent problem". But private sector managers may be better equipped to deal with this problem. Among other things:

  • a firm's share price provides an additional tool, unavailable to the owners of public sector companies, to monitor the performance of individual firms and their managers; and
  • offering managers shares, or future share options, will help to align the interests of owners and managers, and may also allow private sector owners to offer opportunities for high earnings (i.e., if the shares rise in value) that would be difficult for a public sector owner to match. Added to likely constraints on the basic salaries of public sector managers, this means that the private sector may be able to employ better quality and more highly motivated managers.

Equity and debt financing of private sector firms also means that they face the possibility of takeover, if managers or owners are thought to be underperforming, and ultimately bankruptcy (or some form of special administration, for strategically important companies) in the event of sustained poor financial performance. Public sector firms do not face these pressures, as there is no public sector equivalent to the threat of takeover, and it is difficult for governments to commit to a "hard budget constraint" that would reduce or remove the likelihood that they would rescue a struggling firm.

There are a number of reasons, therefore, why privately owned firms are likely to have the incentives, skills, and flexibility necessary to operate more efficiently than publicly owned firms. Even a corporatized, well-run state enterprise, run at arm's length from the government and facing a credible hard budget constraint is unlikely to be able to achieve the efficiency of privately owned firms. Privatization improves firms' flexibility to invest and reorganize, adds the pressures of takeover and bankruptcy, and offers a wider set of tools to ensure the firm is run efficiently.

What Evidence Exists on the Impact of Privatization?

To determine whether there are benefits of private ownership in practice, we consider the experiences of post and other regulated industries, which have undergone different reforms including privatization, liberalization, industry restructuring, and regulatory reform, often simultaneously.

Evidence from the postal industry suggests there have been some benefits, but it is limited by the small number of privatizations that have taken place. Following privatization and market liberalization in Germany and the Netherlands, the incumbents have operated profitably and made efficiency improvements. Service quality has remained high, and both continue to provide universal services without compensation (with Deutsche Post doing so even without a legal obligation).

Evidence is also available from a number of other network industries, covering a range of different situations:

  • Full or part privatization of national telecommunications operators has occurred in all OECD countries. In most cases, this has been accompanied by deregulation and rapid technological change (affecting existing fixed line networks and also introducing competition from mobile networks and now from the Internet), making it difficult to isolate the impacts of privatization. But there is evidence that the combination of deregulation and privatization has delivered net benefits;
  • At least part of the electricity industry has been privatized in a number of countries. These industries have often undergone extensive restructuring, including the separation and liberalization of generation and sometimes also supply activities. There is some evidence for improvements in labor productivity following privatization;
  • Some water industries have been privatized, generally without the structural changes that have accompanied privatization in other industries. There is some evidence that privatization has led to improvements in operational performance and efficiency;
  • There are fewer examples of rail industry privatization, though there is some evidence from countries such as the UK, Switzerland, and Canada. International evidence supports the hypothesis that privatization has a positive impact on productivity. And in the UK, there is some evidence of improvements in train operators' efficiency following privatization, though causality is unclear.

Cross-section international comparisons of airlines provide a further useful source of potential evidence, as there are a number of publicly owned and private firms operating in a fairly similar environment. There is strong evidence that privately owned airlines are more efficient.

Table 1 summarizes the findings from some of the most relevant studies of these other industries. There is strong evidence of efficiency improvements following privatization in conjunction with restructuring or liberalization of these markets. However, in many cases it is difficult to identify the impact of privatization separately from other reforms. In some industries, the evidence suggests there is a separate (and positive) "privatization effect", but evidence is mixed in other industries, particularly water supply and telecommunications, with some studies finding evidence for a positive impact of privatization on efficiency, and others finding little or no evidence for such an impact.

One of the difficulties in considering the relevance of evidence from other industries is the lack of research into the specific reasons that privatization causes improvements in performance.

There are several important differences that mean that the impacts of privatization in the postal industry could differ from those experienced in other industries:

  • Postal networks are more labor intensive – as a result, it might be easier to reconfigure the network than in other industries if this will improve efficiency. But there is a greater risk that opposition from trade unions could limit potential gains;
  • More competition before privatization in the postal industry – whereas liberalization in other industries often occurred at the same time as, or subsequent to, privatization, many national postal operators have already been exposed to competition both from new postal operators and from other forms of communication. In theory, this could mean that some of the efficiency improvements observed in other industries may already have been realized;
  • Demand for postal services is falling – this could lead to increased pressure on private sector managers to improve efficiency and service quality. However, it may also make efficiency improvements more difficult to achieve, for example because there may be more resistance to changes in labor practices if the workforce has already experienced cuts due to falling demand; and
  • The postal industry needs to modernize – this could mean that the potential efficiency gains from postal privatization are larger than those in other industries, as postal operators can benefit from both modernization and the more general improvements that firms have been able to realize following privatization.

Furthermore, the nature of Universal Service Obligations (USOs) is another source of difference between post and other industries. Postal USOs set out products to be made available and associated minimum service standards, typically including the provision of nationwide postal services at a uniform price and an obligation to collect and deliver five or six days a week. These obligations are different from USOs in other industries, which are generally associated with a physical network. Postal operators face a greater risk of competitors "cherry picking" profitable services, as entrants can compete to provide services that are part of the USO, which might threaten its viability.

Conclusions

Both economic theory and empirical evidence suggest that privatization can lead to large efficiency gains. In private firms, the profit motive, greater flexibility, and shareholder pressure may lead to greater efficiency, and there are likely to be benefits over public ownership even if national governments run publicly owned firms relatively well (for example, having the expertise required to exercise effective control and ensuring the firm is free from political influences). In practice, evidence from a range of industries strongly suggests that privatization can help to improve efficiency as part of a package of reforms, some of which already been implemented in the UK postal industry.

In the light of this evidence, privatization seems likely to lead to improvements in Royal Mail's efficiency. Some improvements have already been achieved, reflecting the impact of liberalization, pressures on overall demand, and efforts to improve performance ahead of privatization. But the experience from other industries suggests that significant further improvements should be possible, provided Royal Mail can overcome the challenges associated with falling demand and possible trade union resistance.

The efficiency improvements generated by privatization will also help Royal Mail to sustain the universal service in its current form, one of the biggest challenges faced by postal operators. The combination of falling demand and increased competition within the postal industry may put upward pressure on unit costs, due to the loss of economies of scale and density (particularly in the delivery function), and could lead to price increases and further volume declines. Efficiency gains following privatization will help offset these changes, and private ownership will give Royal Mail the best chance of adapting to developments in the industry, and maintaining the universal service.

References

Affuso, Luisa, Alvaro Angeriz and Michael Pollitt (2009), 'The impact of privatization on the efficiency of train operation in Britain', CGR Working Paper 28, Centre for Globalization Research, School of Business and Management, Queen Mary, University of London

Boardman, Anthony, Claude Laurin, Mark Moore and Aidan Vining (2013), "Efficiency, profitability and welfare gains from the Canadian National Railway privatization", Research in Transport Business & Management, 6, pp 19-30

Bel, Germà and Mildred Warner (2008), 'Does privatization of solid waste and water services reduce costs? A review of empirical studies', Resources, Conservation and Recycling, 52, pp. 1337-1348

Boylaud, Olivier and Giuseppe Nicoletti (2001), 'Regulation, Market Structure and Performance in Telecommunications', OECD Economic Studies No. 32, 2001/I

Cowie, Jonathan (1999), The Technical Efficiency of Public Ownership, Journal of Transport Economics and Policy, 33, pp.241-252

Crew, Michael A. and Paul R. Kleindorfer (2008), 'Reform of the United States Postal Service: an unfinished task' in M.A. Crew, P.R. Kleindorfer and J.I. Campbell Jr. (eds), Handbook of Worldwide Postal Reform, Cheltenham, UK and Northampton, MA, USA: Edward Elgar, pp. 123-142

Daßler, Thoralf, David Parker and David S. Saal (2002), 'Economic performance in European telecommunications, 1978-1998: a comparative study', European Business Review, 14 (3), pp. 194-209

D'Souza, Juliet and William Megginson (2000), "Sources of performance improvement in privatized firms: A clinical study of the global telecommunications industry", working paper U. Oklahoma.

Eckel, Catherine, Doug Eckel and Vijay Singal (1997), 'Privatisation and efficiency: industry effects of the sale of British Airways', Journal of Financial Economics, 43 (2), pp. 275-298

Ehrlich, Isaac, Georges Gallais-Hamonno, Zhiqiang Liu and Randall Lutter (1994), 'Productivity Growth and Firm Ownership: An Analytical and Empirical Investigation', The Journal of Political Economy, 102 (5), pp. 1006-1038.

Gassner, Katharina, Alexander Popov and Nataliya Pushak (2009) Does private sector participation improve performance in electricity and water distribution?, Washington DC: The World Bank.

Holder, Stuart and Helen Smith (2012), "Privatization: could the benefits seen in other network industries be realized in postal industries?", in: M.A. Crew, P.R. Kleindorfer (eds) Multi-modal Competition and the Future of Mail, Cheltenham, UK and Northampton, MA, USA: Edward Elgar, pp. 150-165

Koppe, Peter, Christian Bosch, Silke Hömstreit and Stefan Pohl (2009), 'The IPO as a driving force in the change process', in M.A. Crew and P.R. Kleindorfer (eds), Progress in the Competitive Agenda in the Postal and Delivery Sector, Cheltenham, UK and Northampton, MA, USA: Edward Elgar, pp. 322-338

Kwoka, John. E (1993), 'The effects of divestiture, privatization, and competition on productivity in U.S.and U.K. telecommunications', Review of Industrial Organization, 8, pp. 49–61.

Maschke, Walter (2002), 'Transformation at Deutsche Post World Net using the Example of Socially Compatible Workforce Adjustment', in M.A. Crew and P.R. Kleindorfer (eds), Postal and Delivery Services: Delivering on Competition, Boston, MA: Kluwer Academic Publishers, pp. 303-319

Ng, Charles K. and Paul Seabright (2001), 'Competition, Privatisation and Productive Efficiency Evidence from the Airline Industry', The Economic Journal, 111, pp. 591-619

O' Mahony, Mary and Vecchi, Michela (2001) "The Electricity Supply Industry: A Study of an Industry in Transition", National Institute Economic Review, 177 (1), pp. 85-99

Ofcom (2011), "Securing the universal postal service: Proposals for the future framework for economic regulation"

Ofwat (2009), "Ofwat's response to the independent review of charging for household water and sewerage services", October.

Peda, Peeter, Giuseppe Grossi and Margo Liik (2013), "Do ownership and size affect the performance of water utilities? Evidence from Estonian municipalities", Journal of Management & Governance 17 (2), pp 237-259

Pollitt, Michael G. and Andrew S. J. Smith (2002), "The Restructuring and Privatisation of British Rail: Was It Really That Bad?", Fiscal Studies, 23 (4), pp. 463-502.

PwC (2013), "The outlook for UK mail volumes to 2023"

Ramamurti, Ravi (1997), "Testing the limits of privatization: Argentine railroads", World Development, 25 (12) pp. 1973-1993

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.