Criticism of Amazon and the US Postal Service is justified
Amazon has had a torrid few weeks, with its share price down over 10% from an all-time high of $1600 on March 12th. The decline has several contributing factors, including the tech stock sell-off following the Cambridge Analytica scandal. But it’s also been caused by the tweets of one man: Donald Trump.
It is no secret that Trump dislikes Amazon. Jeff Bezos, the founder of Amazon, is also the owner of the Washington Post, a newspaper Trump has repeatedly labelled ‘fake news’.
This time, Trump is insistent that Amazon benefits from a United States Post Service (USPS) that charges too little to deliver Amazon’s packages. He may actually have a point.
The argument centres on the allocation of fixed costs within the USPS’ two business segments: the competitive parcel delivery side of the business, and the letter side — a government protected monopoly.
The USPS’ competitors, FedEx and UPS, have long argued that due to a misallocation of these fixed costs, the USPS has been able to unfairly charge prices below its actual cost on the competitive parcel side of the business, making it difficult for other firms to compete.
Trump agrees. On 3rd April, the US President tweeted: “I am right about Amazon costing the United States Post Service massive amounts of money for being their delivery boy. Amazon should pay these costs (plus) and not have them bourne by the American Taxpayer. Many billions of dollars. P.O leaders don’t have a clue (or do they?)!.”
The general consensus is that Trump is wrong. Both The New York Times and the Associated Press came out in response to point out that the USPS does make a profit from its contract with Amazon.
But his critics may be missing the point.
This is not an argument about whether or not the USPS’ deal with Amazon is profitable on the balance sheet, but one about whether or not USPS’ fixed costs are correctly divided between the competitive (parcel delivery) part of the business and the government monopoly (letter delivery) part. If they are not, the USPS may be setting prices that are too low, impacting the ability of private parcel delivery companies to compete.
It’s all about costs
In 2006 two important pieces of regulation were introduced as part of the Postal Accountability and Enhancement Act.
The first is that the USPS’ product offerings are to be priced such that they recoup both volume variable costs as well as their “appropriate share” of the organisation’s fixed costs. Since 2006 the share of fixed costs for parcel deliveries has been set at 5.5%, at a time when parcel deliveries only accounted for 11% of the revenue of the USPS. Fast forward to 2018 where parcel deliveries now contribute 30% of USPS’ revenues and the proportion of fixed costs on the parcel delivery segment is still stuck at 5.5%.
This seems bizarre, particularly given that the large cost issues associated with parcel delivery (lower customer density for one) are what dissuades Amazon from fulfilling final-mile delivery for its customers in the first place. As a side note — UPS estimates that the USPS’s parcel side of the business should be allocated 24.6% of the overall fixed costs.
The second piece of regulation from the 2006 Postal Accountability and Enhancement Act forces the USPS to pre-fund its future retirees’ health benefits. The cost is over $5 billion a year, and with a net income of only $0.9 billion in 2006, the USPS quickly began posting a string of losses. In response to these losses, since 2012 the USPS has been allowed to default on its annual pre-funding payments, and the accrued amount stands at $40 billion. This will have to be funded at some stage in the future, and probably by the American taxpayers.
My observations
This is a tough argument to choose one side over the other, particularly as the terms of the USPS/Amazon deal have not been made public.
However, I think it is worth pointing out that USPS’ parcel delivery service is designed to price at cost to support individuals and small American businesses. The requirement to price at cost recognises the fact that the end user will extract most of the economic surplus from the transaction because the USPS foregoes that surplus by intentionally not making any profit.
I believe that enough evidence exists to support the argument that the USPS is actually producing below cost, as its fixed costs are likely to be incorrectly divided between its business activities. As the USPS has pivoted away from delivering letters to delivering parcels, you would expect its fixed costs to have shifted accordingly. This hasn’t happened. Prices have likely stayed lower as a result.
Additionally, the USPS is defaulting on its $5 billion a year health pension benefit contributions. These have to be paid for at some point in the future.
Therefore I believe the USPS has two options:
1. It could re-calibrate its allocation of fixed costs on the balance sheet to take into account the shift of the business towards parcel deliveries. This would see prices rise for USPS parcel deliveries, and would likely be followed by similar price increases from rivals UPS and FedEx, who have long argued that prices in the industry are set far too low. The USPS’ health pension benefit contributions could be covered (depending on the nature of competition following this increase). Amazon and other end users would pay for more for parcel deliveries, but these prices would be a better reflection of the underlying cost pressures at the USPS.
2. Or, the USPS could continue with the way things are now, with Amazon and other end users extracting most of the economic surplus from parcel deliveries. The USPS’ health pension benefits would need to be funded further down the road, most likely by the US taxpayer.
Option 1 would be the most equitable outcome.
Trump may just be targeting Amazon because of Jeff Bezos’ ownership of the Washington Post but I believe in this case, inadvertently, he has a point.
