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The document discusses the financial challenges faced by the USPS, highlighting unprecedented losses driven by volume declines in first-class mail, the burden of retiree health benefit pre-funding, and high fixed costs in its operational network. It outlines projected cumulative losses of $238 billion by 2020 without significant management actions, and suggests potential actions within USPS control to mitigate these losses and improve financial performance. Key trends impacting the USPS include declining mail volumes due to e-diversion, cost pressures from fixed service obligations, and legislative constraints on pricing and cost savings.

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USPS Future Business Model March 2, 2010
McKinsey & Company 1| Contents ƒ Recent context ƒ Base case – minimal management actions ƒ Addressing the challenge ƒ Short term requirements
McKinsey & Company 2| USPS is experiencing unprecedented losses SOURCE: USPS; P.L. 109-435 (PAEA) -7.82 2010 0.9 05 1.4 04 3.1 03 3.9 02 -0.7 01 -1.7 2000 -0.2 06 -2.8 0907 -5.1 08 -3.8 Net profit/loss $ billions Postal Act 2006 signed into law Note: All years in this document refer to Fiscal Years ending on Sept 30 1 Includes one-time $4 billion deferral 2 Per 2010 Integrated Financial Plan (January Year-to-Date results are favorable to Plan) 8.4 5.6 1.41 5.5 RHB pre-funding, $ billions Key drivers ƒ Revenue declines due to: – E-diversion of First- Class Mail – Down-trading from First-Class to Standard Mail – Losses of advertising mail due to the recession ƒ RHB pre-funding requirement introduced by the PAEA ƒ Cost savings, while substantial, have been less than revenue declines due to high fixed costs of the network No rate increase 2003-2006 Recent Context
McKinsey & Company 3| Losses have been driven by volume declines, RHB pre-funding requirements and limitations on cost savings 0.9 FY2006 Net income 4.0 FY2009 Net income -3.8 RHB deferralCost savings 12.6 RHB pre- funding requirement 5.5 Revenue decline1 15.8 Drivers of change in net income 2006 vs. 2009 $ billions SOURCE: USPS 2006 Annual Report; USPS 2010 Budget 1 Revenue declines calculating by applying 2009 prices against 2006-09 volume declines ƒ Volume declines of 17%, driven by – E-substitution – Ad spend shift to other channels – Deep recession ƒ Savings driven by – Reduction of overtime – Extreme slow-down in hiring – Route consolidation – Volume reduction Recent Context
McKinsey & Company 4| Volume declines have been worse than expected when the current legal and regulatory framework was established 240 230 220 210 200 190 180 170 160 0 20100908070605042003 Actual Upside forecast Downside forecast Base case forecast SOURCE: USPS 2005 forecasts2 ƒ When PAEA was passed, volume projections did not anticipate the current scale of declines ƒ PAEA introduced some additional product flexibility, but also two crucial restrictions: – Price increases capped at CPI by class – Significant pre-funding requirements for Retiree Health Benefits (RHB) 1 Postal Accountability and Enhancement Act, 2006 2 Forecasts from “USPS Strategic Transformation Plan”, 2005 Volume forecasts and actuals Billions of pieces PAEA implications1 Recent Context
McKinsey & Company 5| First-Class Mail, Standard Mail and GDP growth Cumulative increase from 1973, percent The recession has exacerbated volume declines, but mail has reached an inflection point, with e-diversion now driving long term decline 250 150 Standard Mail volume 300 100 0 2005200019951990198519801975 First-Class Mail volume Real GDP 200 50 350 400 SOURCE: USPS 2009 Recent Context
McKinsey & Company 6| Retiree Health Benefit funding requirements are a significant burden, equal to 12% of total revenue in 2010 RHB payments, 2006 – 2010 $ billion SOURCE: USPS 2009 10-K; USPS 2010 Budget 8.4 5.6 1.4 5.5 20092 3.4 2.0 2008 7.4 1.8 20071 10.1 1.7 2006 1.6 2010 2.2 7.7 ƒ Pre-funding is unique to USPS within the public sector, and rare (and not required) within the private sector Drivers of RHB requirements ƒ Schedule of pre-funding requirements is accelerated in the first 10 years of the 50 year liability ƒ Actuarial estimates of total RHB liability vary widely based on differences in discount rates, future health care costs, the size of the workforce, and period of pre-funding PAEA scheduled pre-funding requirement Employer premiums Recent Context 1 $8.4B scheduled payment includes $3B legacy payment from CSRS 2 $1.4B scheduled payment includes $4B deferral from Congress
McKinsey & Company 7| Recent reductions in workforce usage have been significant, but pieces per FTE still declined in 2009 262 07 265 06 261 05 258 2009 251 03 243 02 234 04 249 0801 231 2000 227 USPS workforce FTEs1, Thousands Pieces per FTE Pieces per year, thousands SOURCE: USPS 1 Full Time Equivalent, based on work hours (includes overtime) 0 2009 711 08070605 950 900 850 800 750 700 1,000 040302012000 917 Recent Context
McKinsey & Company 8| The USPS has been responsive to declining volume, but recent work hour reductions will become increasingly difficult to replicate SOURCE: FY 2009 10-K; 2007 and 2009 National Payroll Hour Summary Report Work hours reduction Sources of work hours reduction 74M (45%) 12M (7%) 79M (48%) Millions of hours Recent Context 1,175 146 90 2007 1,423 Overtime Non-career 67 2009 1,258 1,101Career 102 -12% Career Non Career Overtime 55% of reductions have come from non-career and overtime
McKinsey & Company 9| Contents ƒ Recent context ƒ Base case – minimal management actions ƒ Addressing the challenge ƒ Short term requirements
McKinsey & Company 10| Four trends will affect postal economics going forward Volume Price Workforce costs USO Obligation ƒ Transactional volume declining due to e-diversion ƒ Advertising mail is subject to increased substitution options ƒ Increases capped by inflation class ƒ Price elasticities are in flux due to growing alternatives ƒ Delivery points ƒ Retail locations ƒ Sortation facilities ƒ Preferred prices for some products (e.g., non-profit mail) ƒ RHB pre-funding driven by law ƒ Legacy costs beyond USPS control ƒ Wages subject to collective bargaining REVENUE TRENDS COST TRENDS These trends will continue to put pressure on USPS ability to provide affordable universal service Declining steadily Fixed cost base Rising cost per hour Rising but capped Base Case
McKinsey & Company 11| 0 40 80 120 160 200 Volume will decline significantly over the next decade driven by a steady decline in First-Class Mail, the most profitable segment SOURCE: BCG; USPS Financial Forecasting Model BCG volume forecast Billions of pieces Change in volume 2009-2020 Portion of margin available to cover fixed costs, 2009 -31 billion +4 billion (1.5%) per year <-1 billion 71% 21% 8%Other (e.g., packages, periodicals) Base Case: Volume Declines 150 Standard First Class 2009 2020 177
McKinsey & Company 12| USPS Revenue $ Billions Overall revenue will slightly increase, as inflation-driven price increases will offset the volume decline and shift to Standard Mail SOURCE: BCG; Global Insights; USPS Financial Forecast Model Price impact $16.8 Mix shift from First-Class to Standard1 $3.8 Volume decline $11.8 2009 Revenue $68.1 B 2020 Revenue $69.3 B An additional 27 Billion pieces are forecast to be lost (15% of total). Assumes no loss due to elasticity An additional 27 Billion pieces are forecast to be lost (15% of total). Assumes no loss due to elasticity The loss in First-Class will be even higher (37% of total), lowering the average price The loss in First-Class will be even higher (37% of total), lowering the average price Prices forecast to rise with inflation Prices forecast to rise with inflation 1 Calculated by applying the 2009 First-Class/Standard mix to 2020 prices. Excludes mix shift in any other categories Base Case: Revenue Projection
McKinsey & Company 13| Costs, from a workforce standpoint, are largely fixed to fulfill the universal service obligation and other service requirements SOURCE: USPS FY 2009 10-K Post Offices (36,500 Post Offices, Stations and Branches1) ƒ Built so that Americans have nearby access ƒ Continued urban sprawl and growth puts pressure to increase retail outlets ƒ Significant resistance and administrative burden to closing existing Post Offices ƒ Prohibited by law from closing Post Offices for economic reasons Delivery network (~150 million delivery points2) ƒ Required to deliver to almost every address in America ƒ 6-day delivery to every delivery point Sortation plants (600 processing facilities) ƒ Built to ensure overnight delivery of local mail ƒ Network largely fixed unless service standards change ƒ Significant political resistance and administrative burden to closing plants e a existing Post Offices from closing Post Offices asons Network historically built to provide high service levels to citizens, on the basis of growing volumes Transportation (220,000 vehicles) ƒ Large vehicle fleet ƒ $2.6 billion in air transportation expenses 1 Includes CPUs 2 Includes approximately 20 million PO Boxes Base Case: Fixed Cost of USO
McKinsey & Company 14| Without aggressive management cost-cutting, work hours will remain flat with volume decline countered by more delivery points Base Case: Impact of Volume and USO/Service Levels on Workforce Costs 5664 2020 1,245 Reduction in overhead 1 Reduction in PO locations 4 Increase in delivery points Mail volume reduction 2009 1,258 Millions of work hours 1.5% per year drop in volume (27B fewer mail pieces) 1.5% per year drop in volume (27B fewer mail pieces) Increase by 0.8% per year (~12 million new delivery points) Increase by 0.8% per year (~12 million new delivery points) Reduction of ~800 PO’s (2% of base) Reduction of ~800 PO’s (2% of base) SOURCE: USPS
McKinsey & Company 15| Health benefits 4.7-5.2 Workers’ Comp 2.0-4.0 Workforce costs continue to rise faster than inflation through 2020 Workforce annual rate increase projections through 2020 Percent 1.3-2.5 Wages Inflation (CPI at 1.9%) Base Case: Workforce cost projection SOURCE: Global Insights; USPS Financial Forecast Model
McKinsey & Company 16| While payments in 2017-2020 drop, RHB funding will continue to be greater than 10% of gross revenues through 2020 2020 8.0 5.3 2.7 19 7.7 5.0 2.7 18 7.4 4.8 2.6 17 7.1 4.5 2.6 16 10.5 4.7 5.8 15 9.9 4.2 5.7 14 9.5 3.8 5.7 13 9.0 3.4 5.6 12 8.6 3.0 5.6 11 8.2 2.7 5.5 10 7.7 2.2 5.5 2009 3.4 2.0 1.4 SOURCE: OPM estimates; P.L. 109-435 1 Based on OPM estimates of future liability, including RHB pre-funding and annual premiums 2 Current retiree health premiums in 2017-2020 are paid directly out of the fund, resulting in no operating expense Retiree Health Benefit payments1 $ Billions Normal costs Premiums PAEA pre-funding schedule + current premiums Additional pre-funding payment + normal cost for current employees2 5% 12% 12% 13% 14% 14% 15% 16% 11% 11% 11% 12% Percent of total revenue PAEA scheduled pre-funding Additional pre- funding Base Case: Workforce cost projection
McKinsey & Company 17| The combination of the trends will put extreme pressure on USPS given it is a largely fixed-cost network business 0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 2000 2005 2010 2015 2020 Cost per piece Revenue per piece Revenue and cost per piece $ ~ 4% per year 2009-2020 growth ~ 2% per year Base Case
McKinsey & Company 18| The “Base Case” leads to a loss of $33 billion and cumulative losses of $238 billion by 2020 78 76 74 72 70 92 96 94 90 88 86 84 82 80 68 66 0 2020181716151413121110090807 Cost Revenue +0.5% p.a.1 +2.2% p.a.1 $ Billions Revenue and cost Annual net loss forecast Cumulative losses 238 205 175 149 125 99 77 58 42 27 17 774 15 2019181716151413121110090807 Statutory debt ceiling of $15 B will be reached in Oct 2010 Statutory debt ceiling of $15 B will be reached in Oct 2010 -3 -34 -32 -30 -28 -26 -24 -22 -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 20 -33 19181716151413121110090807 RHB reset Actual Forecast Even if volumes remained flat instead of declining by 1.5% annually, the loss in 2020 would still be $21 billion 1 Per Annum: Compound annual growth rate, 2010 to 2020 Base Case
McKinsey & Company 19| The financial outlook for the Postal Service is highly dependent on trends in the general economy ƒ Rapid economic recovery ƒ Greater than expected rebound in Advertising Mail ƒ Flattening of e-diversion ƒ Government-led decrease in health care cost inflation ƒ Non-career employee increase ƒ Greater than expected volume declines due to: – Accelerated e-diversion – Further (“double-dip”) recession ƒ Health care uncertainty – Greater than expected health care cost inflation – Legislation to require provision of full medical benefits to non- career employees ƒ Input cost inflation outpacing prices, especially in fuel costs Potential upside Potential downside risks Base Case
McKinsey & Company 20| Contents ƒ Recent context ƒ Base case – minimal management actions ƒ Addressing the challenge ƒ Short term requirements
McKinsey & Company 21| USPS can pursue two sets of actions to address the challenge Description Fundamental Change Actions Within Postal Service Control ƒ Actions requiring legislative change ƒ Actions within USPS authority ƒ No legislation required, although stakeholder support/approval needed ƒ Most options require PRC approval, collective bargaining, or political support ƒ Actions being taken or planned by USPS to grow and improve productivity ƒ May be challenging to achieve ƒ Non- legislative ƒ Legislative
McKinsey & Company 22| USPS can pursue actions within its control to reduce the FY2020 gap Base Case with no additional efficiency or revenue initiatives will lead to a $33B shortfall in 2020, and cumulative losses of $238 billion ($33B) FY2020 Actions within Postal Service control reduce the 2020 annual loss to $15 billion, and the cumulative loss to $115 billion ($15B) FY2020 Actions within Postal Service control -5 -35 -30 -25 -20 -15 -10 5 2005 Break- even 20202009 Actual Forecast Net income $ Billions ($33 $115B cumulative gap remains
McKinsey & Company 23| USPS will continue to take aggressive action to drive revenue and control costs Actions within Postal Service control Net annual income benefit (2020) ~$2BProduct and service actions1 ~$10BProductivity improvements2 ~$0.5BWorkforce flexibility improvements3 Total ~$5BAvoided interest due to reduced debt ~$0.5BPurchasing savings4 Cumulative impact 2010-2020 ~$18B ~$123B
McKinsey & Company 24| The “Actions within Postal Service control” case includes product and service initiatives above the baseline to grow volume Total 2020 income impact SOURCE: USPS 1 Actions within Postal Service control: Product initiatives Key actions ~ $2 billion Mail services ƒ Grow under-penetrated segments and access latent demand through: – Increasing Small Business direct mail – First Class/Standard mail promotions Package services ƒ Leverage network to grow aggressively through: – Priority Mail Flat Rate Box expansion – Commercial contracts – Parcel Select and Returns, including recycling – Product samples Retail services ƒ Maximize profitability by store segment within a plan to reduce costs and increase access though: – PO Boxes – Consumer products – Passport growth Postal Service product and service initiatives
McKinsey & Company 25| Aggressive productivity improvements in the “Actions within Postal Service control” case are worth ~ $10 billion 2 Customer service ƒ Continuous improvement/ Lean Six Sigma ƒ Transactions moving to alternative access points through customer demand Delivery ƒ Flats Sequencing System ƒ Route restructuring Processing plant operations ƒ Continuous improvement/ Lean Six Sigma ƒ Incremental network consolidation Admin ƒ Restructuring and consolidating administration, supported by technology enablers Actions within Postal Service control: Productivity Postal Service productivity initiatives ~ $10 billion Increasing world-class productivity USPS already processes 91% of mail through automation, the best in the world. Further improvements will be highly challenging Key actions Total 2020 income impact
McKinsey & Company 26| Increasing workforce flexibility and improving procurement add ~ $1B in the “Actions within Postal Service control” case SOURCE: USPS National On-roll Complement Actions within Postal Service control: Workforce/Procurement 3/4 Workforce flexibility ƒ As career employees leave, replace with non-career employees up to bargaining limits ƒ Takes advantage of natural attrition Total 2020 income impact ~ $0.5 billion Procurement ƒ Increase transportation efficiency ƒ Improve vendor management for supplies, services and other costs (e.g., IT) Total 2020 income impact ~ $0.5 billion Postal Service workforce flexibility and procurement improvements Key actions
McKinsey & Company 27| The “Actions within Postal Service control” case leads to a loss of $15 Billion and cumulative losses of $115 Billion by 2020 85 80 75 70 65 0 2019181716151413121110090807 Cost Revenue +1.2% p.a.1 +1.5% p.a.1 $ Billions Revenue and cost Net annual loss forecast Cumulative losses 115 100 88 76 66 53 42 33 25 18 14 77 4 15 2019181716151413121110090807 Cumulative losses are reduced to $115B from $238B Cumulative losses are reduced to $115B from $238B -34 -32 -30 -28 -26 -24 -22 -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 20 -33 -15 19181716151413121110090807 RHB reset Actual Forecast Actions within management control Base Case Actions within Postal Service control Statutory debt ceiling of $15 B still reached in Oct 2010 1 Per Annum: Compound annual growth rate, 2010 to 2020 Statutory debt ceiling of $15 B still reached in Oct 2010
McKinsey & Company 28| -15 -20 -25 -30 5 -10 -35 -5 “Fundamental Change” that increases USPS flexibility will be required to close the remaining gap 2005 ($33B) FY2020 Break- even 20202009 Actual Forecast Net income $ Billions ($15B) FY2020 Fundamental Change is required to secure future sustainability ƒ Non-legislative changes ƒ Legislative changes Fundamental Change Base Case with no additional efficiency or revenue initiatives will lead to a $33B shortfall in 2020, and cumulative losses of $238 billion Actions within Postal Service control reduce the 2020 annual loss to $15 billion, and the cumulative loss to $115 billion
McKinsey & Company 29| Definition of non-legislative and legislative change Fundamental Change Description Examples Legislative ƒ Actions requiring legislative change ƒ Includes changes to the base legislation as well as issues that have historically been attached as annual riders (e.g. additional restrictions on closing Post Offices) ƒ Significant change in the retail network through a combination of increased access with partners and eventual franchising and/or closure of existing locations ƒ Eliminating/reducing subsidies non- profits Non-legislative ƒ Actions within USPS authority ƒ No legislative changes required, but will impact some stakeholders and is challenging to implement ƒ Many options require PRC approval ƒ All labor changes subject to collective bargaining ƒ New product innovations such as hybrid mail ƒ Exigent price increases
McKinsey & Company 30| ƒ Hybrid mail USPS will need to pursue multiple “Fundamental Change” options to close the remaining gap Fundamental Change Products and services Pricing ƒ Exigent price increase P1 Service levels Workforce Changes to: ƒ Workforce flexibility W1 Public policy considerations Options for USPS consideration ƒ Price cap modification P3 ƒ Cover costs of un- profitable products P2 ƒ RHBG1 R1 R2 ƒ USO subsidiesG2 ƒ Products and services flexibility R3 ƒ Streamlined oversight G3 Advertising product Changes to ƒ Service standards ƒ Delivery location ƒ Delivery frequency S2 S3 S1 AccessS4 ƒ Benefits requirements W2 Legislative Non-legislative
McKinsey & Company 31| Products and services opportunities were identified through a screen for potential feasibility and impact in the near term ƒ Existing USPS ideas ƒ Foreign post examples from Accenture ƒ Other ideas from McKinsey Examples include… ƒ Financial services (e.g., Banking, Insurance) ƒ Transportation services (e.g., 3PL, warehousing) ƒ Business and government services ƒ Asset commercialization (e.g., truck advertising) ƒ New mail products (e.g., hybrid mail) ƒ Retail products (e.g., vending) Fundamental Change: Products and Services Ideas with low profit impact or low feasibility ƒ High barriers to entry ƒ Significant upfront capital investment required ƒ Current labor cost structure unsuitable ƒ Low U.S. market feasibility ƒ Extremely low industry margins Fundamental Change: Products and services opportunities ~30+ revenue initiativesSource of ideas Options not fully within USPS control ƒ Hybrid mail including E2E, E2P and P2E digital solutions ƒ Simplified advertising products R1 R2
McKinsey & Company 32| Products and services opportunities for USPS Fundamental Change: Products and Services Fundamental Change: Products and services opportunities ƒ Simplify advertising product for direct marketers looking to reach householdsAdvertising products R2 ƒ Develop new products and services consistent with USPS mission Products and Services Flexibility R3 Hybrid Mail Products R1 ƒ Create a suite of hybrid mail products the integrate electronic and physical mail – E2E and electronic postmark – E2P and P2E mail and print solutions Legislative Non-legislative
McKinsey & Company 33| Pricing opportunities for USPS Fundamental Change: Pricing Fundamental Change: Pricing opportunities Exigent rate increase P1 ƒ Apply for exigent price increase Cover costsP2 ƒ Increase prices on select products to cover costs: – Periodicals – Nonprofit mail – Media and Library mail Price cap modification P3 ƒ Set a global cap across all market dominant products, rather than by class ƒ Automatically adjust cap based on volume triggers Legislative Non-legislative
McKinsey & Company 34| Service level opportunities for USPS Fundamental Change: Service Levels Fundamental Change: Service level opportunities Service standards S1 ƒ Change service levels from 1-3 day to 2-5 days for First- Class Mail enabling simplified and standardized mail flows with minimal impact on consumers/businesses Delivery frequency S3 ƒ Reduce delivery frequency to 3 or 5 days per week AccessS4 ƒ Expand access through alternative channels – Private sector partnerships – Kiosks – Direct (e.g., online, mobile) Delivery location S2 ƒ Change delivery location to curbside or cluster mailboxes Legislative Non-legislative
McKinsey & Company 35| Workforce opportunities for USPS Fundamental Change: Workforce Fundamental Change: Workforce opportunities Workforce flexibility ƒ Implement initiatives to – Improve workforce flexibility and leverage natural shift in employee mix due to 5% annual attrition rate – Align workforce costs with overall market trends Benefits requirements W2 ƒ Bring federally-mandated benefits payments more in line with private sector W1 Legislative Non-legislative
McKinsey & Company 36| Public policy considerations Fundamental Change: Public policy considerations Fundamental Change: Public policy considerations RHB ƒ Defer payments ƒ Shift to a “pay as you go” system comparable to other federal agencies and private sector companies Streamlined oversight ƒ Increase flexibility and speed to market by – More clearly defining roles of oversight bodies – Moving toward after-the-fact review – Defining time limits for all reviews USO subsidies ƒ Receive Universal Service Obligation subsidies through federal appropriationsG2 G1 G3 Legislative Non-legislative
McKinsey & Company 37| Contents ƒ Recent context ƒ Base case – minimal management actions ƒ Addressing the challenge ƒ Short term requirements
McKinsey & Company 38| In the short run, USPS will violate its statutory financing requirements in October 2010 ƒ Only a limited subset of options will take effect quickly enough to address the short term financing requirement ƒ Options available to maintain solvency in October 2010: – RHB restructuring by Congress (deferral or relief) – Receive an increased debt limit (does not resolve core issues) ƒ Options available to maintain solvency in September 2011: – RHB restructuring – Receive an increased debt limit – Exigent price increase – 6 to 5 day delivery

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McKinsey Slides Examples

  • 1. USPS Future Business Model March 2, 2010
  • 2. McKinsey & Company 1| Contents ƒ Recent context ƒ Base case – minimal management actions ƒ Addressing the challenge ƒ Short term requirements
  • 3. McKinsey & Company 2| USPS is experiencing unprecedented losses SOURCE: USPS; P.L. 109-435 (PAEA) -7.82 2010 0.9 05 1.4 04 3.1 03 3.9 02 -0.7 01 -1.7 2000 -0.2 06 -2.8 0907 -5.1 08 -3.8 Net profit/loss $ billions Postal Act 2006 signed into law Note: All years in this document refer to Fiscal Years ending on Sept 30 1 Includes one-time $4 billion deferral 2 Per 2010 Integrated Financial Plan (January Year-to-Date results are favorable to Plan) 8.4 5.6 1.41 5.5 RHB pre-funding, $ billions Key drivers ƒ Revenue declines due to: – E-diversion of First- Class Mail – Down-trading from First-Class to Standard Mail – Losses of advertising mail due to the recession ƒ RHB pre-funding requirement introduced by the PAEA ƒ Cost savings, while substantial, have been less than revenue declines due to high fixed costs of the network No rate increase 2003-2006 Recent Context
  • 4. McKinsey & Company 3| Losses have been driven by volume declines, RHB pre-funding requirements and limitations on cost savings 0.9 FY2006 Net income 4.0 FY2009 Net income -3.8 RHB deferralCost savings 12.6 RHB pre- funding requirement 5.5 Revenue decline1 15.8 Drivers of change in net income 2006 vs. 2009 $ billions SOURCE: USPS 2006 Annual Report; USPS 2010 Budget 1 Revenue declines calculating by applying 2009 prices against 2006-09 volume declines ƒ Volume declines of 17%, driven by – E-substitution – Ad spend shift to other channels – Deep recession ƒ Savings driven by – Reduction of overtime – Extreme slow-down in hiring – Route consolidation – Volume reduction Recent Context
  • 5. McKinsey & Company 4| Volume declines have been worse than expected when the current legal and regulatory framework was established 240 230 220 210 200 190 180 170 160 0 20100908070605042003 Actual Upside forecast Downside forecast Base case forecast SOURCE: USPS 2005 forecasts2 ƒ When PAEA was passed, volume projections did not anticipate the current scale of declines ƒ PAEA introduced some additional product flexibility, but also two crucial restrictions: – Price increases capped at CPI by class – Significant pre-funding requirements for Retiree Health Benefits (RHB) 1 Postal Accountability and Enhancement Act, 2006 2 Forecasts from “USPS Strategic Transformation Plan”, 2005 Volume forecasts and actuals Billions of pieces PAEA implications1 Recent Context
  • 6. McKinsey & Company 5| First-Class Mail, Standard Mail and GDP growth Cumulative increase from 1973, percent The recession has exacerbated volume declines, but mail has reached an inflection point, with e-diversion now driving long term decline 250 150 Standard Mail volume 300 100 0 2005200019951990198519801975 First-Class Mail volume Real GDP 200 50 350 400 SOURCE: USPS 2009 Recent Context
  • 7. McKinsey & Company 6| Retiree Health Benefit funding requirements are a significant burden, equal to 12% of total revenue in 2010 RHB payments, 2006 – 2010 $ billion SOURCE: USPS 2009 10-K; USPS 2010 Budget 8.4 5.6 1.4 5.5 20092 3.4 2.0 2008 7.4 1.8 20071 10.1 1.7 2006 1.6 2010 2.2 7.7 ƒ Pre-funding is unique to USPS within the public sector, and rare (and not required) within the private sector Drivers of RHB requirements ƒ Schedule of pre-funding requirements is accelerated in the first 10 years of the 50 year liability ƒ Actuarial estimates of total RHB liability vary widely based on differences in discount rates, future health care costs, the size of the workforce, and period of pre-funding PAEA scheduled pre-funding requirement Employer premiums Recent Context 1 $8.4B scheduled payment includes $3B legacy payment from CSRS 2 $1.4B scheduled payment includes $4B deferral from Congress
  • 8. McKinsey & Company 7| Recent reductions in workforce usage have been significant, but pieces per FTE still declined in 2009 262 07 265 06 261 05 258 2009 251 03 243 02 234 04 249 0801 231 2000 227 USPS workforce FTEs1, Thousands Pieces per FTE Pieces per year, thousands SOURCE: USPS 1 Full Time Equivalent, based on work hours (includes overtime) 0 2009 711 08070605 950 900 850 800 750 700 1,000 040302012000 917 Recent Context
  • 9. McKinsey & Company 8| The USPS has been responsive to declining volume, but recent work hour reductions will become increasingly difficult to replicate SOURCE: FY 2009 10-K; 2007 and 2009 National Payroll Hour Summary Report Work hours reduction Sources of work hours reduction 74M (45%) 12M (7%) 79M (48%) Millions of hours Recent Context 1,175 146 90 2007 1,423 Overtime Non-career 67 2009 1,258 1,101Career 102 -12% Career Non Career Overtime 55% of reductions have come from non-career and overtime
  • 10. McKinsey & Company 9| Contents ƒ Recent context ƒ Base case – minimal management actions ƒ Addressing the challenge ƒ Short term requirements
  • 11. McKinsey & Company 10| Four trends will affect postal economics going forward Volume Price Workforce costs USO Obligation ƒ Transactional volume declining due to e-diversion ƒ Advertising mail is subject to increased substitution options ƒ Increases capped by inflation class ƒ Price elasticities are in flux due to growing alternatives ƒ Delivery points ƒ Retail locations ƒ Sortation facilities ƒ Preferred prices for some products (e.g., non-profit mail) ƒ RHB pre-funding driven by law ƒ Legacy costs beyond USPS control ƒ Wages subject to collective bargaining REVENUE TRENDS COST TRENDS These trends will continue to put pressure on USPS ability to provide affordable universal service Declining steadily Fixed cost base Rising cost per hour Rising but capped Base Case
  • 12. McKinsey & Company 11| 0 40 80 120 160 200 Volume will decline significantly over the next decade driven by a steady decline in First-Class Mail, the most profitable segment SOURCE: BCG; USPS Financial Forecasting Model BCG volume forecast Billions of pieces Change in volume 2009-2020 Portion of margin available to cover fixed costs, 2009 -31 billion +4 billion (1.5%) per year <-1 billion 71% 21% 8%Other (e.g., packages, periodicals) Base Case: Volume Declines 150 Standard First Class 2009 2020 177
  • 13. McKinsey & Company 12| USPS Revenue $ Billions Overall revenue will slightly increase, as inflation-driven price increases will offset the volume decline and shift to Standard Mail SOURCE: BCG; Global Insights; USPS Financial Forecast Model Price impact $16.8 Mix shift from First-Class to Standard1 $3.8 Volume decline $11.8 2009 Revenue $68.1 B 2020 Revenue $69.3 B An additional 27 Billion pieces are forecast to be lost (15% of total). Assumes no loss due to elasticity An additional 27 Billion pieces are forecast to be lost (15% of total). Assumes no loss due to elasticity The loss in First-Class will be even higher (37% of total), lowering the average price The loss in First-Class will be even higher (37% of total), lowering the average price Prices forecast to rise with inflation Prices forecast to rise with inflation 1 Calculated by applying the 2009 First-Class/Standard mix to 2020 prices. Excludes mix shift in any other categories Base Case: Revenue Projection
  • 14. McKinsey & Company 13| Costs, from a workforce standpoint, are largely fixed to fulfill the universal service obligation and other service requirements SOURCE: USPS FY 2009 10-K Post Offices (36,500 Post Offices, Stations and Branches1) ƒ Built so that Americans have nearby access ƒ Continued urban sprawl and growth puts pressure to increase retail outlets ƒ Significant resistance and administrative burden to closing existing Post Offices ƒ Prohibited by law from closing Post Offices for economic reasons Delivery network (~150 million delivery points2) ƒ Required to deliver to almost every address in America ƒ 6-day delivery to every delivery point Sortation plants (600 processing facilities) ƒ Built to ensure overnight delivery of local mail ƒ Network largely fixed unless service standards change ƒ Significant political resistance and administrative burden to closing plants e a existing Post Offices from closing Post Offices asons Network historically built to provide high service levels to citizens, on the basis of growing volumes Transportation (220,000 vehicles) ƒ Large vehicle fleet ƒ $2.6 billion in air transportation expenses 1 Includes CPUs 2 Includes approximately 20 million PO Boxes Base Case: Fixed Cost of USO
  • 15. McKinsey & Company 14| Without aggressive management cost-cutting, work hours will remain flat with volume decline countered by more delivery points Base Case: Impact of Volume and USO/Service Levels on Workforce Costs 5664 2020 1,245 Reduction in overhead 1 Reduction in PO locations 4 Increase in delivery points Mail volume reduction 2009 1,258 Millions of work hours 1.5% per year drop in volume (27B fewer mail pieces) 1.5% per year drop in volume (27B fewer mail pieces) Increase by 0.8% per year (~12 million new delivery points) Increase by 0.8% per year (~12 million new delivery points) Reduction of ~800 PO’s (2% of base) Reduction of ~800 PO’s (2% of base) SOURCE: USPS
  • 16. McKinsey & Company 15| Health benefits 4.7-5.2 Workers’ Comp 2.0-4.0 Workforce costs continue to rise faster than inflation through 2020 Workforce annual rate increase projections through 2020 Percent 1.3-2.5 Wages Inflation (CPI at 1.9%) Base Case: Workforce cost projection SOURCE: Global Insights; USPS Financial Forecast Model
  • 17. McKinsey & Company 16| While payments in 2017-2020 drop, RHB funding will continue to be greater than 10% of gross revenues through 2020 2020 8.0 5.3 2.7 19 7.7 5.0 2.7 18 7.4 4.8 2.6 17 7.1 4.5 2.6 16 10.5 4.7 5.8 15 9.9 4.2 5.7 14 9.5 3.8 5.7 13 9.0 3.4 5.6 12 8.6 3.0 5.6 11 8.2 2.7 5.5 10 7.7 2.2 5.5 2009 3.4 2.0 1.4 SOURCE: OPM estimates; P.L. 109-435 1 Based on OPM estimates of future liability, including RHB pre-funding and annual premiums 2 Current retiree health premiums in 2017-2020 are paid directly out of the fund, resulting in no operating expense Retiree Health Benefit payments1 $ Billions Normal costs Premiums PAEA pre-funding schedule + current premiums Additional pre-funding payment + normal cost for current employees2 5% 12% 12% 13% 14% 14% 15% 16% 11% 11% 11% 12% Percent of total revenue PAEA scheduled pre-funding Additional pre- funding Base Case: Workforce cost projection
  • 18. McKinsey & Company 17| The combination of the trends will put extreme pressure on USPS given it is a largely fixed-cost network business 0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 2000 2005 2010 2015 2020 Cost per piece Revenue per piece Revenue and cost per piece $ ~ 4% per year 2009-2020 growth ~ 2% per year Base Case
  • 19. McKinsey & Company 18| The “Base Case” leads to a loss of $33 billion and cumulative losses of $238 billion by 2020 78 76 74 72 70 92 96 94 90 88 86 84 82 80 68 66 0 2020181716151413121110090807 Cost Revenue +0.5% p.a.1 +2.2% p.a.1 $ Billions Revenue and cost Annual net loss forecast Cumulative losses 238 205 175 149 125 99 77 58 42 27 17 774 15 2019181716151413121110090807 Statutory debt ceiling of $15 B will be reached in Oct 2010 Statutory debt ceiling of $15 B will be reached in Oct 2010 -3 -34 -32 -30 -28 -26 -24 -22 -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 20 -33 19181716151413121110090807 RHB reset Actual Forecast Even if volumes remained flat instead of declining by 1.5% annually, the loss in 2020 would still be $21 billion 1 Per Annum: Compound annual growth rate, 2010 to 2020 Base Case
  • 20. McKinsey & Company 19| The financial outlook for the Postal Service is highly dependent on trends in the general economy ƒ Rapid economic recovery ƒ Greater than expected rebound in Advertising Mail ƒ Flattening of e-diversion ƒ Government-led decrease in health care cost inflation ƒ Non-career employee increase ƒ Greater than expected volume declines due to: – Accelerated e-diversion – Further (“double-dip”) recession ƒ Health care uncertainty – Greater than expected health care cost inflation – Legislation to require provision of full medical benefits to non- career employees ƒ Input cost inflation outpacing prices, especially in fuel costs Potential upside Potential downside risks Base Case
  • 21. McKinsey & Company 20| Contents ƒ Recent context ƒ Base case – minimal management actions ƒ Addressing the challenge ƒ Short term requirements
  • 22. McKinsey & Company 21| USPS can pursue two sets of actions to address the challenge Description Fundamental Change Actions Within Postal Service Control ƒ Actions requiring legislative change ƒ Actions within USPS authority ƒ No legislation required, although stakeholder support/approval needed ƒ Most options require PRC approval, collective bargaining, or political support ƒ Actions being taken or planned by USPS to grow and improve productivity ƒ May be challenging to achieve ƒ Non- legislative ƒ Legislative
  • 23. McKinsey & Company 22| USPS can pursue actions within its control to reduce the FY2020 gap Base Case with no additional efficiency or revenue initiatives will lead to a $33B shortfall in 2020, and cumulative losses of $238 billion ($33B) FY2020 Actions within Postal Service control reduce the 2020 annual loss to $15 billion, and the cumulative loss to $115 billion ($15B) FY2020 Actions within Postal Service control -5 -35 -30 -25 -20 -15 -10 5 2005 Break- even 20202009 Actual Forecast Net income $ Billions ($33 $115B cumulative gap remains
  • 24. McKinsey & Company 23| USPS will continue to take aggressive action to drive revenue and control costs Actions within Postal Service control Net annual income benefit (2020) ~$2BProduct and service actions1 ~$10BProductivity improvements2 ~$0.5BWorkforce flexibility improvements3 Total ~$5BAvoided interest due to reduced debt ~$0.5BPurchasing savings4 Cumulative impact 2010-2020 ~$18B ~$123B
  • 25. McKinsey & Company 24| The “Actions within Postal Service control” case includes product and service initiatives above the baseline to grow volume Total 2020 income impact SOURCE: USPS 1 Actions within Postal Service control: Product initiatives Key actions ~ $2 billion Mail services ƒ Grow under-penetrated segments and access latent demand through: – Increasing Small Business direct mail – First Class/Standard mail promotions Package services ƒ Leverage network to grow aggressively through: – Priority Mail Flat Rate Box expansion – Commercial contracts – Parcel Select and Returns, including recycling – Product samples Retail services ƒ Maximize profitability by store segment within a plan to reduce costs and increase access though: – PO Boxes – Consumer products – Passport growth Postal Service product and service initiatives
  • 26. McKinsey & Company 25| Aggressive productivity improvements in the “Actions within Postal Service control” case are worth ~ $10 billion 2 Customer service ƒ Continuous improvement/ Lean Six Sigma ƒ Transactions moving to alternative access points through customer demand Delivery ƒ Flats Sequencing System ƒ Route restructuring Processing plant operations ƒ Continuous improvement/ Lean Six Sigma ƒ Incremental network consolidation Admin ƒ Restructuring and consolidating administration, supported by technology enablers Actions within Postal Service control: Productivity Postal Service productivity initiatives ~ $10 billion Increasing world-class productivity USPS already processes 91% of mail through automation, the best in the world. Further improvements will be highly challenging Key actions Total 2020 income impact
  • 27. McKinsey & Company 26| Increasing workforce flexibility and improving procurement add ~ $1B in the “Actions within Postal Service control” case SOURCE: USPS National On-roll Complement Actions within Postal Service control: Workforce/Procurement 3/4 Workforce flexibility ƒ As career employees leave, replace with non-career employees up to bargaining limits ƒ Takes advantage of natural attrition Total 2020 income impact ~ $0.5 billion Procurement ƒ Increase transportation efficiency ƒ Improve vendor management for supplies, services and other costs (e.g., IT) Total 2020 income impact ~ $0.5 billion Postal Service workforce flexibility and procurement improvements Key actions
  • 28. McKinsey & Company 27| The “Actions within Postal Service control” case leads to a loss of $15 Billion and cumulative losses of $115 Billion by 2020 85 80 75 70 65 0 2019181716151413121110090807 Cost Revenue +1.2% p.a.1 +1.5% p.a.1 $ Billions Revenue and cost Net annual loss forecast Cumulative losses 115 100 88 76 66 53 42 33 25 18 14 77 4 15 2019181716151413121110090807 Cumulative losses are reduced to $115B from $238B Cumulative losses are reduced to $115B from $238B -34 -32 -30 -28 -26 -24 -22 -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 20 -33 -15 19181716151413121110090807 RHB reset Actual Forecast Actions within management control Base Case Actions within Postal Service control Statutory debt ceiling of $15 B still reached in Oct 2010 1 Per Annum: Compound annual growth rate, 2010 to 2020 Statutory debt ceiling of $15 B still reached in Oct 2010
  • 29. McKinsey & Company 28| -15 -20 -25 -30 5 -10 -35 -5 “Fundamental Change” that increases USPS flexibility will be required to close the remaining gap 2005 ($33B) FY2020 Break- even 20202009 Actual Forecast Net income $ Billions ($15B) FY2020 Fundamental Change is required to secure future sustainability ƒ Non-legislative changes ƒ Legislative changes Fundamental Change Base Case with no additional efficiency or revenue initiatives will lead to a $33B shortfall in 2020, and cumulative losses of $238 billion Actions within Postal Service control reduce the 2020 annual loss to $15 billion, and the cumulative loss to $115 billion
  • 30. McKinsey & Company 29| Definition of non-legislative and legislative change Fundamental Change Description Examples Legislative ƒ Actions requiring legislative change ƒ Includes changes to the base legislation as well as issues that have historically been attached as annual riders (e.g. additional restrictions on closing Post Offices) ƒ Significant change in the retail network through a combination of increased access with partners and eventual franchising and/or closure of existing locations ƒ Eliminating/reducing subsidies non- profits Non-legislative ƒ Actions within USPS authority ƒ No legislative changes required, but will impact some stakeholders and is challenging to implement ƒ Many options require PRC approval ƒ All labor changes subject to collective bargaining ƒ New product innovations such as hybrid mail ƒ Exigent price increases
  • 31. McKinsey & Company 30| ƒ Hybrid mail USPS will need to pursue multiple “Fundamental Change” options to close the remaining gap Fundamental Change Products and services Pricing ƒ Exigent price increase P1 Service levels Workforce Changes to: ƒ Workforce flexibility W1 Public policy considerations Options for USPS consideration ƒ Price cap modification P3 ƒ Cover costs of un- profitable products P2 ƒ RHBG1 R1 R2 ƒ USO subsidiesG2 ƒ Products and services flexibility R3 ƒ Streamlined oversight G3 Advertising product Changes to ƒ Service standards ƒ Delivery location ƒ Delivery frequency S2 S3 S1 AccessS4 ƒ Benefits requirements W2 Legislative Non-legislative
  • 32. McKinsey & Company 31| Products and services opportunities were identified through a screen for potential feasibility and impact in the near term ƒ Existing USPS ideas ƒ Foreign post examples from Accenture ƒ Other ideas from McKinsey Examples include… ƒ Financial services (e.g., Banking, Insurance) ƒ Transportation services (e.g., 3PL, warehousing) ƒ Business and government services ƒ Asset commercialization (e.g., truck advertising) ƒ New mail products (e.g., hybrid mail) ƒ Retail products (e.g., vending) Fundamental Change: Products and Services Ideas with low profit impact or low feasibility ƒ High barriers to entry ƒ Significant upfront capital investment required ƒ Current labor cost structure unsuitable ƒ Low U.S. market feasibility ƒ Extremely low industry margins Fundamental Change: Products and services opportunities ~30+ revenue initiativesSource of ideas Options not fully within USPS control ƒ Hybrid mail including E2E, E2P and P2E digital solutions ƒ Simplified advertising products R1 R2
  • 33. McKinsey & Company 32| Products and services opportunities for USPS Fundamental Change: Products and Services Fundamental Change: Products and services opportunities ƒ Simplify advertising product for direct marketers looking to reach householdsAdvertising products R2 ƒ Develop new products and services consistent with USPS mission Products and Services Flexibility R3 Hybrid Mail Products R1 ƒ Create a suite of hybrid mail products the integrate electronic and physical mail – E2E and electronic postmark – E2P and P2E mail and print solutions Legislative Non-legislative
  • 34. McKinsey & Company 33| Pricing opportunities for USPS Fundamental Change: Pricing Fundamental Change: Pricing opportunities Exigent rate increase P1 ƒ Apply for exigent price increase Cover costsP2 ƒ Increase prices on select products to cover costs: – Periodicals – Nonprofit mail – Media and Library mail Price cap modification P3 ƒ Set a global cap across all market dominant products, rather than by class ƒ Automatically adjust cap based on volume triggers Legislative Non-legislative
  • 35. McKinsey & Company 34| Service level opportunities for USPS Fundamental Change: Service Levels Fundamental Change: Service level opportunities Service standards S1 ƒ Change service levels from 1-3 day to 2-5 days for First- Class Mail enabling simplified and standardized mail flows with minimal impact on consumers/businesses Delivery frequency S3 ƒ Reduce delivery frequency to 3 or 5 days per week AccessS4 ƒ Expand access through alternative channels – Private sector partnerships – Kiosks – Direct (e.g., online, mobile) Delivery location S2 ƒ Change delivery location to curbside or cluster mailboxes Legislative Non-legislative
  • 36. McKinsey & Company 35| Workforce opportunities for USPS Fundamental Change: Workforce Fundamental Change: Workforce opportunities Workforce flexibility ƒ Implement initiatives to – Improve workforce flexibility and leverage natural shift in employee mix due to 5% annual attrition rate – Align workforce costs with overall market trends Benefits requirements W2 ƒ Bring federally-mandated benefits payments more in line with private sector W1 Legislative Non-legislative
  • 37. McKinsey & Company 36| Public policy considerations Fundamental Change: Public policy considerations Fundamental Change: Public policy considerations RHB ƒ Defer payments ƒ Shift to a “pay as you go” system comparable to other federal agencies and private sector companies Streamlined oversight ƒ Increase flexibility and speed to market by – More clearly defining roles of oversight bodies – Moving toward after-the-fact review – Defining time limits for all reviews USO subsidies ƒ Receive Universal Service Obligation subsidies through federal appropriationsG2 G1 G3 Legislative Non-legislative
  • 38. McKinsey & Company 37| Contents ƒ Recent context ƒ Base case – minimal management actions ƒ Addressing the challenge ƒ Short term requirements
  • 39. McKinsey & Company 38| In the short run, USPS will violate its statutory financing requirements in October 2010 ƒ Only a limited subset of options will take effect quickly enough to address the short term financing requirement ƒ Options available to maintain solvency in October 2010: – RHB restructuring by Congress (deferral or relief) – Receive an increased debt limit (does not resolve core issues) ƒ Options available to maintain solvency in September 2011: – RHB restructuring – Receive an increased debt limit – Exigent price increase – 6 to 5 day delivery