Mckinsey Usps Future Bus Model2

USPS Future Business Model
March 2, 2010
Contents
Recent context
Base case minimal management actions
Addressing the challenge
Short term requirements
McKinsey & Company | 1
Recent Context
USPS is experiencing unprecedented losses
Net profit/loss
Key drivers
$ billions
No rate increase
2003-2006
3.9
-1.7
0.9
-0.7
-2.8
-3.8
-5.1
01
02
03
04
05
06
07
8.4
08
5.6
09
1.41
2010
5.5
RHB pre-funding, $ billions
Class Mail
Down-trading from
First-Class to Standard
Mail
Losses of advertising
mail due to the
recession
RHB pre-funding
requirement introduced by
the PAEA
Cost savings, while

substantial, have been
less than revenue declines
due to high fixed costs of
the network
-7.82
2000
Revenue declines due to:
E-diversion of First-
3.1
1.4
-0.2
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)
SOURCE: USPS; P.L. 109-435 (PAEA)
Recent Context
Losses have been driven by volume declines, RHB pre-funding

requirements and limitations on cost savings
Drivers of change in net income 2006 vs. 2009

$ billions
0.9
4.0
15.8
-3.8
12.6
5.5
FY2006
Net income
Revenue
decline1
RHB prefunding
requirement
Volume declines of 17%, driven by

E-substitution
Ad spend shift to other channels
Deep recession
Cost savings
RHB deferral
FY2009
Net income
Savings driven by
Reduction of overtime
Extreme slow-down in hiring
Route consolidation
Volume reduction
1 Revenue declines calculating by applying 2009 prices against 2006-09 volume declines
SOURCE: USPS 2006 Annual Report; USPS 2010 Budget
Recent Context
Volume declines have been worse than expected when the current legal
and regulatory framework was established
PAEA implications1
Volume forecasts and actuals

Billions of pieces
240
Upside
forecast
230
Base case 2005

forecasts2
forecast
220
210
200
Downside
forecast
190
180
When PAEA was passed,

volume projections did not
anticipate the current scale
of declines
PAEA introduced some

additional product
flexibility, but also two
crucial restrictions:
Price increases capped
170
Actual
at CPI by class
160
Significant pre-funding
0
2003 04
05
06
07
08
09 2010
requirements for
Retiree Health Benefits
(RHB)
1 Postal Accountability and Enhancement Act, 2006

2 Forecasts from USPS Strategic Transformation Plan, 2005
SOURCE: USPS
Recent Context
The recession has exacerbated volume declines, but mail has reached an
inflection point, with e-diversion now driving long term decline
First-Class Mail, Standard Mail and GDP growth

Cumulative increase from 1973, percent
400
350
300
Standard Mail
volume
250
200
Real GDP
150
100
First-Class Mail
volume
50
0
1975
SOURCE: USPS
1980
1985
1990
1995
2000
2005
2009
Recent Context
Retiree Health Benefit funding requirements are a significant burden,

equal to 12% of total revenue in 2010
RHB payments, 2006 2010
$ billion
Drivers of RHB requirements
PAEA scheduled pre-funding

requirement
Pre-funding is unique to USPS within

the public sector, and rare (and not
required) within the private sector
Employer premiums
10.1
7.7
7.4
is accelerated in the first 10 years of

the 50 year liability
8.4
5.6
Schedule of pre-funding requirements
3.4
1.4
5.5
Actuarial estimates of total RHB liability
1.6
1.7
1.8
2.0
2.2
2006
20071
2008
20092
2010
vary widely based on differences in

discount rates, future health care costs,
the size of the workforce, and period of
pre-funding
1 $8.4B scheduled payment includes $3B legacy payment from CSRS

2 $1.4B scheduled payment includes $4B deferral from Congress
SOURCE: USPS 2009 10-K; USPS 2010 Budget
Recent Context
Recent reductions in workforce usage have been significant, but pieces

per FTE still declined in 2009
USPS workforce
FTEs1, Thousands
1,000
950
917
900
850
800
711
750
700
0
2000
01
02
03
04
05
06
07
08
258
261
265
262
05
06
07
08
2009
Pieces per FTE

Pieces per year, thousands
227
231
234
243
251
2000
01
02
03
04
249
2009
1 Full Time Equivalent, based on work hours (includes overtime)

SOURCE: USPS
Recent Context
The USPS has been responsive to declining volume, but recent work hour
reductions will become increasingly difficult to replicate
Millions of hours
Work hours reduction
Non-career
Overtime
1,423
102
146
Sources of work hours reduction

Non Career
1,258
90
67
-12%
12M
(7%)
Career
Career
1,175
1,101
74M
(45%)
79M
(48%)
Overtime
2007
2009
55% of reductions have come from non-career and overtime

SOURCE: FY 2009 10-K; 2007 and 2009 National Payroll Hour Summary Report
Contents
Recent context
Base Case
Four trends will affect postal economics going forward
REVENUE TRENDS
Volume
Transactional
volume declining due

to e-diversion
Advertising mail is
subject to increased
substitution options
Price
Increases capped
by inflation class
Price elasticities are
in flux due to
growing alternatives
Declining
steadily
COST TRENDS
USO Obligation
Fixed cost
base
These trends will

continue to put
pressure on USPS
ability to provide
affordable universal
service

Workforce costs
RHB pre-funding
Rising but
capped
Rising
cost per
hour
Delivery points
Retail locations
Sortation facilities
Preferred prices for
some products (e.g.,
non-profit mail)
driven by law
Legacy costs beyond
USPS control
Wages subject to
collective bargaining
Base Case: Volume Declines
Volume will decline significantly over the next decade driven

by a steady decline in First-Class Mail, the most profitable segment
BCG volume forecast
Billions of pieces
200
177
Change in
volume
2009-2020
(1.5%) per year
Portion of margin
available to cover
fixed costs, 2009
160
150
120
First Class -31 billion
71%
Standard
21%
80
+4 billion
40
2009
SOURCE: BCG; USPS Financial Forecasting Model
Other (e.g., <-1 billion

packages,
2020 periodicals)
8%
Base Case: Revenue Projection
Overall revenue will slightly increase, as inflation-driven price increases

will offset the volume decline and shift to Standard Mail
USPS Revenue
$ Billions
$68.1 B
An
An additional
additional 27
27 Billion
Billion
pieces
are
forecast
pieces are forecast to
to be
be
lost
lost (15%
(15% of
of total).
total). Assumes
Assumes
no
no loss
loss due
due to
to elasticity
elasticity
$11.8
$69.3 B
$16.8
$3.8
2009
Revenue
Volume
decline
The
The loss
loss in
in First-Class
First-Class
will
will be
be even
even higher
higher (37%
(37%
of
total),
lowering
the
of total), lowering the
average
average price
price
Mix shift from Price impact

First-Class to
Standard1
2020 Revenue
Prices
Prices forecast
forecast to
to rise
rise
with
inflation
with inflation
1 Calculated by applying the 2009 First-Class/Standard mix to 2020 prices. Excludes mix shift in any other categories
SOURCE: BCG; Global Insights; USPS Financial Forecast Model
Base Case: Fixed Cost of USO
Costs, from a workforce standpoint, are largely fixed to fulfill

the universal service obligation and other service requirements
Post Offices
(36,500 Post Offices, Stations and Branches1)
Delivery network
(~150 million delivery points2)

Built so that Americans have nearby access

Continued urban sprawl and growth puts
pressure to increase retail outlets
Significant resistance
e and
a administrative
burden to closing existing Post Offices
Prohibited by law from closing Post Offices
asons
for economic reasons
Required to deliver to almost

every address in America
6-day delivery to every
delivery point
Network historically built to

provide high service levels to
citizens, on the basis of growing
volumes
Sortation plants
(600 processing facilities)
Transportation
(220,000 vehicles)

Built to ensure overnight delivery of

local mail
Network largely fixed unless service
standards change
Significant political resistance and
administrative burden to closing plants
Large vehicle fleet

$2.6 billion in air
transportation expenses
1 Includes CPUs
2 Includes approximately 20 million PO Boxes
SOURCE: USPS FY 2009 10-K
Base Case: Impact of Volume and USO/Service

Levels on Workforce Costs
Without aggressive management cost-cutting, work hours will

remain flat with volume decline countered by more delivery points
Millions of work hours
1,258
4
64
2009
Mail volume
reduction
1.5%
1.5% per
per year
year drop
drop in
in
volume
volume (27B
(27B fewer
fewer mail
mail
pieces)
pieces)
SOURCE: USPS
1,245
56
Reduction in
Increase in
delivery points PO locations
Increase
Increase by
by 0.8%
0.8%
per
per year
year (~12
(~12
million
million new
new
delivery
delivery points)
points)
Reduction
in overhead
2020
Reduction
Reduction of
of
~800
~800 POs
POs
(2%
(2% of
of base)
base)
Base Case: Workforce cost projection
Workforce costs continue to rise faster than inflation through 2020

Workforce annual rate increase projections through 2020
Percent
4.7-5.2
2.0-4.0
Inflation
(CPI at
1.9%)
1.3-2.5
Wages
Workers Comp
SOURCE: Global Insights; USPS Financial Forecast Model
Health benefits
Base Case: Workforce cost projection
While payments in 2017-2020 drop, RHB funding will continue

to be greater than 10% of gross revenues through 2020
PAEA scheduled
pre-funding
Additional prefunding
Retiree Health Benefit payments1

$ Billions
Premiums
Normal costs
PAEA pre-funding schedule + current premiums
7.7
3.4
1.4
5.5
8.2
5.5
8.6
5.6
9.0
9.5
9.9
Additional pre-funding
payment + normal cost
for current employees2
Percent
of total
revenue
10.5
5.8
7.4
7.7
8.0
7.1
2.6
2.7
2.7
2.6
5.6
5.7
5.7
4.2
4.7
4.5
4.8
5.0
5.3
2.0
2.2
2.7
3.0
3.4
3.8
2009
10
11
12
13
14
15
16
17
18
19
2020
5%
12%
12%
13%
14%
14%
15%
16%
11%
11%
11%
12%
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
SOURCE: OPM estimates; P.L. 109-435
Base Case
The combination of the trends will put extreme pressure on USPS given it
is a largely fixed-cost network business
Revenue and cost per piece
$
2009-2020
growth
0.70
Cost
per piece
0.65
0.60
~ 4% per
year
0.55
0.50
Revenue
per piece
0.45
~ 2% per
year
0.40
0.35
0.30
2000
2005
2010
2015
2020
Base Case
The Base Case leads to a loss of $33 billion and cumulative losses of
$238 billion by 2020
$ Billions
Revenue and cost
Actual Forecast
96
94
92
90
88
86
84
82
80
78
76
74
72
70
68
66
Annual net loss forecast

Cost
Cumulative losses
238
0
-2
-3
205
-4
-6
+2.2%
p.a.1
RHB reset
-8
175
-10
Statutory
Statutory debt
debt
ceiling
ceiling of
of $15
$15 B
B
will
will be
be reached
reached
in
Oct
2010
in Oct 2010
-12
-14
-16
-18
Revenue
+0.5%
p.a.1
149
125
99
-20
-22
77
-24
58
-26
42
-28
27
-30
-32
-33
17
4 7 7
15
-34
0
07 08 09 10 11 12 13 14 15 16 17 18 20 20
07 08 09 10 11 12 13 14 15 16 17 18 19 20
07 08 09 10 11 12 13 14 15 16 17 18 19 20
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
The financial outlook for the Postal Service is highly dependent on trends
in the general economy
Potential upside
Potential downside risks
Rapid economic recovery
Greater than expected rebound in

Advertising Mail
Greater than expected volume

declines due to:
Accelerated e-diversion
Further (double-dip) recession
Flattening of e-diversion
Government-led decrease in health

care cost inflation
Non-career employee increase
Health care uncertainty

Greater than expected health
care cost inflation
Legislation to require provision
of full medical benefits to noncareer employees
Input cost inflation outpacing

prices, especially in fuel costs
Contents
Recent context
USPS can pursue two sets of actions to address the challenge
Description
Actions Within
Postal Service
Control
Actions being taken or planned by USPS to grow and

improve productivity
May be challenging to achieve
Fundamental
Change
Nonlegislative
Actions within USPS authority

No legislation required, although stakeholder
Legislative
support/approval needed
Most options require PRC approval, collective
bargaining, or political support
Actions requiring legislative change
Actions within Postal Service control
USPS can pursue actions within its control to reduce the FY2020 gap
Net income
$ Billions
Actual
Forecast
5
Breakeven
$115B cumulative
gap remains
-5
-10
($15B) Actions within Postal Service

FY2020 control reduce the 2020 annual
loss to $15 billion, and the
cumulative loss to $115 billion
-15
-20
-25
Base Case with no additional

($33
($33B)
FY2020 efficiency or revenue initiatives
-30
-35
2005
2009
2020
will lead to a $33B shortfall in

2020, and cumulative losses of
$238 billion
USPS will continue to take aggressive action to drive revenue and control
costs
Net annual income benefit (2020)

1
Product and service actions
~$2B
Productivity improvements
~$10B
Workforce flexibility improvements
~$0.5B
Purchasing savings
~$0.5B
Avoided interest due to reduced debt
~$5B
Total
~$18B
Cumulative impact 2010-2020
~$123B
Actions within Postal Service control: Product initiatives
1 The Actions within Postal Service control case includes product and
service initiatives above the baseline to grow volume
Postal Service product and service initiatives
Key actions
Mail services
Grow under-penetrated segments and access latent
Package
services
Leverage network to grow aggressively through:

Priority Mail Flat Rate Box expansion
Commercial contracts
Parcel Select and Returns, including recycling
Product samples
Retail
services
Maximize profitability by store segment within a plan
demand through:
Increasing Small Business direct mail
First Class/Standard mail promotions
to reduce costs and increase access though:

PO Boxes
Consumer products
Passport growth
Total 2020
income impact
SOURCE: USPS
~ $2 billion
Actions within Postal Service control: Productivity
2 Aggressive productivity improvements in the Actions within Postal

Service control case are worth ~ $10 billion
Postal Service productivity initiatives
Key actions
Processing
plant
operations
Continuous improvement/ Lean Six Sigma

Incremental network consolidation
Increasing
world-class
productivity
Delivery
Flats Sequencing System

Route restructuring
Customer
service
Continuous improvement/ Lean Six Sigma

Transactions moving to alternative access points
Admin
Restructuring and consolidating administration,
USPS already
processes
91% of mail
through
automation,
the best in the
world. Further
improvements
will be highly
challenging
through customer demand
supported by technology enablers
Total 2020
~ $10 billion
income impact
Actions within Postal Service control: Workforce/Procurement
3/4 Increasing workforce flexibility and improving procurement add ~ $1B

in the Actions within Postal Service control case
Postal Service workforce flexibility and procurement improvements
Key actions
Workforce
flexibility
As career employees leave, replace with non-career

employees up to bargaining limits

Takes advantage of natural attrition
Total 2020 income impact
Procurement
~ $0.5 billion
Increase transportation efficiency

Improve vendor management for supplies, services
and other costs (e.g., IT)
Total 2020 income impact
SOURCE: USPS National On-roll Complement
~ $0.5 billion
The Actions within Postal Service control case leads to a loss of $15
Billion and cumulative losses of $115 Billion by 2020
$ Billions
Revenue and cost
Net annual loss forecast
Actual Forecast
85
RHB reset
0
-2
-4
Actions within
management
control
-6
80
Cumulative losses
-8
-10
Cost +1.5%
p.a.1
75
-15
-16
-18
-20
100
88
76
Statutory
Statutory debt
debt
ceiling
of
$15
ceiling of $15 B
B
still
still reached
reached in
in
Oct
Oct 2010
2010
-12
-14
115
Cumulative
Cumulative losses
losses
are
are reduced
reduced to
to
$115B
from
$115B from
$238B
$238B
66
53
42
-22
70
-24
Revenue +1.2%
p.a.1
Base Case
33
25
-26
18
-28
14
-30
65
-32
-33
15
7 7
-34
0
07 08 09 10 11 12 13 14 15 16 17 18 19 20
07 08 09 10 11 12 13 14 15 16 17 18 19 20
07 08 09 10 11 12 13 14 15 16 17 18 19 20
1 Per Annum: Compound annual growth rate, 2010 to 2020

Fundamental Change
Fundamental Change that increases USPS flexibility will be required to

close the remaining gap
Net income
$ Billions
Fundamental Change is required

to secure future sustainability
Non-legislative changes
Legislative changes
Actual Forecast
5
Breakeven
-5
($15B)
FY2020
-10
-15
Actions within Postal Service

control reduce the 2020 annual
loss to $15 billion, and the
cumulative loss to $115 billion
-20
-25
($33B)
FY2020
-30
-35
2005
2009
Base Case with no additional

efficiency or revenue initiatives
will lead to a $33B shortfall in
2020, and cumulative losses of
$238 billion
2020
Fundamental Change
Definition of non-legislative and legislative change

Description
Non-legislative
Actions within USPS authority New product innovations such as

hybrid mail
No legislative changes
required, but will impact some Exigent price increases

stakeholders and is
challenging to implement
Many options require PRC
approval
All labor changes subject to
collective bargaining
Actions requiring
Legislative
Examples
legislative change
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)
Significant change in the retail
network through a combination of

increased access with partners and
eventual franchising and/or closure
of existing locations
Eliminating/reducing subsidies nonprofits
Fundamental Change
Non-legislative
USPS will need to pursue multiple Fundamental Change

options to close the remaining gap
Products and
services
R1
R2
Hybrid mail
Advertising
product
Products
and services
flexibility
R3
Pricing
Exigent price
increase
P1
Cover costs
of unprofitable
products
P2
Price cap
modification
Service levels
Changes to
Service standards
Delivery location
S1
S2
S3
Workforce
Changes to:
W1
Benefits
requirements
W2
Delivery
frequency
Workforce
flexibility
Legislative
Public policy
considerations
RHB
G1
USO subsidies
G2
Streamlined
oversight
G3
P3
S4
Access
Options for USPS

consideration
Fundamental Change: Products and Services
Products and services opportunities were identified through a screen

for potential feasibility and impact in the near term
Fundamental Change: Products and services opportunities
Source of ideas
~30+ revenue initiatives

Examples include

Existing
USPS ideas
Foreign post
examples
from
Accenture
Other ideas
from
McKinsey
Financial services (e.g.,

Banking, Insurance)
Transportation services (e.g.,

3PL, warehousing)
Business and government

services
Asset commercialization (e.g.,

truck advertising)
New mail products (e.g., hybrid

mail)
Retail products (e.g., vending)
Options not fully within

USPS control
R1 Hybrid mail including

E2E, E2P and P2E
digital solutions
R2 Simplified advertising
products
Ideas with low profit impact or low feasibility

High barriers to entry
Significant upfront capital investment required
Current labor cost structure unsuitable
Low U.S. market feasibility
Extremely low industry margins
Fundamental Change: Products and Services
Products and services opportunities for USPS
Non-legislative
Legislative
Fundamental Change: Products and services opportunities
R1
Hybrid Mail
Products
Advertising
R2
products
Products and
R3 Services
Flexibility
Create a suite of hybrid mail products the integrate

electronic and physical mail
E2E and electronic postmark
E2P and P2E mail and print solutions
Simplify advertising product for direct marketers looking

to reach households
Develop new products and services consistent with

USPS mission
Fundamental Change: Pricing
Pricing opportunities for USPS
Non-legislative
Legislative
Fundamental Change: Pricing opportunities
P1
Exigent rate
increase
Apply for exigent price increase
Increase prices on select products to cover costs:

Periodicals
Nonprofit mail
Media and Library mail
Set a global cap across all market dominant products,

rather than by class
Automatically adjust cap based on volume triggers
P2 Cover costs
Price cap
P3
modification
Fundamental Change: Service Levels
Service level opportunities for USPS
Non-legislative
Legislative
Fundamental Change: Service level opportunities
S1
S2
S3
Service
standards
Delivery
location
Delivery
frequency
S4 Access
Change service levels from 1-3 day to 2-5 days for FirstClass Mail enabling simplified and standardized mail
flows with minimal impact on consumers/businesses
Change delivery location to curbside or cluster mailboxes
Reduce delivery frequency to 3 or 5 days per week
Expand access through alternative channels

Private sector partnerships
Kiosks
Direct (e.g., online, mobile)
Fundamental Change: Workforce
Workforce opportunities for USPS
Non-legislative
Legislative
Fundamental Change: Workforce opportunities
W1
W2
Workforce
flexibility
Benefits
requirements
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
Bring federally-mandated benefits payments more in line

with private sector
Fundamental Change: Public policy considerations
Public policy considerations
Non-legislative
Legislative
Fundamental Change: Public policy considerations
G1 RHB

Defer payments
Shift to a pay as you go system comparable to other
federal agencies and private sector companies
Receive Universal Service Obligation subsidies through

federal appropriations
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
G2 USO subsidies
G3
Streamlined
oversight
Contents
Recent context
In the short run, USPS will violate its statutory financing requirements
in October 2010
Only a limited subset of options will take effect quickly enough to address
the short term financing requirement
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)
Options available to maintain solvency in September 2011:
RHB restructuring
Receive an increased debt limit
Exigent price increase
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USPS Future Business Model

Base case minimal management actions

Addressing the challenge

Short term requirements

McKinsey & Company | 1

USPS is experiencing unprecedented losses

RHB pre-funding, $ billions

Cost savings, while

Revenue declines due to:

Postal Act 2006 signed

McKinsey & Company | 2

Losses have been driven by volume declines, RHB pre-funding

Drivers of change in net income 2006 vs. 2009

Volume declines of 17%, driven by

McKinsey & Company | 3

Volume forecasts and actuals

Base case 2005

When PAEA was passed,

PAEA introduced some

Price increases capped

1 Postal Accountability and Enhancement Act, 2006

McKinsey & Company | 4

First-Class Mail, Standard Mail and GDP growth

Retiree Health Benefit funding requirements are a significant burden,

Drivers of RHB requirements

PAEA scheduled pre-funding

Pre-funding is unique to USPS within

is accelerated in the first 10 years of

Schedule of pre-funding requirements

Actuarial estimates of total RHB liability

vary widely based on differences in

1 $8.4B scheduled payment includes $3B legacy payment from CSRS

McKinsey & Company | 6

Recent reductions in workforce usage have been significant, but pieces

Pieces per FTE

1 Full Time Equivalent, based on work hours (includes overtime)

McKinsey & Company | 7

Work hours reduction

Sources of work hours reduction

55% of reductions have come from non-career and overtime

McKinsey & Company | 8

Base case minimal management actions

Addressing the challenge

Short term requirements

McKinsey & Company | 9

Four trends will affect postal economics going forward

volume declining due

These trends will

McKinsey & Company | 10

Base Case: Volume Declines

Volume will decline significantly over the next decade driven

(1.5%) per year

First Class -31 billion

SOURCE: BCG; USPS Financial Forecasting Model

Other (e.g., <-1 billion

McKinsey & Company | 11

Base Case: Revenue Projection

Overall revenue will slightly increase, as inflation-driven price increases

Mix shift from Price impact

McKinsey & Company | 12

Base Case: Fixed Cost of USO

Costs, from a workforce standpoint, are largely fixed to fulfill

Built so that Americans have nearby access

Required to deliver to almost