RARC-WP-13-007 – April 12, 2013
The Postal Accountability and Enhancement Act (PAEA) introduced a price cap on market dominant products. Under the PAEA, price increases for each class of market dominant mail is limited by the change in the Consumer Price Index (CPI). The purpose of the price cap was to encourage the Postal Service to manage its costs and increase its efficiency. While price caps are commonly used in other regulated industries as a mechanism of incentive regulation, a simple price cap, such as the CPI cap, works best in times of increasing volumes.
This paper, conducted in collaboration with Christensen Associates, looks at the current CPI cap plus two alternative caps that may work better with declining volumes. The first alternative is a revenue-per-delivery (RDP) cap. The RDP cap adjusts the CPI cap for changes in revenue-weighted volume and growth in delivery points. While this cap would allow the Postal Service to earn sufficient revenues in times of declining volume, it ignores the fact that some costs should decline as volumes decline.
The second alternative is a hybrid cap that is similar to the RDP cap, but contains a further adjustment that accounts for the percentage of Postal Service costs that are considered institutional. The purpose of this adjustment is that it allows the Postal Service to maintain enough revenue to cover its institutional costs, but still gives the Postal Service the incentive to manage those costs that should vary with volume. This paper concludes that of the three caps, the hybrid cap would be the most effective.
We asked Christensen Associates to update the 2013 study and provide research on how price caps are regulated in other industries. The updated analysis confirmed the earlier conclusion that the hybrid price cap is more financially sustainable.