Inefficient service that is not delivering

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When Britain began selling off state-owned enterprises in the 1980s, it launched a wave of privatisation that spread throughout Europe and beyond. A quarter of a century later, the UK is a laggard when it comes to privatising Royal Mail.

Most large European countries have privatised or at least partially privatised the once state-owned postal monopolies, or – like France – plan to do so. The review of the postal sector by Richard Hooper, due to be sent to ministers this month, will emphasise the urgent need to bring capital into a business facing competitive challenges. Yet in spite of the support of Lord Mandelson for partial privatisation, the political obstacles are enormous and none of the options is without difficulties. Worse, private investors are not queuing up to buy a stake in a business weighed down by one of the country’s largest pension deficits.

Royal Mail is barely profitable, with private sector competitors creaming off the lucrative contracts to collect bulk mail from banks, utilities and local authorities. They hand it over to Royal Mail for delivery to more than 28m addresses around the UK – the labour-intensive universal service obligation that is loss-making.

Mr Hooper, a former communications regulator, has investigated how to sustain what he prefers to call the universal postal obligation – the collection and delivery of mail anywhere in the country for the same affordable price. He concludes that the situation is untenable.

There are two important reasons for reaching this conclusion. The first is Royal Mail’s pension scheme deficit, which was £3.4bn ($5.9bn) at its last valuation in March 2006. With markets plummeting and life-expectancy soaring, it could be twice as big by the time the latest revaluation is published next year.

The pensions regulator agreed to allow the deficit to be eliminated over 17 years rather than the normal 10, only after the government put £1bn aside to cover any shortfall.

When the valuation is published next year, the regulator is likely to demand higher annual payments – which the business cannot afford – to clear the deficit.

The second is Royal Mail desperately needs further investment to compete with its private sector operators that are 40 per cent more efficient – in a letters market declining at 2-3 per cent a year as e-mail, telephony and texting grow. There are growing opportunities in delivering goods ordered electronically, but investment is needed there too.

Postcomm, the regulator, has called for Royal Mail to be allowed to raise private capital – a move endorsed by the mail operator in its submission to the Hooper review. The Danish, Swedish and Belgian postal services have formed partnerships with CVC, the private equity firm, to raise capital and go for a stock market listing.

TNT of the Netherlands and Germany’s Deutsche Post have already been privatised, and France’s La Poste is planning to sell a stake through a stock market flotation.

However, the postal unions are implacably opposed to privatisation, and bringing in private equity would stir controversy over the sector’s role in other industries. Negotiations to merge Royal Mail with the Dutch operator collapsed in 2002 amid fears that foreign ownership would be unpalatable when TNT demanded a controlling stake.

It is not clear, in any case, that private investors would be prepared to put money into a company with such a large and volatile pension scheme deficit. And none of the options would be easy to sell to the electorate in the run-up to the next election, leading to worries that the Hooper review’s recommendations will be shelved for 18 months.

Given the challenges facing Royal Mail, this is seen by industry insiders as a recipe for disaster. There is a solution to be considered that would involve the government taking over the pension deficit as part of a restructuring that would bring in outside capital through a partnership with another operator or private equity.

But Lord Mandelson will need all his legendary skills if he is to succeed in persuading all the stakeholders that rescuing Royal Mail means bringing in private capital.

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