U.S. Postal Service: Key Postal Transformation Issues

Published by the Government Accountability Office on 2003-05-29.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                            United States General Accounting Office

GAO                         Testimony
                            Before the President's Commission on the
                            United States Postal Service

For Release on Delivery
Expected at 8:30 a.m. EDT
Thursday, May 29, 2003      U.S. POSTAL SERVICE
                            Key Postal Transformation
                            Statement of David M. Walker
                            Comptroller General of the United States

                                              May 29, 2003

                                              U.S. POSTAL SERVICE
                                              Key Postal Transformation Issues
 Highlights of GAO-03-812T, a testimony
 before the President’s Commission on the
 United States Postal Service

The President established this                The ability of the Service to remain financially viable is at risk because
Commission to examine the state               growth in mail volume has stagnated and its business model is not well
of the U.S. Postal Service (the               suited to operate efficiently in a competitive environment. As the figure
Service) and submit a report by               shows, growth in the volume of First-Class and Standard Mail, the two
July 31, 2003, with a proposed                largest revenue-producing classes, has declined.
future vision for the Service and
recommendations to ensure the
viability of postal services. GAO             Growth Rates in Key Mail Classes
has provided congressional
committees with many reports and
testimonies on postal matters, and
this testimony is based largely on
these prior reports and testimonies.

In April 2001, GAO put the
Service’s long-term financial
outlook and transformation on its
High-Risk List for several reasons.
The Service was experiencing                  Key issues for the Commission to consider include the following:
•   significant deficits,
•   severe cash-flow pressures,               Role and Mission. Over the past 30 years, competition has increased and
•   rising debt,                              private-sector firms are performing more traditional postal functions.
•   cost growth outpacing                     Customers’ needs have also changed with new communication alternatives.
    revenue increases,                        In determining what universal postal services are needed and the roles for
•   limited productivity gains, and           public and private providers, factors to consider are how to enhance
•   liabilities in excess of assets.          customer convenience and create opportunities for least-cost providers.
Under its 1970s-era business
model, the Service was relying on
                                              Governance Structure and Accountability Mechanisms. Qualification
raising rates and incrementally               requirements for members of the governing board should ensure that
reducing costs to carry out its               appointees possess the experience needed to oversee a large business-like
mission. GAO concluded that this              operation, and the board should have sufficient authority in areas such as
business model was not sustainable            setting rates and executive pay. Reporting requirements should ensure
in today’s competitive                        accountability and transparency of financial and organizational results.
                                              Flexibilities and Incentives to Increase Revenue and Control Costs.
The Commission’s report will be an            The Service will need appropriate flexibilities and incentives to balance its
important guide for comprehensive             revenue generation and cost containment capabilities in areas such as
postal transformation. In this
                                              allowing retained earnings, closing unneeded post offices, and containing
testimony, GAO presents key
issues the Commission should                  costs related to infrastructure rationalization, workforce realignment, and
consider to enhance the long-term             wage and benefit comparability. Also, the Service’s long-term retiree health
financial viability of the Service by         and workers’ compensation obligations need to be addressed.
making it a more results-oriented
and efficient organization.                   Effective Labor-Management Relations and Support Systems. To
                                              improve operational efficiency and enhance performance accountability for
                                              all employees, postal managers and unions need better cooperation to
To view the full product, click on the link   realign the workforce for the future and focus performance management and
above. For more information, contact Bernie   workforce planning systems on organizational goals and results.
Ungar, 202-512-2834, ungarb@gao.gov.
Messrs. Chairmen and Commission Members:

I am pleased to have this opportunity to appear before you to present our
views on the transformation of the U.S. Postal Service (the Service). GAO
has been involved in reviewing postal issues on behalf of Congress for
decades and has issued many reports and testified numerous times before
congressional committees on postal matters. My testimony today is based
largely on these prior reports and testimonies. (See the section called
Related GAO Products at the end of this statement.)

As you know, in April 2001, we put the Postal Service’s long-term financial
outlook and transformation efforts on our High-Risk List. We did this for
several reasons. The Postal Service was experiencing growing financial,
operational, and human capital challenges, including declining net income,
severe cash-flow pressures and rising debt, increasing competition, and
difficulty cutting costs and achieving productivity gains. These challenges
were threatening the Service’s ability to carry out its mission of providing
affordable, high-quality universal postal services on a self-financing basis.
Given advances in communications, such as electronic communication
devices and the Internet, increasing domestic and foreign competition,
changes in the growth of mail volume, and the need to serve more and
more addresses yearly, we were concerned that the Postal Service would
have difficulty in effectively carrying out its mission in the future. We were
also concerned because the Service did not have a comprehensive
transformation plan to guide it in the future, and because the significant
shift in the Service’s financial outlook came as a surprise to many key
stakeholders. In fall of 2001, the Service’s financial situation became even
more complex and critical due to the events of September 11th and the
subsequent use of the mail to transmit anthrax.

Consequently, we called for a number of actions to address our concerns
about the Postal Service’s financial situation and long-term outlook. We
recommended that the Postal Service develop and implement a
comprehensive transformation plan that would lay out actions it could
take under existing law, actions that would require incremental legislative
action to help address the Service’s more immediate financial difficulties,
and comprehensive legislative action to address key unresolved
transformation issues. We also suggested that Congress consider various
approaches to addressing long-standing and difficult-to-resolve issues
affecting the Postal Service’s financial situation, such as by establishing a
commission to study the issues and make recommendations.

Page 1                                                            GAO-03-812T
                       We are pleased that the President established a Commission to examine
                       the state of the Postal Service and submit a report to the President by July
                       31, 2003, that would propose a vision for the future of the Service and
                       recommendations to ensure the viability of postal services. We have
                       previously provided this Commission with a number of GAO reports,
                       testimonies, and other information related to the Postal Service and offer
                       our assistance to the Commission as it completes its work. We look
                       forward to the Commission’s report and believe it will be an important
                       guide for Congress as it considers comprehensive postal transformation.
                       In this testimony, I will discuss four key issues the Commission should
                       consider to address deficiencies in the Service’s business model and
                       enhance the Service’s long-term financial viability by making it a more
                       results-oriented, efficient organization. These areas include the Service’s
                       (1) role and mission, (2) governance structure and accountability
                       mechanisms, (3) flexibilities and incentives to increase revenue and
                       control costs, and (4) effective labor-management relations and support
                       systems to improve organizational efficiency.

                       The Service has responded to a number of our concerns and taken actions
Short-Term Financial   to address its short-term financial challenges. In April 2002, the Service
Pressures Have Been    published its Transformation Plan and has begun to implement it. The
                       Service has also taken actions to control costs by reducing the size of its
Alleviated but         work force and labor hours usage and by improving productivity. In fiscal
Fundamental Issues     year 2002, the Service reported that, for the first time in over 30 years, its
                       operating expenses were reduced below those of the previous year.
Remain                 Furthermore, in large part based on an Office of Personnel Management
                       (OPM) study undertaken at the request of GAO, legislation was passed in
                       April 2003 that enabled the Postal Service to reduce its pension cost by
                       about $3 billion per year over the next few years.

                       These incremental steps, although useful, cannot resolve the fundamental
                       and systemic issues associated with the Service’s current business model.
                       The Postal Reorganization Act of 1970 (P.L. 91-375) provided the legal
                       framework for the Service’s current business model. In passing the Act,
                       Congress intended the Service to operate in a business-like manner.
                       However, in contrast, the Act also included such provisions as monopoly
                       protections on letter mail and access to mailboxes, a mandate to break
                       even financially over time, and a rate-setting process that is based on
                       specific cost-coverage requirements—often referred to as “cost-of-service
                       regulation.” Furthermore, the Act generally did not envision the extent to
                       which the Postal Service would be directly competing with private-sector
                       companies. As such, the Service’s current business model, which relies on

                       Page 2                                                            GAO-03-812T
    increasing mail volumes to finance universally available postal services
    through an expanding delivery network, is outmoded in today’s rapidly
    changing and increasingly competitive business environment.

    Today, businesses and consumers have many more communications and
    delivery choices than they did 30 years ago. New types of electronic
    communication devices include E-mail, cell phones, fax machines, and
    electronic bill payment services. There is also greater competition in the
    mail and package delivery markets. These market changes have been
    driven by the need for more time-sensitive movement of products and
    services, as well as the ability to track products and services throughout
    the delivery process from origin to destination.

    These changes in the postal marketplace have highlighted the following
    fundamental issues with the Service’s business model:

•   The Service’s ability to remain financially viable under its current business
    model is at risk as the growth in mail volumes has stagnated or declined,
    leading to less revenue unless rates are increased. Further, it has been
    estimated that about 45 percent of the Service’s mail delivery routes do not
    generate adequate revenue to cover their costs.

•   The Service does not have the flexibilities or incentives necessary to
    operate efficiently in a highly competitive environment. This is particularly
    important because the Service has historically not been able to
    significantly control and/or reduce costs in its two major cost areas:
    employee-related costs, which continue to account for over three-quarters
    of the Service’s total operating expenses, and overall infrastructure costs
    for the Service’s retail and processing networks.

•   Long-standing adversarial relationships between postal managers and
    labor unions have hindered efforts to increase efficiency and create a
    more results-oriented culture that would help achieve long-term financial
    viability for the Service, along with a fair and positive work environment
    for employees.

    Fundamental changes will need to be made to the Service’s business
    model, and the legal and regulatory framework that supports it, to provide
    for the Service’s long-term financial viability. The Postal Service’s short-
    term financial relief provides a limited window of opportunity to bring
    about this fundamental change. The time has come to take bold and
    comprehensive action designed to transform the Postal Service to meet
    the challenges and new realities of the 21st century. This will involve

    Page 3                                                           GAO-03-812T
                               actions by both the executive and legislative branches of government as
                               well as a variety of other postal stakeholders.

                               Today, I will direct my comments to the following four areas that will be
                               critical to addressing problems with the Service’s current business model
                               and ensuring its future financial viability: (1) role and mission, (2)
                               governance structure and accountability mechanisms, (3) flexibility and
                               incentives to increase revenues and control costs, and (4) the link between
                               labor-management relations and improving operational efficiency.

                               Over the years, postal stakeholders have raised numerous issues regarding
Role and Mission               the Service’s role and mission relative to the private sector. Among these
                               issues are the following:

                           •   How should universal postal service be defined given past changes and
                               future challenges?

                           •   Should the Service remain a government entity or should it be wholly or
                               partially privatized?

                           •   Is a government monopoly needed to provide universal postal services?
                               Should the Postal Service’s monopoly protections be reduced or
                               eliminated, and if so, how should a minimal service level be ensured?

                           •   Should the Service retain its governmental functions, including regulatory
                               responsibilities related to protecting the mail monopoly and the integrity
                               of the mail, as well as its law enforcement functions related to mail fraud,
                               security, and theft?

                           •   To what extent should the Postal Service, the mailing industry, and other
                               private-sector companies perform various postal functions, such as
                               collection, processing, transportation, and retail services? Should
                               additional worksharing be encouraged, and how should long-standing cost
                               issues be resolved?

                           •   Should the Service be allowed to compete in areas where there are
                               private-sector providers? If so, on what terms, and what transparency and
                               accountability mechanisms are needed to prevent cross subsidies between
                               competitive and monopoly products and services?

Universal Postal Service       The Postal Service’s current mission is to provide access to universal
                               postal services in all communities at reasonable rates. Universal postal

                               Page 4                                                           GAO-03-812T
                           service is not defined in law, but the Service’s interpretation of this
                           responsibility has evolved throughout its history to accommodate
                           changing customer demands. Currently, universal postal service includes a
                           uniform rate for one category of mail, 6-day per week mail delivery, and
                           access to postal retail services. Vast changes in communications and
                           delivery options, as well as the growth of the related competitive
                           environment, over the past 30 years are continuing at a rapid pace. These
                           changes provide an impetus for reconsidering what universal postal
                           service will be needed for the 21st century. Such considerations should
                           include recognition of different needs for different customer segments. As
                           the mail stream has evolved away from personal correspondence and
                           towards more advertising mail, the need for uniform rates and service may
                           be changing. In addition, access to postal services involves many more
                           options today, such as vending machines, ATMs, and grocery stores, which
                           could reduce reliance upon traditional post offices and improve service.

Postal, Government, and    Once the scope of universal postal service is addressed, the next questions
Private-sector Functions   relate to whether core postal functions should be discharged by a public
                           entity, private companies, or a combination of both. The current statutory
                           framework provides the Service with a monopoly on letter mail and access
                           to mailboxes to fund universal postal service. The Service generally carries
                           out its mission by collecting, transporting, processing, and delivering mail
                           to addresses throughout the United States and to foreign postal
                           administrations for deliveries to addresses outside this country. In
                           addition to its retail services and mail delivery roles, the Postal Service is
                           also charged with governmental functions for enforcing federal laws
                           related to mail fraud, security, and theft.

                           Since the 1970 reorganization, the Service’s role has changed as it has
                           engaged the private sector in postal activities in several ways. For
                           example, the Service has (1) arranged for private entities, such as grocery
                           stores, to sell stamps; (2) increased its contracting with private firms to
                           transport mail; and (3) offered worksharing rates, which include discounts
                           to mailers to carry out certain mail processing operations, such as
                           presorting, barcoding, and transporting mail directly to Postal Service
                           facilities for delivery by the Service to its customers. The purpose of these
                           activities has been to increase customer convenience, cut Postal Service
                           operating costs, and create the opportunity for the least-cost provider to
                           perform certain postal activities. For example, as shown in figure 1, mail
                           volume growth since fiscal year 1972 has been in workshared mail. In
                           fiscal year 2002, nearly three-quarters of the Postal Service’s mail volume
                           consisted of mail that involved some aspect of worksharing.

                           Page 5                                                           GAO-03-812T
Figure 1: Growth in Workshared Mail Volume Between Fiscal Years 1972 and 2002

Note: Workshared mail receives a lower rate due to such mailer activities as presorting, bar coding,
and destination entry. Most Standard Mail and Periodicals volumes were counted as workshared
beginning in fiscal year 1971 because the Service required presorting of this mail by Zip Code and
such worksharing was recognized in its postal rates. Worksharing rates for First-Class Mail were
introduced in fiscal year 1977.

A number of issues have been raised related to whether the worksharing
rates accurately reflect the Service’s estimated cost savings from mailer
worksharing activities. We are currently assessing these issues and plan to
issue a report later this year.

At the same time, the Service’s involvement in what is often called
“nonpostal” or “nontraditional” areas has also been controversial. These
nonpostal activities refer to new products or services that generate
revenues and are not directly related to the Service’s core postal activities.
Nonpostal activities are not subject to the same regulatory scrutiny by the
Postal Rate Commission (PRC) that postal activities currently face. Some
examples of nonpostal activities include electronic billing and payment
services, as well as electronic greeting cards. As we discuss later, we have
reported on the Service’s difficulties in meeting its performance goals

Page 6                                                                                GAO-03-812T
                       related to nonpostal activities and about controversies regarding the
                       Service’s involvement in nonpostal activities that are also provided by
                       private-sector companies. Recently, the Service discontinued some of its
                       nonpostal activities, but it remains a valid question as to whether the
                       Service has the appropriate incentives, transparency and accountability
                       mechanisms, cost-structure, and marketing skills to succeed in nonpostal-
                       related areas.

                       Key issues have been raised about whether the Service’s current
Governance Structure   governance structure and accountability mechanisms are sufficient for an
and Accountability     organization with annual revenues approaching $70 billion and over
                       850,000 employees. Some of the issues relate to the Board of Governors’
Mechanisms             limited authority in areas such as setting postal rates and executive pay;
                       qualifications requirements that are too general to ensure that Board
                       appointees possess the kind of experience necessary to oversee a major
                       government business; and limited transparency and accountability
                       mechanisms for organizational performance and results. If the Service is
                       to successfully operate in a more competitive environment, the role and
                       structure of a private-sector Board of Directors may be a more appropriate
                       guide in this area.

                       Having a qualified and independent board is important to ensuring that the
                       board can play a significant role in the following three areas:1

                   •   First, boards should provide strategic advice to management in order to
                       help comply with overall statutory requirements and realize organization

                   •   Second, boards need to help manage risk, including risk related to
                       attempts to maximize current value at the expense of mortgaging the
                       future. Risk management must also consider the interests of key
                       stakeholder groups, such as employees, customers, and the communities
                       in which the organization operates.

                   •   Third, boards have a clear responsibility to hold management accountable
                       for results.

                        U.S. General Accounting Office, Major Management Challenges and Program Risks: U.S.
                       Postal Service, GAO-03-118 (Washington, D.C.: Jan. 2003).

                       Page 7                                                                 GAO-03-812T
The Service is not subject to the same level of transparency and
accountability mechanisms as other “business-like entities,” such as
private-sector companies, that regularly report to shareholders and/or
regulators (e.g., the Securities and Exchange Commission). Some
important issues to consider include what regulatory structure and
oversight mechanisms may be needed, to whom the Service should be
accountable, and what appropriate mechanisms are needed for consumer
protection—particularly for those with few or no alternatives to the mail
system? Concerns have also been raised about the need to provide
accountability for performance, especially in areas where the Service is
provided with additional flexibility. As we have reported in the past, many
concerns have been raised about areas where the Service has had
flexibility, such as the international and new products areas, and its
financial performance has not met its stated goals and objectives.2 Further,
if the Service is allowed to compete, should it be subject to the same laws
and regulations as its competitors? If the Service retains some monopoly
protections while also providing competitive products, steps will be
needed to ensure that products are not being cross-subsidized.

Another key question involves determining what level of transparency
through public reporting on the Service’s financial and operating
performance, as well as its progress in implementing its transformation, is
appropriate. We have reported concerns about the Service’s public
reporting in the following areas: retiree health benefit obligations; periodic
financial reporting; nonpostal new products and services, including e-
commerce initiatives; annual performance reporting as required under the
Government Performance and Results Act (GPRA); and the status of
implementing initiatives from its Transformation Plan.3 Our concerns
related to the Service’s reporting on its retiree health benefit obligations
are discussed in more detail later in this statement.

 U.S. General Accounting Office, U.S. Postal Service: Update on E-Commerce Activities
and Privacy Protections, GAO-02-79 (Washington, D.C.: Dec. 21, 2001); U.S. Postal Service:
Postal Activities and Laws Related to Electronic Commerce, GAO/GGD-00-188
(Washington, D.C.: Sept. 7, 2000); U.S. Postal Service: Development and Inventory of New
Products, GAO/GGD-99-15 (Washington, D.C.: Nov. 24, 1998).
 U.S. General Accounting Office, U.S. Postal Service: Accounting for Postretirement
Benefits, GAO-02-916R (Washington, D.C.: Sept. 12, 2002). U.S. Postal Service Actions to
Improve Its Financial Reporting, GAO-03-26R (Washington, D.C.: Nov. 13, 2002). See also
GAO-02-79, GAO-00-188, and GAO-03-118.

Page 8                                                                     GAO-03-812T
                         Regarding the Service’s periodic financial reporting, we reported in
                         November 2002 on the lack of sufficient and timely periodic information
                         on the Service’s financial condition and outlook available to the public
                         between publications of its audited year-end financial statements.4 Since
                         our report was issued, the Service has taken steps to improve this
                         information, including making its quarterly financial reports available on
                         its Web site. However, we continue to have concerns about some of the
                         Service’s financial and performance information, including information
                         related to its e-commerce and other nonpostal activities, as well as the
                         lack of delivery performance information for all of its major mail
                         categories. In order to determine whether further changes in financial
                         reporting are needed, the Commission should consider the SEC reporting
                         requirements as a possible guide in this area. In addition, other current
                         reporting mechanisms, such as the Service’s annual performance reports
                         required under GPRA, could be adapted to communicate the Service’s
                         delivery performance for all of its major mail categories, as well as update
                         its progress on implementing its Transformation Plan.

                         The Service has limited financial incentives under its current business
Flexibilities and        model with its break-even mandate and cost-of-service rate-setting
Incentives to Increase   structure. To enhance its long-term financial viability in a competitive
                         environment, the Service will need appropriate flexibilities and incentives
Revenues and Control     to balance its revenue generation and cost containment capabilities. The
Costs                    Postal Service argues that it has difficultly raising revenue under the
                         lengthy rate-setting process, which does not allow the Service to change
                         its prices in a timely manner to respond to changing economic conditions.
                         The Service indicated that it would like additional flexibility in connection
                         with retaining earnings, setting rates, and developing and promoting new
                         products and services. These flexibilities could enhance its revenue-
                         generating capability and help offset continued anticipated volume
                         declines. However, these flexibilities will need to be coupled with
                         reasonable transparency and appropriate accountability mechanisms to
                         prevent abuse.

                         The Service also does not have adequate flexibility to address its cost
                         structure, especially in the areas of infrastructure rationalization and
                         workforce realignment. Furthermore, cost issues related to compensation
                         and benefits, including its workers’ compensation obligations and its long-

                         See GAO-03-26R.

                         Page 9                                                           GAO-03-812T
                             term retiree health obligations, need to be addressed. The Commission
                             will need to consider what flexibility and incentives are appropriate to
                             allow the Postal Service to make changes in its revenue and cost structure
                             to reflect changing economic conditions and improve its efficiency in an
                             increasingly competitive environment.

Break-even Mandate           Although the Service’s break-even mandate was established to foster
                             reasonable rates, this mandate removes the profit motive. In its
                             Transformation Plan, the Service proposed a revision to its break-even
                             mandate that would permit it to retain earnings. Key questions for
                             consideration include the following:

                         •   Could the Service remain self-supporting under its mandate to break even
                             over time?

                         •   Should the Service’s business model be adjusted to allow some additional
                             flexibility to retain a reasonable level of earnings?

                         •   Would changing the Service’s break-even mandate lead to a reduction in
                             the quality and scope of universal postal service?

                             To address concerns about potential service reductions, some other
                             countries, such as Germany and the Netherlands, whose postal
                             administrations operate on a for-profit basis, have imposed specific
                             minimum requirements for universal postal service and added regulatory
                             oversight in connection with the quality of postal service.

Rate-setting Structure       The Service’s cost-of-service rate-setting structure allows the Service to
                             cover rising costs by increasing rates. The rate-setting process was created
                             to ensure prior independent review of Service-proposed domestic postal
                             rates and fees. It also includes due process for all interested parties in
                             hearings on the record. This process has led to proceedings that are often
                             lengthy and adversarial. Although the current system was designed to
                             enable the Service to break even over time, in practice the Service has
                             accumulated significant prior years’ losses and debt and has had difficulty
                             funding capital investments without borrowing. Some of the key questions
                             related to the current rate-setting process include the following:

                         •   Should the current rate-setting process be retained, modified, or replaced
                             with a different system? Are changes to the current rate-setting structure
                             needed to provide sufficient funds for the Service’s operating and capital

                             Page 10                                                         GAO-03-812T
                         needs and to repay debt? Should the Service’s rate setting be subject to
                         prior regulatory review?

                     •   What should be the respective authorities and responsibilities of the
                         Service and any independent regulator, including the authority to compel
                         provision of information and final decision-making authority over what
                         rates are set?

                     •   Should legal requirements that affect rates—including that each mail class
                         cover its costs, and preferred rates for certain groups—be retained,
                         changed, or eliminated?

                         Consensus on these issues will be difficult to achieve, but improvements in
                         the rate-setting structure will be a fundamental component of a
                         comprehensive transformation. One innovation in the rate-setting process
                         that was recently approved by the PRC on an experimental basis was the
                         Service’s proposal for a negotiated service agreement (NSA). An NSA is a
                         customer-specific agreement with the Service, whereby the customer
                         agrees to perform specified mail preparation activities; and if the
                         customer’s total mailings exceed a pre-set volume threshold, then the
                         customer receives a discount rate and/or predetermined services. The
                         Service anticipates that such agreements will result in additional volume
                         and revenue.

Revenue Generation       The key financial challenge facing the Service is whether it will be able to
                         generate sufficient revenues to cover its costs in the face of stagnating or
                         declining mail volume growth. Some of the limitations in the Service’s
                         current business model related to its revenue-generating capacity have
                         become more evident as mail volumes have recently declined in major
                         mail classes, particularly in First-Class Mail. The overall growth rate for
                         First-Class Mail has been trending downward for about 20 years. These
                         declines are significant because, as seen in figure 2, the revenue generated
                         from First-Class Mail is used to cover about 69 percent of the Service’s
                         institutional costs. The Service’s institutional costs comprise nearly 40
                         percent of its total costs.

                         Page 11                                                         GAO-03-812T
Figure 2: First-Class Mail Volume, Revenue, and Contribution to Institutional Costs in Fiscal Year 2002

                                          As seen in table 1, the loss in contribution from declining First-Class Mail
                                          volume would be difficult to recover from other classes of mail.

                                          Table 1: Additional Volume Increases that Would be Necessary to Recover Loss in
                                          Contribution From a 1 Percent Decline in First-Class Mail Volume

                                                                                                                    Actual volume change between
                                           Type of mail                  Volume increase necessary                      fiscal years 2001 and 2002
                                           Priority                                           14%                                            (11%)
                                           Express                                            43%                                            (12%)
                                           Standard                                            3%                                             (3%)
                                           Package Services                                  116%                                             (2%)
                                          Source: GAO analysis of Postal Service and Postal Rate Commission data.

                                          As part of its Transformation Plan, the Service stated that it would like to
                                          generate revenues from new products and services, and it has requested
                                          additional flexibility in this area. Many questions, however, have been
                                          raised about the Service’s ability to generate revenues to cover the costs
                                          from its new products and services. This area has been the source of much
                                          controversy, particularly related to whether the Service is or should be
                                          allowed to enter into markets where private-sector companies are
                                          operating, and whether these products and services are being cross-
                                          subsidized by monopoly-protected postal products and services. We have
                                          issued several reports regarding the Service’s activities related to new

                                          Page 12                                                                                     GAO-03-812T
                    products and services.5 We have consistently found that the Service’s
                    performance did not meet its stated goals, and that it did not have
                    appropriate financial information and controls in this area. Although it was
                    not possible for us to determine the extent of any cross-subsidy due to
                    incomplete financial information, it was clear that, as of fiscal year 2002,
                    the Service was not generating sufficient revenues to cover its costs
                    related to these new product areas.

                    Another revenue-generating opportunity discussed in the Transformation
                    Plan is leveraging existing assets and infrastructure, such as postal-owned
                    vehicles, facilities, and its nationwide 6-day-a-week, last-mile delivery
                    network. Further explorations of opportunities related to its existing
                    assets could potentially provide additional revenue. As part of its
                    Transformation Plan, the Service has stated that it may have the capacity
                    to generate revenue by offering access to available space in warehouses
                    and vehicles.

Cost Restrictions   Clearly, one of the fundamental deficiencies in the current business model
                    is that it does not provide appropriate incentives to operate in the most
                    cost-effective manner. The cost-based rate structure, monopoly
                    protections, and break-even mandate provide limited incentives for the
                    Service to control costs, particularly in its two largest cost areas—
                    infrastructure and workforce. The Service’s extensive infrastructure
                    network has evolved piecemeal over time and may not reflect the most
                    efficient operating structure. The Service may be able to operate more
                    economically and efficiently by consolidating a number of its processing
                    facilities. Many concerns have also been raised about the efficiency of the
                    Service’s retail network, consisting of thousands of post offices, branches,
                    and stations. In the workforce area, employee wages and benefits
                    comprise about three-quarters of the Service’s total operating expenses.
                    This percentage has not changed dramatically over the last 30 years,
                    despite numerous automation initiatives undertaken by the Service.

                    Some of the key questions that relate to improving the Service’s efficiency
                    include the following:

                    See GAO-02-79, GAO/GGD-00-188, and GAO/GGD-99-15.

                    Page 13                                                         GAO-03-812T
                              •   What is the optimal size and composition of the Postal Service’s
                                  infrastructure and workforce? What service levels should be provided?

                              •   What impediments limit the Service’s ability to sustain long-term efficiency
                                  and productivity improvements, such as standardization of its processing

                              •   Should current restrictions on closing or consolidating post offices be
                                  changed to facilitate optimizing the Service’s retail network?

                              •   How should mail safety and security considerations be incorporated into
                                  the Service’s network optimization plans? Should operations be
                                  redesigned to accommodate mail security concerns, particularly for high-
                                  risk “unknown” sender or collection mail? What are the costs and who
                                  should pay for mail security enhancements?

Infrastructure Optimization       A key to becoming a more cost-effective and efficient organization will be
                                  to rationalize the Service’s infrastructure to better support its future
                                  operations. A wide variation exists in the efficiency levels across mail
                                  processing plants, and the Service does not have standardized operations
                                  throughout its nationwide network of processing plants. According to
                                  postal officials, in some areas it is difficult to achieve efficient operations
                                  due to plant layouts or locations. For example, in some older facilities
                                  processing operations are spread over multiple floors or span several
                                  buildings, while many of the newer plants are laid out on one floor to
                                  better accommodate the automated equipment used today. In addition, the
                                  location of some plants, such as those in big cities, may hinder operations
                                  because of surrounding traffic congestion. On the retail side, the Service
                                  has estimated that many of its post offices are not profitable and many of
                                  the transactions that take place at a post office, like selling stamps, can be
                                  conducted more efficiently through other retail alternatives.

                                  Currently, the Service is analyzing the optimization of its retail function
                                  and has begun to put additional emphasis on using means other than post
                                  offices to provide retail services to its customers. In addition, the Service
                                  is studying the optimization of its mail processing and transportation
                                  network. According to the Service’s Transformation Plan, its strategy for
                                  optimizing its mail processing and transportation network was to have
                                  been developed by fall of 2002. However, recently postal managers told us
                                  that the Service is still in the process of developing its overall concept and
                                  strategies for its revised network and anticipates that it will release its
                                  initial plans in January 2004. We are reviewing the Service’s approach to

                                  Page 14                                                           GAO-03-812T
its network optimization study and will report later on the results of our

The Postal Service’s infrastructure includes a variety of structures,
including over 300,000 collection boxes, 38,000 post offices, stations, and
branches, 500 mail processing plants, and various other types of facilities.
The Service delivers mail to over 140 million business and residential
addresses, including individual mailboxes, cluster boxes, and post office
boxes. As of October 2002, it reported having 115 facilities or land parcels
that were vacant or underutilized. The federal government’s real property
area is a new area that GAO has recently identified as high-risk.6 Long-
standing problems with excess and underutilized property, deteriorating
facilities, unreliable real property data, and costly space are challenges
shared by several agencies. These factors have multibillion-dollar cost
implications and can seriously jeopardize mission accomplishment.
Rationalization of any excess infrastructure can also result in additional
cash from sales proceeds.

Historically, closing and consolidating post offices and processing plants
has often been controversial on account of worker, community, and
congressional interests. The Service’s current business model includes
statutory restrictions that limit its ability to close and/or consolidate post
offices. We have reported that the Service has faced resistance to closures
because of the potential effects on jobs and mail delivery service to local
communities.7 Given the controversy that surrounds closure of postal
facilities, some mechanism, such as the military base-closure process, may
be needed. Once agreement is reached on closing/consolidating postal
facilities, steps would need to be taken to help ensure that unneeded
postal properties are promptly and appropriately handled.

Furthermore, safety and security concerns will need to be considered as
part of the Service’s network optimizing efforts. At the request of the
House Committee on Government Reform, we held a conference on issues
related to mail security in December 2001 and issued a report on the

 U.S. General Accounting Office, High-Risk Series: Federal Real Property, GAO-03-122
(Washington, D.C.: Jan. 2003).
 U.S. General Accounting Office, U.S. Postal Service: Deteriorating Financial Outlook
Increases Need for Transformation, GAO-02-355 (Washington, D.C.: Feb. 28, 2002).

Page 15                                                                    GAO-03-812T
                                   concerns and suggestions that resulted from that conference.8 Some of the
                                   conference discussion revolved around whether separate processing
                                   operations would be needed for mail streams with different levels of risk.
                                   For example, mail from collection boxes is deemed to be higher risk
                                   because the sender is unknown, while much of the bulk business mail is
                                   considered lower risk because it is from known shippers. The Service will
                                   need to determine whether it should place biohazard detection equipment
                                   in all processing plants or establish separate processes for various levels
                                   of risk in the mail stream. Another related issue is who should pay for
                                   costs related to enhancing mail security—ratepayers, taxpayers, or both.
                                   To date, the Postal Service has received $762 million in appropriated funds
                                   to cover costs associated with the anthrax and terrorist attacks. The
                                   Service requested another $350 million in its fiscal year 2004
                                   appropriations request for emergency preparedness costs.

Workforce Size, Composition,       In the workforce area, the Service has significant unresolved cost issues
and Costs                          related to

                               •   wage and benefit premiums associated with some of its employees whose
                                   compensation is determined through collective bargaining;

                               •   compensation limitations for executives subject to executive pay caps;

                               •   impact on Service costs of recent legislation requiring the Service to cover
                                   pension costs for the time its employees served in the military;

                               •   rising health care costs for current and retired employees;

                               •   impact on Service costs of not accruing its retiree health benefit costs; and

                               •   growth in workers’ compensation costs.

                                   We recognize that the Service’s recent workforce reductions have resulted
                                   in some cost savings. However, achieving more significant savings in total
                                   costs will require further reducing the size of its workforce and examining
                                   its current compensation and benefits arrangements, including workers’
                                   compensation. Further, the Service should revisit the accounting and
                                   funding treatment of its long-term retiree health obligations. In fiscal year
                                   2002, the Service had over 854,000 total employees, and the compensation

                                   U.S. General Accounting Office, Highlights of GAO’s Conference on Options to Enhance
                                   Mail Security and Postal Operations, GAO-02-315SP (Washington, D.C.: Dec. 20, 2001).

                                   Page 16                                                                 GAO-03-812T
                   and benefit costs for these employees amounted to about $53 billion.
                   About 90 percent of the Service’s 750,000 career employees are covered by
                   collective bargaining agreements.

Wage and Benefit   One of the most difficult challenges that the Service faces is making
Comparability      changes to its compensation systems. The Postal Service is required by
                   statute to provide its employees with wages and benefits comparable to
                   those of private-sector employees, but it faces several problems in this
                   area. On the one hand, postal officials have stated that the statutory pay
                   cap for postal executives has limited its ability to provide compensation
                   that is comparable to that in the private sector for selected managerial,
                   executive, and officer level positions. This restriction may make it more
                   difficult for the Service to recruit and retain key executive talent. On the
                   other hand, the Commission heard testimony from Professor Wachter at
                   its hearing in Chicago that postal employees whose pay is set through
                   collective bargaining have a significant wage and benefit premium over
                   comparable private-sector employees.9 This premium was estimated to be
                   34.2 percent in the 2000-2001 interest arbitration proceeding between the
                   Postal Service and the American Postal Workers Union, which covers
                   approximately 366,000 employees.

                   The issues of wage and benefit comparability and factors that need to be
                   considered under the collective bargaining process are fundamentally
                   important to the Service’s future transformation efforts. As the Postal
                   Service noted in its testimony before the Commission, the cost of postal
                   benefits has risen about 27 percent more than those of the private sector
                   in the last 20 years. The Service also testified that there are substantial
                   fringe benefit costs (retirement and retiree health care benefits) that are
                   statutorily mandated, and thus outside the scope of collective bargaining.
                   The Commission has also heard that the Service’s costs for some
                   employee benefits within the scope of collective bargaining—those for
                   health benefits for active employees—are higher than those in the private
                   sector as well as other federal agencies. For example, the Postal Service
                   pays about 85 percent of its employees’ health benefit premiums, while
                   other federal agencies pay up to 75 percent of these costs. Furthermore,
                   we believe the fact that the Service pays a higher percentage of its

                    See Statement of Michael L. Wachter, Before the President’s Commission on the United
                   States Postal Service, April 29, 2003. Professor Wachter is a professor of Law and
                   Economics at the University of Pennsylvania. He has consulted for the Postal Service since
                   1981 and testifies on its behalf in interest arbitration panels on issues involving Postal
                   Service wage and benefit comparability.

                   Page 17                                                                     GAO-03-812T
                              employees’ insurance premiums and continues to pay a portion of the
                              premiums after retirement is an important consideration in assessing the
                              total wage and benefit comparability of postal employees.

                              Although the parties disagree about whether a wage and benefit premium
                              exists and about the basis for making these comparisons, the Service’s
                              ability to control costs in this area will be critical to achieving a more
                              efficient organization. One of the limitations in the existing collective
                              bargaining process is that the interests of all postal stakeholders, such as
                              ratepayers, do not appear to have been sufficiently considered. As a
                              starting point, the Commission may want to revisit the guiding principles
                              incorporated into the wage and comparability standard so that it would
                              more fully reflect all stakeholder interests and the Service’s overall
                              financial condition and outlook. These principles could include the full
                              compensation and benefit costs, as well as the relationship of these costs
                              relative to total costs, impact on rates and revenues, and the Service’s
                              overall financial condition. In addition, postal labor and management have
                              disagreed on the benchmarks that should be used in making total
                              compensation comparisons. For example, questions exist as to whether
                              the private-sector comparison group should be unionized workers, non-
                              unionized, or some combination thereof, and whether the total value of
                              benefits has been factored into this comparison. It may be beneficial for
                              any legislation requiring compensation comparability to include specific
                              criteria and factors upon which a comparison must be made.

Workers’ Compensation Costs   Another benefit area where costs have been difficult to control is the
                              Service’s workers’ compensation benefits. This presents a significant
                              challenge to the Service, because these costs totaled $1.5 billion in fiscal
                              year 2002, an increase of over $500 million, or 50 percent, from the
                              previous year. In addition, the Service’s total liability for its workers’
                              compensation benefits amounted to $6.7 billion at the end of fiscal year
                              2002. The Service attributed the cost increases to a record number of
                              compensation claims filed and a rise in the average cost per medical claim.
                              While we have not reviewed the reasons for the cost increases, we believe
                              that the significantly increased costs warrant attention by the Service.

                              In addition, the Commission may want to consider the comparability of
                              the Service’s workers’ compensation benefits as it considers the Service’s
                              total compensation and benefits for postal employees. Several GAO
                              reports have raised issues about benefit payment policies under the
                              Federal Employees’ Compensation Act (FECA), including how these
                              benefits compare to those of other federal and state workers’
                              compensation laws and changing benefit payments for retirement-aged

                              Page 18                                                         GAO-03-812T
    beneficiaries.10 In April 1996, we reported on our comparison of benefits
    authorized by FECA with those authorized under the Longshore and
    Harbor Workers’ Compensation Act and state workers’ compensation
    laws. 11 We found that, in general, FECA provided the same types of
    benefits to injured federal workers as those provided under other federal
    and state workers’ compensation laws; however, there were three
    principle ways in which FECA benefits were more generous:

•   FECA’s authorized maximum weekly benefit amount was greater;

•   FECA provided claimants who had a spouse and/or dependent with an
    additional benefit of 8-1/3 percent of salary; and

•   FECA provided eligible federal workers who suffered traumatic injuries
    with additional salary continuation benefits for a period not to exceed 45

    We have also reported on possible changes to FECA benefits for
    beneficiaries who are at or beyond retirement age.12 We noted that older
    FECA beneficiaries made up a high percentage of cases on the long-term
    rolls and accounted for a substantial portion of the FECA benefits paid for
    long-term compensation. We identified two prior proposals for reducing
    FECA benefits to those who become eligible for retirement. One would
    convert compensation benefits received by retirement-eligible injured
    workers to retirement benefits. However, this approach raises complex
    issues related to changing workers’ compensation benefits to taxable
    income and allowing for varying amounts of retirement benefits. The
    second proposal would convert FECA benefits to a newly established
    FECA annuity, thus avoiding the complexity of shifting from one benefit
    program to another. To help address FECA-related cost issues, the
    Commission and Congress could consider converting from the current
    FECA benefit structure to a FECA annuity.

      U.S. General Accounting Office, Recent GAO Reports on the Federal Employees’
    Compensation Act, GAO/T-GGD-97-187 (Washington, D.C.: Sept. 30, 1997).
      U.S. General Accounting Office, Workers’ Compensation: Selected Comparisons of
    Federal and State Laws, GAO/GGD-96-76 (Washington, D.C.: Apr. 3, 1996).
     U.S. General Accounting Office, Federal Employees’ Compensation Act: Issues
    Associated With Changing Benefits for Older Beneficiaries, GAO/GGD-96-138BR
    (Washington, D.C. Aug. 14, 1996).

    Page 19                                                                  GAO-03-812T
Pension and Retiree Health   Recent statutory changes in how the Service funds its Civil Service
Obligations                  Retirement System (CSRS) pension costs will result in substantial
                             financial savings to the Service. Those savings represent an opportunity
                             for the Service to address its significant financial challenges, including its
                             large unfunded retiree health obligation. While the pension obligation is
                             being funded as benefits are earned and recovered through rates, the
                             retiree health obligation is not. The health obligation is also not reflected
                             in the Service’s financial statements. Recent estimates put the present
                             value of the Service’s retiree health obligation at between $40 and $50
                             billion. Under the Service’s current rate-setting method, the increasing
                             cost of these obligations will result in sharply escalating future rates. The
                             Commission could be instrumental in guiding the Service on how best to
                             address this and other major financial management challenges as the
                             Service strives to transform itself.

                             In April 2003, the President signed into law the Postal Civil Service
                             Retirement System Funding Reform Act of 2003 (P.L. 108-18). The Act was
                             the culmination of an analysis we requested in May 2002 that the Office of
                             Personnel Management (OPM) perform on the extent to which the Service
                             had funded and was projected to have funded the CSRS costs of its
                             employees and annuitants.13 In November 2002, OPM reported that, based
                             on the level of contributions set forth in what was then the current law,
                             the Service would overfund its pension obligation by $77.7 billion.
                             However, OPM’s calculation assumed that the Service was responsible at
                             that time for funding the cost of military service of applicable Service
                             employees, which was consistent with the administration’s legislative
                             proposal. According to OPM, the administration’s legislative proposal was
                             modeled after the other major federal retirement system, the Federal
                             Employee Retirement System (FERS), whereby the agencies fund benefits
                             related to military service. Because under then current law this military
                             funding was the responsibility of Treasury, we asked OPM to recalculate
                             this overfunded amount, excluding the benefits attributable to military

                              These costs are those attributable to service rendered since the July 1, 1971, effective date
                             of the Postal Reorganization Act.

                             Page 20                                                                        GAO-03-812T
service, and found that it was actually $104.9 billion.14 Measured on a
present value basis as of September 30, 2002, this shift in military service
cost amounts to over $27 billion. (See appendix for additional details on
these calculations.)

P.L. 108-18 did in fact make the Service responsible for funding these
military costs. The Act also changed how the Service funds its CSRS
pension costs and, in so doing, reduced its payments to the Civil Service
Retirement and Disability Fund (CSRDF) by an average of over $3 billion
per year over the next 5 years and the full $77.7 billion over the next 40
years to prevent any overfunding from occurring. Furthermore, Congress
acted on our suggestion to consider the Service’s $11 billion in outstanding
debt to the federal government and directed the Service to apply the
savings in fiscal years 2003 and 2004 that result from enactment of this
legislation to reducing its debt. The legislation also requires that the
Service submit a proposal to the President, Congress, and GAO detailing
how savings attributable to any fiscal year after 2005 and held in escrow
should be expended, including for debt repayment, pre-funding its retiree
health obligation, productivity and cost saving capital investments,
delaying or moderating postal rate increases, or any other matter. GAO has
60 days from the time it receives the Service’s report to submit a written
evaluation of it. Furthermore, we are beginning work on developing
various alternatives for funding the existing unfunded retiree health
obligation and future costs. Without a major change in its funding
approach, this obligation will exacerbate the Service’s financial problems
in the future.

The law also requires the Service to consider your work in formulating its
plan for the savings. Accordingly, we believe that the issue of how the
Service currently accounts for and funds its retiree health benefits needs
to be seriously considered as part of any effort to address the future
viability of the Postal Service and should be factored into the
Commission’s deliberations.

  Until passage of P.L. 108-18, Treasury funded the cost of military service creditable
towards a CSRS benefit not otherwise paid for by employees. The Act shifted responsibility
for funding military service costs from the Treasury to the Postal Service – retroactive to
July 1, 1971, and prospectively. However, the Act also requires the Postal Service, the
Treasury, and OPM each to review this provision and submit proposals by September 30,
2003, detailing whether and to what extent the Treasury or the Postal Service should be
responsible for funding these benefits in the long term. GAO has 60 days from the time it
receives these reports to submit a written evaluation of them to the House and Senate
oversight committees.

Page 21                                                                      GAO-03-812T
Unlike its CSRS pension obligation, which the Act put on course to be fully
funded, the retiree health benefit obligation is funded on a pay-as-you-go
basis as premiums are paid, rather than on a full accrual basis.15
Consequently, while the pension benefits being earned now by Postal
Service employees are recovered through current postal rates, the retiree
health benefits of those same employees are not being recognized in rates
until after they retire. This pay-as-you-go approach is also being used to
reflect retiree health costs in the Service’s financial statements. We believe
that it would be preferable for the Service to account for these retiree
health costs and related obligation in its financial statements on an accrual
basis. As we noted in our September 2002 correspondence to the
Postmaster General,16 the Service’s current accounting treatment does not
reflect the economic reality of its legal obligation to pay for these costs,
and current ratepayers are not paying for the full costs of the services they
are receiving. Although the Service did revisit this issue and did discuss it
in the management discussion and analysis section of its financial
statements for fiscal year 2002, it did not adopt accrual accounting for
retiree health benefit costs, or change its financial disclosure treatment as
we suggested. Consequently, we continue to believe that the Service’s
treatment of retiree health benefit costs in its financial statements does
not sufficiently recognize the magnitude, importance, or meaning of this
obligation to decision makers or stakeholders. In our view, the time has
come for the Service to formally reassess how it accounts for and
discloses this very significant financial obligation.

Irrespective of the accounting treatment, we believe the Service needs to
work with the PRC to determine how best to address this issue in the rate-
setting process. We recognize that the adoption of accrual accounting for
retiree health obligations and inclusion of the related costs in postal rates
could mean that customers face significant rate increases sooner than
might otherwise be the case. However, without a change now, a sharp
escalation in rates in future years will be necessary to fund these costs on
a pay-as-you-go-basis.

 The Postal Service paid about $1 billion to OPM in fiscal year 2002 for the cost of retiree
health care benefits for its more than 475,000 employees and survivor annuitants who
participate in the Federal Employees Health Benefits Program (FEHBP).
 See GAO-02-916R.

Page 22                                                                        GAO-03-812T
                         Thus far, I have focused most of my comments on areas that require
Effective Labor-         statutory or regulatory changes. However, one of the most important
Management               factors in the Service’s future success may not depend solely on actions by
                         the Commission, Congress, or other stakeholders. Rather, it will depend to
Relations and Support    a large extent on the Service’s support systems and its ability to work
Systems Are Key to       together with its unions to make the changes needed to improve
                         organizational efficiency and sustain productivity improvements. This may
Improving                require significant changes in organizational culture and practices, which
Operational              have historically been difficult to achieve. We have written many reports
Efficiency               discussing the long-standing adversarial relationships between postal
                         managers and unions.17 These adversarial relationships have major
                         financial, operational, and human capital implications because personnel-
                         related costs represent the largest single element of the Service’s annual
                         expenses, and they are the primary determinant of prices and the key
                         factor in the Service’s overall financial viability. In addition, postal
                         employees represent a valuable asset and are a key element in any overall
                         transformation effort. Disagreements between these groups have included
                         performance management issues, including whether to implement some
                         type of performance-based incentive system for employees covered under
                         collective bargaining, and work rules, such as the deployment and
                         utilization of the workforce. Furthermore, the Service’s ability to realign
                         its workforce may be limited because its workforce planning is essentially
                         designed to support short-term operations rather than assess long-term
                         workforce needs, and it may not have sufficient flexibility to make needed
                         changes in its work rules.

Performance Management   We have found that high-performing organizations often must
                         fundamentally change their cultures so that they are more results-oriented,
                         customer-focused, and collaborative in nature.18 To foster such cultures,
                         these organizations use their performance management systems as a
                         strategic tool to drive change and achieve desired results. The Service will
                         need to modernize its performance management systems to create a clear
                         linkage—”line of sight”—between individual performance and

                          For example, see U.S. General Accounting Office, U.S. Postal Service: Labor-
                         Management Problems Persist on the Workroom Floor, GAO/GGD-94-201A/B (Washington
                         D.C.: Sept. 29, 1994); U.S. Postal Service: Little Progress Made in Addressing Persistent
                         Labor-Management Problems, GAO/GGD-98-1 (Washington D.C.: Oct. 1, 1997).
                          U.S. General Accounting Office, Results-Oriented Cultures: Creating a Clear Linkage
                         between Individual Performance and Organizational Success, GAO-03-488 (Washington,
                         D.C.: Mar. 14, 2003).

                         Page 23                                                                    GAO-03-812T
organizational success. First among the key practices high-performing
organizations use to develop effective performance management systems
is to align individual performance expectations with organizational goals.
Another key practice is to involve employees and stakeholders to gain
ownership of the performance management system.

Poor relationships between postal managers and employees have made it
difficult to develop and implement changes to the Service’s performance
management systems. One of the key challenges in developing a more
performance-based culture will be for the Service to work in collaboration
with its labor unions and management associations to align individual
performance with institutional goals and objectives. The Service’s
bargaining unit employees, who make up approximately 90 percent of its
workforce, do not have performance-based compensation systems and
have generally opposed them. Another key challenge will be in addressing
those areas where the Service believes it needs additional human capital
flexibilities to realign its workforce or modify work rules, but has been or
could be hampered through current collective bargaining agreements.19

Modern, reliable, effective, and as appropriate, validated performance
management systems with adequate safeguards, including reasonable
transparency and appropriate accountability mechanisms, must serve as
the fundamental underpinning of any successful results-oriented pay
reform. The Service reported that it implemented a pay-for-performance
system for its executives, managers, postmasters, supervisors, and other
non-bargaining employees in fiscal year 1995, but that this system was
discontinued in fiscal year 2002. Congress and the Postal Service’s Office
of Inspector General have expressed concerns about certain aspects of
this system, such as the payouts made at the same time the Service was
incurring huge losses. The Service reported that it implemented a merit-
based pay program in 2002 for its executives and officers, under which
goals related to the Service’s overall performance goals are set for
individuals at the beginning of the fiscal year. The Service also reports that
it is in the process of extending a merit-based pay system for the
remaining non-bargaining employees later this year. Care should be taken
in the design of these systems to ensure that they comply with applicable
law (e.g., pension cost savings cannot be used for management bonuses)

 In broad terms, human capital flexibilities represent the policies and practices that an
organization has the authority to implement in managing its workforce to accomplish its
mission and achieve its goals.

Page 24                                                                      GAO-03-812T
                        and that any productivity-based measures result in real savings or more
                        effective utilization of any existing excess capacity.

                        Addressing challenges in performance management will require the
                        Service’s managers and employees to share a common vision for the future
                        and a mutual responsibility for the Service’s financial and operating
                        performance. Postal managers and employees will need to balance their
                        individual interests with those of the organization, particularly in the
                        performance management and workforce realignment areas. A common
                        vision and a balanced approach should help achieve and sustain
                        productivity improvements that will be necessary to enhance overall
                        organizational effectiveness and individual performance while
                        appropriately protecting workers’ rights.

Workforce Realignment   Another key human capital challenge is to take steps to ensure that an
                        organization has sufficient numbers of people in place with the right skills,
                        tools, and incentives to get the job done. The Service’s ability to make
                        changes in the size, cost, and deployment of its workforce has been
                        hampered by some provisions of the collective bargaining agreements. For
                        example, in our reviews, postal plant managers have told us that because
                        of restrictive job classification rules, the Service has too little flexibility to
                        move employees to locations and positions where they are needed. A
                        postal plant manager told us that because of restrictive workforce rules,
                        many supervisors believe it is too arduous to deal with poor performers
                        and that about 60 percent of grievances were work rule based. Changes to
                        the Service’s operating environment, such as optimizing its mail-
                        processing network, may require a different mix in the number, skills, and
                        deployment of its employees. These changes may involve repositioning,
                        retraining, outsourcing, and reducing the workforce.

                        To deal with these challenges, the Service will need effective human
                        capital strategies. It will also need reasonable flexibility to address certain
                        challenges. However, these additional authorities should include
                        appropriate safeguards to prevent abuse of employees. In previous reports
                        and testimonies, we have emphasized that in addressing these human
                        capital challenges, organizations should identify and use the flexibilities
                        already available under existing laws and regulations and then seek
                        additional flexibilities when necessary and based on sound business

                        Page 25                                                              GAO-03-812T
    cases.20 These additional flexibilities could include (1) more flexible pay
    approaches, (2) greater flexibility to streamline and improve the hiring
    process, (3) increased flexibility in addressing employees’ poor job
    performance, (4) additional workforce restructuring options, and (5)
    expanded flexibility in acquiring and retaining part-time or temporary
    employees. The tailored use of such flexibilities for acquiring, developing,
    and retaining talent is an important cornerstone of strategic human capital
    management so that organizations become more results-oriented,
    integrated, and customer focused. To address employees’ concerns that
    some flexibilities could be unfairly applied, the Service will need to
    develop clear and transparent guidelines for using flexibilities, and then
    hold managers and supervisors accountable for their fair and effective use.
    By more effectively using flexibilities, the Service would be in a better
    position to manage its workforce, ensure accountability, and transform its
    culture to become more results-oriented and efficient.

    In closing, this Commission’s report will be an important tool to guide
    comprehensive postal transformation by addressing the major issues
    related to the legal and regulatory framework of the Service’s business
    model along with various operational and governance issues. As the
    Commission considers the future direction of the Service, its efforts will
    involve balancing the Service’s future role and mission; governance
    structure, transparency and accountability mechanisms; and various
    incentives to increase revenues and control costs. More fundamentally, the
    Commission’s report can provide proposals and mechanisms to help
    Congress and the President deal with the controversial and long-standing
    issues that have hampered various postal reform efforts in the past.

    For the Service to become a more efficient organization in the 21st
    century, it will need to

•   continue implementation of its Transformation Plan and other
    Commission recommendations aimed at driving down costs and
    increasing efficiencies;

•   continue enhancements to its financial transparency, including
    appropriate recognition of its expenses and obligations for retiree health

     U.S. General Accounting Office, Human Capital: Effective Use of Flexibilities Can
    Assist Agencies in Managing Their Workforces, GAO-03-2 (Washington, D.C.: Dec. 6,

    Page 26                                                                   GAO-03-812T
                      benefits as well as disclosure of performance information and
                      transformation progress;

                  •   provide thoughtful consideration of how its pension cost savings can be
                      effectively used after fiscal year 2004 to enhance the long-term viability of
                      the Service;

                  •   develop a comprehensive plan for optimizing its infrastructure and
                      workforce; and

                  •   work with its unions and management associations to create a results-
                      oriented culture, as well as appropriate work rules and realignment
                      flexibilities, that would help achieve both long-term financial viability for
                      the Service and a fair, positive work environment for employees.

                      Finally, in many ways, the Service’s transformation issues are an
                      illustration of the types of challenges that many government agencies face
                      in positioning themselves for the 21st century rather than simply building
                      on past practices. The Postal Service plays an important role for our
                      nation and all Americans. It helps to connect our nation both domestically
                      and internationally. However, the world has changed dramatically since
                      the last postal reorganization in 1970. The Service must change to
                      recognize these realities and position itself for the future. The time for
                      action is now.

                      Messrs. Chairmen, this concludes my testimony. I would be pleased to
                      answer any questions that you or Members of the Commission may have.

                      For further information regarding this testimony, please call Bernard L.
Contacts and          Ungar, Director, Physical Infrastructure Issues, on (202) 512-2834 or at
Acknowledgments       ungarb@gao.gov, or call Linda Calbom, Director, Financial Management
                      and Assurance, on (202) 512-8341 or at calboml@gao.gov for pension and
                      retiree health issues. Individuals making key contributions to this
                      testimony included Teresa Anderson, Joshua Bartzen, Margaret Cigno,
                      William Doherty, Scott McNulty, Lisa Shames, and Jill Sayre.

                      Page 27                                                           GAO-03-812T
Appendix: Analysis of the Postal Service’s
Civil Service Retirement System Liability

               In May 2002, we asked OPM to estimate—as of September 30, 2002—the
               extent to which the Postal Service had funded and was projected to have
               funded the CSRS costs of its employees and annuitants for civilian service
               rendered since July 1, 1971, the effective date of the Postal Reorganization
               Act. In order to make these determinations, OPM had to first estimate how
               much of the net assets of the Civil Service Retirement and Disability Fund
               (CSRDF) were attributable to the Service’s CSRS participants. OPM
               accomplished this task by first constructing a hypothetical “Postal Fund,”
               into which agency and employee contributions were credited and from
               which benefit payments and a portion of the CSRDF’s administrative
               expenses were charged. It was also necessary for OPM to allocate a
               portion of the CSRDF’s actual investment returns since fiscal year 1972 to
               the “Postal Fund,” even though under what was then current law Treasury
               bore all investment risk and any resulting gains and losses. OPM also
               assumed in its initial calculations that the Service was responsible for the
               applicable military service costs of its employees, which was consistent
               with the administration’s legislative proposal. However, under the then
               current law, funding of these military costs was the responsibility of the

               Table 2 shows the current and projected funded status of future CSRS
               benefits payable to the Service’s employees and annuitants calculated to
               reflect both the administration’s proposal that the Service be responsible
               for military service costs and the then current law, which had Treasury
               responsible for these costs. The present value of future contributions in
               table 2 reflects the Postal Service’s funding of CSRS benefits as
               established in the then current law.

               Table 2: Funded Status of Postal Service CSRS Benefits Under Pre-P.L. 108-18
               Funding Approach

                Dollars in billions as of September 30, 2002
                                                                                                        The Service not
                                                                           The Service responsible      responsible for
                                                                            for benefits attributable           benefits
                                                                                  to military service    attributable to
                                                                                                        military service
                Present value of future CSRS benefits                                       ($190.4)            ($179.1)
                “Postal fund” net assets                                                       168.4               185.0
                Current amount of benefits (to be
                funded) / overfunded                                                          (22.0)                5.9
                Present value of future contributions                                           99.7               99.0
                Projected overfunding                                                         $ 77.7             $104.9
               Source: Developed by GAO based on OPM data and actuarial calculations.

               Page 28                                                                                     GAO-03-812T
The extent to which the Service had already funded all future benefits is
the difference between the present value of those future benefits and the
hypothetical “Postal Fund.” The extent to which the Service is projected to
have funded all future benefits is the difference between the current
amount to be funded (or the current overfunding) and the present value of
all future contributions based on what was then the current law.
Calculating the funded status of civilian benefits established a benchmark
from which the cost of alternatives to the funding of military service could
be calculated.

Table 3 shows the effect on the projected overfunding as a result of
changing the approach to funding future CSRS benefits. All present value
figures in tables 2 and 3 reflect CSRS-wide demographic assumptions. P.L.
108-18 permits the Postal Service to request that OPM reconsider
calculating these present values using Postal Service-specific demographic
assumptions. Both tables show that the shift of military service costs from
the Treasury to the Postal Service amounts to over $27 billion.

Table 3: Funded Status of Postal Service CSRS Benefits Under P.L. 108-18 Funding

 Dollars in billions as of September 30, 2002
                                                                             The Service
                                                                         responsible for    The Service not
                                                                                 benefits   responsible for
                                                                          attributable to    military related
                                                                         military service            benefits
 Current amount of benefits (to be funded) /
 overfunded                                                                      ($ 22.0)              $ 5.9
 Present value of regular agency contributions                                       11.8               11.8
 Present value of employee contributions                                              4.7                4.7
 Present value of future employee military
 service deposits                                                                     0.7                  0
 Projected (underfunding) / overfunding                                           ($ 4.8)             $ 22.4
Source: Developed by GAO based on OPM data and actuarial calculations.

The administration believed that making the Postal Service responsible for
funding military service benefits—both retrospectively to fiscal year 1972
and prospectively from enactment of any legislation—was appropriate in
part because its legislative proposal would shift investment risk to the
Postal Service. Since fiscal year 1972, the CSRDF earned more than OPM
assumed it would. Consequently, while P.L. 108-18 made the Service
responsible for funding the cost of military service benefits for all
employees hired after June 30, 1971, and a portion of the costs for those
employees hired before July 1, 1971, the Service received the benefit of

Page 29                                                                                        GAO-03-812T
these higher than expected investment returns. Similarly, in the future,
investment returns that are above or below expectations will decrease or
increase the Postal Service’s pension costs, respectively. Furthermore, P.L.
108-18 results in postal ratepayers paying for the cost of military service
creditable towards a CSRS benefit the same as they currently do for the
Service’s employees who participate in the Federal Employees Retirement

Page 30                                                         GAO-03-812T
Related GAO Products

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Transformation            GAO-03-118. Washington, D.C.: Jan. 2003.

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                          Page 31                                                      GAO-03-812T
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                Page 32                                                       GAO-03-812T
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                Page 33                                                       GAO-03-812T
           The Results Act: Observations on the Postal Service’s Preliminary
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           U.S. Postal Service: Development and Inventory of New Products.
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           Page 34                                                      GAO-03-812T
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