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The 500-year-old organisation faces major obstacles to remain one of the UK’s leading businesses
Royal Mail is back at the top table of British business.
The postal delivery group reclaimed a place in the FTSE 100 this week, half a year after its relegation from the blue-chip index raised concerns about whether investors who bought into its 2013 stock market float had received goods with a hidden defect.
A long and bitter industrial dispute triggered by the closure of a generous pension fund last year almost erupted into the first nationwide strikes since privatisation, weighing heavily on Royal Mail shares.
But the stock has gained 9.5 percent after a wide-ranging labour agreement that averted walkouts was struck last month with the Communication Workers Union, whose 110,000 members will vote on the deal in the coming weeks.
With the conflict almost behind it, Royal Mail must now refocus its efforts on ensuring the 500-year-old organisation is fit for the future.
“In many ways I think its destiny is at least in its own hands now,” says Nick Pendleton, a former director. “There were a lot of clouds over the company and the share price in many ways that I think are no longer there.”
But there is a tough balancing act.
The challenge for Royal Mail lies in expanding its UK parcel business on the back of the ecommerce boom in order to navigate the inexorable decline of letters, which are being substituted by electronic communications.
The company faces fierce competition from rival parcel carriers who often engage workers on inferior and precarious terms and conditions through the “gig economy”, while Amazon takes more of its deliveries in-house.
At the same time, Royal Mail has to juggle its statutory duty to deliver mail throughout the UK at uniform prices six days a week with the need to shrink its wage bill, which eats up roughly half of its £9.8bn annual revenues.
Crucially, Royal Mail is shutting a defined benefit retirement scheme, the cost of which was set to balloon from £400m a year to above £1bn. A proposed new arrangement would keep its contributions to £400m a year.
Further productivity improvements will be vital to retaining its dominance in parcels, say analysts and people familiar with the company.
“That will be difficult to achieve as they’ve already cut all the low-hanging fruit over the past three years,” says David Kerstens, an analyst at Jefferies.
This is all the more pressing given that the proposed labour agreement includes a commitment to reduce Royal Mail’s working week to 35 hours by 2022, from 39 hours. That combined with a pay rise has led some analysts to predict higher operating costs.
With industrial relations on an even keel again, people familiar with the company expect a more co-operative attitude from trade unions when it comes to eking out efficiency gains.
One hour will be chopped off the working week in October, subject to trials of productivity initiatives, with a further one-hour reduction a year later. Royal Mail says these changes will not increase costs “materially”.
One project that management intends to pilot involves the removal of a preparation step in delivery offices, meaning that postmen and women would spend less time indoors and so be out on the streets longer.
For evidence of its record on driving efficiency, Royal Mail points to a modernisation programme under Moya Greene, chief executive since 2010, which it says has delivered “significant benefits”.
This has concentrated on introducing technology, such as parcel sorting equipment, handheld devices for posties and the tracking of packages, although investment has peaked.
“As the business captures more data from its technology, [it will be able to better] understand where the efficiencies or inefficiencies are,” says Mr Pendleton. “As you roll out more automation and are able to scan and track every parcel, you get lots more insight about areas you might be able to be more productive in.”
Another limb to the overhaul is more flexible working practices, leading to longer opening hours at delivery offices and later consignment acceptance times at its depots.
It appears to be paying off. Revenues are on the rise in parcels, where Royal Mail controls roughly half the UK market and has been winning contracts from large retailers, although it has lost some share around the margins.
Management has also said it is on track to deliver a cumulative £600m of cost avoidance by the end of this financial year and recently upgraded its earnings target.
However, underlying operating profits shrank at Royal Mail’s core UK business in its most recent half year, with earnings growth at the group level propped up by its overseas parcels arm GLS.
The unit has been beefed up with a series of acquisitions in Europe and on the US west coast and recently posted a 9 per cent underlying rise in half-year sales, against flat revenues in the UK business.
People familiar with Royal Mail expect GLS to occupy a larger role in the group in future through more deals and organic expansion.
Yet with much focus in the UK business on short-term cost savings and productivity gains, some observers ask whether Royal Mail is doing enough to survive as a successful business.
“What posties do today is what they’ve done for the last couple of hundred years. The question remains what will posties be doing in 10 years’ time,” says one former senior manager. “Is that business model really sustainable in the long term — or is there going to be a disruption to it?”
If it is the latter, Royal Mail may struggle to keep its place at the top table.