Notice of mod to the control preventing margin squeeze

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Notice of modification to the control preventing Royal Mail margin squeeze

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Summary
1.1 On 27 March 2012 we published our Statement 'Securing the Universal Postal Service: Decision on the new regulatory framework' ('the March 2012 Statement'). This set out our decision on the new regulatory framework for the postal sector, which gave Royal Mail Limited ('Royal Mail') more commercial and operational flexibility (particularly in relation to setting the majority of its prices). Regulatory safeguards were implemented to protect consumers and, where appropriate, promote effective competition.
1.2 Together with the March 2012 Statement, we imposed a set of controls and accounting conditions. Included in these was a regulatory condition made pursuant to powers under section 38 and Schedule 3 of the Postal Services Act 2011 (the "Act") (and in made in accordance with section 53 and paragraph 3 of Schedule 6 of the Act) to impose on Royal Mail, the universal service provider, an access condition. The access condition was made and notified on 27 March 2012 and is available at Annex 9 of the March 2012 Statement the ("USP Access Condition").
1.3 The USP Access Condition gives access to Royal Mail's postal network to other postal operators and users. The USP Access Condition includes a price control condition on Royal Mail. This was imposed because it appeared to Ofcom (when setting the condition) that in the absence of the condition the Royal Mail might impose a price squeeze with adverse consequences for users of postal services.
1.4 The Access Condition as a whole relates to "D+2" services, which are retail services offered by Royal Mail that aim to deliver two working days after collection from the sender. Access to these services must be offered on reasonable request. Key obligations on D+2 services access are set out in paragraphs 2 and 3 of the USP Access Condition.
1.5 The margin squeeze condition is set out in paragraph 6 of the USP Access Condition. The condition aims to ensure that Royal Mail's pricing for retail services for bulk mail D+2 letters does not involve a price squeeze, with adverse effects for users of Royal Mail access services. An adverse effect might arise because such users of Royal Mail access services are themselves competing with Royal Mail for collection and outward processing i.e. upstream operations.
1.6 A central component of these conditions is the calculation of Royal Mail's upstream costs incurred by Royal Mail. These are the costs which Royal Mail incurs in relation to the collection and processing of post for presentation to the inward mail centre as part of its D+2 retail bulk services.
1.7 The condition requires this cost to be calculated by subtracting identified Access services downstream costs from the total Royal Mail (end-to-end) cost of the D+2 retail bulk services. However, as part of our regular compliance reviews of Royal Mail's retail activities, we have highlighted an ambiguity with respect to cost items to be included in the calculation of downstream access cost (required in paragraph 6.4 of the USP Access Condition).
1.8 Specifically, the condition may, as it is currently drafted, be unclear and incorrect in one respect as to the treatment of unrecoverable VAT as a cost in this calculation. Unrecoverable VAT is a significant cost element in Access services downstream costs but not in Royal Mail's cost of the D+2 retail bulk service.
1.9 In light of the fact that VAT is recoverable in the Royal Mail's bulk retail activities it is therefore not relevant when considering the calculation of costs of providing those services (and the pricing floor) under price control condition and it should not included in any part of the calculation of Royal Mail's upstream costs. However, as unrecoverable VAT is a cost element for Access services downstream costs (as Access services are exempt from VAT), the condition as it is currently drafted might appear to allow unrecoverable VAT to be part of the calculation.
1.10 Ofcom considers that if VAT costs were included there would therefore be potential to distort the outcome sought by the operation of the pricing condition.
1.11 We are proposing, therefore to modify paragraph 6.4 in the USP Access Condition to explicitly remove unrecoverable VAT from the downstream cost calculation. A marked-up version of the USP Access Condition which shows these modifications to paragraph 6.4 is set out in Annex 4.
1.12 Section 2 explains the nature of unrecoverable VAT that concern Ofcom, how it arises and how it affects the calculation.
1.13 Ofcom is satisfied that this proposal satisfies the general test in paragraph 1 of Schedule 6 to the Act.
1.14 Copies of this Notice and the accompanying Consultation document have been sent to the Secretary of State in accordance with paragraph 5(1)(a) of Schedule 6 to the Act.

Notice of modification to the control preventing Royal Mail margin squeeze PDF Document (154 kB)
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