DOCKET SECTION
BEFORETHE
POSTAL RATE COMMISSION
WASHINGTON, D.C. 20266-0001
RECEIVED
OCT I
4 44 PH ‘97
RESPONSE OF UNITED STATES POSTAL SERVICE
WITNESS PANZAR TO INTERROGATORIES OF ADVO, INC.
AND MOTION FOR LATE ACCEPTANCE
(ADVOIUSPS-Tl l-l-6)
The United States Postal Service hereby provides responses of witness Panzar
to the following interrogatories of Advo, Inc.: ADVOIUSPSTl
l-l-6,
filed on
September 15, 1997. The Postal Service also moves for late acceptance of these
responses, which were delayed due to the high volume of recent discovery and the
requirements of the witness’s teaching schedule.
Each interrogatory is stated verbatim and is followed by the response
Respectfully submitted,
UNITED STATES POSTAL SERVICE
By its attorneys:
Daniel J. Foucheaux, Jr.
Chief Counsel, Ratemaking
475 L’Enfant Plaza West, S.W.
Washington, D.C. 2026&l 137
(202) 266-2993; Fax -6402
October 1, 1997
Responseof Postal ServiceWitness Panzarto ADVO Interrogatories
ADVOKJSPS-Tl l-1. On page 4, you statethat:
“There are two especially natural types of [volume] changesto consider. The first
is an increment of one unit of mail volume of a particular subclassof service.
the secondtype of volume changeto consideris that of an entire mail subclass.”
Within a particular subclassof service,assumethat (I) the SnaJ(end-to-end) serviceto
the mailer/consumercan be supplied by two intermediateinput services(e.g.,
transportation and delivery) and (2) one of the input servicescartbe provided by either
the USPS or a competitor.
(a) Should the input servicesbe consideredseparatelyin the generationof
efficient rates? Pleaseexplain.
@I) If the USPS facescompetition in providing both input services(i.e., neither
input service is perfectly inelastic), how should it price those servicesin order to generate
efficient ratesand still breakevenfinancially?
ANSWERS:
(a) It may be useful or necessaryto analyzethe “input services” separatelyin developing
the marginal cost estimatesupon which rates should be based,much as the Postal Service
analyzesvarious cost componentsseparately.
(b) I do not understandthe question. Ratesare typically developedfor mail subclasses,
not “input services” or cost components.
Responseof Postal ServiceWitness Panzarto ADVO Interrogatories
ADVOIUSPS-TI l-2. On page 7, you state:
“In addition, the marginal cost pricing floor plays an important role in allocating
output among firms when there are multiple providers of a service. Competitive
rids of the Postal Servicewould maximize their profits by selectingtheir output
levels to equatetheir marginal coststo the market price. If that price were below
the marginal cost of the Postal Service,productive efftciency could be improved
by shifting output from the Postal Serviceto its rival(s).”
(a) Assume scaleand scopeeconomiesfor a multi-product firm and no perfectly inelastic
service demands. Under what circumstancesshould one of the firm’s servicesbe
efficiently priced at marginal cost (rather than averageincrementalcost) when the firm
has competitors which provide equivalent, substitutableservices? Pleaseexplain your
responsefully.
(b) For your responseto (a), pleaseexplain whether the circumstancesidentified (pricing
one service at marginal cost) would generatea cross-subsidyand, if so, (2) how a crosssubsidy would be compatible with efficient pricing.
ANSWERS:
(a) The question doesnot specify the notion of efftciency you have in mind. However,
in the situation you describe,most notions of efftciency would require a service’s price to
equal its marginal cost whenever both of the following conditions hold: (1) The supply
curve of competitive suppliers is perfectly elastic. (2) Marginal cost is at least as large as
averageincremental cost.
(b) There would be no cross-subsidyunder the circumstancesdescribedin part (a).
Responseof Postal ServiceWitnessPanzerto ADVO Interrogatories
ADVOAJSPS-Tl l-3. On page 8, you describethe incrementalcost test and state:
‘I
if a service’srevenuesdo not cover the additional coststhe enterpriseincurs
in providing it, the usersof that serviceare receiving a subsidy from the
enterprise’sother customers.”
(a) Does the incremental cost test also apply to USPS serviceswhich may be considered
intermediate inputs (1) to a final (end-to-end)servicewhich both the USPS and its
competitors provide and (2) which competitorsmay separatelyproduce or purchasefrom
the USPS (e.g., transportation or sort&ion)? Pleaseexplain your responsefully.
(b) For an intermediateinput service which either the USPSor a competitor can produce
(e.g., transportation or sortation), is the efficient comparisonbetween(1) the competitor’s
stand-alonecost for that input serviceand (2) the USPS’s incrementalcost for that same
input service? Pleaseexplain your responsefully.
(c) Pleasedescribethe conditions under which it would be economically efficient for the
USPS to price an intermediate input service(to a competitor who could also produce that
input service) at marginal cost, when its marginal cost is lessthan its incremental cost.
ANSWERS:
(a) The incremental cost test only applies to serviceswhich generaterevenues. If the
intermediate inputs you refer to are actually sold in the marketplace,the incremental cost
test could be applied.
(b) I am not sure what you meanby the term “efficient comparison.” It is true that, from
the point of view of industry cost minimimtion, whether an operation is most efficiently
performed by the Postal Serviceor a competitor is determinedby comparing the
incremental cost of the former with the stand-alonecost of the latter.
(c) I presumethe question meansto assumea situation in which “its marginal cost is less
than its average incremental cost.” It would be economically efficient for the Postal
Serviceto sell the input serviceat marginal cost ifthere were a competitive sector with a
perfectly elastic supply curve that also supplied the input serviceto the external market
(but not the Postal Service). In that situation, efficiency would require that ‘anyexternal
Responseof Postal Service WitnessPanzarto ADVO Interrogatories
salesof the input by the Postal Servicebe made at marginal cost. Effkiency would also
require that the averageincrementalcostsofthe exrernul salesmust be no larger than the
price received. Note that the averageincrementalcostsof the external salescan be less
that the averageincrementalcostsof the input service,taken as a whole.
Responseof Postal ServiceWitness P-to
AOVO Interrogatories
ADVOKJSPS-Tl l-4. On page9, you state:
“It is certainly possible, in principle to calculatethe incrementalcostsof
providing certain servicequality attributes, such as daily delivery. While the
results may be important for decision-makingpurposes,they have nothing directly
to say about whether or not a servicewith given quality attributes is being
subsidized.”
Pleaseclarify this statement. If the level of servicequality for a particular subclass
causesnon-volume variable costswhich can be avoided if that subclassis eliminated, are
those costs consideredincrementalto that subclass?Pleaseexplain fully.
ANSWER Any costswhich would be avoided if a subclasswere eliminated are
incremental to that subclass,
Responseof Postal ServiceWitness Panzarto ADVO Interrogatories
ADVO/USPS-Tl l-5. On page 9, you state:
“From a social point of view, stand-aloneprovision would be desirablewhenever
the stund ozonecostsof independentprovision of a mail service (or group of mail
services)are less than the Postal Service’sincrementalcostsof tbat service (or
group of services).”
(a) Within a particular geographicarea,assumethere is volume which a mailer can enter
at either the USPS delivery office or at a competitive delivery carrier’s office. And,
assumethe competitor’s stand-alonedelivery cost/rateis lessthan the USPS delivery rate.
In that event, is the USPS rate for delivery of mail enteredat the destination delivery
office greaterthan the relevant stand-alonecost? Pleaseexplain.
(b) Pleasedescribethe conditions which are required in order to properly comparethe
Postal Service’s service incremental co&ate to the stand alone cost/rateof a competitor.
(For example, would the competitor have to provide the samegeographicservice
coverage,the samelevel of service quality, the sameworksharing discounts,etc.)
ANSWERS:
(a) In the hypothetical you describe,the USPS rate is higher than the stand-alonecosts
relevant for proper use of the sfund-alone cost test usedto test for cross-subsidization.
However, in any practical situation, it must be recognizedthat ratesare basedon a nationwide averageof Postal Servicecosts. Thus, for any specific type of mail (or for any
particular geographicarea),it may be quite possible for a competitor’s stand-alone
averagecoststo be lower than postal rateswithout necessarilybeing lower than the
averageincremental costsof the Postal Service. In that case,any failure of the standalone cost test would be due to rate-averaging,not Postal Serviceinefficiency.
@) First, a clarifying comment. Rates would be comparedto a competitors stand-alone
averagecosts in order to test for cross-subsidization.Postal Service incremental costs
would be the subject of such comparisonfor the efficiency reasonsoutlined in the quoted
passagefrom my testimony. Theseare two different issues. For either purpose,it is
important to compare“likes with likes.” That is, serviceswith the samecharacteristics.
Responseof Postal ServiceWitness Panzu to ADVO Interrogatories
However, the competitor need not have the samepricing options as the postal service,nor
cover the samegeographicalareasin order for suchteststo be meaningful.
Responseof Postal ServiceWitness Panzarto ADVO Interrogatories
ADVOAJSPS-Tll-6. On pages10-l 1, you state:
“Yet monopoly tariffs can till play ao efficiency enhancing,signaling role by
satisfying the constraintsimposedby the incrementalcost test. If the
monopolist’s prices are set below per unit incrementalcosts,firms with superior
productive techniqueswould be inefficiently deterredfrom entering the market.
Their entry would necessarilyimprove social efficiency by decreasingthe total
resourcecost of providing industry services. In addition, the monopoly could be
required to lower prices on its remaining servicesand still break even.”
Does this statementapply also to prices for serviceswhich are intermediate inputs (e.g.,
transportation or sortation) to final (end-to-end)products? If not, why not?
ANSWER: Yes, subject to the clarification introduced in my responseto ADVOILTSPSTl l-3 (c). That is, the price should be comparedto the averageincrementalcost of
external sales,not the firm’s entire production of the intermediateinput.
Responseof Postal ServiceWitness P-
to ADVO Interrogatories
ADVOILTSPS-Tl l-7. In evahratingthe incrementalcosts of a subclass,is it ever
appropriate to considerthe coststhat could be eliminated by reconfiguring the systemin
the absenceof that subclass. Pleaseexplain your answer,including a description of the
kinds of circumstanceswhere it would and would not be appropriateto consider such
reconfiguration savingsas incremental costs.
ANSWER: Yes, to the extent the reconfiguration could be consideredpart of a
reasonableoperating plan. I have not investigatedthe details of the operating plan
sufficiently to be able to provide specific circumstances,
Responseof Postal ServiceWitness Panzarto ADVO Interrogatories
ADVOLJSPS-T-11-8. Assumethat there are functions or operationsin the postal system
that are usedpredominantly, but not exclusively, by a single subclassof mail. Further
assumethat thesefunctions or operationsare not essentialto maintaimng the quality of
service afforded to other subclasses,and that the systemcould be reconfigured to
eliminate such functions in the absenceof that subclass. In that circumstance,would it be
appropriate to treat the non-volume variable costsof such functions as incremental to that
sut&ss? Explain your answer.
ANSWER: No. To the extent that there are other subclassesof mail in the hypothetically
eliminated operation, the cost of handling that mail in the remaining operationsneedsto
be accountedfor.
-
DECLARATION
I, John C. Panzar, declare under penalty of perjury that the foregoing answers
are true and correct, to the best of my knowledge, information, and belief.
J
Dated:
/9-
i-97
il#zQPm
C. Panzar
lJ
CERTIFICATE OF SERVICE
I hereby certify that I have this day served the foregoing document upon all
participants of record in this proceeding in accordance with section 12 of the Rules
of Practice.
475 L’Enfant Plaza West, SW.
Washington, D.C. 20260-l 137
October 1. 1997