USPS is not Correctly Allocating Overhead Costs to Package Business, Giving Amazon and Maybe Other Big Etailers a Discount, Accelerating Brick and Mortar Demise

Is Amazon getting a big cost break on parcel shipments sent via the United States Post Office – by far its largest delivery vendor – due to quirks in the Federal law about how the USPS must price its services?

That's the contention made in a Wall Street Journal article last week by Josh Sandbulte of investment Greenhaven Associates, based on recent analysis from Citigroup.

Supply Chain Digest Says... That may be why some two-thirds of Amazon deliveries are made by the USPS, with UPS and FedEx enjoying much smaller shares of the business. What do you say? Click here to send us your comments Click here to see reader feedback

Before we get to that, SCDigest would first like to recall a two-part series of columns authored earlier this year by SCDigest editor Dan Gilmore, which stated that the rise of ecommerce – and the resulting turmoil in most brick & mortar retail – is accelerated far beyond what it otherwise would be because etailers are offering discounted or free shipping, far below their actual costs.

"Is the growth of ecommerce - and major financial woes in some but not all sectors of brick and mortar retail - something of a fraud, based on irrational shipping charges by virtually everyone in the market?" Gilmore wrote back in February. (See Irrational Shipping Prices and the Demise of Brick and Mortar Retail and Ha! Walmart Proves Me Right on eFulfillment.)

The analysis of Amazon and the UPS is along the same lines, in the end.

Starting in 2001, regular US mail started to decline substantially, given email, electronic bill pay, etc. So in the following years, the USPS looked to keep itself financially viable by focusing more attention on its parcel delivery business.

That got the executives at UPS and FedEx nervous, concerned the Post Office would undercut them on prices. After a lobbying effort, the 2006 Postal Accountability and Enhancement Act made it illegal for the Postal Service to price parcel delivery below its cost.

But how do you account for those costs? Cost accounting is always tricky – especially in how "overhead" costs are allocated to different activities.

As Sandbulte asked in his column, "When our postal worker delivers 10 letters and one box to our home, how should we allocate the cost of her time, her truck, and the sorting network and systems that support her? What if the letter-to-box ratio changes?"

In 2007 the Postal Service and its regulator determined that, at a minimum, 5.5% of the agency's fixed costs must be allocated to packages and similar products. But now 10 years later, about 25% of USPS revenue comes from packages, while the amount of fixed cost overhead allocated to business has largely stayed flat.

So, the regular mail business is providing a big subsidy to the parcel business, allowing the USPS to calculate its package costs at a lower level than if the overhead were more fairly allocated. That in turn allows the USPS to offer lower prices to Amazon and other big shippers without running afoul of the law to not price below its costs.

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How large a subsidy?

The April analysis from Citigroup estimates that if costs were fairly allocated, on average parcels would cost $1.46 more to deliver.

"Amazon is big enough to take full advantage of "postal injection," and that has tipped the scales in the internet giant's favor," Sandbulte says. "Select high-volume shippers are able to drop off presorted packages at the local Postal Service depot for "last mile" delivery at cut-rate prices. With high volumes and warehouses near the local depots, Amazon enjoys low rates unavailable to its competitors."

That may be why some two-thirds of Amazon deliveries are made by the USPS, with UPS and FedEx enjoying much smaller shares of the business.

Similar to what Gilmore wrote in his columns, Sandbulte adds that "Like an accelerant added to a fire, this subsidy is speeding up the collapse of traditional retailers in the US and providing an unfair advantage for Amazon."

He calls for Congress to demand real enforcement of the Postal Accountability and Enhancement Act, and for "the Postal Service needs to stop picking winners and losers in the retail world."

What is your take on this piece? Is Amazon giving huge price break to Amazon? Let us know your thoughts at the Feedback section below.

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