- Concerted efforts to improve efficiency
- Weakened demand
International Distributions Services (IDS) published its full-year results last week. As expected, they didn’t make for easy reading. The group reported a £748mn operating loss, down from a £577mn profit the previous year. A robust performance from European courier GLS did little to offset the debacle at Royal Mail, which posted an operating loss of £1bn.
The company's board, which is searching for a chief executive following the resignation of Simon Thompson, put on a brave face. Chair Keith Williams said there “is now a clear path towards a more competitive and profitable Royal Mail” and that the “destination is coming into sight”. His message is very different from that of a few weeks ago, when Royal Mail was said to be exploring special administration.
The question is: do investors believe it? Or is there worse to come for the postal service?
People costs
Wages are at the heart of Royal Mail’s financial problems. The courier has more than 150,000 employees, and total people costs come to well over £5bn, having risen by 10 per cent over the past five years. This has coincided with a decline in the number of letters sent and, more recently, a fall in parcel volumes linked to the cost of living crunch. As of March 2023, people costs represented 73 per cent of Royal Mail’s turnover, compared with 64 per cent in 2018.
Attempts to save money have clearly backfired: posties went on strike for 18 days last year over pay and changes to their working conditions, which led to “disappointing” quality of service and lots of lost business. Now the group has struck a deal with the Communication Workers Union, but there are new questions about its cost base.
According to its latest results, the pay deal will increase Royal Mail’s annual costs by around £350mn – not ideal for a courier where outgoings are already higher than income. Progress has been made elsewhere, though. The business started the financial year, for example, with 10,000 fewer full-time equivalent employees. This was a significantly bigger fall than it had anticipated, and management said that “far fewer” people had left under voluntary redundancy than expected.
While rampant attrition rates don’t reflect well on company morale, they are useful for reducing people costs in the short term.
Demand dilemma
Wages and redundancy packages aren’t the only thing Royal Mail has to worry about. Non-people costs – such as distribution, conveyance and infrastructure expenses, among others – have also risen over the past five years. Infrastructure proved particularly troublesome last year due to electricity prices, and a cyber attack in January piled on additional pressure.
However, a key aspect of Royal Mail’s business model is its operational gearing. It has a very high fixed cost base, which is why the past year was so painful, but now posties are delivering mail again margins should recover quickly.
The group has also been ploughing money into “transformation” measures to improve efficiency. In the year ended March 2022, for example, its capital expenditure was £441mn, which was funnelled into automation, new parcel hubs and electric vehicles. While management intends to rein in future spending, it is confident that it’s now in a position to benefit from these investments.
There’s one big problem, though: demand has not bounced back. Revenue in the final quarter of last year was “slightly weaker” than anticipated, and losses are expected to widen in the first half of 2023-24. Last year, the courier lost around 4 percentage points of market share.
Cost control will ultimately be fruitless if Royal Mail cannot retain and expand its customer base, and there has been little sign of this in recent months. Strikes have obviously played a part, but the core business model also looks flawed: the group is bound by law to deliver letters six days a week, which diverts its attention and resources away from growth areas such as next-day parcels.
Royal Mail is insistent that this Universal Service Obligation needs to be modernised, but Ofcom has refused its requests so far, and recently opened an investigation into the courier’s delivery performance. Unless this changes, it’s unclear how Royal Mail can thrive as a commercial entity.
