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To: Secretary of State Ci: McFadden MPST
Bender MPST
Geoffrey Norris
Stephen Lovegrove (ShEx)
Marc Middleton (ShEx)
Jo Shanmugalingam (ShEx)
From: — Will Gibson Susannah Storey (ShEx)
Shareholder Executive Jon Booth (BR2)
POL Team (ShEx)
Jennie Fuller (LEGAL)
Mark Fletcher (LEGAL)
lan Webster (MPST)
21 November 2008 Martin Simmons (FRM)
Alex Thompson (COMMS)
Tel:
POST OFFICE NETWORK: FUTURE POLICY OPTIONS
1. Following your 30 October letter to the Prime Minister, and the award of the POCA
contract, what are the future policy options for the Post Office network?
2. We will need to settle the policy options in this paper early in 2009. Government's
current funding commitment to Post Office Limited (POL) expires in March 2011. State aid
approval processes, and POL’s ongoing solvency, require us to agree a further funding
deal for POL by the end of 2009. Without a new funding deal we can also expect
increasing external speculation about the Governments commitment to the network.
3. While some of the ideas mentioned here have been discussed with POL
management in the past few months, the contents of this submission have not been
cleared with them.
Recommendation
4. That you:
(i) agree the policy objectives for the Post Office network (para 9);
(ii) consider the broad strategic options to deliver those objectives (para 11), and
provide any initial views;
(iii) I consider the timetable for negotiating and announcing the Government's next
funding commitment to POL (paras 18 and 19); and
(iv) agree the next steps (para 20), including handling James Purnell's
commitment to an MP task force on the future of the Post Office.
Timing
5. Routine — though the role of the “MP Task Force” will need to be settled before
BERR Oral PQs on 27 November (see Annex B).
Current Post Office policy
6. The Post Office network has been in decline since the 1960s. The number of Post
Offices closing accelerated through the 1990s, with significant reductions since 2000. This
recent decline has been driven by consumers choosing to access Government services
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(e.g. buying car tax discs) online and the move to paying benefits directly into bank
accounts. As a result, Post Office Limited (POL) became loss-making in 2000. To
maintain the network in the face of these losses, the Government provided £2bn between
1999 and 2005, and in May 2007 announced a further £1.7bn package to March 2011.
This includes an annual £150m subsidy to support the non-commercial parts of the
network. Annex A provides further background on POL’s recent history.
7. The May 2007 funding package was designed to improve the sustainability of the
network, in part by closing 2,500 branches. The funding package was predicated on a
commercial plan to return POL to profitability (after the £150m annual subsidy) by 2011.
Overall POL should just about meet this objective. However, revenue growth in financial
services and telephony is falling short of expectations and additional cost savings will need
to be identified.
8. In the longer-term the Government's publicly stated aspiration (shared by POL
management) to date has been to eradicate the need for subsidy. The realism of this
aspiration is highly questionable and we may have reached the point where we need to
acknowledge that POL will always be a hybrid public service/commercial organisation.
Policy objectives
9. Looking forward to the 2011 funding package our proposed objectives are:
A. To maintain the future of a network of around the current size - 11,500 Post Office
branches — and geographical distribution.
B. To minimise the size of POL’s requirement for public subsidy, by maximising POL’s
commercial and Government services revenues and running the organisation
efficiently.
Cc. To maximise POL’s contribution to meeting Government's broader public policy
objectives (e.g. social and financial inclusion) in a way that does not jeopardise the
first two of these objectives.
10. There will be some tension between these objectives: the greater the size of the
network, the greater the potential need for public funding. And unless relevant departments
provide the required funding, supporting broader Government policy objectives could
increase the overall need for subsidy. Government will only be intervening if there is a
market failure preventing the private sector (so also POL) from providing a commercial
service. We are working on the basis that your primary goal will be to maintain the size of
network, provided we can demonstrate that the funding required represented value for
money. This was a challenging test to meet in 2007, and will be so again.
How can these objectives be achieved?
11. To maintain the size of the network, POL will need to develop a sustainable
business for itself, and develop products which provide sufficient income and footfall to
create viable businesses for individual subpostmasters. It will need to both increase
revenues (profitably), and provide its services more cost effectively.
e Maximising commercial and public service revenues
There are four key opportunities:
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Financial services: While POL has a wide range of financial services products
(principally through its Bank of Ireland JVs), it is still a “niche” player in the market. It is
looking to grow existing products but also to develop its offering to a full suite of
financial services products. Key options and opportunities include:
. Introducing a transactional, interest-bearing current account.
. Considering whether the advantages of POL continuing to develop its business
through its Bank of Ireland JVs continue to outweigh those of becoming a
standalone provider. POL’s balance sheet would need to be completely
overhauled, with very significant implications for HMG. Additionally, we would
need to be confident that POL could develop in-house banking expertise.
Additionally,
° Deepening POL’s ties with National Savings & Investments.
. Any DWP or HMT interest in providing direct funding to meet perceived market
failures in the provision of financial inclusion products (e.g. Savings Gateway).
. Rebranding POL’s JV with Bank of Ireland as a “Postbank”.
Government services: POCA is POL’s principal Government contract, though this will
decline over time as more people choose to have their benefits paid directly into a bank
account. POL therefore needs to expand into a broader range of Government services.
Key options and opportunities include:
. Providing ID verification services for passports, driving licences and visas.
e« Making POL the physical channel for Government customers who do not use
internet or phone channels (e.g. replacing local DVLA or HMRC offices).
. Securing further business from Local Authorities: disseminating local information,
providing services (e.g. parking permits; registering births, marriages and deaths),
or co-location with their own physical infrastructure.
While POL needs itself to be proactive in seeking new Government services business,
BERR needs to be active in identifying opportunities for them within Government (see
the suggested “Next Steps” at para 20 below) and reminding all parts of Government of
the collective value of the Post Office network.
Mails services: As internet shopping has grown, there has been greater demand for
services that allow customers to collect purchases from Post Offices. POL currently
only provides this service for goods sent through Royal Mail. POL has also been
looking at providing more flexible services for small businesses. Key options and
opportunities include:
. Broadening POL’s collection service to encompass packages delivered by other
mails providers.
. Developing models of service provision that make posting packages more
convenient (e.g. automated “Post and Go” machines).
Customer experience: POL could also drive revenue growth by reversing the decline in
its customer base through improved service. For example it could:
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° Support its financial services strategy, through refurbishing larger town-centre
branches with an appropriate bank-style layout.
. More widely, many of its branches would benefit from refurbishment, which might
make potential customers more likely to visit Post Offices.
There will need to be a clear commercial business case for any Government funding to
improve the branch infrastructure.
e Improving cost effectiveness
Subpostmasters currently receive fixed pay (similar to an annual salary) alongside
variable income dependent on the volume of transactions they process. This contrasts
with POL’s competitors (such as PayPoint) which pay retailers solely on a transaction
volume basis. POL’s standard operating model is therefore uncompetitive.
POL has sought to address this issue by developing new delivery models. To date,
these have principally been outreach services (e.g. vans) designed for rural
communities. However, POL has recently developed a model that involves no fixed
payments with subpostmasters paid on a per-transaction basis. This is the Post Office
Essentials (POE) model Alan Cook talked to you about when he came in to see you
last month.
POEs are based in local (independently viable) retail outlets, offering POL products
during the shop’s full opening hours. This is usually significantly longer than normal
post office hours. Key options and opportunities therefore include:
° A large-scale (approx. 6,000) conversion of outlets from the traditional model to
POE could put the network on a subsidy-free footing by 2016. This would either
be through the compensated conversion of existing outlets, or closing an outlet
and opening a new POE nearby. The efficiency gains would need to exceed
compensation costs.
. Considering how best to minimise the perception that this represented any change
to Post Office provision. Voluntary rather than compulsory conversions?
. Further rollout of low-cost outreach services in rural areas.
12. A large-scale conversion programme could prove controversial and the National
Federation of SubPostmasters (NFSP) is unlikely to be supportive. If the objective is to
take the future of the Post Office out of the political arena there may be a limit to our ability
to pursue this option. However, in the longer term this may be an opportunity to
significantly reduce POL’s need for public subsidy and therefore the threat of further
closures.
Status and structure
13. Our current Post Office policy is predicated on the basis that POL is best able to
maximise its revenues and minimise its costs by being a commercial, limited company.
However, given that POL has received £3.6bn of public funding since 1999, and that
Government will always be nervous about POL taking the steps it needs to reduce its cost
base fundamentally, we should reassess whether that assumption still holds true. If the
aspiration of a subsidy-free business is unrealistic, would it be better to bring it back under
direct Government control as some form of agency?
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14. We need to do some urgent work to understand the detailed consequences of a
change of status. On a preliminary view, the potential advantages are:
e It would potentially be easier for Government to route its services through POL
without always having to go through a competitive tender process. We need to
explore this matter further but our initial legal advice is that the more we make POL
a part of central Government the smaller the procurement problems would become.
However, this would limit the revenues POL was able to source from commercial
services.
e Giving Ministers a greater degree of control over how POL spends its money.
e Other mail providers would find it easier to use the Post Office network.
15. The potential disadvantages are:
e Could make Ministers more directly accountable for the operational performance of
the business and, for example, whether individual post offices remain open.
e It could jeopardise POL’s contractual relationship with the Royal Mail letters
business which represents c.30% of POL’s revenues.
e It removes the possibility of using money held within the Royal Mail group which
might in due course be available for ongoing funding for POL.
16. ‘If there are significant procurement advantages to making POL a Government
agency, we will consider whether there are any ways to minimise the potential downsides.
17. Any change to POL’s constitutional status would require primary legislation. If we
were to seek to add it to any 4" session postal services bill, it is likely to make an already
exceptionally demanding timetable for that legislation undeliverable. Assuming it was not
possible we would need to find a different legislative vehicle. This is unlikely to be a
legislative priority and could well fall into the next Parliament.
Funding deal
18. I These broad policy options will shape POL’s 2011-16 strategic plan, which we will
be asked to fund. It is only in announcing the next funding package for the network that
Government will be able to demonstrate its long-term commitment to the network. Simply
maintaining current subsidy levels would take us to c.£750m over five years, and with
investment in the network (or any further deterioration in POL’s financial position) this
could reach £1.5bn. However, Treasury has already indicated that BERR should plan to
receive a flat cash (or flat real at best) settlement in SRO9, so any increase in the subsidy
above the existing £150m per annum could well require compensating cuts elsewhere in
the BERR budget.
19. I State aid approval processes, and POL’s ongoing solvency, dictate the need to
agree a further funding deal for POL by the end of 2009 and we have had preliminary
discussions with Treasury officials on this basis. It could be possible to proceed faster,
though it would be stretching. Are you happy with an end-2009 funding deal, or do you
want us to aim for a faster timetable? Treasury’s commitment to negotiate with us and
POL to an accelerated timetable would be key. We are unlikely to secure this commitment
at official level: you would probably need to speak to the Chancellor to secure his personal
commitment to an accelerated timetable.
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Next steps
20. We would suggest the following next steps:
« Select Committee
In a POCA debate on 10 November, James Purnell agreed to establish a task force
of MPs to identify new services (beyond the POCA contract) that could help secure
the long term viability of the post office network. Having discussed with Pat
McFadden, we consider this would best be conducted through the Business and
Enterprise Select Committee (BEC). Annex B provides further details. We will need
to settle handling before BERR Oral PQs on 27 November.
« Government business
We believe that using the Cabinet Committee structure will be the most effective
way of getting traction with other Departments to push POL’s Government services
offering. A number of your predecessors sought to increase Government business
channelled through the network, with very limited success. Your commitment, and
that of the Treasury, will be vital if we are to get a more constructive response. As
a start, we therefore propose that you chair a meeting of the Post Office
Cabinet Committee (MISC 33) to push ministerial colleagues. We will ask Cabinet
Office to arrange this for before Christmas. Are you content?
e POL commercial plan
We will continue to engage with POL and HMT on the development and funding of
its 2011-16 commercial plan. We will feed in any steers you are able to provide now
on the policy options in this paper.
e Media handling
COMMS will provide you with separate advice on Post Office media handling.
Will Gibson
Shareholder Executive
21 November 2008
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ANNEX A - POST OFFICE OVERVIEW
Over 20 years from 1986/87 to 2006/07, the post office network shrank by 7,000 offices
from 21,200 to 14,200 (as set out in the graph below).
Decline of Network Over the Last 20yrs
22,000
20,000
18,000
16,000
14,000
12,000
BE 2
1993
z 8
196
gE
200
REE 2 £8
2m
This included a Government funded programme of 2,500 urban office closures between
2003 and 2005. A second compensated closure programme (now virtually completed) has
seen the closure of a further 2,450 offices, of which 500 will be offset by a new outreach
(e.g. mobile van) service. At the end of this programme the network will comprise around
12,000 offices, of which some 7,500 are not commercial and supported by a Government
social network subsidy of £150m a year until 2011. The non-commercial offices are
predominantly in rural and deprived urban areas.
POL revenue streams
POL’s revenues in 2007/08 were £1,268m of which mails services generated £335m
(26%); financial services £326m (26%); Government services (incl POCA) £294m (23%);
telephony £100m (8%), retail and lottery £58m (5%) and Government subsidy £150m
(12%).
600 551
500
400 368
—=Financial Services
353 TS
—Telephony Services
300 335 336 319
—nail Services
Government Service:
1
100
40
6 10 15
2003 2008 200s 2006 2007
The chart above shows the trends in revenue mix over the past five years. The decrease in
revenues from Government services corresponds to the move by DWP to pay more
benefits via direct payment into bank accounts, leading to lower POCA revenues for POL
as time has passed.
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ANNEX B - MP TASK FORCE
1. In a POCA debate on 10 November, the Secretary of State for Work and Pensions
agreed, to a proposal from Lindsay Hoyle MP to establish a task force of MPs to identify
new services (beyond the POCA contract) that could help secure the long term viability of
the post office network.
2. Having discussed with Pat McFadden, we consider that this would best be
conducted through the Business and Enterprise Select Committee (BEC). This has the
advantage of:
e being a cross party group of MPs, constituted under Parliamentary procedures
e the BEC already having extensive knowledge of post office network issues
e allowing the Task Force to make an early start on its work. There would be
inevitable delays in convening a new free standing body and identifying funding.
e Pat McFadden has established that Lindsay Hoyle considers the BEC to be well
suited to take on the Task Force role. Soundings have yet to be taken of the
Chairman, Peter Luff, but we would expect him to welcome the proposal as
continuing to give topical political prominence to the Committee's role.
3. Are you content that we ask BEC to take on the Task Force role? If so we will
provide a letter for you to send to Peter Luff.
4. It would be helpful to focus the direction of the Committee’s interest. Based on its
existing work, it can be expected to focus particularly on the scope for increasing
Government (central and local) services through the network - making ‘joined up’
Government a particular (if long standing) theme.
6. A second area of particular interest will be in extending the range of financial
services available at post offices, drawing on your recent letter to the Prime Minister, and
the wider (also long standing) view that all High Street banks should allow access to their
current accounts at post offices. Now only RBS and HSBC do not. It could be helpful to
seek to encourage the Committee to consider the scope for new business opportunities for
POL beyond central Government and Government Agencies.
7. There is also scope for some management of the Task Force’s expectations at the
outset. This could perhaps be achieved by an informal meeting of Ministers and Alan
Cook, POL Managing Director, with members of the Committee.
8. Such a meeting would enable POL (on a confidential basis where necessary) to
inform the Committee of products and services under development/negotiation and where
potential sensitivities might lie. It would also enable a frank discussion about the
requirements of competition and procurement law. This could help prevent the Committee
saying for example, that the BBC TV licence contract, currently with Pay Point, must be
returned to the Post Office, irrespective of relevant law.
9. Are you content that the scope for a meeting of this kind be explored?