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\begin{titlepage}
\begin{center}
	\vspace*{12mm}
		\huge {Liberalization and  Regulation \\ of Postal Services and Markets}\\[1.5ex]
	\vspace{20mm}
		\large{Dissertation zur Erlangung des akademischen Grades \\ Doktor der Wirtschaftswissenschaften \\ - Dr. rer. pol. -} \\
	\vspace{12mm}
		\large{eingereicht an der \\ Wirtschaftswissenschaftlichen Fakult\"{a}t \\ der Heinrich-Heine-Universit\"{a}t D\"{u}sseldorf} \\
	\vspace{32mm}
	\normalsize
\begin{tabular}{rl}
	Verfasst von:		& \quad Dipl.-Volkswirt \href{mailto:sven.heitzler@web.de}{Sven Heitzler}\\[1.0ex]
	& \quad geb. am 10. M\"{a}rz 1975 in Freiburg i.\,Br. \\[6.0ex]
	Erster Gutachter:		& \quad Prof. Dr. Christian Wey \\[1.0ex]
	Zweiter Gutachter:		& \quad Prof. Dr. Christian von Hirschhausen \\[5.0ex]
	Eingereicht am:		& \quad 12. Dezember 2012\\[1.0ex]
	M\"{u}ndliche Pr\"{u}fung:		& \quad 22. Oktober 2013, D\"{u}sseldorf\\[1.0ex]
\end{tabular}\\[1.5ex]		
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%\chapter*{Eidesstattliche Versicherung}
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%\noindent D\"{u}sseldorf, 12.\thinspace Dezember 2012
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%\noindent (Sven Heitzler)
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\chapter*{Acknowledgement}

\setcounter{page}{1} \renewcommand{\leftmark}{ACKNOWLEDGEMENT}

I have to thank the many people who I encountered during my Ph.D. studies,
who supported me during these years and to whom I feel deeply indebted.

First, I want to express my gratitude to my advisor Christian Wey who
encouraged me to face the challenge of such a research journey. He kindly
offered me the possibility to join the DIW\ Berlin and always provided me
with numerous opportunities to develop my own research agenda, very valuable
comments and motivating guidance from the supervision of my diploma thesis
to the finishing of this thesis. He has always been available for me not
only with his advice. There are also two chapters of this dissertation based
on joint writing. Also, I want to thank Christian von Hirschhausen, who
acted as my second advisor. He cordially invited me to the academic
community, supporting me to join the DIW Berlin Graduate Center and provided
me many stimulating comments.

During my time spent at the DIW\ Berlin, I had the luck to find an inspiring
research environment with a very collaborative and collegial atmosphere as
well as to meet many colleagues from whose advice I have profited a lot and
to which a number of amicably relationships arose.

At the department Information Society and Competition, I have to thank
especially Pio Baake who helped me to overcome many difficult moments
throughout my Ph.D. time with his clear guidance and patient support. I am
also particularly in debt to Vanessa von Schlippenbach and G\'{e}za S\'{a}%
pi, who helped me to grow intellectually and personally through their advise
on economic matters as well as through the many personal discussions we had
while sharing our offices. I would like to thank my colleagues Kornelia
Hagen, Nicola Jentzsch, Irina Suleymanova and Georg Erber for the enjoyable
time spent together and Sibylle Kremser for taking care of all
administrative issues.

My thanks also go to all members\ of the DIW\ Berlin Graduate Center of
Social and Economic Research. I\ wish to thank the founding dean, Georg
Meran, who eminently set up and managed the programme, the professors
providing excellent lectures and all my fellows in the programme, of which
especially Johannes Ziemendorff and Marc Vothknecht helped me to pass some
stern phases with their companionship and amity. Furthermore, I would like
to thank Kurt Geppert, Manfred Schmidt and all the other colleagues at the
DIW\ Berlin for their kindness and assistance.

Many thanks also go to my supervisors and workmates at the stations of the
practice stations during the Graduate Center programme. In particular Wayne
Crews at the Competitive Enterprise Institute in Washington, DC, and Michael
Baron, Klaus Dobler and Jan-Stephan Ritter at the Federal\ Ministry of
Economics and Technology, Berlin, further supported my personal advancement
by providing interesting challenges in the areas of regulation and
competition policy.

For my expertise on the postal industry, I have to thank the community of
the Rutgers Center for Research in Regulated Industries Conference on Postal
and Delivery Economics, the EPFL\ Lausanne Trends in Innovation in the
Postal Market Conference, and the Competition and Regulation in Network
Industries\ Conference where I\ also received the best paper award for my
first chapter which further affirmed my decision to work on postal topics.
Especially the vivid and amicable discussions with Bernhard Bukovc, Paul
Schoorl, Michael Crew, Paul Kleindorfer, Matthias Finger, Christian Jaag and
Martin Maegli opened me deep insights into the industry. It was a pleasure
to work with them and their helpful comments and suggestions greatly allowed
me to develop and test my ideas.

I wish to thank in total six anonymous referees for their comments and
suggestions on my works, too.

Financial support provided through the scholarship of the DIW\ Berlin
Graduate Center and by the International Post Corporation for the research
project \textquotedblleft Economics and Regulation of the Postal
Industry\textquotedblright\ is gratefully acknowledged. In addition, chapter
three benefited from the access to IPC's databases.

To all my friends is due my heartfelt gratitude for their friendship,
encouragement and support through the ups and downs, most notably Tom
Stargardt and Carolin Quenzer. Caroline Hammann is the person who merits my
deepest thank. She was on my side and always supported me with her love,
patience, and comprehension.

Last but not least, I am enormously indebted to my family, my parents
Susanne and Karl-Heinz, my grandparents Greta and Kurt, and my brother John.
I owe them many of my skills and abilities, they never lost confidence and
supported every decision of mine to the utmost extent. Therefore this work
is dedicated to them.

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\chapter*{General Introduction}

\addcontentsline{toc}{chapter}{General Introduction} \renewcommand{%
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\noindent Despite rapid technological progress in electronic communication
technologies and changing user habits, modern postal services remain one of
the essential services for a modern information society economy as a whole
to run smoothly and efficiently. Although the liberalization and the related
privatization of formerly state-owned incumbent telecommunications operators
from the year 1984 on received much more attention due to the drastic gains
from massively falling prices and increased choice for consumers, the
development of the postal sector is of similar importance. Even in the
European Union with a very well developed information and communications
technology sector, the postal operators still are responsible for about
0.7\thinspace \% of total gross domestic product and 0.5\thinspace \% of
total employment. Further factors which likely contributed to the lower
attention for postal liberalization are \textit{i)}\ that postal markets
have been effectively opened up ten to fifteen years later (for example, in
the EU,\ the process started with the European Commission's publication of
the Green Paper on the Development of the Postal Market in the year 1992 and
led to the first postal directive in the year 1997, requiring the member
states to open up their formerly monopolistic markets not before 1999) and 
\textit{ii)} that the technological advances in this sector happened largely
invisibly for most of the users of postal services: Letterboxes, envelopes
and stamps remained largely unchanged over time.\\[2ex]
\noindent \textit{Traditional Regulatory Approaches and Postal Services}\\[%
1.4ex]
For the liberalization of the postal industry, it could often be observed
that the telecommunication frameworks have been used as a starting point.
However, although both industries are network industries with the according
economies of scale and scope, there are significant differences which do not
allow to simply transfer the regulation of either of the industries to the
other one. Especially the view that regulations concerning the access to
competitors' networks should also be applied to the postal industry
improperly reflects the characteristics of postal networks.

The first chapter shows, that while the underlying rationale, namely the
existence of natural monopolies and essential facilities leading to entry
barriers and the inefficiency of unregulated competition has been
constituted correctly for the telecommunications sector, fundamental
assumptions to justify such regulatory interventions are not fulfilled in
the postal industry.

Following from the different characteristics of postal networks, the
concentration of demand with very few large companies and institutions
sending the largest share of all mail (and thus being in a favorable
position to negotiate appropriate prices) and from the existence of strong
intermodal competition (allowing demand-side substitution), price
regulations should also be applied more sparsely than in the
telecommunications sector.\\[2ex]
\noindent \textit{The Impact of Regulation on Postal Markets}\\[1.4ex]
The second chapter assesses the influences of regulation on letter mail
volumes and revenues, as well as other factors' influence on employment. The
results coincide with the existing literature, although the effects which
can be seem from existing data appear to be very small. The strongest
confirmation, we can give, however, is the importance of coporatization for
the national postal operators to become efficient. Regulation might have a
smaller impact on the development of the postal industry than it has in the
telecommunications industry.

It is often assumed, that the reasons for that are, that sender and user
preferences play a much more important role in determining the market
developments, that --~despite a growing number of alternative communication
means evolved over time~-- the substitution declines over time, leading the
demand to become more and more inelastic and thus non-responsive to policy
changes, or a combination thereof. In addition, with declining letter mail
markets, advancing automatization and increasing cost, potential entrants
might be discouraged to enter postal markets, again limiting the
effectiveness of policies that aim to foster competition.\\[2ex]
\noindent \textit{Social Regulation:\ The German Postal Minimum Wage Case}\\[%
1.4ex]
Although \textit{economic} regulations might have only limited impact, the
German case of the introduction of generally binding minimum wages for the
postal industry provides a good example how large the impact of \textit{%
social} regulation can be, given the relatively large share of labor cost
and the difficult economic conditions to compete in the letter mail market.
Chapter three illustrates the drastic impact of the introduction of minimum
wages base on a wage agreement between the incumbent and a union on
competition. Although the regulation intended to protect the postal workers
from unintended side effects of liberalization, competition has been impeded
by raising the cost of operators which did not operate on the same scale and
thus with lower margins. The well-meant instrument to limit wage erosion and
to establish a level playing field between the operators turned out to be a
very effective instrument to deter competition. Moreover, in one case, it
contributed to force one of the competitors out of the market.\\[2ex]
\noindent \textit{A Model of Raising Rivals'\ Fixed (Labor)\ Costs}\\[1.4ex]
Since the famous Pennington case seminal article of Oliver Williamson it is
well known in the economic literature that a monopolist and the unions might
have an incentive to raise wages in order to limit entry or force rivals out
of the market. In the forth chapter, we analyze the bargaining problem of an
incumbent firm and a union when the wage contract becomes generally binding
with particular relation to competition among operators of mail delivery
networks and thus the German case which is described in the preceding
chapter. We highlight the raising rivals' cost incentives and the
consequences resulting from labor laws that make such collective agreements
generally binding. We show that minimum wages implemented by means of
extension regulation are an effective deterrence instrument which frustrates
both, market entry as well as investments into the build-up of a mail
delivery network.

Taking together the insight from the two chapters on minimum wages, the
lesson learned is that social regulation should be applied very cautiously
and balance the interests of existing players and potential entrants.\\[2ex]
\noindent \textit{Modernizing the Postal Universal Service}\\[1.4ex]
Finally, chapter five bridges the past and the future. During the last 25
years, the rapid advancements in information and communication technologies
(ICT) led to far-reaching implications not only for the industries involved
but also transformed the whole society. Electronic alternatives to
traditional postal products and services have led to substantial shifts in
the mail mix and to significant substitution of products due to rapidly
declining prices and increasing variety and quality. Nevertheless, while the
universal service obligations (USOs) in the telecommunications sector are
under discussion with regard to broadband access, the postal USOs remained
basically unchanged despite the increased competition not only from new
postal operators but also from electronic substitution which further
increases the competitive pressure on the established operators.

This chapter discusses the development of the USOs in the two industries,
and links them to the recent developments including the EU 2020 strategy
which aims for smart, sustainable growth with access to high speed internet
for all Europeans. Considering in addition the potential replies to these
industry challenges, it becomes clear, that not only the telecommunications
USO, but also the postal USO should be re-evaluated and re-designed in order
to account for the existing interdependencies on the wider communication
market. Thereby, especially the differences in the developments between
urban and rural areas suggest considering approaches that differentiate
between their respective specifics and pay more attention to the underlying
cost characteristics.

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\chapter{Traditional Regulatory Approaches and Postal Services}

\renewcommand{\leftmark}{TRADITIONAL REGULATORY APPROACHES AND POSTAL
SERVICES}

Postal services are an important part of modern economies' communication and
distribution infrastructure. They provide a distribution system for
information and goods that connects communications and logistics, and often
add important financial services to support economic transactions. Numerous
industries such as the e-commerce, banking and insurance, and advertisement
and marketing industry directly or indirectly depend on the postal industry.

Stepwise market liberalization and privatization of former public postal
monopolists pursue the goal to enhance the efficiency of the postal service
sector. The creation of a level playing field that ensures fair competition
is an important element of the liberalization process. The general trend to
introduce competition in the postal industry is possibly most visible in
Europe. Since the European Commission published a Green Paper on the
development of the internal postal market (EU~1991), the reserved monopoly
areas of public operators were reduced three times (1999, 2003, 2006), and
the Europe-wide full market opening is envisioned by the end of 2012 at
latest.

In the telecommunications industry, regulation is based on the existence of
fundamental market failure in network industries due to network effects in
combination with natural monopoly properties and large sunk costs which lead
to substantial barriers to entry. Regulation basically is justified by the
economic rationale that it is impossible to achieve efficient competition
under these conditions. Access regulation is based on the identification of
essential facilities (or \textit{monopolistic bottlenecks}) and aims at
providing efficiency incentives for the incumbent firms and inducing
(efficient) entry and competition in the remaining potentially competitive
parts of the industry. Accompanying retail price regulations prevent the
abuse of monopoly power in retail markets which are dominated by the former
state-owned monopolists.

Recent trends in the EU show that postal service markets are likely to be
regulated as if they essentially shared the characteristics with the
telecommunications sector. The alleged similarity, however, disappears when
we study technological and economic features of postal service markets
precisely.

In the following, the two instruments \textit{downstream access} and \textit{%
retail price regulation}, typically used in telecommunications regulation,
are discussed and assessed from the postal sector perspective. Our
comparison provides transparent illustration of the differences and allows
to highlight the specifics of postal markets.

\section{Network regulation}

\subsection{Competition and economic efficiency}

In principle, competition is expected to lead to economically efficient
allocations with respect to both static and dynamic efficiency. The
underlying reasoning is based on the firms' incentives to maximize their
profits as well as a number of additional assumptions concerning the market
structure and the firms' conduct.

\textit{First}, in order to avoid monopolistic and thus inefficiently high
consumer prices, each firm has to face either actual or potential
competitors. Low entry barriers as well as the firms' ability to use the
same or similar technologies are basic conditions which have to be fulfilled
in order to guarantee that competitive market allocations are efficient.

\textit{Second}, consumers need to have sufficient information about the
firms' prices and the qualities of the products they offer.

\textit{Finally}, a number of further conditions concerning the functioning
of the legal system have to be satisfied. That is, the enforcement of
agreements has to be ensured in order to allow the parties to write
enforceable contracts that circumvent potential commitment problems and
moral hazard through conditional clauses.

Whereas the just mentioned conditions are crucial for static efficiency,
dynamic efficiency is based on efficient investment decisions and timing
with respect to both process and product innovations based on the firms'
expectations to gain competitive advantages vis-\`{a}-vis their competitors
and to earn at least temporarily supra-competitive profits. The analysis of
investment decisions in risky environments and taking into account those
firms' incentives to invest are based on the potential gains from
innovations and reveals that there is basic trade-off between static and
dynamic efficiency.

Hence, to reach dynamically efficient competition, innovations have to be
protected such that potential profits are high enough to give the firms the
right incentives to undertake risky investments in order to develop new
technologies or products. Although this basic conflict between static and
dynamic efficiency cannot be solved in a first best manner, it is generally
assumed, that decentralized innovation processes driven by expected gains
from temporarily limited dominant market positions are the most efficient
way to solve the related investment problems.\footnote{%
Concerning innovation dynamics, cf.\ Schumpeter (1918/1964). The question
about the relationship between market structure and innovation incentives
dates back to Arrow (1962).}

\subsection{Network industries}

Traditionally, nearly all network industries, e.g., telecommunications,
electrical energy supply, railways, water supply and disposal, and postal
services, have been assumed to be characterized by technologies with
subadditive cost functions.\footnote{%
For a formal definition of subadditivity, cf.\ Baumol, Panzar and Willig
(1982, p.\thinspace 17).} This view had led to the provision of the
respective services by protected private monopolies, public owned
enterprises or directly by public administration entities. Over time, views
changed and competition is now supposed to lead to more efficient
allocations in large market segments. The basic argument for this new
approach rests on the idea that many production processes are vertically
structured. Basic infrastructures like telecommunication cables or
electricity grids are inputs for the products and services to be carried
over the networks.

Consequently, the current approach emphasizes that production processes have
to be considered such that competition should be introduced in all market
segments where the respective production technologies allow for competition.
More specifically, monopolistic provision of inputs should be reduced to
market segments where \textit{essential facilities} (or \textit{monopolistic
bottlenecks} as a slightly weaker justification for regulation) exist.
Essential facilities are inputs that are unconditionally necessary to
provide certain goods or services and that are unfeasible or too costly to
be duplicated or to be bypassed.\footnote{%
Cf.\ Bergman (2002, p.\thinspace 110). The foundations of the essential
facilities concept originally was developed in the 1912 U.S. Supreme Court
case United States v Terminal Railroad Association of St. Louis (224 U.S.,
383).} At the same time there must not exist sufficient demand side
substitution possibilities for the service itself. Shortly, essential
facilities not only have to be non-replicable but also non-substitutable
with regard to the service they are needed for.

\subsection{Networks and regulation}

Following the idea that competition leads to efficient market allocations
whenever the conditions mentioned above are met, regulation should be
confined to market segments where essential facilities exist. That is,
regulation should address the industry specifics that lead to market
failures, limit the firms' exercise of market power and try to prevent
abusive conduct of market dominance.

\subsubsection{Access regulation}

The basic idea of access regulation relies on the concept of essential
facilities. If the provision of goods or services is based on the use of
essential facilities, the right to use these facilities should allow for
competition in all other market segments. If firms face the same conditions
to use the respective essential facilities, there exists a level playing
field such that market entry and actual or potential competition between
firms leads to efficient allocations.

Thus, access regulation tries to combine competition in potentially
competitive market segments with a regulated monopoly where it cannot be
avoided (or where a legal monopoly is granted). Access regulation grants
competitors access to elements or parts of the production chain. Table~1.1
provides some examples for regulated access in network industries.

%TCIMACRO{%
%\TeXButton{DA in NI}{\begin{center}
%{
%\begin{threeparttable}
%[htbp]\centering
%\caption{Examples of downstream access in network industries
%\label{tab:tableexda}}
%\vspace{3mm}
%\begin{tabular}{l l l}\hline
%Industry & Downstream access to & Competitive segment \\\hline
%Electricity	& Distribution grid	& Generation \\
%Rail transport	& Rail tracks	& Transport operations \\
%Telecommunications	& Local loop\superscript{1} &	Long distance networks \\
%Water	& Supply and disposal & Treatment \\ \hline
%\end{tabular}
%\begin{tablenotes}\footnotesize 
%\item[1] Under Calling Party Pays regime, call termination is also an essential facility.
%\item[] Source: modified from Haucap and Dewenter (2007, chapter 1).
%\end{tablenotes}
%\end{threeparttable}
%}
%\end{center}}}%
%BeginExpansion
\begin{center}
{
\begin{threeparttable}
[htbp]\centering
\caption{Examples of downstream access in network industries
\label{tab:tableexda}}
\vspace{3mm}
\begin{tabular}{l l l}\hline
Industry & Downstream access to & Competitive segment \\\hline
Electricity	& Distribution grid	& Generation \\
Rail transport	& Rail tracks	& Transport operations \\
Telecommunications	& Local loop\superscript{1} &	Long distance networks \\
Water	& Supply and disposal & Treatment \\ \hline
\end{tabular}
\begin{tablenotes}\footnotesize 
\item[1] Under Calling Party Pays regime, call termination is also an essential facility.
\item[] Source: modified from Haucap and Dewenter (2007, chapter 1).
\end{tablenotes}
\end{threeparttable}
}
\end{center}%
%EndExpansion

\bigskip In all cases, the starting point for access regulation is imperfect
competition based on the existence of a monopolistic bottleneck and the
observation that even if the owner of the monopolistic bottlenecks is not
vertically integrated, unconstrained monopolist behavior would lead to an
abuse of the monopolistic market power and thus inefficient allocations.

Additionally, the introduction of competition by means of regulated access
might be desirable even at a loss in economies of scale and increased
overall costs\footnote{%
Overall costs might increase furthermore from technical and organizational
co-requirements.} mainly for two reasons (Laffont and Tirole 2000,
p.\thinspace 100):

\begin{Itemize}
\item Competitors might offer differentiated services, improving the match
with consumer preferences, and

\item they might offer existing services at lower prices due to lower
(downstream) production costs, e.g., for retailing, and due to lower profit
margins.
\end{Itemize}

Downstream access regulation therefore pursues a dual purpose: First, it
aims at improving the incumbent operators' incentives for efficiency and,
second, it aims at encouraging (downstream) competition (Laffont and Tirole
2000, p.\thinspace 37). Access policy has to balance the efficient use of
existing networks and entry including successive investments in
complementary assets and efficient bypass in order to achieve the market
structure being most efficient in the long run (Vogelsang 2003).\\[2ex]
\noindent \textit{Instruments and access charges} \\[1.4ex]
In cases where access regulation is introduced, access (and resale)
obligations include a wide range of possibilities that are asymmetrically
imposed on the owner of the essential facility.\footnote{%
Symmetric downstream access usually is applied in cases where access to the
final users is needed, as, e.g., in the case of termination monopolies. In
these cases, the distinction between one-way- and two-way-access depends on
the characteristics of the access-seeking firm.} Regulated access implies
not only non-discriminatory access to physical resources and corresponding
pricing to effectively lower entry barriers. In order to ensure a level
playing field, further remedies may be necessary. To address the problem of
exclusionary abuses, even more intrusive additional structural measures like
divestiture obligations (also called \textquotedblleft ownership
unbundling\textquotedblright ) might be used. In any case, access regulation
cannot prevent dominant positions and only reduces the incentives for
anti-competitive conduct. The effectiveness of access regulation depends to
a large extent on the national regulatory agencies' monitoring effectiveness.

Considering the design of access charges, the main problems are to encourage
efficient third party entry, and encourage efficient network investment and
network utilization, while being manageable\ (Vogelsang 2003, p.\thinspace
832). The two major problems concerning access charges are based on \textit{%
i)} the observation that deviations from marginal cost pricing are necessary
in order to ensure that the regulated parts of the network can be operated
profitably and \textit{ii)} the fact that any distortions due to imperfect
competition on downstream markets have to be taken into account as well.

Focusing on the first problem, theoretically optimal access charges are
based on the classical \textit{Ramsey} rule. Such access charges minimize
the efficiency loss due to their inequality to the marginal cost of getting
access. They are based on both marginal costs as well as the properties of
the demand functions in downstream markets. However, the informational
requirements of such access charges as well as the necessity to adapt access
charges whenever demand or cost change imply that they cannot be implemented
without high costs of the regulation itself (Neu 1993).

For the determination of the level of access charges, one has to decide
between historic cost and forward-looking cost. While cost measures based on
historic costs guarantee that the incumbent's actual costs can be covered,
the related access charges may lead to inefficient investment decisions of
competitors. For example, with technological progress and decreasing network
costs, they tend to induce too much investment by competitors inasmuch
historic costs and thus the respective access charges are higher than the
actual opportunity costs (Armstrong 2002, pp.\thinspace 334-337).

Vogelsang (2003) provides an extensive overview of the related literature
concerning access regulations and the calculation of access prices, which is
briefly summarized in the following paragraphs:

Access charges based on forward-looking costs (FLC) mitigate this problem
since costs are calculated such that they reflect the costs for setting up
the respective infrastructure at the moment. However, with costs that are
decreasing over time, FLC imply that the actual costs of the regulated firm
might not be fully covered. Furthermore, compared to historic costs, FLC
induce higher risk for the regulated firm. FLC are subject to technological
uncertainty and thus increase the uncertainty with respect to future access
charges. Both cost variants neglect ex ante risks with respect to future
demand. Therefore, they are not able to capture the option value of waiting
that is relevant for investment decisions under uncertainty.

Moreover, linear access charges based on simple costs measures ignore
potential economies of scale and scope from providing access either for
large scale competitors or for competitors who use different modes of
access. If price regulation gives the regulated firm the right to choose
relative access charges as well as non-linear access charges, these
mechanisms also imply that the regulated firm will distort its access
charges in order to increase its profits from either providing access or
from distorting downstream competition: Rate of Return (RoR) regulation
implies that relative access charges tend to be distorted in favor of
relatively capital intense access services. Price cap regulation provides
the incentive to use non-linear access charges with inefficiently high fixed
fees and large quantity discounts.

Additionally, access charges under both types of regulation are vulnerable
to strategic manipulations concerning downstream competition. Under both
regulatory approaches incumbents can choose their access charges such that
access in specific market segments is unprofitable. Hence, Rate of Return
regulation and price cap regulation both have to be complemented by
non-discrimination obligations and (single) price controls.

Overall, it turns out that it is not possible to develop theoretically
optimal access prices that rely on costs only. Hence, while commonly used
cost measures have the advantage of relatively low informational
requirements, they are not appropriate if efficient investment decisions
under uncertainty with respect to technological developments and future
demand are considered. Ignoring risk and the appropriate option values leads
to inefficiently low access charges and therefore to inefficiently low
investment incentives.

\subsubsection{Retail price regulation}

At first glance, retail price regulation seems to be dispensable if access
to essential facilities is regulated. Providing a level playing field,
access regulation alone should suffice to ensure competitive market
allocations on downstream markets. However, this reasoning is correct only
if one adheres to the assumption of perfectly competitive downstream
markets. In this case, retail prices would be equal to the charges for the
required access services plus the costs for the provision of the respective
downstream products or services.

These results change drastically if imperfect competition on downstream
markets and dominant market positions of vertically integrated incumbents
are considered. Then, retail price regulation serves the following two
purposes:

\begin{Itemize}
\item Deterring the dominant firm from abusive practices on downstream
markets.

\item Re-aligning price distortions induced by regulatory interventions.
\end{Itemize}

While inefficiently high price levels point to monopolistic price cost
margins and predominantly harm consumers, distorted price structures as
mentioned above can serve to extract additional consumer surplus and to harm
potential competitors.

On the one hand, non-linear tariffs with properly adopted quantity discounts
serve as simple means to differentiate between heterogeneous consumers with
different willingness to pay. On the other hand, bundling effects induced by
non-linear tariffs which include more than one product can also serve as
instruments to deter entry by small scale competitors, e.g., if quantity
discounts depend on the sum of products purchased. The potentially
anti-competitive effects of non-linear tariffs in combination with bundling
or tying are reinforced if access regulation is based on simple linear
access charges that render large quantity discounts unprofitable for
competitors, thus limiting their feasible offer range, e.g., making flat
rate offers unprofitable. \\[2ex]
\noindent \textit{Rate of Return (cost plus) regulation} \\[1.4ex]
The two most important approaches for price regulation were Rate of Return
(RoR) and price cap regulation. Under RoR regulation, the regulated firm is
only allowed to recover the costs and to achieve a \textquotedblleft
fair\textquotedblright\ rate of return on capital. In practice, setting
prices requires an enormous amount of data. Additionally, the regulator sets
the prices for all of the goods and services provided by the regulated firm
besides its rate of return (Guthrie 2006, p.\thinspace 930). Although they
are in principle set such that distortion of consumer behavior is minimized,
often the regulated firm provides universal service and the retail prices
are regulated also to achieve social goals, e.g., urban-rural and
usage-fixed cross-subsidization.

Overall, the revenue requirement has to be calculated as the sum of the
operating expenses, depreciation, taxes and the rate of return times the
eligible asset base. It has to be noted, that the costs are the actual
embedded costs, not forward-looking costs. For calculating the revenue
requirement including a \textquotedblleft fair\textquotedblright\ rate of
return, multiple difficulties arise: \textit{i)} in multiproduct firms, the
asset base and costs have to be allocated to the different products, which
is further eschewed if accounting rules for public entities apply and 
\textit{ii)} the calculation of the cost of equity becomes central (cf.,
e.g., Lamdin 2003).\\[2ex]
\noindent \textit{Price cap regulation} \\[1.4ex]
The price cap regulation approach uses long-run forward-looking cost
estimations for single products, or product baskets in combination with a
weighting scheme, based on a hypothetical efficient firm or (more rarely)
benchmarking. This approach allows the regulated firm to adjust its own
prices subject to the weighted average of prices not exceeding a defined
cap. Because the prices are disconnected from actual costs and the price
ceiling is fixed for a certain period of time, the firms can keep additional
profits from cost savings, and therefore price cap regulation provides
effective incentives to lower costs (Sappington 2002, p.\thinspace 3.).

Flipside of the coin is that this incentive also leads to quality reduction
incentives. This can be illustrated, e.g., with a case in the UK, where
severe phone booth maintenance problems arose. To achieve service quality
targets, often the incorporation of service quality assessments, or quality
provision sanctions, and/or incentives (which allow higher prices for better
services) shall encounter this, but require co-regulation.

Another disadvantage is the danger of regulatory taking, which refers to a
situation where regulation effectively uses the government's eminent domain
power without actually divesting the property from the property's owner.
Examples include the lowering of the price cap ex post in order to take the
profits from the regulated firm, if they were considered as excessive. In
addition to the drawback, that unexpected cost increases have to be borne by
the firm, it further increases their risk expectations, which in turn leads
to even higher necessary expected profit margins for investment than in
cost-plus regimes required.\footnote{%
\textquotedblleft Given that firms are more risk averse than the buyer
(perhaps the government or the collective of all consumers), this risk
transfer is in itself inefficient. It follows that the optimal regulation
can then be seen as a trade-off between an efficient risk allocation and
good incentives for cost control (the \textquotedblleft incentive - rent
extraction trade-off\textquotedblright )\textquotedblleft\ Bergman (2004,
p.\thinspace 19).}

Over time, the price ceiling has to be adjusted to inflation and
productivity developments, which first requires the choice of a measure of
the rate of inflation for the goods purchased by consumers. For this
purpose, either a Retail Price Index (RPI) or a Consumer Price Index (CPI)
is used. The so-called X-factor in the common RPI-X formula reflects
productivity developments and plays also an essential role.\footnote{%
The RPI-X formula first was proposed as a policy innovation by Littlechild
(1983).} The design of this factor might increase policy credibility and
reduce regulatory capture, if it employs the productivity gains relative to
other sectors in the economy and input price inflation in a way, such that
discretionary options for the regulatory agency are limited effectively, and
regulatory uncertainty, the probability of renegotiation attempts and other
might-be rent-seeking activities are reduced.\footnote{%
For a detailed discussion of the X-factor, cf.\ Baake and Wey (2007b).}

Not only retail price regulation may in fact be necessary if access charges
are not in line with the actual costs of using the respective network
elements or services and if downstream markets are not perfectly
competitive. Additional measures like the imposition of replicability
standards, restrictions concerning potential price cost squeezes as well as
obligations concerning the offer of unbundled products and services are
necessary to prevent (vertically integrated) dominant firms from abusive
practices on downstream markets.

These conclusions continue to hold if retail prices are regulated according
to either type of regulation. Since Rate of Return regulations as well as
price cap regulations mainly focus on the price levels they are not designed
to deal with anti-competitive effects. Similar distortions can arise under
RoR regulations. Whereas different elasticities of demand are crucial under
price cap regulation, RoR regulations provide strong incentives to offer
capital intense products at prices that are below the (undistorted)
opportunity costs of competing firms. This results from the return rate
constraint and the possibility to retain high market shares and at the same
time keeping profits low in competitive areas in order to be allowed to
extract higher profits from non-competitive market segments.

\subsection{Summary}

The modern approach to regulation of network industries relies on the notion
of essential facilities and the idea that competition should be allowed
wherever it leads to efficient market allocations. A closer look at the
implied regulatory necessities shows that the actual implementation of
efficient regulations is rather demanding. Considering dynamic efficiency
reveals that simple cost based access charges lead to inefficient investment
incentives as long as uncertainty about future developments of technologies
and demand is taken into account. Moreover, the relation between the optimal
regulation of access to existing infrastructures or essential facilities and
the incentives to invest in bypass technologies is even theoretically a
still unsolved problem.

Assessing actually used regulations like linear access charges based on
forward looking costs and price cap regulation in downstream markets shows
that these mechanisms lead to additional distortions and potential
inefficiencies. This is especially true if downstream markets are not
perfectly competitive. In order to prevent regulated incumbents from abusing
their dominant market positions simple regulatory mechanisms have to be
complemented by additional obligations which are specifically targeted at
the regulated firm's incentives to extract consumer surplus and to restrain
competition.

Therefore it becomes questionable, whether access regulation is an
appropriate default answer for network industry frameworks, especially if
largely unregulated competition would be feasible, e.g., through
technological progress or in the form of intermodal competition.

\section{Downstream access}

\subsection{Economic rationale and implementation in tele\-communi\-cations}

\begin{flushright}
\hangindent=3cm \hangafter=0 \textquotedblleft \textit{The fundamental
problem of all communications policy is the access network, also called the
last mile or local loop.\textquotedblright\ }\footnote{%
Hundt and Rosston (2006, p.\thinspace 1).}
\end{flushright}

\noindent For illustrative purposes, the bottleneck elements within the
telecommunications value chain are illustrated on basis of (fixed network)
voice telephony. Voice telephony consists most basically of the services
call origination, call switching including connection, and call termination.
All of these services fundamentally rest on physical network access over the%
\textit{\ last mile} (the local loop) as well as on a suitable \textit{%
addressing scheme}. The last mile consists of the connections to the network
in the street cabinets and the access lines between the street cabinets and
the customer premises. Therefore it represents the crucial gateway for
service provision. Figure 1.1 illustrates a typical telecommunications
network.

\bigskip 
%TCIMACRO{%
%\TeXButton{Abb_IPC1}{\begin{figure}[!htb] 
%\caption{Telecommunication networks and related services}
%\begin{center}
%\includegraphics*[width=\textwidth]{./IPC1-Grafik1.jpg}
%\label{telconet}
%\end{center} 
%\end{figure}}}%
%BeginExpansion
\begin{figure}[!htb] 
\caption{Telecommunication networks and related services}
\begin{center}
\includegraphics*[width=\textwidth]{./IPC1-Grafik1.jpg}
\label{telconet}
\end{center} 
\end{figure}%
%EndExpansion

Additionally, telephony networks are service specifically optimized
infrastructure-tied networks (such as electricity, railway and water
networks). Services are provided over an electronic network which starts at
the end user device interfaces in the facilities of the customers and
connect the users bidirectionally over street cabinets, local and long
distance exchanges which are permanently physically connected. To install
such a network, substantial construction work is required in order to set up
the facilities required. Once in place, the subsequent costs are largely
independent of the actual network usage.

Usually, the last mile is considered to represent an essential facility,
while undisputedly being a natural monopoly (for a given fixed network
technology) and the least replicable input. Whether monopolistic bottleneck
elements in the telecommunications are true essential facilities or
\textquotedblleft near-essential\textquotedblright\ facilities (CRTC 2001),
depends not only on the costs for duplication given of the technology used,
but in addition on the extent, to that the costs are indivisible sunk
investments, and on demand conditions.

Economies of scale, scope, or density by themselves might create a natural
monopoly and high entry barriers, but are not sufficient to constitute an
essential facility. Usually, one-way access regulation does not rest on the
rigorous criteria of essential facilities but rather on the identification
of SMP of the network operator and the expected gains from introducing
competition to potentially competitive segments.

Especially in highly dynamic industries like the telecommunications
industry, two additional aspects arise: First, technological progress might
increase the replicability of certain assets, in extreme making essential
facilities obsolete, or, more moderate, bottlenecks or possible access
points might change with the evolution of technology. One example for this
phenomenon can be observed in UK, where the evolution of BT/Openreach's
legacy telephony network to the \textit{21CN Next Generation Network}
reduced the network by one layer and, as a consequence, changed the
geographical network structure including the location of access points as
well as the technically viable options for access to the network (Ofcom
2004, pp.\thinspace 17-19). In this case, the reluctance of competitors to
the existing network and the related path dependencies led to the need to
deal with compensation claims from competitors due to stranded costs from
specific investments in infrastructure complementary to BT's former network. 
\\[2ex]
\noindent \textit{Service competition} \\[1.4ex]
Telecommunication networks provide a wide range of possibilities for
mandated access, which generally can be classified according to the
requirement for entrants to build their own infrastructure, the extent of
control over the customer's local loop, and whether they are considered as a
transitory step towards facilities-based competition or intended to be
permanent regulation. While the entry strategies and business models that
become possible are closely related to the scope of the regulation, both,
service competition and access-based infrastructure competition might be
limited with regards to the possibilities to offer differentiated products.

Call-by-call and carrier preselection, where price competition, e.g., based
on cost or strategy advantages in marketing, is focused, are widely
considered as important step stones to introduce competition and to allow
consumers to \textquotedblleft try\textquotedblright\ competition with low
switching costs, they were also responsible for technically inefficient (re%
\nobreakdash-)\,routing and a lack of technological innovation.

As unbundling and line sharing were dominated by wholesale offerings in the
beginning, infrastructure investments were not really observable (Hundt and
Rosston 2006). Champeaux, Hennes and Lebourges (2006,~p.\thinspace 161)
confirm this view, stating that \textquotedblleft the 1998
telecommunications liberalization [\ldots ] (has) a doubtful record on
productivity, innovation and sustainable entry. Concerning unbundling and
wholesale obligations (there have to be noticed) negative results for
industry conduct and performance\textquotedblright , as, e.g., a stop of
network growth induced by significantly increased monthly charges. In some
countries, less than half of the household are subscribers to a fixed line
network, which today causes significant problems concerning internet access
penetration and usage.\\[2ex]
\noindent \textit{Facilities-based competition} \\[1.4ex]
Access to ducts, local loop unbundling, naked DSL, line sharing, and
bitstream access are the regulatory policy options that require
facilities-based entry. Unbundling has been introduced 1996 in the U.S. with
the Federal Communications Act (1996) 47 U.S.C. \S \S\ 251-252 as well as in
the EU with the Directive 96/19/EG, two of the most important legislations
in the history of telecommunications regulation. Within the EU, in the
meanwhile a directive dealing exclusively with unbundling and
interconnection was added to the regulatory framework (EU 2002a). In both
frameworks, fair charges are mandated and non-discrimination as well as
transparency rules apply. The selection of elements eligible for access in
both legislations is based on the concept of significant market power (SMP).
Furthermore, with the exception of Mexico, in the meantime all OECD
countries require some form of local loop unbundling (LLU, as downstream
network access usually is called in telecommunications), although with a
widely varying scope of the obligations imposed (OECD 2007, pp.\thinspace 53
ff.).

The theoretically predicted difficulties arose in all areas, concerning the
discrimination incentives between competing firms (especially the question
whether to prevent the rollout of competing networks with low access
prices), concerning mutual dependencies, as illustrated above for the 21CN
restructuring case, and that with complementary assets, investment and
innovation are expected to be higher for vertically integrated systems.
Additionally, fierce discussions of the access terms (on prices, qualities,
requirements) and extensive renegotiation attempts could be observed.

Considering the access pricing, according to the U.S. \textit{Total Element
Long-Run Incremental Cost }(TELRIC) approach, a rate for each network
element is calculated. Thereby the approach ignores the fact, that the lack
of compensation for investment risks is anticipated by investors, thus
leading to underinvestment. At least, to account for historical decisions
(and related path dependencies), in some cases certain elements of the
network are considered as given instead of being variable, e.g., the network
node buildings.\footnote{%
Similarly, the EU the \textit{Cost of Efficient Service Provisioning} are
calculated (which can be regarded similar to a \textit{Total Service
Long-Run Incremental Cost} (TSLRIC) approach). Both concepts share the
attempt to determine the (hypothetical) costs of an efficient
cost-minimizing firm with an optimally configured network built with an
efficient technology. For a more detailed discussion, cf.\ Vogelsang (2003,
pp.\thinspace 840 ff.).} Generally, access obligations and the related price
controls have high information requirements. Hence, the best choice strongly
depends on the incentives and ability of the regulatory authority to carry
out the related analysis methods. \\[2ex]
\noindent \textit{Additional requirements} \\[1.4ex]
With access regulation, overall costs increase additionally from technical
and organizational co-requirements, e.g., from the implementation of
accompanying co-location space, access management services and measurements
to reduce switching costs (like number portability). Also, in most cases
behavioral remedies to the problem of bottleneck governance are unlikely to
be successful in eliminating anti-competitive practices, especially in the
case of deteriorate access quality, long service request response times and
other non-pricing anticompetitive behavior (Lyon 2000, p.\thinspace 79).\\[%
2ex]
\textit{Vertical separation} \\[1.4ex]
Following the logic to separate monopolistic and competitive market
segments, the most consequent measurement is structural or vertical
separation that re-establishes a separated monopoly which can be interpreted
as an access obligation with the extended requirement of ownership
divestiture. In infrastructure based networks, one central issue often is to
what extent vertical integration should be allowed. Vertical integration
alters the industry performance by changing the composition and the nature
of downstream competition (direct welfare effects), where retail supply can
enhance competition and by affecting the incentives to discriminate
(indirect welfare effects) against rivals.\footnote{%
E.g., by seeking to extract rents or at least raising their costs,
exaggerating input costs, or degrading the quality of the supplied input,
burdensome purchasing requirements or delaying access.} Thereby, the merits
of vertical divestiture vary with type and competition in the retail market,
scale and scope economies, relative social value of consumer surplus and
profits. The empirical evidence varies strongly for different industries,
countries, and firms.

A further point concerning vertical separation is, without full ownership
divestiture, that if it is correctly implemented, the upstream company is
effectively shielded from competitive market forces, if not, discrimination
incentives remain (Sappington 2006).\\[2ex]
\noindent \textit{Regulatory timing} \\[1.4ex]
Considering dynamic efficiency, regulation biased in favor of service-based
competition is likely to preempt efficient investments and sustainable
competitive market structures. Concerning access to elements of \textit{Next
Generation Access Networks} (mainly pure fiber or fiber-copper/coax-hybrid
networks as successors of the legacy twisted-pair copper cables), the
regulatory authorities are more reluctant to impose regulation in order to
keep investment incentives high. Additionally it is taken into account that
the investments necessary are substantial and to a large part sunk in their
nature, but nevertheless relevant due to investors' capital remuneration
expectations.

One example for such regulatory scrutiny has been the amendment to the
German telecommunications law (Telekommunikationsgesetz, TKG) which included
explicitly dynamic aspects, favoring a hands-off policy for
\textquotedblleft new markets\textquotedblright\ (which has been also the
title of the \S 9 of the TKG\ after its revision of 2007). The newly added 
\S\ 9a\thinspace (1) stated, that new markets principally should stay
unregulated. \S\ 9a\thinspace (2) still allowed for regulation of new
markets, but only if two conditions are fulfilled: \textit{i)} there are
facts that justify the assumption that without regulation the tendency
towards sustainable effective competition is impeded in the long run, and 
\textit{ii)} particularly the aspects of efficient investments in
infrastructures and the promotion of innovations have been considered.
However, after a dispute with the European Commission, these regulations
were declared incompatible with the European market rules at the end of 2009
and removed from the law as of April 2011. Although its effectiveness would
have been critically dependent on the definition of new markets (which is a
rather deliberate and complex task itself), the approach stimulated a
dynamic view on regulation, allowing for less stringent interventions and
even regulatory holidays, if this would have served dynamic efficiency.

In the latest revision of the TKG (of May 2012), the regulatory certainty
has again been strengthened by a combination of the possiblity to define
regional markets and the right of potential investors to obtain in-advance
information about the regulatory conditions for a certain area. Together
with the requirement that the regulator should commit for longer periods
(two instead of three years), thus the timing has been improved again.
However, how the law translates into regulatory reality in the future and
how the European Commission influences its practical implementation is yet
to be seen.

\subsection{Application to postal markets}

Network infrastructures are not necessarily permanently connected networks.
They might also consist of a set of network nodes that are connected only
dynamically, like it is in the postal industry which mainly consists of road
and transport/delivery capacity.

Concerning this aspect, postal distribution is completely different from
physical networks like telecommunications, electricity, rail, water and so
on. Postal services are provided by a sequence of activities connecting
senders with receivers. The activities are collection, outward sorting,
transportation, inward sorting, and delivery of postal items (cf.\ figure
1.2).

%TCIMACRO{%
%\TeXButton{Abb_IPC2}{\begin{figure}[!htb] 
%\caption{Postal networks and related services}
%\begin{center}
%\includegraphics*[width=\textwidth]{./IPC1-Grafik2.jpg}
%\label{postalnet}
%\end{center} 
%\end{figure}}}%
%BeginExpansion
\begin{figure}[!htb] 
\caption{Postal networks and related services}
\begin{center}
\includegraphics*[width=\textwidth]{./IPC1-Grafik2.jpg}
\label{postalnet}
\end{center} 
\end{figure}%
%EndExpansion

\vspace*{-8mm} The first concept for the European postal market was sketched
in the European Commission's Green Paper (EU\ 1992), where it was concluded,
that sector-specific regulation would be required. Today, the European
framework for postal regulation consists mainly of three directives (EU
1997, EU 2002b, EU 2008), with Directive COM 2008/6 EC being the most recent
one. This directive aims to complete the gradual opening of the postal
markets to competition by 2009, or for some countries after another
transitional period by the end of 2012.

Elements of the regulatory framework like in the telecommunications industry
are: the promotion of competition, the development of the internal market
and safeguarding or to ensure citizen interests. The EU \textit{Postal
Framework} does not impose access, but if it is mandated by the regulator,
the usual transparency and non-discrimination rules apply, and prices have
to be \textquotedblleft geared to cost\textquotedblright . The framework
also covers services of general interest and the financing thereof. \\[2ex]
\noindent \textit{Economies of scale and scope} \\[1.4ex]
Mail collection, sorting, transport and delivery access might exhibit
economies of scale and represent a natural monopoly in remote areas, but
economies of scale alone do not create an essential facility. Also, the
scale of indivisible sunk investments are rather low, with the possibility
to lease the equipment needed, and labor cost accounting for the by far
largest share of total cost.\footnote{%
For the European Universal Service Providers, 2002, labor cost accounted for
a share of total cost of 63\thinspace \% on average (Nera 2004, p.\thinspace
67).}

Concerning economies of scale, the assumption of a natural monopoly is not
justified. For sustainable competition to be feasible, entry must be
profitable, which in turn is highly interdependent with the proper design of
universal service obligations to keep the minimum efficient size of entry
low.

The estimated minimum efficient sizes of entry (the critical market share)
is country- and operations-specific, ranging from 3\,\% market share with
two day per week delivery (NL) to 30\,\% with 1 day per week delivery (UK).
Actual data seems to confess these estimates, in the Netherlands, two
operators with a market share of 2.5\,\% each, and in Sweden on operator
with 7.5\,\% overall share and 25\,\% share of the market segment of
presorted bulk mail for urban delivery are all profitable. The same is true
for some regional postal operators in Germany. Sunk costs seem to occur only
from full-scale or otherwise high-level entry as the high number of small
licensees in Germany illustrates (De Bijl, van Damme and Larouche 2005).

In addition, the economies of scope are rather limited due to different
transportation means (road, rail, air) depending on different qualities, and
also with respect to geographic differentiation. Even companies with mail,
parcels, express, and logistics operations can only share a fraction of
their networks to obtain scale advantages. Therefore, the argument of the
existence of entry barriers caused by economies of scope can be rejected
largely. \\[2ex]
\newpage

\noindent \textit{Non-replicable assets} \\[1.4ex]
While in telecommunications, the (copper) local loop (of existing networks)
in most cases seems to represent a natural monopoly, this is not so clear
for wireless and new technology networks, especially in combination with
innovative deployment technologies, which provide lower cost per added
subscriber and have different service properties, e.g., the mobility of
services.

In the postal industry, non-replicable network elements and services hardly
exist (if at all) and the economies of scale and scope are limited, if
differentiation among service providers is allowed and not narrowed too much
by regulation. The postal industry represents a production chain, of which
only few segments might be candidates to have natural monopoly properties.

One of the unique attributes of the postal industry is, that the work can be
done (at least partly) by the sender itself, e.g., (pre-)sorting or
hand-over at distant point. If there is no monopolistic bottleneck, the
postal (upstream) operator should probably find it in his own interest to
provide access in order to keep at least a part of the revenues. This and
the vivid competition among different postal providers, from the development
of electronic communications such has e-mail, through parcels, express and
logistics operators, print media distribution firms, and by their customers'
own efforts to distribute mail (e.g., utility companies employing own staff
to deliver mail; one example for this option provides the case of Vattenfall
Europe, which permanently employed several people to deliver invoices and
other mail in Berlin) lead to significant competitive pressure, effectively
restricting the possibilities to execute market power. \\[2ex]
\noindent \textit{Low entry barriers} \\[1.4ex]
In the postal industry, the requirements for access regulation generally are
not met. There are no indivisible sunk investments, entry is easily possible
at different scales, and users are free to switch their service provider,
quickly and without significant switching costs (Panzar 2008, p.\thinspace
15).

Low entry barriers and potential competition lead to efficient market
structures and allocations (see for example parcel and express services),
therefore downstream access regulation is judged to be not justified.
Regulation of \textit{worksharing}, as downstream access is called in the
postal sector is not necessary, if all potentially competitive segments are
open to competition when there are no natural, strategic or legal entry
barriers such as the mail box monopoly of the United States Postal Service
(Panzar 2008, p.\thinspace 18). Not only in the industrialized countries,
but generally, \textquotedblleft on a national, regional, and global level,
private operators are playing an increasingly important role in the
provision of even the most basic postal services. As just one example of
this process, in the Latin America region, incumbent universal service
providers have a share of the postal marketplace estimated less than
40\thinspace \%, in spite of benefiting from some of the highest \textit{de
jure }protection in the world\textquotedblright\ (UPU 2004), providing
evidence for the possibility for duplication (Panzar 2008, pp.\thinspace
6-7).

The only elements that could be identified to be susceptible to access
regulation are address and mail redirection and return databases based on
information asymmetry grounds , and access to post office boxes (PO boxes)
in the operators facilities, which can be compared with the termination
monopoly in the telecommunications sector (Panzar 2008, p.\thinspace 17).
The service \textquotedblleft full coverage delivery including PO
boxes\textquotedblright\ is impossible for \textit{any} operator, thus all
operators have significant market power. Especially in this case, agreement
seems to exist, that this kind of access to subscribers is necessary (Panzar
2008, p.\thinspace 34). For PO boxes, the possibility for freely negotiated
access exists, pointing to the antitrust approach. In any case, if
competition law alone is considered to be insufficient to cope with market
deficiencies, non-discrimination obligations concerning freely negotiated
access should be considered first (cf.\ also Bergman 2002). Access
regulation is justified, if a privately negotiated solution cannot agreed
upon. If regulation has to be imposed, the principles, e.g., concerning the
pricing should be applied as discussed above. The view, that there are no
non-replicable assets (at least in the narrow sense) was confirmed by the
Court of Justice of the European Communities in the case decision Oscar
Bronner vs. Mediaprint (C-7/97).

\section{End user tariff regulation}

\begin{flushright}
\hangindent=2.5cm \hangafter=0 \textquotedblleft \textit{As a starting
point, retail regulation can only be envisaged if and once it has been
concluded that wholesale regulation cannot suffice to achieve the regulatory
objectives set out above the retail level.\textquotedblright }\footnote{%
Brunekreeft, van Damme, Larouche and Sorana (2005, p.\thinspace 12).}
\end{flushright}

\noindent Basically, wholesale regulation may be insufficient, if an
essential input is provided by a vertically integrated operator, which is
also operating in downstream markets with imperfect competition. The
underlying sources for the resulting inefficiencies are little competitive
restraints from actual or potential entry, on the dynamic side strategic
conduct, such as foreclosure and predation, and discrimination incentives as
with regards to discrimination between other operators and between market
segments as discussed above in section 1.2.1.

\subsection{Economic rationale and implementation in tele\-communi\-cations}

Brock (2002) provides a decent overview over the early years:\ Historically,
in the first half of the 19$^{\text{th}}$ century in the U.S., for many
infrastructure industries, municipal franchise contracts administered by
council subcommittees or boards were used. In most cases, the franchises
were not exclusive contracts, but the municipalities frequently issued
duplicative franchises. Price had to satisfy the conditions to be
\textquotedblleft reasonable with reference to the costs of producing and
delivering the same\textquotedblright , \textquotedblleft not unreasonable
or exorbitant\textquotedblright\ or \textquotedblleft not exceeding the
average rate charged by other cities\textquotedblright .

In telecommunications, during that time, Bell developed its long distance
voice telephony system, due to protection from the basic patent from 1879
until its expiration 1893 as a full monopoly, and since then under
competition of many entrants, especially in regions that had not been served
by the Bell system under the American Telephone and Telegraph Corporation
(AT\&T) as the parent company. 1907, Bell's president Vail started to pursue
a three part strategy including mergers with independent phone companies,
emphasis on basic research and patent purchases, and to embrace regulation
as a way to preserve monopoly power by justifying a system without
competition.

1922, the second monopoly era began, 40 of 48 states were granting the AT\&T
monopoly and regulating rates concerning level and structure, e.g., through
geographically averaged prices, with line rental fees subsidized by usage
charges, and so on. The 1934 Communications act confirmed the regulated
private monopoly of AT\&T and introduced federal regulation, administered by
the Federal Communications Commission (FCC) which was created by the act.
During the next 60 years, regulation evolved continuously, and the monopoly
area was reduced significantly. On the other hand, until the 1960's state
regulators and the FCC protected AT\&T's core monopoly.

After minor steps from the \textquotedblleft Commission price setting
system\textquotedblright , in the 1960's, price regulation gradually became
cost-oriented, using a cost-plus approach or Rate of Return regulation,
although still the individual state Public Service Commissions shared this
task with the FCC. In this \textit{Rate of Return era }until 1989, prices
were set by the different regulatory bodies focusing first profit regulation
and prices and underlying costs instead of profits from the 1980's on. 
\textit{Incentive regulation} in the form of price cap regulation tried to
introduce additional incentives to increase cost efficiency and to allow
higher pricing flexibility, with a growing tendency in the 90's.\footnote{%
Price-cap regulation as proposed by Littlechild (1983) subsequently was
adopted first by the British government and instituted for the first time in
the U.S. 1989 by the Federal Communications Commission (FCC) for AT\&T
long-distance service (Acton and Vogelsang 1989). Afterwards, this
regulatory tool quickly spread to other countries and industries.} Since
then, the FCC reregulated retail pricing and implemented different versions
of end user tariff regulation.\footnote{%
Federal Communications Act (1994), treatment of mobile services. Second
report and order, 9 F.C.C.R. 1411, Sections 3 and 332, para 12, 14-16; and
Federal Communications Act (1996) 47 U.S.C. \S \S\ 251-252.} Finally, the
1996 Communications act not only ended the second monopoly era of AT\&T,
introduced the whole set of today's requirements including unbundling,
resale obligations etc., but also implemented the forward-looking cost
orientation concept (TELRIC) as it is still used today (Brock 2002).

In Europe, as in the U.S., telecommunication services were provided by
vertically integrated monopolists for equipment, and basic network and
service provision. The difference was that these monopolies in Europe mainly
were organized as public entities. The national telecommunications operators
at the same time were policy-makers under direct political control instead
of being a regulated firm. Performance varied across Europe.\footnote{%
For example, in France the \textit{Minitel}, or ISDN in Germany were
considered to have been considerably successful, whereas the \textit{%
Bildschirmtext} system in Germany never reached significant market
penetration.} From the 1990's on, the markets for equipment, value-added
services, mobile services, basic services, and lastly infrastructure
networks were liberalized. The national operators were restructured,
corporatized\footnote{%
Shirley (1999, p.\,115) defines corporatization \textquotedblleft as efforts
to make SOEs [State-Owned Enterprises; author's note] operate as if they
were private firms [...]. The definition includes not only incorporating
SOEs under the same commercial laws as private firms, but other steps to put
state firms on a level playing field with private firms by removing barriers
to entry, subsidies and special privileges, forcing SOEs to compete for
finance on an equal basis with private firms, and giving state managers
virtually the same powers and incentives as private
managers\textquotedblright . Corporatization aims to achieve similar
efficiency of SOEs as of private companies although the government remains
the sole shareholder of the firm. It is based on the presumption that firms
which operate under a public administration setting tend to be less
efficient than their private counterparts.} and (partly) privatized, and
independent regulatory authorities were installed. Prices were set by newly
established regulatory agencies. The evolution of price regulation towards
incentive-controls in the form of price caps in the EU mostly preceded the
privatization process.\\[2ex]
\noindent \textit{Additional pricing requirements}\\[1.4ex]
Telecommunication and postal legislations include elements on universal
service, and related pricing. Examples for such price controls include
uniformity obligations and the definition of \textquotedblleft
affordability\textquotedblright , as well as the requirement to offer
special tariffs for low-income users. Thereby, the current framework in the
EU exhibits some contradictions. For example, the Swedish regulatory agency
claims, that the European framework imposes incompatible demands for
legislation on the member states: uniform tariffs and prices geared to cost
at the same time would be infeasible under most conditions (PTS\ 2000).

In practice, a mixture of price caps and RoR regulation (based on cost
models) can be observed. In addition, discretionary ex ante approvals by the
regulatory bodies and structural requirements (uniform prices) apply and ex
post supervision of prices concerning price cost margins and price cost
squeezes is in place (cf.\ table~1.2 below). Due to the complex dependencies
within these regulatory systems, regular adjustments to changing competitive
environments are necessary, e.g., concerning the baskets, prices, or market
definitions.

At the moment, the regulatory framework is under development to meet the
challenges from buzzword processes like the deployment of next generation
networks or media convergence and the related increase in the use of
bundling in the telecommunications industry. UK still is at the
\textquotedblleft deregulatory forefront\textquotedblright : After the
vertical divestiture of BT into OpenReach (upstream) and BT
(downstream/retail division), Ofcom removed on July 31st 2006 after 22 years
all retail price controls (Ofcom 2006).

%TCIMACRO{%
%\TeXButton{Priceregulationtelcotable}{\begin{center}
%{
%\begin{threeparttable}
%[htbp]\centering
%\caption{Examples of downstream access in telecommunications
%\label{tab:daexamplestelco}}
%\vspace{3mm}
%\begin{tabular}{l l}\hline
%
%Country &	Telecommunications service regulation (2007) \\\hline
%Canada &	Price cap or prior approval with SMP \\
%Germany &	Price cap for SMP market segments, three baskets\superscript{1} \\
%Netherlands &	Price cap for SMP operators (voice and leased lines) \\
%Sweden &	Cost plus  and price cap combined\superscript{2} \\
%United Kingdom &	Only ex post control \\
%United States &	Price cap on SMP operator \\\hline
%\end{tabular}
%\begin{tablenotes}\footnotesize 
%\item[1]  Voice, fixed, mobile.
%\item[2] Cost plus for fixed network access and capacity, price cap for leased lines.
%\item[] Source: OECD (2007), ITU Regulatory Database.
%\end{tablenotes}
%\end{threeparttable}
%}
%\end{center}}}%
%BeginExpansion
\begin{center}
{
\begin{threeparttable}
[htbp]\centering
\caption{Examples of downstream access in telecommunications
\label{tab:daexamplestelco}}
\vspace{3mm}
\begin{tabular}{l l}\hline

Country &	Telecommunications service regulation (2007) \\\hline
Canada &	Price cap or prior approval with SMP \\
Germany &	Price cap for SMP market segments, three baskets\superscript{1} \\
Netherlands &	Price cap for SMP operators (voice and leased lines) \\
Sweden &	Cost plus  and price cap combined\superscript{2} \\
United Kingdom &	Only ex post control \\
United States &	Price cap on SMP operator \\\hline
\end{tabular}
\begin{tablenotes}\footnotesize 
\item[1]  Voice, fixed, mobile.
\item[2] Cost plus for fixed network access and capacity, price cap for leased lines.
\item[] Source: OECD (2007), ITU Regulatory Database.
\end{tablenotes}
\end{threeparttable}
}
\end{center}%
%EndExpansion

%\clearpage
\vspace*{7mm}

\noindent \textit{Practical drawbacks and caveats} \\[1.4ex]
Comparing the functions and incentives of price cap and RoR regulation, it
quickly gets clear, that the two approaches have few in common, despite the
aim to prevent the exercise of market power and to correct the associated
socially inefficient prices.

Scientific studies tried to examine the effects of incentive regulation:
\textquotedblleft In summary, the studies to date provide varied evidence
regarding the impact of incentive regulation on performance in the U.S.
telecommunications industry. Incentive regulation appears to increase the
deployment of modern switching and transmission equipment, to spur an
increase in total factor productivity growth, and to foster a modest
reduction in certain service prices. There is little evidence, though, that
incentive regulation leads to a significant reduction in operating costs.
There is also little evidence of a systematic decline in service quality
under incentive regulation.\textquotedblright\ (Sappington 2002,
p.\thinspace 78).

Design and implementation of regulation often could take a wider perspective
on long-run efficiency and include product innovation, process innovation
and intermodal competition appropriately. If quality is of concern,
introducing adequate incentives for service quality as suitable
modifications of price cap plans can be implemented in addition to
potentially existing standard price cap regulation in a variety of ways
(Sappington 2002, p.\thinspace 25).

In competition suits, the definition of predation is of highest importance
to distinguish between competitive and anti-competitive behavior. The four
criteria to be assessed are, \textit{i)} whether the retail prices are below
a certain level, \textit{ii)} whether with intention to drive competitors
out of the market, \textit{iii)} whether with the aim to raise future
prices, and \textit{iv)} whether there exists an acceptable efficiency
defense (Brodley, Bolton and Riordan 2000, p.\thinspace 2241). Often, the
first criterion is used for a first assessment; thereby \textquotedblleft
hard-to-match prices\textquotedblright\ can easily qualify as
anti-competitive at a first glance. Thereby, neither RoR regulation nor
price caps are designed to deal with anticompetitive effects or to include
other goals such as \textquotedblleft affordable uniform
prices\textquotedblright\ or social tariffs. \\[2ex]
\noindent \textit{Predation, preemption and foreclosure incentives remain}

\begin{flushright}
\hangindent=3.4cm \hangafter=0 \textquotedblleft \textit{Although pricing
flexibility can enable an incumbent supplier to respond to competitive
pressures and thereby prevent operation by a higher-cost rival, the
flexibility can also serve to undo cross-subsidies that regulators have
implemented to promote equity, fairness, and/or other political
objectives.\textquotedblright } \footnote{%
Sappington (2002, p.\thinspace 24).}
\end{flushright}

\noindent To deter abusive practices on final consumers and competitors,
still competition policy and strict enforcement is needed. Over time,
predatory pricing, leveraging, foreclosure, tying, pure bundling, refusals
to deal, undue cross-subsidization, and raising rivals' costs strategies
were engaged to monopolize markets, with the intention to preempt entry or
drive competitors out of the market (cf.~Spulber (2002) for an overview).
The pricing flexibility might be used implicitly for cross-subsidization,
either horizontally (downstream) or vertically to downstream. The result
might be a \textquotedblleft margin squeeze\textquotedblright , which
denotes a reduction of the margin between wholesale and retail charges by a
vertically integrated dominant operator so as to make entry difficult or to
encourage exit (Geradin and O'Donoghue 2005, p.\thinspace 356). This margin
squeeze imposes additional efficiency constraints on the competitors which
the incumbent's retail branch does not have to fulfill.\footnote{%
European Commission, in DT case, OJ 2003 L 263/9, para 140.}

The formalization of such cases might happen either as margin squeeze or
predatory pricing cases. Generally, while wholesale caps usually are based
on production costs in competition policy cases, the retail floor levels
might reflect production costs, economic value or benchmark prices (Haag and
Klotz 1998).

Case law is mainly shaping also national competition policy in this area.
Generally, fines depend on gravity and duration plus (or minus) aggravating
(or attenuating) circumstances.\footnote{%
According to: Guidelines on the method of setting fines imposed pursuant to
Article 15 (2) of Regulation No 17, OJ C9, 14.1.1998, point A.} Within the
EU, national competition law proceedings were launched in numerous
countries, e.g., in Denmark, France, Italy, the Netherlands, and UK. The
cases \textit{Deutsche Telekom}, \textit{Wanadoo}, and \textit{Telef\'{o}nica%
} were the most important precedents for price abuses (respective margin
squeeze and predatory pricing) under art. 82 EC treaty. In Australia,
pricing behavior with retail prices even below wholesale prices was
observable (EU 2003a, 2003b).\footnote{%
For an overview over national cases in the telecommunications sector see
Geradin and O'Donoghue (2005, p.\thinspace 355).}

Additionally pure bundling and exclusion are of concern, which both reflect
the possibility to leverage market power from an SMP-product to a non-SMP
product, as, e.g., the bundling of access and services in
telecommunications, which can be dealt with securely through competition
policy only, if the consequences are not irreversible and sufficiently
severe (Brunekreeft et al. 2005, p.\thinspace 63).

\subsection{Application to postal markets}

Concerning end user tariff regulation, conceptually the same problems as in
telecommunications are likely to arise. As in telecommunications, price
regulation in practice is implemented as a mixture of different approaches
for different segments of the postal market (cf.\ table~1.3).

%TCIMACRO{%
%\TeXButton{Priceregulationpostaltable}{\begin{center}
%{
%\begin{threeparttable}[hbtp]\centering
%\caption{Examples of downstream access in postal industries
%\label{tab:daexamplespostal}}
%\vspace{3mm}
%\begin{tabular}{l l}\hline
%
%Country &	Postal service regulation (2007, Germany: 2008) \\\hline
%Canada &	Price cap or single price approval, basic letter rate  \\
%& rate and single piece mail, notification in advance, \\
%& multi-year pricing plan approval \\
%Germany &	Price cap for SMP operators with ex ante approvals  \\
%& of single prices, bulk mail above 50 items/mailing \\
%& excluded, efficient-cost-concept \\
%Netherlands &	Price cap with two baskets (all products and \\
%& small users), uniformity obligations \\
%Sweden &	Cost orientation and uniformity required, only \\
%& domestic letter rate regulated, otherwise free to \\
%& set prices if compliant with competition rules \\
%United States &	Price caps and floors, increases limited by CPI,  \\
%& notification in advance, ban on below-cost pricing \\\hline
%\end{tabular}
%\begin{tablenotes}\footnotesize 
%\item[] Source: IPC Regulatory Database.
%\end{tablenotes}
%\end{threeparttable}
%}
%\end{center}}}%
%BeginExpansion
\begin{center}
{
\begin{threeparttable}[hbtp]\centering
\caption{Examples of downstream access in postal industries
\label{tab:daexamplespostal}}
\vspace{3mm}
\begin{tabular}{l l}\hline

Country &	Postal service regulation (2007, Germany: 2008) \\\hline
Canada &	Price cap or single price approval, basic letter rate  \\
& rate and single piece mail, notification in advance, \\
& multi-year pricing plan approval \\
Germany &	Price cap for SMP operators with ex ante approvals  \\
& of single prices, bulk mail above 50 items/mailing \\
& excluded, efficient-cost-concept \\
Netherlands &	Price cap with two baskets (all products and \\
& small users), uniformity obligations \\
Sweden &	Cost orientation and uniformity required, only \\
& domestic letter rate regulated, otherwise free to \\
& set prices if compliant with competition rules \\
United States &	Price caps and floors, increases limited by CPI,  \\
& notification in advance, ban on below-cost pricing \\\hline
\end{tabular}
\begin{tablenotes}\footnotesize 
\item[] Source: IPC Regulatory Database.
\end{tablenotes}
\end{threeparttable}
}
\end{center}%
%EndExpansion

\vspace*{6mm}

The effectiveness of price regulation might be limited by universal service
obligations, especially in combination with hybrid or partial competition.
Universal service obligations in effect may restrict differentiation
possibilities and require consistent market definitions which make highly
differentiated products or networks problematic to be handled by the
regulatory framework. Protecting end users, intermodal competition by
e-mail, fax, telephone, short messages etc. is yet a strong disciplining
market force which limits excessive pricing.

Additionally, postal service pricing is somehow simpler than
telecommunications pricing, because for private customers in most cases only
linear tariffs apply, which in turn leads to increased market transparency.
Finally, provider switching costs are very low because there are no
subscriber contracts, attributes which both are likely to further restrict
prices.

Facing the fact, that the by far largest share of letter post items (EU
wide) is sent by businesses and organizations rather than individuals; the
business to consumer (B2C) segment of the letter post now accounts for
62\thinspace \% of total volume (EU 2006b, p.\thinspace 56). This market
concentration on the sender side might also limit prices because of their
option to scale to replicate the postal network.

With the ongoing liberalization process, tariff regulation usually only was
introduced for universal services and the legal monopoly of the reserved
area and the potential to withdraw stringent tariff regulation raises.
Accordingly, in the Netherlands, the regulatory focus shifted from the whole
postal market to small users and led to the introduction of a further price
cap basket to reduce the regulated market segment. In Germany, regulation
applies partly only up to 50 items per sending and in Sweden only the
domestic (single) letter rate is directly retail price regulated.

Safeguarding competition is likely to be achieved by ex post control based
on competition policy. For margin squeezes as in telecommunications, the
dominant operator must be \textit{i)} vertically integrated, \textit{ii)}
the input must be essential, and \textit{iii)} the input must constitute a
relatively high proportion of the downstream/total cost. For such a margin
squeeze being judged anti-competitive, it depends furthermore on \textit{iv) 
}the imputation results and the definitions of \textquotedblleft reasonably
efficient service provider\textquotedblright\ and \textquotedblleft normal
profit\textquotedblright , on the possibility of \textit{v)} an efficiency
defense providing a reason other than strategic anti-competitive behavior,
e.g., achieving critical masses through introductory offers, and \textit{vi)}
harmful effects on consumers and substantial negative effect on competition
have to be proven. Due to the low entry barriers to postal markets, also
predatory pricing becomes unlikely, because the short-run losses from such
strategies are unlikely to be compensated in the future. Therefore, ex post
price control based on competition policy should be sufficient (Panzar 2008,
p.\thinspace 19).

\section{Conclusion}

Assessing the regulation of telecommunications markets from the postal
sector perspective, the main conclusion is that regulation of postal markets
should not follow the regulatory policies used for telecommunications
markets, which also confirms the findings of Baake and Wey (2007a). Even if
the idea of just regulating bottlenecks seems appealing and to lead to
rather straightforward regulatory regimes, more complex regimes with high
information requirements are needed to achieve efficient outcomes.

Postal service markets have much more in common with standard markets such
as retailing, where sector-specific regulations are absent. Underestimating
the differences between postal service markets and telecommunications
markets concerning contestability or the technological features of the
underlying network may very well lead to distortions and suboptimal market
performance when the toll set used in telecommunications markets is
imprudently applied to postal services.

The markets are highly contestable due to the differences in the network
characteristics which allow for competition. The experience from access and
price regulation of telecommunications industries is problematic: Access
regulation and wholesale obligations distort investment decisions and spur
service based competition. In the longer run, this might lead to
inefficiencies from the lack of investment into innovations and concerning
intermodal competition.

Especially in the most open markets, dynamic reform processes have resulted
not only in greater efficiency of postal operators but also in a market
which focuses more and more on the interests of the customers.
Reorganization, consolidation and diversification are continuing, and low
cost business models are developing. Overall, service quality and
performance increased. From a consumer perspective, all this has increased
the ability of Europe's postal operators to meet customer needs and thus has
a positive effect on universal service. Analyses of market shares of
competitors as well as the subjective perception of key players confirm that
in cases where the monopoly has been completely abolished or substantially
reduced, real competition is emerging (EU 2006b, p.\thinspace 57).

Generally, in the postal industry there are neither non-transitory entry
barriers of structural or (with the abolishment of the reserved area) legal
nature, nor does the market do not tend towards effective competition over
time. In addition, most problems can be addressed sufficiently by
competition law alone. Hence, there is only limited scope for regulation,
and regulation should focus on competitive bottlenecks with proportionate
remedies applied in a punctual fashion. If structural bottlenecks are
symmetric, regulation should prefer market-based negotiation outcomes to
symmetric rules, which allow for end-to-end competition on a level playing
field.

\clearpage\ifodd\count0\else\thispagestyle{empty} \hbox{}\newpage \fi

\fancyhead[RO]{\rightmark}

\chapter{The Impact of Regulation on Postal Markets}

\renewcommand{\leftmark}{THE IMPACT OF REGULATION ON POSTAL MARKETS}

\begin{flushright}
\hangindent=1.4cm \hangafter=0 \textquotedblleft \textit{Although there has
been much theoretical and empirical research on the effects on privatization
and competition in infrastructure in general, relatively little work has
been done on how the degree of pri\-va\-ti\-za\-tion and competition affects
performance and how components of the \linebreak policies interact in
shaping the reform outcomes.\textquotedblright }\footnote{%
Li and Xu (2004, p.\thinspace 1).}
\end{flushright}

\noindent Especially in physical infrastructure industries like, e.g.,
telecommunications, electricity, railways, and also in the postal industry,
regulatory policies have a major impact on the outcome of the market. This
includes quantities, prices, and productivity, but also the industry
structure and the conduct of the players on the markets.

While the literature on policy analysis and evaluation mainly focused
infrastructure-tied industries in the past, with the ongoing regulatory
reform and the high importance of the postal markets -- not alone in terms
of the product market size, but also in employment terms -- the postal
industry is becoming focused increasingly. Against the background of the
ongoing process of liberalization especially throughout Europe, and the
contemporarily difficult overall economic conditions which even seem to
accelerate the trend of declining mail volumes, the importance to regulate
markets in an optimal way in order to minimize potentially negative effects
of regulation has become increasingly important.

Therefore, we consider the effect of different economic, social, and
demographic factors for the countries Finland, France, Germany, the
Netherlands, Spain, Switzerland, the United Kingdom as well as the United
States. The variables contain factors that already have been identified to
be significant drivers of mail volumes including population data and
telecommunications penetration data (as a proxy for possible
e-substitution). In addition, we introduce new variables with regard to the
relationship of the postal operators with the respective governments (such
as the independence of the operators and the share held by government) and
with regard to regulation (such as the access regulation or the market
regulatory index) to analyze their impact on the market development because
a better understanding of their impact would help to improve postal policies.

We estimate different fixed effects (FE)\ least squares and FE logit models
to assess those relationships. We would expect, that high overall product
market regulation affect market volumes negatively because of the related
regulatory restrictions to their strategy and tactics which constrain
operators to act fully market-driven.

Corporatization and independence (or reduced government shares) of the
incumbent operator are expected to affect both, volumes and turnover
positively because of an optimization of the product offerings and pricing%
\footnote{%
Aivazian, Ge and Qiu (2005, in particular p.\thinspace 807) empirically
confirm the view that \textquotedblleft corporatization has had a
significantly positive impact on SOE [State-Owned Enterprises; author's
note] performance. Our results suggest that, even without full
privatization, coporate governance reform of SOEs can effectively improve
performance. They suggest an alternative policy prescription for countries
looking for a way of restructuring their SOEs without massive privatization%
\textit{\textquotedblright }.} while decreasing employment due to an
increased incentive to optimize cost. This expectation that independence and
corporatization lead to a decreasing workforce stems from an expectedly
increased industrialization of the postal industry (automation) on the one
hand and the optimization of the workforces including measures such as
real-time route optimization and flexibilization of working hours (which
both increase labour efficiency and thus allow the reduction of staff in
terms of full time equivalents).

\section{Literature review}

The work is motivated by the existing literature on postal demand
estimation, articles on electronic substitution and -- more in general --
the drivers of different mailstreams, as well as on regulatory impact
analysis.

So far, the main drivers of mail demand have been mainly the gross domestic
product (GDP), prices, and other variables reflecting economic activity, for
example income. But since quite a while, the explanatory power of these
models appears to be decreasing and the portion of unobserved heterogeneity
increased over time.\footnote{%
Cf.\ also Diversified Specifics (2002) for the disaggregated view on
different mailstreams.} E.g., Diakova (2005) shows, that total mail volumes
so far have been explained to a large extent by real GDP (with up to
90\thinspace \% of the variance observed explained solely by this factor),
but since 1998, the correlation has been falling behind (in particular for
the US). This is especially observable if different types of mail purposes
are considered separately.

Harding (2004) provides an extensive overview over the models which have
been used up today and proposes to include the distribution of the incomes
to be included in order to correct for some deviances from the previous
situation where GDP\ alone used to statistically explain more than
85\thinspace \% of the postal volumes. He still finds, that GDP is able to
explain a large share of the observed variance, but also proxies for
economic activity such as households having a bank account, having a phone
and so on contributes a lot of explanation to the data observed.\footnote{%
E.g., Jimenez, Harding and Lintell (2007) propose the inclusion of income
dispersion (inequality) measures in order to improve model fits to some
remarkable extent.}

Nader and Lintell (2008, based on Nader 2004) point to some further aspects
that should be included in the analysis, for example the possibility that
the volume gains by competitors might offset the decline in mail volumes
delivered by the incumbent National Postal Operators (NPOs), that quality
improvements lead to the shift of mail from priority to economy categories
as well as quality improvement in targeting customers with direct mail might
lead to a shift to mail categories of higher quality or even to small
promotional parcels at the expense of the amount of direct letter mail sent.

Common to all authors is the proposal to disaggregate the mailstream and to
add additional explanatory variables.

Substitution not between different mail types but to electronic alternatives
is another central issue for the postal industry, since the choice of
mailers and the receiver preferences are also not fully understood yet (cf.,
e.g., Nader and Jimenez 2005 and Szeto and Jimenez 2005). One example for an
extensive econometric model of the US market based on the Household Diary
Survey predicts further decline of mail demand with rising personal computer
penetration, growing stamp prices, and declining telephone service prices
(Hong and Wolak 2008), whereas other authors additionally predict an
increased pace of the decline in the current economic downturn, albeit the
impact on the various mail categories differs substantially between short
and long run, different mail attributes and contents, and depending on the
different needs of senders and receivers.\footnote{%
Although mainly the sender chooses the communication channel (because she is
the party that pays), it has to fulfil the needs of both, the senders and
the recipients (Koppe and H\"{o}mstreit~2009).} Surprisingly, at least in
the volumes from 1999 until 2009, the OECD does not include letter mail in
their \textit{Communications Outlook } (OECD 1999, 2001, 2003, 2005, 2007
and 2009), but concentrates on electronic communication and broadcasting. On
the other hand, they issued once a report on the \textit{Impact on
Substitute Services on Regulation} (OECD 2006).

The articles on regulatory analysis in the postal sector start from verbal
discussions of postal reforms like the seminal article of Coase (1939), to
theory-based qualitative assessments concerning the optimal regulation of
the postal market (cf.\ in particular Baake and Wey 2007a, De Bijl, Van
Damme and Larouche 2005, Heitzler 2009). Additionally of high importance is
to embed the postal service markets and the governing regulation into the
communications market as a whole, an idea which is elaborated more in detail
in chapter 5 with regard to the future of the universal service.

Closely related to the regulation of competition in these markets especially
is the impact of the universal service obligations on consumers and on
competition. Overall, the right assessment of these services of public
interest and the right policy implications might substantially improve the
preconditions for competition to evolve, if no operator is restricted overly
and the mandated services are adapted to the preferences and need of the
consumers (cf., e.g., Finger 2006). The result of efficient regulatory
policies might not only be optimal conditions for the consumers and
customers, but also efficient competition patterns to evolve (De Bas and van
der Lijn 2008). Game-theoretic models of the industry thereby provide
additional valuable insights into the postal industry (cf., e.g., Crew and
Kleindorfer 1998, Dietl, Felisberto et al. 2006 or Mizutani and Uranishi
2003).

The articles on regulatory reform in a broader context comparing
international product and labor market reforms either are not
industry-dependent, for example if they employ a macroeconomic \textit{%
General Equilibrium} model (see Blanchard and Giavazzi 2003 for an example)
or if they empirically analyze macro effects and the interdependence of
labor and product market institutions and/or reforms and the related
outcomes (e.g., Koedijk, Kremers et al. 1996, Loayza, Oviedo and Serv\'{e}n
2004), or these articles are mainly dealing with other sectors than the
postal industry. Prominent examples are the texts dealing with the
regulation, market structure and performance of telecommunications and other
physical network industries (e.g., Boylaud and Nicoletti 2000, Grajek and R%
\"{o}ller 2009, Li and Xu 2004, Nicoletti, Scarpetta and Lane 2003, R\"{o}%
ller and Waverman 2001, Wallsten 2001, Waverman, Meschi et al. 2007).

For example, Grajek and R\"{o}ller (2009) analyze the trade-off between
access and investment incentives using a dataset covering over 70 fixed line
operators in 20 countries over 10 years. Their data sources include the
Amadeus firm level database for capital stock levels and investments and the
Plaut Economics telecoms regulatory index amongst others. Not surprisingly,
these studies provide very robust results. They find that a regulatory
commitment problem which leads to the fact that access regulation negatively
impacted overall and individual carrier investments (including individual
entrants) and regulatory endogeneity which leads to the problem, that the
higher the incumbents' investments, the higher the probability that mandated
access had to be provided, additionally undermining the investment
incentives.

Koedijk, Kremers et al. (2006) find a clearly negative relationship between
regulation and economic performance, both of labor and product market
regulation. They state the view, that it is key to avoid unnecessary
restrictive regulations, although not all regulation has a negative impact
on the overall development of the market, for example regulations which
increase market transparency or facilitate market entry might be well in
place.

Waverman, Meschi et al. (2007) examined also the telecommunications sector
and the impact of access regulation (local loop unbundling, LLU) on
investment in infrastructures including alternative access platforms in
order to capture the most important aspect of telecommunications regulation
and competition, namely sustainable inter-modal competition between
different platforms. Their main result is, that low local loop access prices
cause a strong substitution from broadband over alternative platforms
towards access-based competition, which leads to massive distortions
concerning the market evolution and innovation.

Similarly, with \textit{End-to-End competition} instead of \textit{%
Worksharing} (which is synonymous to downstream access) in the postal
industry, greater diversity of access platforms is to be expected to provide
greater opportunities for innovation and product differentiation (Waverman
and Meschi 2007, p.\thinspace 2). Factoring in the impact of access
regulation (and even worse in combination with regulated low access and
retail prices) leads to the effect of overall decreased service. Their
findings included, that low LLU prices prevented the roll-out of competing
access networks as well as the upgrading or increasing the footprint of
existing networks, thus limiting last mile innovations.

Common to these articles are sophisticated econometric models and the use of
data compiled from different sources in order to obtain a dataset which
allows for very detailed analysis of the question in doubt. For this
chapter, the data availability for the postal industry was explored with the
goal to conduct a similar analysis for the postal industry to bridge the gap
between the methods employed in the articles mentioned and to obtain
insights for recommendations of postal policies based on econometric
analysis.

The results of this chapter confirm the findings of the literature with
regard to the directions of the effects of the variables analyzed, but also
underline the need for better and faster available data with regard to the
postal markets.

\section{The data}

In order to estimate a model of similar value, data of similar extent and
quality is necessary. Therefore we tried to collect the data relevant for
postal policy and to understand the effect of regulation on the
interdependencies between the postal and the neighboring telecommunications
sector from existing sources (cf.\ table~2.1: Data and data sources).%
\footnote{%
The full dataset is included as an attachment to the Adobe Acrobat version
of this thesis.} The telecommunications sector variables representing the
share of internet users and of mobile telecommunications subscribers among
the populations in the considered countries have been included because of
the potential effect of substitution of letters by electronic communication.

Starting point was a set of eight countries, namely Finland, France,
Germany, the Netherlands, Spain, Switzerland, the United Kingdom and the
United States. These industrialized countries were expected to have
relatively large amount of data available and to be heterogeneous enough to
allow for estimations.

The timeframe was set to include the year 1992 to 2006. 1992 was chosen as
the starting year of the European postal reforms with the publication of the 
\textit{Green Paper} by the European Commission (EU\ 1992), intentionally
including Switzerland and the US as countries not covered by the European
reform agenda.

Most of the data is freely available. This includes all data on the country
characteristics, such as size, population, degree of urbanization and
macroeconomic factors such as gross domestic product, national income, or
price indices.

%TCIMACRO{%
%\TeXButton{Data and sources}{{
%\small
%\begin{threeparttable}
%[!ht]\centering
%\caption{Data and data sources
%\label{tab:dataandsources}}
%\vspace{3mm}
%\begin{tabular}{l l}\hline
%Market and operator data & International Post Corporation \\
%(on postal services and & Universal Postal Union \\
%Telecommunications) & International Telecommunications Union \\
%\multirow{5}{*}{} & OECD \\
%& Eurostat \\
%& National statistics offices \\
%& Annual reports and webpages of operators and NRAs \\
%& Publicly available consulting reports \\
%Regulatory data and indices & Fraser Institute's \textit{Economic Freedom Indicator} \\
%(on Postal services and & (see Gwartney, Robert et. al. 2009) \\
%Telecommunications) & OECD Product market indicator \\
%& The World Bank \textit{Doing Business Index} \\
%National economy, & OECD \\
%geographic, and & Eurostat \\
%demographic data & The World Bank \\
%\multirow{2}{*}{} & CIA World Factbook \\
%& Governmental webpages \\ \hline
%\end{tabular}
%\end{threeparttable}
%}}}%
%BeginExpansion
{
\small
\begin{threeparttable}
[!ht]\centering
\caption{Data and data sources
\label{tab:dataandsources}}
\vspace{3mm}
\begin{tabular}{l l}\hline
Market and operator data & International Post Corporation \\
(on postal services and & Universal Postal Union \\
Telecommunications) & International Telecommunications Union \\
\multirow{5}{*}{} & OECD \\
& Eurostat \\
& National statistics offices \\
& Annual reports and webpages of operators and NRAs \\
& Publicly available consulting reports \\
Regulatory data and indices & Fraser Institute's \textit{Economic Freedom Indicator} \\
(on Postal services and & (see Gwartney, Robert et. al. 2009) \\
Telecommunications) & OECD Product market indicator \\
& The World Bank \textit{Doing Business Index} \\
National economy, & OECD \\
geographic, and & Eurostat \\
demographic data & The World Bank \\
\multirow{2}{*}{} & CIA World Factbook \\
& Governmental webpages \\ \hline
\end{tabular}
\end{threeparttable}
}%
%EndExpansion
\bigskip

The data on the postal sector was very difficult to find for the years, in
particular after 2006 and before 1994. Therefore, for the estimations the
dataset had been restricted to the years 1994 to 2006. Especially surprising
was the fact, that Eurostat had dropped gathering data on the postal sector,
although the liberalization agenda had been initiated by the European
commission. Eurostat started the collection of data on postal markets not
before 2005 again. Regrettably, all data sets are characterized by missing
values and high aggregation levels, which has been an especially difficult
issue to deal with due to the high level of merger, divestiture and
diversification activities. Consequently, the data has to be examined very
carefully. The market and operational data was especially difficult to deal
with due to the operators' reluctance concerning their publication and the
high levels of aggregation.

The variables of the uniquely constructed dataset are descibed in the
following table~2.2: Variables and data description. The according summary
statistics are given in the subsequent table~2.3: Summary statistics.\bigskip

%TCIMACRO{%
%\TeXButton{Variables and description}{{
%\small
%\begin{center}
%{
%\begin{threeparttable}
%[!tph]\centering
%\caption{Variables and data set description
%\label{tab:datadesc}}
%\vspace{3mm}
%\begin{tabular}{l l}\hline
%Country	& Country name \\
%cc	& Country code (short descriptor) \\
%cid	& Country ID (1 to 8)\\
%year	& Year \\
%d\_pop\_gro	& Growth rate of population \\
%d\_population	& Population (number of inhabitants) \\
%m\_gdp\_gro	& Gross Domestic Product Growth Rate \\
%npo\_corp	& Corporatization of National Postal Operator \\
%npo\_fte\_gro	& National Postal Operators' staff growth rate \\
%npo\_fte\_ls	& Number of national postal operators' employees \\
%& (FTE, letter segment) \\
%npo\_govshare	& Share of National Postal Operator held by government\\
%npo\_indep	& Independence of National Postal Operator \\
%npo\_letrev\_gro	& National Postal Operators' letter mail \\
%& revenues growth rate \\
%npo\_lpi\_gro	& National postal operators' Letter Post Items Growth Rate \\
%npo\_lpi\_gro\_bin	& National postal operators' Letter Post Items Growth \\
%& (binary variable indicating positive growth value) \\
%reg\_access	& Access to the postal network is mandated by regulation \\
%reg\_fraser\_5	& Fraser Institute's Economic Freedom of the World \\
%& (subindex 5 \textit{Regulation of Credit, Labor, and Business}, \\
%& see Gwartney, Robert et. al. 2009, p. 198) \\
%reg\_oecd	& OECD product market regulatory index \\
%tk\_inetusrs	& Internet users per 100 inhabitants \\ \hline
%\end{tabular}
%\end{threeparttable}
%}
%\end{center}
%}}}%
%BeginExpansion
{
\small
\begin{center}
{
\begin{threeparttable}
[!tph]\centering
\caption{Variables and data set description
\label{tab:datadesc}}
\vspace{3mm}
\begin{tabular}{l l}\hline
Country	& Country name \\
cc	& Country code (short descriptor) \\
cid	& Country ID (1 to 8)\\
year	& Year \\
d\_pop\_gro	& Growth rate of population \\
d\_population	& Population (number of inhabitants) \\
m\_gdp\_gro	& Gross Domestic Product Growth Rate \\
npo\_corp	& Corporatization of National Postal Operator \\
npo\_fte\_gro	& National Postal Operators' staff growth rate \\
npo\_fte\_ls	& Number of national postal operators' employees \\
& (FTE, letter segment) \\
npo\_govshare	& Share of National Postal Operator held by government\\
npo\_indep	& Independence of National Postal Operator \\
npo\_letrev\_gro	& National Postal Operators' letter mail \\
& revenues growth rate \\
npo\_lpi\_gro	& National postal operators' Letter Post Items Growth Rate \\
npo\_lpi\_gro\_bin	& National postal operators' Letter Post Items Growth \\
& (binary variable indicating positive growth value) \\
reg\_access	& Access to the postal network is mandated by regulation \\
reg\_fraser\_5	& Fraser Institute's Economic Freedom of the World \\
& (subindex 5 \textit{Regulation of Credit, Labor, and Business}, \\
& see Gwartney, Robert et. al. 2009, p. 198) \\
reg\_oecd	& OECD product market regulatory index \\
tk\_inetusrs	& Internet users per 100 inhabitants \\ \hline
\end{tabular}
\end{threeparttable}
}
\end{center}
}%
%EndExpansion
\bigskip

%TCIMACRO{%
%\TeXButton{Summary stats}{{
%\small
%\begin{center}
%{
%\begin{threeparttable}
%[!ht]\centering
%\caption{Summary statistics
%\label{tab:sumstats}}
%\vspace{3mm}
%\begin{tabular}{l l l l l l}\hline
%Variable & Obs. & Mean & Std.\,Dev. & Min. & Max. \\ \hline
%cid & 120 & 4.5 & 2.300895 & 1 & 8 \\
%year & 120 & 1999 & 4.338609 & 1992 & 2006 \\
%d\_pop\_gro & 112 & 0.5528202 & 0.3902987 & -0.1127073 & 1.671469 \\
%d\_population & 120 & 6.84E+07 & 8.39E+07 & 5035000 & 2.98E+08 \\
%m\_gdp\_gro & 112 & 2.530666 & 1.462679 & -1.031505 & 6.091118 \\
%npo\_corp & 120 & 0.4666667 & 0.5009794 & 0 & 1 \\
%npo\_fte\_gro & 98 & -0.6063324 & 3.332847 & -9.435067 & 9.187724 \\
%npo\_fte\_ls & 106 & 179281.5 & 247807.7 & 15076 & 851780.5 \\
%npo\_govshare & 120 & 92.31667 & 20.98355 & 0 & 100 \\
%npo\_indep & 120 & 0.7833333 & 0.4137009 & 0 & 1 \\
%npo\_letrev\_gro & 96 & 2.411153 & 3.384417 & -3.989182 & 16.00538 \\
%npo\_lpi\_gro & 97 & 0.8751374 & 2.795438 & -5.262009 & 8.100731 \\ 
%npo\_lpi\_gro\_bin & 97 & 0.5257732 & 0.5019293 & 0 & 1 \\
%reg\_access & 120 & 0.2041667 & 0.4021781 & 0 & 1 \\
%reg\_fraser\_5 & 120 & 6.95825 & 0.8021648 & 5.37 & 8.29 \\
%reg\_oecd & 120 & 3.29838 & 0.8254949 & 1.698 & 4.4385 \\
%tk\_inetusrs & 120 & 29.05833 & 25.84612 & 0 & 81 \\ \hline
%\end{tabular}
%\end{threeparttable}
%}
%\end{center}
%}}}%
%BeginExpansion
{
\small
\begin{center}
{
\begin{threeparttable}
[!ht]\centering
\caption{Summary statistics
\label{tab:sumstats}}
\vspace{3mm}
\begin{tabular}{l l l l l l}\hline
Variable & Obs. & Mean & Std.\,Dev. & Min. & Max. \\ \hline
cid & 120 & 4.5 & 2.300895 & 1 & 8 \\
year & 120 & 1999 & 4.338609 & 1992 & 2006 \\
d\_pop\_gro & 112 & 0.5528202 & 0.3902987 & -0.1127073 & 1.671469 \\
d\_population & 120 & 6.84E+07 & 8.39E+07 & 5035000 & 2.98E+08 \\
m\_gdp\_gro & 112 & 2.530666 & 1.462679 & -1.031505 & 6.091118 \\
npo\_corp & 120 & 0.4666667 & 0.5009794 & 0 & 1 \\
npo\_fte\_gro & 98 & -0.6063324 & 3.332847 & -9.435067 & 9.187724 \\
npo\_fte\_ls & 106 & 179281.5 & 247807.7 & 15076 & 851780.5 \\
npo\_govshare & 120 & 92.31667 & 20.98355 & 0 & 100 \\
npo\_indep & 120 & 0.7833333 & 0.4137009 & 0 & 1 \\
npo\_letrev\_gro & 96 & 2.411153 & 3.384417 & -3.989182 & 16.00538 \\
npo\_lpi\_gro & 97 & 0.8751374 & 2.795438 & -5.262009 & 8.100731 \\ 
npo\_lpi\_gro\_bin & 97 & 0.5257732 & 0.5019293 & 0 & 1 \\
reg\_access & 120 & 0.2041667 & 0.4021781 & 0 & 1 \\
reg\_fraser\_5 & 120 & 6.95825 & 0.8021648 & 5.37 & 8.29 \\
reg\_oecd & 120 & 3.29838 & 0.8254949 & 1.698 & 4.4385 \\
tk\_inetusrs & 120 & 29.05833 & 25.84612 & 0 & 81 \\ \hline
\end{tabular}
\end{threeparttable}
}
\end{center}
}%
%EndExpansion
\bigskip

\section{The models}

As the impact of the regulatory framework for postal services might vary by
the type of regulation, we assessed the impact of regulation on the letter
mail volumes and revenues. The expected effects which also served as the
working hypotheses were, that low regulatory requirements and low internet
usage would correlate with high physical mail volumes and revenues, with
population sizes and GDP\ (and the growth thereof) determining the base
level for a given country (number of addressable users and their wealth).

The control variables included in the specifications also cover overall GDP\
development (as this factor was one of the main driver of postal volumes and
revenues in the past, see the literature review above) as well as measures
covering the legal situation of the national postal operator and the
internet usage in the countries considered.

The model we chose for the estimation was mainly (for no. 1, 2, 5, 6, 7) a
fixed effects panel model in the usual form $y_{it}=x_{it}^{^{\prime }}\beta
+z_{i}^{^{\prime }}\alpha +\varepsilon _{it}$ (see, e.g., Greene 2003, p.
285). Fixed effects have been chosen due to the clear advantage that they
allow to correct for a (presumable) omitted variable bias, as they capture
all individual time invariant information on the fixed effect, which implies
that only information that is varying over time is used to determine the
coefficients. Although this implies imposing a restriction to the used
sample and to accept some side-effects, we discarded the pooled ordinary
least squares (OLS)\ model, random effects panel models and instrumental
variable approaches.

The pooled OLS\ model has been discarded because it has to fulfill the same
strict assumptions of a cross-sectional OLS\ model, namely the assumption
that there are neither unobserved heterogeneity nor serial correlation and
because it is neither consistent nor efficient with individual heterogeneity
(cf. Greene 2003, sect. 2.3). In addition, random effects (RE) models impose
additional requirements such as the strict exogeneity of the independent
variables and independence (orthogonality) of the errors (Wooldridge 2002,
p. 257). Although Hausman tests failed to reject the RE, testing for serial
correlation produced results which have been close to be significant. Greene
(2003, p. 301) confirms the view, that, in doubt, FE\ models should be
used:\ \textquotedblleft There is little justification for treating the
individual effects as uncorrelated with the other regressors, as is assumed
in the random effects model.\textquotedblright

Thus, we chose fixed effects (FE) for our estimations (individually). Those
models provide the advantage of allowing unobserved heterogeneity which is
partially correlated with the explanatory variables (cf. Wooldridge 2002, p.
257), even if \textquotedblleft the random effects treatment does allow the
model to contain observed time invariant characteristics, such as
demographic characteristics, while the fixed effects model does
not\textquotedblright\ (Greene 2003, p. 303), as our variables are not
complete invariant. However, with especially the regulatory variables being
only slowly changing, on could expect that some of their effect is
considered as being a country-specific fixed effect and thus their impact
being underestimated. \ Instrumental variable (IV) estimation has been
discarded because of the relatively weak small-sample properties of this
approach. In small samples, the IV\ estimator can have a substantial bias
(Wooldridge 2009, ch. 15) and the precision of IV estimates is lower than
that of OLS estimates (least squares). In the presence of weak instruments
(we did not find good instruments for the postal industry), the loss of
precision will be severe, and IV estimates may be no improvement over OLS
(Baum 2007). In order to counter potential heteroskedasticity problems, we
employ robust standard errors for our estimations, as the alternative of a
cluster-robust estimator may be very incorrect with a small number of
clusters (8, in our sample) and maybe substantially biased downwards
(Wooldridge 2003).

For the remaining estimations (3 and 4 ) we employed a fixed effect logit
model which served mainly for checking the first two ones, again with robust
errors.

%TCIMACRO{%
%\TeXButton{Estoutputs}{{
%\small
%\begin{sidewaystable}
%\centering
%\caption{Estimation outputs
%\label{tab:estoutputs}}
%\vspace{3mm}
%\begin{tabular}{l c c c c c c c}\hline
%& (1) & (2) & (3) & (4) & (5) & (6) & (7) \\
%& {\footnotesize{npo\_lpi\_gro}} & {\footnotesize{npo\_lpi\_gro}} & {\footnotesize{npo\_lpi\_gro\_bin}} & {\footnotesize{npo\_lpi\_gro\_bin}} & {\footnotesize{npo\_letrev\_gro}} & {\footnotesize{npo\_letrev\_gro}} & 
%
%{\footnotesize{npo\_fte\_gro}} \\ \hline
%{\footnotesize{Estimation}} & {\footnotesize{Lin. FE (r)}} & {\footnotesize{Lin. FE (r)}} & {\footnotesize{Logit FE}} & {\footnotesize{Logit FE}} & {\footnotesize{Lin. FE (r)}} & {\footnotesize{Lin. FE (r)}} & {\footnotesize{Lin. FE (r)}}\\ \hline
%m\_gdp\_gro & 0.516 & 0.612* & 0.648** & 0.975*** & 0.319 & 0.428 & 0.000 \\
%& {\footnotesize{(2.23)}} & {\footnotesize{(3.31)}} & {\footnotesize{(2.81)}} & {\footnotesize{(3.62)}} & 
%
%{\footnotesize{(1.01)}} & {\footnotesize{(1.53)}} & {\footnotesize{(0.00)}} \\
%reg\_oecd & 0.248 & & 1.004* & & -0.729 & & \\
%& {\footnotesize{(0.56)}} & & {\footnotesize{(2.05)}} & & {\footnotesize{(-1.27)}} & & \\
%reg\_fraser\_5 & & -0.883 & & -2.040 & & -1.049 & \\
%& & {\footnotesize{(-0.98)}} & & {\footnotesize{(-2.39)}} & & {\footnotesize{(-1.76)}} & \\
%tk\_inetusrs & -0.053* & -0.055** & & & -0.241 & -0.007 & -0.279 \\
%& {\footnotesize{(-2.99)}} & {\footnotesize{(-5.33)}} & & & {\footnotesize{(-0.97)}} & {\footnotesize{(-0.33)}} & 
%
%{\footnotesize{(-1.37)}}\\
%npo\_indep & 2.906** & 2.895** & & & 2.173 & 2.078 & \\
%& {\footnotesize{(4.63)}} & {\footnotesize{(4.99)}} & & & {\footnotesize{(1.70)}} & {\footnotesize{(1.51)}} & \\
%npo\_corp & 2.141* & 1.875* & & & 2.921* & 2.311* & -1.595 \\
%& {\footnotesize{(2.86)}} & {\footnotesize{(3.30)}} & & & {\footnotesize{(3.33)}} & {\footnotesize{(2.79)}} & 
%
%{\footnotesize{(-1.04)}} \\
%npo\_govshare & & & & & & & -0.109 \\
%& & & & & & & {\footnotesize{(-0.55)}} \\
%d\_pop\_gro & 0.299 & 0.610 & & & 1.408 & 1.713 & 2.239* \\
%& {\footnotesize{(0.51)}} & {\footnotesize{(0.79)}} & & & {\footnotesize{(1.64)}} & {\footnotesize{(1.75)}} & 
%
%{\footnotesize{(3.25)}} \\
%\_cons & -3.054 & 3.630 & -0.528** & 3.085 & 0.662 & 5.005 & 0.966 \\
%& {\footnotesize{(-1.82)}} & {\footnotesize{(0.58)}} & {\footnotesize{(-4.13)}} & {\footnotesize{(2.20)}} & 
%
%{\footnotesize{(0.38)}} & {\footnotesize{(1.22)}} & {\footnotesize{(0.32)}} \\ \hline
%{\textit{N}} & 97 & 97 & 97 & 97 & 96 & 96 & 98 \\ \hline
%\end{tabular}
%\begin{tablenotes}\footnotesize 
%\item[] {\textit{t}}-/{\textit{z}}-statistics in parentheses
%\item[] *{\textit{p}}<0.05 **{\textit{p}}<0.01 ***{\textit{p}}<0.001
%\end{tablenotes}
%\end{sidewaystable}
%}}}%
%BeginExpansion
{
\small
\begin{sidewaystable}
\centering
\caption{Estimation outputs
\label{tab:estoutputs}}
\vspace{3mm}
\begin{tabular}{l c c c c c c c}\hline
& (1) & (2) & (3) & (4) & (5) & (6) & (7) \\
& {\footnotesize{npo\_lpi\_gro}} & {\footnotesize{npo\_lpi\_gro}} & {\footnotesize{npo\_lpi\_gro\_bin}} & {\footnotesize{npo\_lpi\_gro\_bin}} & {\footnotesize{npo\_letrev\_gro}} & {\footnotesize{npo\_letrev\_gro}} & 

{\footnotesize{npo\_fte\_gro}} \\ \hline
{\footnotesize{Estimation}} & {\footnotesize{Lin. FE (r)}} & {\footnotesize{Lin. FE (r)}} & {\footnotesize{Logit FE}} & {\footnotesize{Logit FE}} & {\footnotesize{Lin. FE (r)}} & {\footnotesize{Lin. FE (r)}} & {\footnotesize{Lin. FE (r)}}\\ \hline
m\_gdp\_gro & 0.516 & 0.612* & 0.648** & 0.975*** & 0.319 & 0.428 & 0.000 \\
& {\footnotesize{(2.23)}} & {\footnotesize{(3.31)}} & {\footnotesize{(2.81)}} & {\footnotesize{(3.62)}} & 

{\footnotesize{(1.01)}} & {\footnotesize{(1.53)}} & {\footnotesize{(0.00)}} \\
reg\_oecd & 0.248 & & 1.004* & & -0.729 & & \\
& {\footnotesize{(0.56)}} & & {\footnotesize{(2.05)}} & & {\footnotesize{(-1.27)}} & & \\
reg\_fraser\_5 & & -0.883 & & -2.040 & & -1.049 & \\
& & {\footnotesize{(-0.98)}} & & {\footnotesize{(-2.39)}} & & {\footnotesize{(-1.76)}} & \\
tk\_inetusrs & -0.053* & -0.055** & & & -0.241 & -0.007 & -0.279 \\
& {\footnotesize{(-2.99)}} & {\footnotesize{(-5.33)}} & & & {\footnotesize{(-0.97)}} & {\footnotesize{(-0.33)}} & 

{\footnotesize{(-1.37)}}\\
npo\_indep & 2.906** & 2.895** & & & 2.173 & 2.078 & \\
& {\footnotesize{(4.63)}} & {\footnotesize{(4.99)}} & & & {\footnotesize{(1.70)}} & {\footnotesize{(1.51)}} & \\
npo\_corp & 2.141* & 1.875* & & & 2.921* & 2.311* & -1.595 \\
& {\footnotesize{(2.86)}} & {\footnotesize{(3.30)}} & & & {\footnotesize{(3.33)}} & {\footnotesize{(2.79)}} & 

{\footnotesize{(-1.04)}} \\
npo\_govshare & & & & & & & -0.109 \\
& & & & & & & {\footnotesize{(-0.55)}} \\
d\_pop\_gro & 0.299 & 0.610 & & & 1.408 & 1.713 & 2.239* \\
& {\footnotesize{(0.51)}} & {\footnotesize{(0.79)}} & & & {\footnotesize{(1.64)}} & {\footnotesize{(1.75)}} & 

{\footnotesize{(3.25)}} \\
\_cons & -3.054 & 3.630 & -0.528** & 3.085 & 0.662 & 5.005 & 0.966 \\
& {\footnotesize{(-1.82)}} & {\footnotesize{(0.58)}} & {\footnotesize{(-4.13)}} & {\footnotesize{(2.20)}} & 

{\footnotesize{(0.38)}} & {\footnotesize{(1.22)}} & {\footnotesize{(0.32)}} \\ \hline
{\textit{N}} & 97 & 97 & 97 & 97 & 96 & 96 & 98 \\ \hline
\end{tabular}
\begin{tablenotes}\footnotesize 
\item[] {\textit{t}}-/{\textit{z}}-statistics in parentheses
\item[] *{\textit{p}}<0.05 **{\textit{p}}<0.01 ***{\textit{p}}<0.001
\end{tablenotes}
\end{sidewaystable}
}%
%EndExpansion

\section{Results}

Most notably, corporatization\footnote{%
For an explanation of \textquotedblleft corporatization\textit{%
\textquotedblright }, see above (Chapter 1, footnote 17).} has consistently
(in 1, 2, 5, 6) a significant impact on the number of letter items as well
as on the related revenues, whereas the independence of a postal operator
has only a significant impact on the number of items. Thus we clearly
confirm the results Aivazian, Ge and Qui (2005). Furthermore, as expected,
an increasing number of internet users corresponds to a lower number of
items. However, the assessments of the impact of the two regulatory
variables, namely the OECD\ product market regulations indicator and the the 
\textit{Economic Freedom of the World} indicator (sub-indicator 5) by the
Fraser Institute (Gwartney, Robert et. al. 2009) on the growth of the
corresponding dependent variables are of little significance.

In addition, albeit the sign of the indicator of the Fraser Institute points
to the right direction, the signs of the OECD\ indicator are surprising, as
according to them higher regulation increases the number of letter post
items - which could be the case, if for example worksharing mail volumes
increase with the intensification of competition (cf. especially estimation
3).

Negative impact could be expected from the share of users with access to the
internet (presumably proxying e-substitution), which they provide
significantly on volumes but not on revenues. One explanation could be that
internet users have already sent and received a low number of letters even
before joining the online community. Furthermore, on the revenue side, all
variables except corporatization are insignificant. It remains unclear
whether this is due to the fact that there is actually no effect or whether
the high level of data aggregation masks the effects through revenues from
diversification of the national postal operators.

As previously described in the literature section, the influence of the
development of the gross domestic product has vanished. Although it is
visible in the Logit estimations (with their reduction to a binary dependent
variable), it is only significant in (2), but not with the above-90 \%
impact levels which have been reported in the literature section of this
chapter. Similarly, the growth of the population of the countries does not
show significant effect, which could be due to the fact, that there is not
much movement in the variable, or that the number of letter mail items has
been decoupled from the GDP\ development.

In times of electronic delivery of messages, also the FTE growth of the
incumbent operators has no significant effect on the number of employees at
the national postlal operator. Unfortunately, there is not sufficient data
available to see, whether emerging competition and the related employment
capture this effect.

\section{Conclusion}

Although the direct estimation results here provide limited statistical
evidence for the influence of explanatory variables concerning regulations,
the issue should be re-examined with a comparable model as soon as a
suitable dataset is available. The outcomes\ are well in line with
theoretical articles concerning the postal industry as well as many
empirical papers, including works examining other industries. The data
leaves room for further variables influencing the overall postal market
development, however, it does suggest that the policy influences on volumes,
prices, markets, employment, and agents' behavior also from the variables
taken into consideration should be taken into account when economically
sound policies are to be designed.

Because of the data limitations, statistical significance is hard to
achieve. Due to the lack of sufficiently complete and precise data,
currently no database seems to be suffiently suitable for cross-country
policy analysis in the postal industry. Although firms are generally
reluctant to provide precise data, the data for research not necessarily has
to be up to date. If there would be a lag of two or three years between the
generation and the disclosure of the data, there could be a useful set
provided which keeps the interests of the research community, the
policy-making institution as well as the firms active on the markets in
balance, a view which is clearly shared by Boldron, Cazals et al. (2009),
which also state the \quotedblbase need for a better
database\textquotedblleft\ (p.\thinspace 13).

Limitations of the data include that there was a relatively small number of
observations left, especially if growth rates or differences were computed,
leading to the loss of another year in the time dimension. An ideal dataset
would include harmonized and complete data from official statistics.
Comparable data on prices and competition measurements, such as Herfindahl
indices or concentration ratios like the market share of the largest firm in
a well-defined market (CR1) or the joint market share of the three biggest
companies (CR3) were completely unavailable.

Overall, the importance of precise data to evaluate policies and estimate
the likely impact of different regulatory settings being discussed is
especially high in industries which are undergoing rapid changes as the
postal industry at the moment. The test of the inclusion of a variety of new
indicators and variables could provide significant advantages when it comes
to the creation of the optimal regulatory conditions in order to focus on
market growth.

Deeper understanding of the regulatory influence on the overall market
development not only could lead to improved regulatory conditions but could
also uncover further drivers of business development. Thus this chapter is
intended to serve as a starting point for a debate about the impact of
postal regulation based on solid statistical evidence.

Although the postal sector is much older than the telecoms sector, data
availability is much more limited due to the slower introduction and
development of regulation and competition than it is in the
telecommunications sector and due to the regulators'\ parsimony to postal
data collection. Especially when it comes to future regulation, improved
data availability might provide important insights; although theory says,
that the market can largely be left unregulated, it could be expected, that
regulators might try to \textquotedblleft advance\textquotedblright\
competition in a direction they believe it is right rather than to know what
the real impact and possible costs are.

Therefore, a comprehensive database containing much more detailed
information than the existing databases would be very helpful for research
and policy work. Data availability, comparability and correctness thereby
are more important than immediate disclosure. \newpage

\fancyhead[RO]{\rightmark}

\chapter{Social Regulation:\ The German Postal Minimum Wage Case}

\renewcommand{\leftmark}{THE GERMAN POSTAL MINIMUM WAGE CASE}

Increasingly, the postal industry is under pressure for transformation to
response to changing conditions resulting from market liberalization,
emerging competition and structural changes in demand. This situation as
well as proposals to privatize the national incumbent operators (where they
are still run as a public entity) widely lead to concerns of employees,
unions and politicians that the transition could worsen the working
conditions in the industry, and that in the extreme case precarious
conditions might emerge from low-quality-cheap-prices business models, where
market entrants' cost advantages are mainly based on low wages and social
standards. Therefore, not only the evolution of economic regulation such as
pricing regulation is under discussion, but also socioeconomic and
sociopolitical issues like the further development of social regulation,
ranging from universal service obligations to specific employment
regulations.

Although other industries in which the operators were mostly
monopoly-protected public entities with the employees having civil servant
or public employee status (such as telecommunications) were liberalized
before, these aspects have not been as prominent as in the postal industry
even though also in these industries the workers often enjoyed significant
wage differentials over comparable jobs in private firms. The special
importance of the policy goal to preserve socially acceptable conditions for
the postal industry stems from the distinctive fact, that the by far largest
share of the operating expenses has to be accounted to labor costs and is
reinforced by the expected decline of demand in many markets of the industry.

One of the most controversially discussed policy instruments to achieve this
goal is the introduction of a sector-specific minimum wage for the postal
industry. While the proponents of such a legislation argue, that such
minimum wages avoid \textquotedblleft unfair competition\textquotedblright\
at the expense of the postal workers and that they are needed in order to
level the playing field between entrants and the former monopolist (since
the wages of the incumbent operator cannot be swiftly reduced to a
competitive level), the opponents argue, that such minimum wages could not
only raise prices but also hamper employment and, moreover, inhere the
danger to be strategically exploited as a competition-deterrence device.
Bonini et al. (2006) provide a broader overview over different areas of
social regulation and their strategic implications.

In this article, we analyze the case of the minimum wages in the postal
industry in Germany from the public discussion mid-2007 to their
introduction in January 2008 and until their expiry end of April 2010 from
the latter competition perspective. We describe the collective bargaining
system and the case of the minimum wages in the postal industry in Germany
and discuss the case with regard to our respective article (Heitzler and Wey
2010). We describe in section 3.1 the legal foundations of collective
bargaining in Germany and the regulations which transform collective wage
agreements into generally binding minimum wages. Section 3.2 provides an
extensive discussion of the Deutsche Post case, section 3.3 highlights the
raising rivals' cost incentives and their consequences when the collective
wage agreement becomes generally binding. Section 3.4 concludes.

Our work is related to Williamson (1968) and contributes to the literature
linking the raising rivals' cost literature (Salop and Scheffmann 1983,
1987), the literature on entry barriers (Dixit 1979, Rogerson 1984) and the
literature analyzing the interaction between monopolized labor markets and
oligopolistic product markets (\textquotedblleft unionized
oligopolies\textquotedblright , cf.\ Dewatripont 1987, 1988, Horn and
Wolinsky 1988a, 1998b, Haucap, Pauly and Wey 2001).

\section{The collective wage bargaining system in Germany}

In this section, we briefly describe the legal foundations of the German
system of collective bargaining and the traditional procedure of declaring
wage contracts as generally binding by means of extension regulation. We
then explain how the most recent minimum wage legislation has significantly
increased the scope for making wage contracts generally binding.

\pagebreak \flushbottom

\noindent \textit{The legal basis of collective bargaining}\\[1.4ex]
In Germany, wage bargaining occurs primarily at the sectorial level between
an industry union and an employers' association representing most of the
firms in the industry.\footnote{%
Labor markets and labor laws differ substantially between countries (see,
e.g., Nickell 1997, OECD 1997, or Blau and Kahn 1999), where a salient
dimension that differentiates national labor markets is the degree of wage
setting centralization (Calmfors and Driffill 1988 and Wallerstein 1999).
From this angle, Germany's collective wage bargaining system is somehow
positioned in the middle between a decentralized system (with collective
bargaining at the firm level) and a fully centralized system (with
collective bargaining at the national level).} Those collective negotiations
usually result in standard wages and labor contracts which cover most of the
firms and workers in the industry. This so-called area tariff system
(\textquotedblleft Fl\"{a}chentarifsystem\textquotedblright ) still
dominates the German labor market. As has been argued by Haucap, Pauly and
Wey (2006, 2007) the stability of the area tariff system in Germany is
mainly externally supported by various labor market regulations which
systematically protect the collective bargaining system against deviant
behavior and outside competition.

One core institution of the German collective bargaining system is the
so-called tariff autonomy (\textquotedblleft
Tarifautonomie\textquotedblright ) which empowers unions, employers and
employer associations to form coalitions and to bargain collectively.%
\footnote{%
The legal grounds for the tariff autonomy can be found in Article 9
Paragraph 3 of the German Constitution (\textquotedblleft
Grundgesetz\textquotedblright ) and the law concerning tariff agreements
(\textquotedblleft Tarifvertragsgesetz\textquotedblright ).} The principle
of tariff autonomy protects the constitutional right of the
\textquotedblleft social partners\textquotedblright\ to agree upon
collective agreements on their own and, with that, makes outright minimum
wage setting through state intervention virtually impossible.

The legal nature of the collective bargaining process is specified in the
Collective Agreements Act (\textquotedblleft
Tarifvertragsgesetz\textquotedblright , TVG). According to the TVG, only the
tariff parties (unions, firms, and employer associations) can conclude
collective labor contracts. Most unions (as the united services union
\textquotedblleft Vereinigte Dienstleistungsgewerkschaft\textquotedblright ,
in short: Verdi) are organized within the German confederation of trade
unions (\textquotedblleft Deutscher Gewerkschaftsbund\textquotedblright ,
DGB). While there is no doubt that all unions which are members of the DGB
have the right to conclude tariff agreement, this is typically not the case
for outsider unions.\footnote{%
The case of the Christliche Gewerkschaft Metall (CGM), which is a member of
the Christliche Gewerkschaftsbund (CGB), is instructive in this regard. Ever
since its appearance, the dominant union Industriegewerkschaft Metall (IGM)
(which is member of the DGB) has continuously tried to challenge the right
of the CGM to strike collective agreements (see Haucap, Pauly and Wey 2006).}
In fact, as summarized in Haucap, Pauly and Wey (2006, pp.\thinspace
365ff.), legal practice and the legal literature have arranged extremely
restrictive conditions which have to be fulfilled by worker associations on
order to be eligible to conclude collective agreements (see also Wiedemann
and Stumpf 1977, pp.\thinspace 357ff.).\footnote{%
An exceptionally restrictive condition is the so-called mightiness
(\textquotedblleft social power\textquotedblright ) requirement which
unfolds a vicious circle that ulimately counters attempts to establish a new
rival union. According to the Federal Labor Court an indication for the
existence of social power comes from the fact whether the union already
concluded collective agreements. Obviously, the incumbent union meets this
requirement but a new union can hardly refer to collective contracting in
the past.}

The TVG states that, in general, only members of the bargaining parties are
actually bound to obey the regulations of the tariff contract. In practice,
though, a firm which is member of an employers' association pays the tariff
wage to all of its employees (for the reasons see Haucap, Pauly and Wey,
p.\thinspace 363), although on June 23, 2010, the Federal Labour Court
weakened the system by allowing the application of multiple competing tariff
agreements within one firm (FLCE 2010).\\[2ex]
\noindent \textit{Traditional extension rule}\\[1.4ex]
While there are many stabilizers of the area tariff system, a stabilizer of
last resort is provided by the possibility to make collective bargaining
contracts compulsory for all unorganized employers (and hence, all$)$
unorganized workers) within an industry by an extension rule. Specifically,
paragraph 5 of TVG provides the bargaining parties with such a device, the
so-called \textquotedblleft Allgemeinverbindlichkeitserkl\"{a}%
rung\textquotedblright\ (AVE).

The first prerequisite to declare an employment contract to be generally
binding is the existence of a collective bargaining agreement in accordance
with TVG; i.e., a collective contract between a union and an employer
association at the industry level. Secondly, at least 50\,\% of employees in
the tariff area for which an AVE\ is initiated have to be employed in firms
of contract-bound employers and the AVE\ must be \textquotedblleft in the
public interest\textquotedblright .

The implementation of the AVE is regulated by the TVG. Initially, one of the
bargaining parties must apply for an AVE at the Ministry of Labor.
Concerning unorganized employees and employers as well as employer
associations, unions and the Ministry of Labor of the state affected by the
AVE are given the right to express their opinion. Afterwards a public
hearing of a council consisting of three representatives of umbrella
organizations of unions and employers respectively (\textquotedblleft
Tarifausschuss\textquotedblright ) is initiated. The council then decides
with the majority of votes whether or not to recommend the use of an AVE to
the Ministry of Labor. Though the Ministry of Labor is not bound by the
council's recommendation, it nevertheless has proved to affect the
ministry's final decision.

Once an AVE has been put into force, it remains effective until the
collective bargaining contract expires or the Ministry of Labor puts the AVE
out of force.\\[2ex]
\noindent \textit{Posted Workers Act}\\[1.4ex]
The Posted Workers Act (\textquotedblleft
Arbeitnehmer-Entsendegesetz\textquotedblright , AEntG) came into force in
1996 and has been revised several times later on (the latest version dates
back to April 20th, 2009). Its original objective was to ensure binding
labor standards for workers employed by businesses of foreign origin (with a
focus on construction workers). Yet, right from the beginning it was clear
that the act could also be used to force all employers (including
non-organized domestic firms) in a certain sector to adhere to the same
working standards and, in particular, minimum wages. Nowadays, the Act's
main purpose has become to enforce minimum wages in several service sectors
on domestic firms.

The Posted Workers Act reduced significantly the bar for the German Federal
Ministry of Labor to implement minimum wages when compared with the
traditional extension rule according to the TVG. First, it allows to declare
a collective wage contract as generally binding even if less than 50
\thinspace \% of the employees of the tariff area concerned are employed by
contract-bound firms.\footnote{%
In the latest version of the Posted Workers Act a representativeness
requirement was introduced which applies to those industry where competing
collective labor contracts exist. A collective contract is more
\textquotedblleft representative\textquotedblright\ if both the number of
workers employed by contract-bound employers and the number of union members
affected by the tariff agreement are larger (see also Blanke 2007).} Second,
until 2009 the Act did not require a public hearing of a council consisting
of the involved umbrella organizations.\footnote{%
In its latest version of 2009, the Posted Workers Act was supplemented by a
paragraph which requires the Ministry of Labor to ask the involved
bargaining parties as well as the parties of competing collective agreements
(if applicable) for their statements.} Finally, the Ministry of Labor can
declare a wage contract generally binding by legal decree (\textquotedblleft
Rechtsverordnung\textquotedblright ) without having to go through a
complicated procedure as required under the TVG.\footnote{%
For example, under the TVG the Labor Ministry of a Land can block an AVE. In
this case, the Federal Ministry of Labor must ask the Federal Government for
permission.}

The Act does not apply automatically to all service sectors. Instead, the
Act explicitly states the sectors which can apply for a minimum wage ruling.
Initially, the Act only mentioned the construction industry. By the end of
2007 (shortly before full liberalization), mail delivery services and, most
recently, several other sectors have been added (as, e.g., commercial
cleaning and waste management, while nursing is currently on its way to be
included).

\section{The postal industry minimum wage case 2007-2010}

In Germany, the transition period towards market liberalization started on
January 1st, 1998\ with the implementation of the first EU\ Directive on
postal service markets.\footnote{%
In the EU, the stepwise liberalization process of the market for postal
services is governed by three EU Directives; namely, Directive 97/67/EC,
Directive 2002/39/EC, and Directive 2008/06/EC, where the latter one
requires the member states to abolish any remaining reserved areas by the
end of 2010, with some exceptions until the end of 2012.} Initially, the
date for full liberalization and the abolition of the remaining legal
monopoly was planned to be January 1st, 2003 but the German federal
government decided prior to that date to postpone the date for five years.
During winter 2006/2007 it became clear, that the Federal Government was
committed to the January 1st, 2008 as the date for the full market opening.\\%
[2ex]
\noindent \textit{The road towards minimum wages}\\[1.4ex]
In the forefront of the full liberalization of the postal market, labor
unions (especially Verdi) and several political parties called for the
introduction of a generally binding minimum wage for the industry. Their
main argument was that wage dumping at the expense of established postal
workers should be prevented this way\ and the debate was intensified by the
release of a study on the allegedly precarious employment conditions at the
postal service competitors (Input Consulting 2006).\footnote{%
Therefore, these developments represent a textbook example of the expected
concerns descibed by Bailly and Meidinger (2010).}

During the years of the liberalization process Deutsche Post had already
significantly restructured operations; e.g., through outsourcing of its post
offices and transport services, but the mail delivery network has been kept
inhouse. Until full liberalization in 2008, the reserved area included
letters up to 50 grams (with some exceptions for large senders). At that
time, virtually all operators who had entered the non-reserved segments of
the market provided end-to-end services, many of them at a local or regional
level, competing with Deutsche Post through alliances. Thereby, the
competition that emerged was primarily in the area of value-added services
as little requirements had to be fulfilled to operate outside the reserved
area (Dieke and Wojtek 2008).

Deutsche Post claimed that its disadvantage of having relatively high wages
due to the former legal status of its employees as civil servants requires
the implementation of minimum wage legislation in order to ensure a level
playing field when the market was fully accessible to competitors. On the
one hand, Deutsche Post claimed that they would not be able to compete in
public procurement tenders anymore, while on the other hand, low wages at
the competing firms led to social security transfer payments to the workers
employed at these firms, thus leading to a subsidization of the competitors.
Therefore, the minimum wages should also serve as a flanking measure to
liberalization in order to avoid such transfers.

During the summer of 2007, the momentum on this issue further increased and
the lawmakers stepped in and formalized the social expectations. In August
2007, the grand coalition of the federal government agreed upon the
introduction of minimum wages in the postal sector via amendment of the
Posted Workers Act, leaving the exact details open until the end of 2007.%
\footnote{%
See \textquotedblleft Bundesregierung beschlie\ss t Mindestlohn f\"{u}r
Brief-Branche\textquotedblright ,\ August 22nd, 2007
(www.post-und-telekommunikation.de).} Shortly after this decision, a swift
series of strategic moves by the involved parties followed.

On August 28th, 2007, the Postal Employer Association (Arbeitgeberverband
(AGV)\ Postdienste) dominated by the Deutsche Post and its subsidiaries was
established. Subsequently the competitors proclaimed that this establishment
was a strategic move to implement excessive minimum wages in order to
squeeze them out of the market after the full market opening.\footnote{%
At court hearings in 2009, the main competitors claimed that they did not
have the opportunity to join the association or to take part in the
negotiations. Cf.\ German Parliament, Commission for Labor and Social
Affairs, meeting protocol 16/65, statement of F.~Gerster, p.\thinspace 875.}

On September 4th, 2007, the newly founded AGV\ Postdienste and Verdi reached
a collective wage agreement which was intended to serve as the reference
contract for minimum wages in the postal service sector.\footnote{%
The contract is posted on the website of AGV Postdienste
(www.agv-postdienste.de).} Accordingly, the contract was submitted to the
Federal Ministry of Labor and Social Affairs to be declared as generally
binding. The agreements stipulated a general minimum wage per hour of \euro\
8.00 in East Germany and \euro\ 8.40 in West Germany. Additionally, the
minimum wage for mail delivery was set even higher at \euro\ 9.00 and \euro\
9.80, respectively. Thereby, the minimum wages should have become effective
on December 1st, 2007.\footnote{%
See \textquotedblleft Mindestlohn im Postbereich
vereinbart,\textquotedblright\ Handelsblatt online (www.handelsblatt.com).
The tariff contract was signed on 29 November, 2007 (www.verdi.de).}
Interestingly, the contract provided an extraordinary termination clause
which became effective if and only if the contract would not have been
declared as generally binding as an industry-wide minimum wage.\footnote{%
Precisely, article 6, paragraph 3 of the tariff contract stipulates:
\textquotedblleft Both parties have an extraordinary termination right if
the contract is not declared generally binding according to the Collective
Agreements Act and the Posted Workers Act. In that case [...] the contract
can be terminated within a period of one week by the end of the calendar
month.\textquotedblright}

To investigate the actual working conditions in the postal industry, the
Federal Network Agency (\textquotedblleft
Bundesnetzagentur\textquotedblright ) conducted a survey about working
conditions and wages at licensed postal service operators from summer to
autumn 2007 (BNetzA 2008). Table \ref{tab:WagesBefore} provides an overview.

\begin{center}
{\ 
\begin{threeparttable}[tbph]
\centering
\caption{Industry wages before the introduction of the minimum wage}
\label{tab:WagesBefore}
%\vspace{2mm}
\begin{tabular}{lcccc}
& Deutsche & \multicolumn{3}{c}{Competitors} \\ 
& Post AG & West & East & Average \\ \hline
Sorters & 11.34 & 8.10 & 6.11 & 7.68 \\ 
Drivers & 11.99 & 8.08 & 6.23 & 7.73 \\ 
Delivery postmen & 12.13 & 7.71 & 6.18 & 7.28 \\ 
Administrative staff & 16.01 & 11.24 & 9.23 & 10.97 \\ 
Average & 13.04 & 8.23 & 6.38 & 7.79 \\ \hline
\end{tabular}%
\begin{tablenotes}\footnotesize 
\item[] Source: BNetzA (2008).
\end{tablenotes}
\end{threeparttable}
}
\end{center}

Focusing on wages per hour for postmen, table~3.1 clearly shows that the
tariff agreement between AGV Postdienste and Verdi set minimum wages which
exceeded the average wage rates paid by competitors by 20 to 30\thinspace
\%, although the average wage rate of \euro\ 12.13 calculated for the
Deutsche Post should be treated with caution. This relatively high wage rate
reflects, to a certain part, Deutsche Post's burden of having senior postmen
who still enjoy the benefits of civil servant status or similar working
contracts. However, the wage rate that Deutsche Post's partner firms have
been paying for new employees (including postmen) were substantially lower
and have been even lower than the minimum wage set in the tariff contract
between AGV\ Postdienste and Verdi.\footnote{%
For details, see BNetzA (2008) and Dieke and Zauner (2007). Considering
other industries where minimum wages existed in Germany, the wages per hour
were not as high as, e.g., for constuction workers, but higher than for
other industries with comparable qualification requirements, e.g., facility
security or cleaning services.}

Immediately, the competitors complained heavily about the level of the wages
and the procedure how the tariffs have been agreed upon. The coverage of the
tariff agreement was another issue of importance. Initially, it was planned
that the tariff agreement should hold for all firms delivering letters no
matter of the firms' core business (as, e.g., publishing and newspaper
delivery). By November 29th, 2007, the draft of the wage contract was
revised such that it only applied to firms with letter delivery being their
core business.\footnote{%
See \textquotedblleft Koalition einigt sich auf
Post-Mindestlohn,\textquotedblright\ Spiegel online, November 29th, 2007
(www.spiegel.de).} The main competitors responded on September 18th, 2007,
with the establishment of another employers' association \textquotedblleft
Arbeitgeberverband Neue Brief- und Zustelldienste\textquotedblright\ (AGV
Neue BuZ) which stated that a minimum wage would be reasonable and
acceptable if it was between \euro\ 6.00 and \euro\ 7.50.\footnote{%
See Press Release of the AGV Neue BuZ, September 27, 2007 (www.agv-nbz.de).}

Furthermore, a new union for letter and delivery services\ (Gewerkschaft
Neue Brief- und Zustelldienste, GNBZ) was founded which agreed upon a wage
contract with the new employer association AGV Neue BuZ, stipulating a
general minimum wage per hour of \euro\ 6.50\ and \euro\ 7.50\ for East
Germany and West Germany, accordingly. That contract was also submitted to
the Federal Ministry of Labour as an alternative proposal for a mandatory
minimum wage.\footnote{%
See BdKEP Press Release, 12 December, 2007 (www.bdkep.de).}

The minimum wage critically depended on a revision of the Posted Workers Act
by adding letter delivery services to the sectors eligible for a minimum
wage regulation. Market surveys conducted by the Federal Network Agency
revealed that the introduction of a minimum wage by means of the extension
rule of the TVG would be problematic, as the wage contract between AGV
Postdienste and Verdi hardly represented at least 50\thinspace \% of the
employees in postal delivery services that had to be employed in firms of
contract-bound employers according to the TVG (BNetzA 2008).

On December 20th, 2007, the amended Act (BMAS\ 2007) which now included
letter services, was passed by the Upper House (\textquotedblleft
Bundesrat\textquotedblright ). On December 28th, 2007, a decree was issued
by the Federal Labor Ministry, declaring the wage contract between Verdi and
AGV\ Postdienste generally binding for all mail service providers. The
decree became effective on January 1st, 2008, and was set to expire by April
31st, 2010.

Since then, there were no further legislatory attempts to re-introduce a
sector-specific minimum wage for the letter mail sector. Recently, however,
the issue re-appeared in the media. According to a newspaper article, a
report of the Federal Network Agency is going to appear which will contain
an investigation of the wages. The wages reportedly are mainly in the range
between \euro\ 6.00 and \euro\ 8.00 per hour. Subsequently, the
communication union DPV already re-called for an industry-specific minimum
wage of \euro\ 9.80, whereas the Federal Network Agency does not consider
this an issue which justifies them to step in.\footnote{%
Cf.\ Streit um Briefmarkt-Niedrigl\"{o}hne, faz.net, 23.11.2012.}.\\[2ex]
\noindent \textit{The impact on competition}\\[1.4ex]
The extension of the wage contract between Verdi and AGV\ Postdienste by
means of the Posted Workers Act had a significant impact on the competitors'
businesses. According to a statement of the German Federal Government, 153
postal service companies shut down operations in 2008-2009 and about 19,000
jobs had been cut.\footnote{%
See the reply of the Federal Government to the inquiry of the parliamentary
group of the liberal party (FDP) (available at
http://dip21.bundestag.de/dip21/btd/16/091/1609192.pdf) and Press Release of
the Federal Network Agency (available at
http://www.bundesnetzagentur.de/media/archive/15280.pdf).} Nevertheless,
although the minimum wages are considered frequently as the main source of
these market developments, additional factors like the overall difficult
situation and managerial errors might have contributed significantly to the
observable developments.

In the first quarter of 2008, the PIN\ group filed insolvency after its main
shareholder, the Axel Springer group, had ended support for its postal
operations already in December 2007. Since then, the PIN group has been run
by an insolvency administrator. During this period, the group paid the
minimum wages while being subsidized out of public social security funds
(Ecorys 2008a). In the first quarter of 2008, about 50\thinspace \% of
formerly about 11,400 jobs have been slashed, so that the delivery network
has been cut down substantially (already in February 2008, 37 of
approximately 91 companies of the PIN\ group filed bankruptcy). While the
insolvency administrator tried to preserve the PIN\ group as a whole, it
turned out, that the selling of the different regional companies separately
was a more viable solution. The publishing house Holtzbrinck acquired twelve
PIN firms in metropolitan areas. In mid-sized cities regional publishers
took over several other PIN firms. Subsidiaries of PIN\ in smaller towns and
rural areas often could neither be preserved nor sold to other firms and had
to shut down operations.

Turning to the other main competitor TNT, the picture is somewhat different.
Right after the introduction of minimum wages, TNT\ announced that it is
\textquotedblleft considering withdrawal from the German
market\textquotedblright\ as a consequence of the minimum wage, but this
point seemed to loose prominence over time, especially against the
background of the insolvency of the other main competitor PIN.\
Interestingly, TNT decided not to pay the minimum wages but kept its own
lower wage rates effective. This decision, though, put an additional
financial burden on the company as it had to build up reserves for the wage
differential and associated social security contributions.

Finally, as competing postal operators relied on building alliances with
partner firms to reach nearly full geographic coverage, market exit of small
regional players has resulted in reductions of the main competitors
coverage. For example, it is documented in Ecorys (2008a) that as a
consequence of partner insolvency, the coverage of the TNT network including
allied partners went down from 93 to 87\thinspace \% in Germany. However,
shortly after the Federal Administrative Court declared the minimum wages
void,\ TNT\ announced new plans to extend its area coverage and delivery
frequency. By January 2010, TNT, Holtzbrinck, Madsack, Citipost and some
other companies in the mailing industry founded the Mail Alliance which
started operations on January 25th, 2010.\footnote{%
Their offerings are limited to firms and institutions, but include hybrid
mail. Coverage is claimed to be nation-wide with a conveyance speed of E+2.
The wages paid by the companies of the alliance are mainly in the range of
\euro\ 6.50 to \euro\ 7.50 (see the Mail Alliance' website:
www.mailalliance.net).}

Despite the difficulties for the competitors during the minimum wage period,
the remaining competitors managed to compete, although the development of
competition has been limited. Over the period 2008-2010, according to the
Federal Network Agency (BNetzA 2011), the trend towards cooperations and the
overall economic recovery in 2010 (p.\thinspace 133) helped the remaining
alternative operators to increase their share of the letter mail market from
8.1\thinspace \% to 10.2\thinspace \%, their revenues from \euro\ 800m to
\euro\ 900m, and the number of their employees from 16.000 to 17.000 full
time equivalents (pp.\thinspace 137-138).

As of December 2012, the cooperation trend of the competitors is still
ongoing. The Mail Alliance and another large group, P2 Brief+Paket,
announced to form an alliance to achieve a high-coverage alternative postal
delivery network (covering at least 80\thinspace \% of all households) from
April 2013 onwards to pursue the goal to significantly increase their
combined market share.\footnote{%
Cf.\ "Verhandlungen \"{u}ber Zustellnetz kurz vor Abschluss", Christian
Schlesinger, wiwo.de, 03.11.2012.}\\[2ex]
\noindent \textit{Legal disputes}\\[1.4ex]
With the implementation of minimum wages, a series of legal disputes has
been triggered which took two years to settle, while the period of the law
was set to two years and three months anyhow. On January 9th, 2008, TNT and
other competitors (organized in the new employer association AGB\ Neue BuZ)
filed a lawsuit against the German Federal Government. They insisted on
their constitutional right to conclude a collective wage agreement on their
own (namely, the tariff contract concluded in 2007 between the AGV Neue BuZ
and GNBZ). On March 7th, 2008, the Berlin Administrative Court
(\textquotedblleft Verwaltungsgericht Berlin\textquotedblright ) declared
the minimum wage void. The court argued that the Federal Government was not
empowered by the Posted Workers Act to overturn a competing collective
contract by declaring another collective tariff contract as generally
binding. By that, the court clarified that a minimum wage can only be
imposed on employers and workers not bound to any tariff agreement (BAC\
2008). The Federal Ministry of Labor and Social Affairs appealed the
decision, but the preceding decision was confirmed by the Higher
Administrative Court Berlin (\textquotedblleft Oberverwaltungsgericht
Berlin\textquotedblright ) on December 18th, 2008 (BHAC\ 2008).

After the Federal Labor Ministry appealed for a second time, on January
28th, 2010, the Federal Administrative Court (\textquotedblleft
Bundesverwaltungsgericht\textquotedblright ) finally judged the declaration
of the minimum wage void due to another formal defect. In its decision, the
court argued that the Federal Labor Ministry had failed to give other
affected parties the opportunity to comment prior to issuing the ordinance.
As a consequence, the minimum wage was not binding for the plaintiffs from
its beginning on, while it remained in force for unorganized competitors who
did not go to court.

Furthermore, already on February 13th, 2009, a new amendment of the Posted
Workers Act was put into force which should cure the Act's shortcomings when
more than one collective contract has been concluded in the same sector.
First, the amendment specifies a new \textquotedblleft
representativeness\textquotedblright\ criterion which should guide the
Federal Labor Ministry's decision concerning the choice of the tariff
contract as the basis for an extension rule when more than one collective
contract exist. Second, the amendment incorporates a procedure of hearings
of the affected parties into the Act which was missing in the former
version. Those amendments have been acknowledged by legal experts as
sufficient to guarantee that a minimum wage based on the collective contract
between Verdi and AGV Postdienste could stand the test of a labor court but
would have required to repeat the extension procedure from beginning on
(Blanke 2007).

The new amendment is closely related to Verdi's accusation that the new
union GNBZ was not empowered to conclude collective labor contracts. Verdi
argued that the GNBZ does not meet the minimum standards a \textquotedblleft
tariff-enabled\textquotedblright\ union must fulfill according to the TVG.
Blanke (2007) provides an example for an expert's report which argues that
the new union should not be regarded as tariff-enabled according to the TVG.
He also argues that the \textquotedblleft
representativeness\textquotedblright\ criterion of the revised Posted
Workers Act requires to neglect the competing collective agreement.

On October 30th, 2008 the Cologne Labor Court shared this view and denied
that the GNBZ\ is a tariff-enabled union in the sense of the TVG (CLC\
2008). Accordingly, the wage contract between AGV Neue BuZ and GNBZ was
declared void by the court. This court ruling together with the Federal
Government's political commitment to find ways to implement minimum wages
has been inflicting considerable uncertainty on the viability of the
competitors' future businesses. Both, GNBZ and AGV Neue BuZ, appealed
against the court ruling, but both parties withdrawed their appeals.

At the European level, the claimants also filed complaints about the law,
but since the regulation of the labor markets is outside of the competence
of the European Union and fully under the authority of the member states,
the European Commission did not open any procedures.\footnote{%
At the EU level, the Federal Association of International Express and
Courier Companies (\textquotedblleft Bundesverband Internationaler Express-
und Kurierdienste\textquotedblright ) filed a complaint addressed to the
European Commission. It was argued that the minimum wage agreement's only
objective was to block competition. In additon, TNT\ filed a complaint
against the German government based on Art. 82 of the European Treaty. It
was claimed that the minimum wage decree leads to an unfair infringement on
competition and violates the freedom to establish business throughout the
European Union by raising rivals' costs. The European Commission examined
the issue but decided to abstain from opening a procedure.}

Currently, there are no legal disputes ongoing. However, as there is
currently a new Postal law under preparation, the Monopoly Commission
requested to drop the so-called social clause (which requires equal
conditions for comparable tasks at comparable locations) and to leave this
aspect to social laws (Monopolkommission 2011, pp.\thinspace 56-57), which
might help to avoid legal disputes in the future. Although mainly for
concerns with regard to the competition control by the Federal Cartel Office
and to the lacking powers of the Federal Network Agency to encounter
potential anti-competitive conduct, on November 2, 2012, the Federal Coucil
(Bundesrat)\ has rejected to recommend the current draft to the Federal
Parliament (Bundestag).\footnote{%
Cf.\ Pressebox (12.11.2012): Press release BoxID 554227:\ Postgesetz vorerst
abgelehnt.} Thus, whether the case of postal minimum wages in Germany is
finally closed or not remains to be seen.

\pagebreak \setlength\LTleft{11pt}
\setlength\LTright\fill

\begin{center}
\begin{longtable}{p{2cm}p{10.6cm}}
	\caption{Postal minimum wage in Germany: Timeline\label{tab:timeline}} \\ \hline
\endfirsthead 
%\hline
%\multicolumn{2}{l}{{{\small{(Continued from previous page)}}}} \\
%\hline
\endhead 
\hline 
\multicolumn{2}{r}{{{\small{(Continued on next page)}}}} \\
\endfoot
\hline
\endlastfoot
%\begin{tabular}{ll}
01.01.1998 & Introduction of gradual liberalization of postal markets in Germany \\ 
15.07.2007 & Chancellor Angela Merkel rejects the introduction of a postal minimum wage for 2007 \\ 
21.08.2007 & Establishment of Postal Employers Association (AGV Postdienste), member of BDA \\
04.09.2007 & Verdi and AGV Postdienste agree on minimum wage for postal services from 1st December 2007 on \\ 
05.09.2007 & Complaints of competitors concerning the negative impact on competition \\ 
06.09.2007 & BNetzA supports the competitors claim \\ 
08.09.2007 & Federal Ministry of Economics and Technology (BMWi) shares the concerns \\ 
10.09.2007 & Federal Employers Association (BDA) and CDU express same concerns \\ 
12.09.2007 & Establishment of competing employers association Arbeitgeberverband neue Brief- und Zustelldienste (AGV\ Neue BuZ) \\ 
18.09.2007 & BDA, Bundesverband der Zeitungsverleger, Bundesverband der Kurier-, Express- und Paketdienste (BdKEP), Bundesverband der Neuen Brief- und Zustelldienste \\ 
19.09.2007 & Government coalition: Only letter services instead of all postal services should be covered by minimum wage\\ 
23.09.2007 & Coalition disagrees on topic \\ 
09.10.2007 & VAT exemption proposed - competitors defeat \\ 
10.10.2007 & Competitors-employed announce to establish an \emph{anti-union} \\ 
12.10.2007 & SPD fails with general minimum wage plan and extension of AEntG \\ 
29.10.2007 & Federal Network Agency issues recent figures on employment in the postal sector: Less than 50\,\% of all workers covered \\ 
01.11.2007 & BMWi supports that position and opposes again \\ 
02.11.2007 & BMAS and SPD consider the quota as fulfilled \\ 
02.11.2007 & CDU refuses to adopt the extension of the AEntG \\ 
06.11.2007 & Springer tries to sell PIN to TNT (bought end of June) \\ 
14.12.2007 & Bundestag accepts minimum wage draft bill \\ 
21.12.2007 & TNT threatens with operations withdrawal \\ 
21.12.2007 & 7 out of 91 PIN companies register for insolvency \\ 
28.12.2007 & Minimum wage legislation (Bundesrat) and minister decree: Gross minimum wages for sorting workers \euro\ 8.00 (east) and \euro\ 8.40 (west), and \euro\ 9.00 and \euro\ 9.80 for letter-delivering workers, respectively \\ 
01.01.2008 & Full Market Liberalization in Germany \\ 
09.01.2008 & Competitors file lawsuit against the German government \\ 
25.01.2008 & PIN AG requests insolvency procedure \\ 
07.03.2008 & Administrative Court Berlin (VG\ Berlin) declares minimum wage void \\ 
20.03.2008 & TNT expresses optimism concerning its future in Germany \\ 
31.03.2008 & About 50\,\% of about 11400 jobs shed at PIN \\ 
19.06.2008 & DG Internal Market: Commissioner Charlie McCreevy announces infringement procedure preparation \\ 
23.09.2008 & TNT announces thoughts about delivery speed improvement (E+2 to E+1 service) \\ 
30.10.2008 & Labor Court Cologne (AG K\"{o}ln) decides that GNBZ cannnot make tariff-agreements \\ 
22.01.2009 & AEntG changed, parliament (Bundestag) decision \\ 
13.02.2009 & Bundesrat accepts new AEntG \\
28.01.2010 & Federal Administrative Court (Bundesveraltungsgericht) finally declares minimum wage rules void for the plaintiffs that went to court \\
31.04.2010 & Expiry of minimum wage ordinance (by sunset clause) \\
15.12.2011 & Monopoly Commission recommends to drop the social clause in their special report on the postal industry \\
%\end{tabular}
\end{longtable}
\end{center}

\section{Minimum wage regulation and raising rivals' costs}

Throughout Europe, 1.6 million people are employed directly in the postal
sector with an average age above 40 years and mainly low to medium
qualification levels. Especially in this industry, the need to adapt to
large mail volume decreases and tailoring the networks to demand and
profitability as well as increased competition leads to the necessity of
business model revisions, workforce optimization with a decrease in
employment volume and the evolution of jobs' nature and status. As in other
industries, where wage cost represent a very large share of the overall
cost, efficiency goals likely involve downward pressure on wages (Wachter et
al. 2001). Although there are some counter-strategies as, e.g.,
diversification, there is generally a trend toward modernization of the
postal networks involving automatization and delivery optimization which in
turn lead to decreasing employment and other social consequences such as the
simplification of tasks and the flexibilization of the workforce through
part-timers and external workers (SDCPS~2010).

New social standards and social regulation aim to address these undesired
consequences of the liberalization and the related introduction of
competition, such as \textquotedblleft unfair competition\textquotedblright\
at the expense of the postal workers or to level the playing field between
the starting position of former monopolists and entrants into the respective
industry. This growing importance of social regulation is also reflected in
the third European Framework Directive addressing the concern and aiming to
prevent social and wage dumping in the context of the full market opening.
Thereby, the main goal of social regulation is to achieve \textquotedblleft
fair competition at socially acceptable conditions despite the needs for
operational and social optimization of their activities, [...] although it
is sometimes challenged as being hampering the sector evolution through the
creation of entry barriers\textquotedblright\ (Bailly and Meidinger 2010).

One of the most controversially debated issues are especially
industry-specific minimum wages, since such minimum wages not only are means
to stabilize the social conditions during the introduction of competition,
but in turn also might lead to drawbacks. The potential adverse effects
include rising prices and the introduction of new limits to competition,
especially in industries where an oligopolistic rather than a fully
competitive industry structure can be expected due to network effects and/or
economies of scale.

If the minimum wages are not set nationwide but for a certain industry, they
could in particular represent powerful tools to raise rivals' costs and
inhere the danger to be strategically exploited as an entry-deterring
device. This strategy might not only be profitable for the incumbent firm
but also the unions might be interested in pursuing such a deterrence
strategy, since the incumbent may profit from reduced competition and the
union from higher wages of their members. Such a situation may especially
arise in cases, where the workers of the entrant firms are organized less
and thus the unions are representing primarily the employees of the
incumbent.\\[2ex]
\textit{The case in relation to our model}\\[1.4ex]
In the following chapter based on our article (Heitzler and Wey 2010), we
provide also a model of the case of the minimum wages in the postal industry
in Germany, where we theoretically analyze the research questions, \textit{i)%
} what the conditions are such that both a union and the incumbent agree on
an entry deterring wage, \textit{ii)}\ whether there are instances such that
a even more efficient competitor can be deterred from entry through minimum
wages and \textit{iii)} whether there are instances where overall productive
efficiency decreases through minimum wages.

In the basic setting, we model two (postal)\ operators providing their
services with full (geographic) coverage\ at positive non-labor marginal
costs plus fixed labor costs to run their delivery network, facing a linear
demand. Thereby, we allow their non-labor marginal costs to differ in order
to reflect their relative cost efficiency what might be in favor of the
incumbent as well as the entrant. Concerning the workers, we assume for
simplicity, that all workers of the incumbent firm are represented by a
union (with identical and sufficiently low reservation wages), while the
workers at the entrant firm are not organized at all. The union is assumed
to maximize the wage bill of their members (since unions often receive
simply a share of their members' wages as membership fees). The game follows
a two-stage timing where in the first stage the union and the incumbent firm
Nash-bargain about the wage rate and in the second stage the two firms
compete \`{a} la Cournot.\footnote{%
We interpret Cournot competition in the sense of Kreps and Scheinkman (1983)
such that the postal operators are assumed to set first their mail
capacities and then compete in prices. As shown by the authors, that game
yields the Cournot outcome if products are homogeneous. In addition, we
suppose that both firms' mail delivery networks are sufficiently large to
guarantee a certain delivery quality for their supplied mail volumes.}

For the analysis, we consider two alternative regimes concerning the
existence of an extension rule which makes the wage agreed upon by the
incumbent and the union generally binding for all firms in the industry.
Without the extension rule, the entrant pays its employees their reservation
wage, while the wage rate negotiated between the union and the incumbent
firm applies only to the employees of the incumbent firm. In contrast, if an
extension rule is in place, then the entrant firm must pay the (minimum)
wage which is determined jointly by the union and the incumbent firm.

The results from our model confirm the existence of the incentives to raise
fixed costs in the industry in order to deter entry. More precisely, \textit{%
i)}\ the incentives to raise the fixed costs of all firms in the industry
increase with decreasing cost efficiency of the competitor and \textit{ii)}\
entry is deterred for sure in some cases with strictly positive probability.
Furthermore, \textit{iii)} the expected wage rate, the union's (expected)
wage bill and the incumbent's (expected) profit are all strictly larger
under an extension rule.

In an extension of the model, we abstract from efficiency differences and
relax the assumption that the entrant provides full network coverage, since
the entrant may choose its network size freely while the incumbent is
assumed to be obliged to provide full coverage by universal service
obligations. In this extension, we add an investment stage at the beginning
of the game, where the entrant incurs sunk costs to build up its delivery
network in this initial stage, while the fixed labor costs of operating the
network in the subsequent game (as in the base model) increase linearly in
network coverage.

In the extended model we show, that in the regime with a generally binding
wage, entry is also deterred completely in some situations (depending on
reservation wages and demand conditions), while under all conditions the
investments and the network coverage are strictly smaller with an extension
rule in place.\\[2ex]
\textit{The case in relation to the literature}\\[1.4ex]
Our analysis is also related to the literature on entry barriers (Dixit
1979, Rogerson 1984). Most importantly, Rogerson (1984) shows that under
symmetric cost conditions a dominant firm has incentives to raise fixed
entry costs. In his model, the level of fixed entry costs is exogenously
given (since no vertical structure is taken into consideration), while in
our analysis the fixed labor costs of operating a mail delivery network are
the outcome of negotiations between the union and the incumbent operator,
which in turn leads to the strategic role of the union and the incentives
(depending on the share of organized workers at the entrant firm) to raise
industry wages in favor of the incumbent firm. In consequence, both, the
union and the employers' association may have both incentives to agree on a
minimum wage to deter entry. Even small labor productivity advantages of the
incumbent firm cause an incentive for raising rivals'(variable labor) costs.
While typically minimum wages increase productive efficiency, this may not
hold any longer in our setting, since even more efficient rivals can be
deterred effectively.

The case where employers and a union increased (variable)\ labor costs has
been analyzed in the related paper of Williamson (1968). He showed that an
incumbent firm may pursue the strategic goal to accept high wage rates if
this also raises rivals' costs (see also Haucap, Pauly and Wey 2001).
Precisely, Williamson analyzed the so-called Pennington case and he argued
that an industry-wide wage contract which increases the cost of relative
labor-intense firms to a larger extent than the costs of relative
capital-intensive firms can be used to force labor intensive firms to
withdraw from the market.

Quite generally, the raising rivals' cost literature assumes that the
strategic variable (as, e.g., a generally binding minimum wage rate) impacts
directly on firms' variable costs.\footnote{%
\textquotedblleft The Raising Rivals' Costs paradigm requires (1) that the
conduct of the challenged firm \textquotedblleft unavoidably and
significantly\textquotedblright\ increase the costs of its competitors and
(2) that the raising of rivals' costs enables the excluding firm to raise
prices above the competitive level\textquotedblright (Krattenmaker and Salop
1986). Cf.\ also Salop and Scheffman (1983, 1987).} In those settings a
necessary condition for making a raising rivals' cost strategy profitable is
that the rival firms' labor productivity (in the case of wage being the
strategic variable) is smaller than the firm's labor productivity which
executes the anticompetitive practice. As a consequence, in papers
considering variable labor costs, overall productive efficiency is likely to
increase as the more productive firm gains market shares while less
productive firms loose market shares.

Overall, through the combination of these approaches, our model delivers new
insights on the nature of union-firm bargaining when labor costs are fixed
instead of variable costs and the effects of labor laws which make wage
contracts generally binding. It thus also extends the literature analyzing
the interaction between monopolized labor markets and oligopolistic product
markets (\textquotedblleft unionized oligopolies\textquotedblright , see
Dewatripont (1987, 1988), Horn and Wolinsky (1988a, 1988b), Haucap, Pauly
and Wey (2001)).

\section{Conclusion}

In this chapter, we showed the development of the minimum wages for the
postal industry in Germany from 2007 until 2010 which started in the context
of the full postal market liberalization on January 1st, 2008. Those
developments also included the foundation of two new employers'\
associations and a competing union (GNBZ) which additionally created a
competition of unions (between Verdi and the GNBZ). We also described the
collective wage bargaining system in Germany including its legal basis and
the different options to declare a wage contract generally binding, namely
the traditional extension rule (AVE) and the Posted Workers Act, which
significantly lowered the bar for the introduction of minimum wages.

With the case, we illustrated how minimum wage regulations in combination
with extension rulings can be used strategically to hamper competition
through raising rivals' costs. As one could expect from the existing
literature on raising rivals' costs, existing competitors have been driven
out of the market, and new entry likely has been deterred. It can be safely
assumed, that investments and the extension of the networks of the new
competitors have been reduced or delayed, respectively. Investments and
market entry that did not happen, are not observable. Therefore, the actual
effects of the strategy might be partly hidden, since \textquotedblleft
quite often, the theory of the case is not that the defendant has \textit{%
gained }power over price by raising its rivals'\ costs, but that it has 
\textit{defended} its power over prices against the threat of new
entry\textquotedblright\ (Tom and Wells 2003, p.\thinspace 393).

The contingency rule of the tariff contract, which stated that it should
only become valid if it became generally binding, supports the suspicion
that the incumbent firm and the established union have strategically agreed
upon relatively high wage levels.

The conclusion of the case not only highlights the strategic importance of
the establishment of an employer association for the incumbent operator and
the agreement on a wage rate with the incumbent union as a prerequisite for
the introduction of the minimum wages, but also the strategy of the
establishment of a competing employer association and of a competing union
as well as the agreement on a competing tariff contract.

Quite obviously, the procedure widely neglected competing firms' (and their
employees') interests. The resulting legal disputes over the minimum wage
and the status and rights of the newly founded union took over two years and
four courts have been concerned with the matters (while the law was set to
expire after two years and three months anyhow through a sunset clause).

Hence, before the introduction of such social regulations, not only
competitors but also competition authorities should have the right to be
heard in order to balance the interests of the existing players in the
market and actual and potential entrants to the industry.

\fancyhead[RO]{\rightmark}

\chapter{A Model of Raising Rivals' Fixed (Labor) Costs}

\renewcommand{\leftmark}{A MODEL OF RAISING RIVALS' FIXED (LABOR) COSTS}

Motivated by the case of the introduction of minimum wages for the postal
industry in Germany as portrayed in the previous chapter, in this chapter we
analyze the bargaining problem of an incumbent firm and a union when a
collectively agreed upon wage contract becomes the minimum wage in the
entire industry. This is a typical case in Germany, where collective wage
agreements between a union and an employers' association can be made
compulsory even for independent employers through so-called extension rules.%
\footnote{%
German labor market institutions and extension regulations are decribed in
Haucap, Pauly and Wey (2006). Below we identify the key elements of labor
laws in Germany which implement industry-specific minimum wages via
extension regulations.}

In contrast to previous works on raising rivals' (wage) cost strategies we
analyze the case where labor costs are mainly fixed operating costs. We
consider a market with an incumbent firm and an entrant firm. The employees
of the incumbent firm are represented by a union, while none of the workers
of the entrant firm is organized. The incumbent firm and the union bargain
about a collective wage agreement. We compare two labor market regimes
depending on whether or not the agreed upon wage becomes generally binding
for all employees in the industry. Our results highlight the raising rivals'
cost incentives of both bargaining parties (the incumbent firm and the labor
union) when an extension rule is in place. When firms' wage bills constitute
fixed costs, then generally binding (minimum) wages become an extremely
effective deterrence device such that even a more efficient rival can be
deterred from entering the industry.

According to our motivation, our main application is the German postal
minimum wage case which nicely highlights the parties' incentives and the
consequences of labor laws which make collective agreements generally
binding. In Germany, the Posted Workers Act of 1996 allows the Federal
Ministry of Labor to implement minimum wages in certain service industries,
as e.g., postal services. In contrast to minimum wage legislations in other
countries, minimum wages in Germany are based on existing collective
contracts which are typically the outcome of negotiations between the
established industry union and incumbent firms (organized within an employer
association). The Federal Ministry of Labor can then decide to declare such
an existing collective contract generally binding. Quite obviously, that
procedure tends to neglect new and entrant firms' (and their employees')
interests. And even worse, the procedure of declaring collective wage
contracts generally binding may be used strategically by the incumbent
players to directly harm entrant firms. This is exactly what happens in the
Deutsche Post case.

This chapter is related to Williamson (1968) who showed that an incumbent
firm may accept high wage rates if this also raises rivals' costs (see also
Haucap, Pauly and Wey 2001). Precisely, Williamson analyzed the so-called
Pennington case and he argued that an industry-wide wage contract which
increases the cost of relative labor-intense firms to a larger extent than
the costs of relative capital-intensive firms can be used to force labor
intensive firms to withdraw from the market. Quite generally, the raising
rivals' cost literature assumes that the strategic variable (as, e.g., a
generally binding minimum wage rate) impacts directly on firms' variable
costs (Salop and Scheffman 1983, 1987). In those settings a necessary
condition for making a raising rivals' cost strategy profitable is that the
rival firms' labor productivity (in the case of wage being the strategic
variable) is smaller than the firm's labor productivity which executes the
anticompetitive practice. As a consequence, overall productive efficiency
may very well increase as the more productive firm gains market shares while
less productive firms lose market shares.

Our analysis of a setting where labor costs are fixed costs reveals that a
raising rivals' costs strategy may also be profitable when rival firms are
more efficient. Hence, the adverse effects of labor laws which make wages
generally binding are likely to be more pronounced when firms' labor costs
are fixed.

We also examine how the presence of wage extension regulations impacts on
the entrant firm's incentives to invest into its mail delivery network which
determines the entrant's coverage. We show that an entrant may never invest
into building up its own delivery network irrespectively of the effectivity
of its investment cost function. If investments take place, then an entrant
will enter with a network which entails a smaller coverage when compared
with the case without an extension rule. Hence, besides more standard
(static) anticompetitive effects, minimum wage legislation unfolds
additional adverse dynamic effects on the entrant's willingness to invest
into the coverage of its own mail delivery network.

This chapter contributes to the literature which analyzes the interplay
between monopolized labor markets and oligopolistic product markets
(\textquotedblleft unionized oligopolies\textquotedblright ). Since
Dewatripont (1987, 1988) and Horn and Wolinsky (1988a, 1988b) this
literature has been focusing on both the properties of the union-firm
bargaining problem and labor market institutions. Accordingly, our model
delivers new insights on the nature of union-firm bargaining when labor
costs are fixed costs and the effects of labor laws which make wage
contracts generally binding.

The chapter is related to the literature on entry barriers (Dixit 1979).
Most importantly, we extend the paper by Rogerson (1984) who shows that
under symmetric cost conditions a dominant firm has incentives to raise
fixed entry cost. In Rogerson (1984) the level of fixed entry costs is
exogenously given, while in our analysis the fixed labor costs of operating
a mail delivery network are the outcome of negotiations between the union
and the incumbent operator.

The chapter is organized as follows. In section 4.1 we introduce the set-up
of our model and in Section 4.2 we derive and compare the industry
equilibria depending on whether or not an extension regulation is in place.
In Section 4.3 we examine how the different labor market regimes affect the
entrant's incentives to invest into the coverage of its mail delivery
network. Section 4.4 concludes.

\section{The model}

We assume an incumbent firm $i=1$ and an entrant firm $i=2$. We think of the
firms as postal network operators which offer mail delivery services. The
incumbent firm operates a delivery network by employing a fixed volume of
mailmen services, $\eta _{1}>0$, which guarantees a certain mail service
quality (e.g., maximum delivery transit times). Hence, the incumbent's labor
costs of operating its mail delivery network are fixed costs which are
independent of the overall mail volume. For a given wage rate $w_{1}$, the
incumbent's total labor costs are then given by $\eta _{1}w_{1}$. In
addition, the incumbent's (non-labor) marginal costs of mail delivery
service are given by $c_{1}=c\geq 0$.

With regard to the entrant firm's costs we also assume that labor costs for
operating its own delivery network constitute fixed costs with $\eta
_{2}w_{2}$.\footnote{%
We focus on competition between delivery network operators. By that we
abstract from the issues of access regulation which may counter competitors'
incentives to set-up own delivery networks (as, e.g., in the UK where
relatively low access prices prevail). See Armstrong (2008) for a model of
optimal access prices in postal service markets.} The entrant has
(non-labor) marginal costs of $c_{2}=c+\Delta $, where $\Delta $ stands for
the relative cost efficiency of the entrant firm. The relative cost
efficiency of the entrant increases with lower values of $\Delta $. We
suppose that the entrant firm's mail delivery network is more efficient when
compared with the incumbent firm's delivery technology, so that $\eta
_{1}\geq \eta _{2}$ holds (we measure the relative network efficiency of the
entrant by the ratio $\eta _{2}/\eta _{1}\leq 1$, where a lower value
indicates a higher efficiency level).

We assume a linear inverse demand for mail services $p(X)=a-X$, with $a>c$,
where $X:=x_{1}+x_{2}$ stands for the sum of mail services offered by the
incumbent, $x_{1}$, and the entrant firm, $x_{2}$, respectively. Firms
determine their mail service supplies $x_{i}$ (e.g., through outlets and
sorting capacities) which are perceived as homogenous by consumers.\footnote{%
Because of the linearity of our model we can reinterpret $\Delta $ as
measuring vertical product differentiation (see H\"{a}ckner 2000).} In the
following it is useful to define $\alpha :=a-c$.

All workers of the incumbent firm are represented by a union which maximizes
the wage bill $L=w_{1}\eta _{1}$ of its members. We suppose that all workers
in the sector have the same reservation wage $\rho \geq 0$ (which is
typically determined by unemployment benefits). We assume collective wage
bargaining between the incumbent firm and the union. The union's
disagreement point is then given by $\rho \eta _{1}$. We apply the Nash
bargaining solution to solve for the wage settlement (Nash 1950).

Workers of the entrant firm are assumed to be not organized in a union.
Hence, in the absence of an extension rule, the entrant is able to hire
workers at their reservation wage $\rho $.

We consider the following two stage game: In the first stage, the incumbent
firm and the union bargain about the wage rate. In the second stage, the
incumbent and the entrant simultaneously determine their mail volume
capacities (i.e., compete \`{a} la Cournot).\footnote{%
We interpret Cournot competition in the sense of Kreps and Scheinkman (1983)
such that the postal operators are assumed to set first their mail
capacities and then compete in prices. As shown by the authors, that game
yields the Cournot outcome if products are homogeneous. In addition, we
suppose that both firms' mail delivery networks are sufficiently large to
guarantee a certain delivery quality for their supplied mail volumes.}

We distinguish two labor market regimes depending on whether or not an
extension rule is in place. If no extension rule exists, then the entrant
firm pays the reservation wage to its employees while the incumbent bargains
with the union about the wage rate, $\widehat{w}_{1}$, which only applies to
its own employees. In contrast, if an extension rule is in place, then the
entrant firm must pay the (minimum) wage, $\overline{w}$, which is
determined jointly by the union and the incumbent firm.

At this point some more general remarks are helpful to specify a meaningful
parameter range for our linear model. Let us denote the net revenue of firm $%
i$ by $R_{i}=\left[ p(X)-c_{i}\right] x_{i}$ for $i=1,2$. Suppose a unique
interior Nash-Cournot equilibrium $(x_{1}^{\ast },x_{2}^{\ast })$ exists with%
\begin{equation*}
x_{i}^{\ast }=\arg \max_{x_{i}}\text{ }R_{i}(x_{i},x_{j}^{\ast })\text{, for 
}i=1,2\text{, }i\neq j\text{.}
\end{equation*}%
As products are homogenous, differences in firms' equilibrium quantities
only depend on $\Delta $ and are independent of the wage rate. Quite
generally, in a Cournot duopoly model increasing the relative cost
efficiency of one firm leads to a relative increase of the firm's
equilibrium output; i.e., $\partial x_{1}^{\ast }/\partial \Delta >0$ and $%
\partial x_{2}^{\ast }/\partial \Delta <0$ holds, with $x_{1}^{\ast
}=x_{2}^{\ast }$ at $\Delta =0$.\footnote{%
See Vives (1999) for a general treatment of the Cournot oligopoly model and
the conditions which ensure \textquotedblleft intuitive\textquotedblright\
comparative statics.} We specify that $x_{2}^{\ast }(\Delta )>0$ and $%
x_{1}^{\ast }(\Delta )>0$ holds for all admissible $\Delta $, so that the
range of $\Delta $ is restricted to an interval which guarantees strictly
positive output levels for both firms.

Denote now the optimal net revenue of firm $i$ under duopoly by $R_{i}^{D}:=%
\left[ p(x_{1}^{\ast }+x_{2}^{\ast })-c_{i}\right] x_{i}^{\ast }$ (where the
superscript \textquotedblleft D\textquotedblright\ stands for the duopoly
outcome in the product market). As we assumed constant marginal costs, we
obtain $dR_{1}^{D}/d\Delta >0$ and $dR_{2}^{D}/d\Delta <0$, with $%
R_{1}^{D}=R_{2}^{D}$ if $\Delta =0$.

Our approach implies that the wage rate only affects firms' profit levels
but not optimal quantity choices. We assume that workers' reservation wage
is sufficiently low such that $R_{2}^{D}-\eta _{2}\rho >0$ holds. For all
admissible $\Delta $, this assumption ensures that the entrant firm always
finds it profitable to enter the market whenever it pays the reservation
wage to its employees operating the mail delivery network. Similarly, we
assume that $R_{1}^{D}-\eta _{1}\rho >0$ holds for all admissible $\Delta $,
so that the incumbent operates with a strictly positive profit if it pays
the reservation wage under duopoly. This assumption also ensures that the
joint surplus of the union-incumbent relationship is strictly positive
implying, in turn, a negotiated wage strictly larger than workers'
reservation wage.

Given that an extension rule exists, the entrant firm must pay the generally
binding wage rate, $\overline{w}$, which is the outcome of bilateral
bargaining between the union and the incumbent firm. Clearly, as long as the
entrant's net revenue $R_{2}^{D}$ is not smaller than its fixed labor costs, 
$\overline{w}\eta _{2}$, the entrant will enter the market. We denote the
limit wage, where $R_{2}^{D}=w\eta _{2}$ holds, by $\widetilde{w}$. Note
that $d\widetilde{w}/d\Delta <0$ and $d\widetilde{w}/d\eta _{2}<0$ which
says that the limit wage decreases as the entrant's cost efficiency or its
network efficiency decreases, respectively.

If $\overline{w}\geq \widetilde{w}$, then the entrant does not enter the
market and the incumbent realizes the monopoly net revenue $%
R_{1}^{M}:=R_{1}(x_{1}^{M})$, with $x_{1}^{M}=\arg \max_{x_{1}}$ $\left[
p(x_{1})-c_{1}\right] x_{1}$ (where the superscript \textquotedblleft
M\textquotedblright\ stands for the monopoly outcome in the product market).
Note that $R_{1}^{M}$ is independent of both $\Delta $ and $\overline{w}$.
We now invoke the assumption that $R_{1}^{M}>\widetilde{w}\eta _{1}\equiv
(\eta _{1}/\eta _{2})R_{2}^{D}$ which guarantees the existence of a limit
wage $\widetilde{w}$ which leaves the incumbent with a strictly positive
payoff at the limit wage. This assumption guarantees scope for entry
deterrence as, otherwise, the incumbent would always be better off under the
duopoly outcome.

Taking these considerations together, we can formulate the following
assumption which we maintain throughout the entire analysis.\medskip

\noindent \textbf{Assumption 1.} \textit{We invoke the following parameter
restrictions.}

\textit{i) }$\Delta \in (-\alpha ,\frac{\alpha }{2})$\textit{\ which ensures
that both firms' equilibrium quantities are strictly positive, whenever the
entrant firm enters the market.}

\textit{ii) }$\rho <\min \left\{ \frac{R_{1}^{D}}{\eta _{1}},\frac{R_{2}^{D}%
}{\eta _{2}}\right\} $\textit{\ which ensures that both the incumbent and
the entrant firm make strictly positive profits if they pay the reservation
wage to their employees.}

\textit{iii)\ }$\frac{\eta _{2}}{\eta _{1}}>\frac{R_{2}^{D}}{R_{1}^{M}}$%
\textit{\ which guarantees that the incumbent's profit is strictly positive
at the limit wage, }$\widetilde{w}$\textit{.}\medskip

Part \textit{iii)} of Assumption 1 mirrors the fact that entry deterrence is
in principle possible as the incumbent realizes monopoly net revenues which
are larger than the wage bill at the limit wage. This constellation is
guaranteed by imposing an upper limit on the relative network efficiency of
the entrant. However, the share the incumbent may get from the realized
monopoly revenues may be quite small when the limit wage becomes large.

\section{Equilibrium analysis}

We first analyze the equilibrium when no extension rule is in place. Then,
we turn to the case where an extension rule makes the wage agreement between
the incumbent and the union generally in the entire industry. Finally, we
compare the results under both labor market regimes.\\[2ex]
\newpage

\noindent \textit{Bargaining without extension rule }\\[1.4ex]
We first analyze the equilibrium when no extension rule is in place. The
profit functions of the incumbent and the entrant are given by%
\begin{equation*}
\pi _{1}=(\alpha -X)x_{1}-w_{1}\eta _{1}\text{ and }\pi _{2}=(\alpha -\Delta
-X)x_{2}-w_{2}\eta _{2}\text{,}
\end{equation*}%
respectively, from which we obtain the first-order conditions%
\begin{equation*}
\alpha -2x_{1}-x_{2}=0\text{ and }\alpha -\Delta -2x_{2}-x_{1}=0\text{,}
\end{equation*}%
and hence, the optimal quantities 
\begin{equation*}
x_{1}^{\ast }=\frac{\alpha +\Delta }{3}\text{ and }x_{2}^{\ast }=\frac{%
\alpha -2\Delta }{3}\text{.}
\end{equation*}%
Hence, $R_{1}^{D}=\left[ \left( \alpha +\Delta \right) /3\right] ^{2}$ and $%
R_{2}^{D}=\left[ \left( \alpha -2\Delta \right) /3\right] ^{2}$. In the
absence of an extension rule, the entrant pays the reservation wage $\rho $
to its workers. Hence, the entrant firm's equilibrium profit becomes%
\begin{equation}
\widehat{\pi }_{2}^{D}=R_{2}^{D}-\rho \eta _{2}\text{.}  \label{profentrnoex}
\end{equation}%
We now turn to the first stage of the game, where the union bargains with
the incumbent firm about the wage rate $w_{1}$. We apply the Nash bargaining
solution which requires that the joint surplus $R_{1}^{D}=\left[ \left(
\alpha +\Delta \right) /3\right] ^{2}$ is shared equally relative to the
union's disagreement point $\rho \eta _{1}$ (the incumbent's disagreement
point is zero). Hence, the equilibrium wage bill, $\widehat{w}_{1}\eta _{1}$%
, must fulfill%
\begin{equation}
R_{1}^{D}-\widehat{w}_{1}\eta _{1}=\widehat{w}_{1}\eta _{1}-\rho \eta _{1}%
\text{.}  \label{splitduop}
\end{equation}%
The following proposition follows immediately from solving Equation (\ref%
{splitduop}) for the wage rate, $\widehat{w}_{1}$, the incumbent's profit
and the union's wage bill.\medskip

\noindent \textbf{Proposition 1.} \textit{Suppose that no extension rule
exists. Then the entrant firm always enters the market, pays its employees
the reservation wage and realizes the profit level }$\widehat{\pi }%
_{2}^{D}=R_{2}^{D}-\rho \eta _{2}$\textit{. In equilibrium the union and the
incumbent settle on the wage rate }%
\begin{equation*}
\widehat{w}_{1}=\frac{1}{2}\frac{1}{\eta _{1}}\left[ R_{1}^{D}+\rho \eta _{1}%
\right]
\end{equation*}%
\textit{which implies a profit level of }%
\begin{equation}
\widehat{\pi }_{1}^{D}=\frac{1}{2}\left[ R_{1}^{D}-\rho \eta _{1}\right] 
\text{\textit{,}}  \label{profincnoex}
\end{equation}%
\textit{for the incumbent, while the union's wage bill is} 
\begin{equation*}
\widehat{L}=\frac{1}{2}\left[ R_{1}^{D}+\rho \eta _{1}\right] \text{\textit{.%
}}
\end{equation*}%
By Assumption 1, the entrant firm enters the market with a strictly positive
quantity and receives strictly positive profits. Comparing both firms'
profit levels (\ref{profentrnoex}) and (\ref{profincnoex}), we observe that
the entrant typically realize a higher profit level than the incumbent. To
see this, suppose that both firms are equally cost efficient (i.e., $\Delta
=0$). Then comparison of (\ref{profentrnoex}) and (\ref{profincnoex}) yields
that $\widehat{\pi }_{2}^{D}>\widehat{\pi }_{1}^{D}\Leftrightarrow \rho \eta
_{2}<(1/2)(R_{1}^{D}+\rho \eta _{1})$, where the latter inequality holds
always as we assumed $\eta _{1}\geq \eta _{2}$ and $R_{1}^{D}>\rho \eta _{1}$%
. The obvious reason for this result is that the incumbent must share its
surplus with the union, while the entrant pays its workers' the reservation
wage. However, the incumbent's profit can be larger than the entrant's
profit if the entrant's cost efficiency is sufficiently small (i.e., $\Delta 
$ positive and sufficiently large).\\[2ex]
\noindent \textit{Bargaining with extension rule}\\[1.4ex]
In the case of an extension rule, the outcome of the negotiations between
the union and the incumbent firm determines the minimum wage rate, $%
\overline{w}$, which is binding for all firms in the industry. With an
extension rule in place, firms' optimal strategies in the second stage
remain unaffected as long as the entrant firm finds it optimal to enter the
market. This is the case as long as $\pi _{2}=R_{2}^{D}-\overline{w}\eta
_{2}>0$ holds. However, if the agreed upon wage rate does not fall short of
the limit wage, $\overline{w}\geq \widetilde{w}$, then the incumbent sets
the monopoly output level, $x_{1}^{M}=\alpha /2$, and realizes the monopoly
net revenues, $R_{1}^{M}=\left( \alpha /2\right) ^{2}$, in the product
market. Depending on the generally binding wage rate, $\overline{w}$, the
incumbent firm's profit function is then given by%
\begin{equation*}
\pi _{1}(\overline{w})=\left\{ 
\begin{array}{ll}
R_{1}^{M}-\overline{w}\eta _{1}=\left( \alpha /2\right) ^{2}-\overline{w}%
\eta _{1} & \text{for }\overline{w}\geq \widetilde{w} \\ 
R_{1}^{D}-\overline{w}\eta _{1}=\left[ (\alpha +\Delta )/3\right] ^{2}-%
\overline{w}\eta _{1} & \text{for }\rho \leq \overline{w}<\widetilde{w}\text{%
.}%
\end{array}%
\right.
\end{equation*}%
Let us assume for a moment that bargaining only occurs over a certain wage
rate. We can then state the corresponding bargaining frontier, $\Lambda (\pi
_{1})$, which gives the maximum payoff of the union for a given profit level
of the incumbent as%
\begin{equation}
\Lambda (\pi _{1})=\left\{ 
\begin{array}{ll}
R_{1}^{M}-\pi _{1} & \text{for }0\leq \pi _{1}\leq R_{1}^{M}-\widetilde{w}%
\eta _{1} \\ 
R_{1}^{D}-\pi _{1} & \text{for }R_{1}^{M}-\widetilde{w}\eta _{1}<\pi
_{1}\leq R_{1}^{D}-\rho \eta _{1}\text{.}%
\end{array}%
\right.  \label{certainbf}
\end{equation}%
We, therefore, obtain a non-convex bargaining problem if 
\begin{equation}
R_{1}^{D}-\rho \eta _{1}>R_{1}^{M}-\widetilde{w}\eta _{1}
\label{nonconv_cond}
\end{equation}%
holds. Condition (\ref{nonconv_cond}) requires that the joint surplus under
duopoly net of the wage bill at the reservation wage is strictly larger than
the joint surplus under monopoly net of the wage bill at the limit wage. In
those instances, the incumbent would be able to realize a larger payoff
under duopoly than under monopoly if it had all the bargaining power.

If, to the contrary, Condition (\ref{nonconv_cond}) does not hold, then the
bargaining frontier is described by $L(\pi _{1})=R_{1}^{M}-\pi _{1}$ for $%
0\leq \pi _{1}\leq R_{1}^{M}-\widetilde{w}\eta _{1}$. In that case, we
obtain a convex bargaining problem. In the former case, however, we have to
use lotteries to \textquotedblleft convexify\textquotedblright\ the
bargaining frontier. We do this by allowing for bargaining over a lottery $%
l=(\widetilde{w},\rho ;p,1-p)$ which chooses the limit wage, $\widetilde{w}$%
, with probability $p\in \lbrack 0,1]$ and the reservation wage, $\rho $,
with counter probability $1-p$. We assume that the union and the incumbent
are risk-neutral.\footnote{%
By allowing for bargaining over lotteries and assuming von
Neumann-Morgenstern expected utilities, our model fulfills the axioms of the
Nash bargaining solution in expected terms. One may question whether
bargaining over lotteries and the requirement to implement the ex post
outcome of the lottery is a convincing image of real world wage bargaining.
However, bargaining solutions which abstain from using lotteries are also
problematic. For instance, Conley and Wilkie (1996) propose an extended Nash
bargaining solution for nonconvex but comprehensible bargaining problems.
Their approach is not applicable to our problem as the smallest
comprehensible set of the bargaining frontier (\ref{certainbf}) has a jump
at the limit wage $\widetilde{w}$. Moreover, Conley and Wilkie's proposed
solution is not necessarily strictly Pareto-efficient (see Hougaard and
Tvede 2010, for a solution which requires strict Pareto-efficiency but lacks
a noncooperative implementation).}

Using the lottery $l$, we can describe the convexified bargaining frontier by%
\begin{equation}
L(\pi _{1})=\left\{ 
\begin{array}{ll}
R_{1}^{M}-\pi _{1} & \text{for }0\leq \pi _{1}\leq R_{1}^{M}-\widetilde{w}%
\eta _{1} \\ 
\left[ p\widetilde{w}+(1-p)\rho \right] \eta _{1} & \text{for }R_{1}^{M}-%
\widetilde{w}\eta _{1}<\pi _{1}\leq R_{1}^{D}-\rho \eta _{1}\text{\textit{,}}%
\end{array}%
\right.  \label{convex}
\end{equation}%
where the lottery fulfills%
\begin{equation*}
\left[ p\widetilde{w}+(1-p)\rho \right] \eta _{1}=\widetilde{w}\eta _{1}-%
\frac{\widetilde{w}\eta _{1}-\rho \eta _{1}}{(R_{1}^{D}-\rho \eta
_{1})-(R_{1}^{M}-\eta _{1}\widetilde{w})}\cdot \left[ \pi
_{1}-(R_{1}^{M}-\eta _{1}\widetilde{w})\right] \text{.}
\end{equation*}%
Applying the Nash bargaining solution to the convexified bargaining frontier
(\ref{convex}) and noting the union's disagreement payoff, $\rho \eta _{1}$,
we obtain the following proposition which summarizes the bargaining outcome
under an extension rule.\medskip

\noindent \textbf{Proposition 2.} \textit{Suppose that an extension rule
exists. If }$R_{1}^{D}-\rho \eta _{1}\leq R_{1}^{M}-\widetilde{w}\eta _{1}$%
\textit{, then entry is deterred for sure and the Nash bargaining solution
yields the generally binding wage rate}%
\begin{equation*}
\overline{w}=\left\{ 
\begin{array}{ll}
\frac{1}{2}\frac{1}{\eta _{1}}(R_{1}^{M}+\rho \eta _{1}) & \text{for }%
R_{1}^{M}-\widetilde{w}\eta _{1}\geq \widetilde{w}\eta _{1}-\rho \eta _{1}
\\ 
\widetilde{w} & \text{for }R_{1}^{M}-\widetilde{w}\eta _{1}\leq \widetilde{w}%
\eta _{1}-\rho \eta _{1}\text{.}%
\end{array}%
\right.
\end{equation*}%
\textit{If }$R_{1}^{D}-\rho \eta _{1}>R_{1}^{M}-\widetilde{w}\eta _{1}$%
\textit{, then the (expected) wage rate is given by }%
\begin{equation*}
\overline{w}=\left\{ 
\begin{array}{ll}
\frac{1}{2}\frac{1}{\eta _{1}}(R_{1}^{M}+\rho \eta _{1}) & \text{for }%
R_{1}^{M}-\widetilde{w}\eta _{1}\geq \widetilde{w}\eta _{1}-\rho \eta _{1}
\\ 
\left[ p^{\ast }\widetilde{w}+(1-p^{\ast })\rho \right] & \text{for }%
R_{1}^{M}-\widetilde{w}\eta _{1}\leq \widetilde{w}\eta _{1}-\rho \eta _{1}%
\text{\textit{,}}%
\end{array}%
\right.
\end{equation*}%
\textit{with }$p^{\ast }=\left[ 1+\frac{(\widetilde{w}\eta _{1}-\rho \eta
_{1})-(R_{1}^{M}-\widetilde{w}\eta _{1})}{R_{1}^{D}-\rho \eta _{1}}\right]
^{-1}$\textit{, so that entry is deterred for sure or with probability }$%
p^{\ast }$\textit{.}\medskip

The first part of Proposition 2 follows directly from applying the
split-the-surplus rule and taking notice of the corner solution. The second
part of Proposition 2 follows from applying the split-the-surplus rule to
the convexified problem. In particular, whenever the Nash solution requires
to use a lottery, then the lottery must guarantee that the expected net
joint surplus is shared equally which gives the condition%
\begin{equation}
\left[ p^{\ast }\widetilde{w}+(1-p^{\ast })\rho \right] \eta _{1}-\rho \eta
_{1}=p^{\ast }(R_{1}^{M}-\widetilde{w}\eta _{1})+(1-p^{\ast
})(R_{1}^{D}-\rho \eta _{1})\text{,}  \label{indiff_prob}
\end{equation}%
from which we obtain $p^{\ast }$ as stated in Proposition 2.

We are now in a position to analyze how the parameters of our model affect
the likelihood of a monopoly outcome where the union and the incumbent agree
on a minimum wage which deters entry. From Proposition 1 we observe that
deterrence for sure depends on the condition $R_{1}^{M}-\widetilde{w}\eta
_{1}>\widetilde{w}\eta _{1}-\rho \eta _{1}$ being fulfilled. We can rewrite
that condition as follows%
\begin{equation*}
f:=(\widetilde{w}\eta _{1}-\rho \eta _{1})-R_{1}^{M}+\widetilde{w}\eta _{1}=%
\frac{2\eta _{1}}{\eta _{2}}\left( \frac{\alpha -2\Delta }{3}\right)
^{2}-\rho \eta _{1}-\left( \frac{\alpha }{2}\right) ^{2}<0\text{.}
\end{equation*}%
Differentiation of $f(\cdot )$ gives $\partial f/\partial \eta _{1}>0$, $%
\partial f/\partial \eta _{2}<0$ and $\partial f/\partial \Delta <0$.

We can also examine the probability $p^{\ast }$ of entry deterrence which we
can rewrite as $p^{\ast }=\left( 1+f/g\right) ^{-1}$ with 
\begin{equation*}
g:=R_{1}^{D}-\rho \eta _{1}=\left( \frac{\alpha +\Delta }{3}\right)
^{2}-\rho \eta _{1}\text{.}
\end{equation*}%
Differentiation of $g(\cdot )$ yields $\partial g/\partial \Delta >0$ and $%
\partial g/\partial \eta _{1}<0$. It is now straightforward to establish the
following corollary.\medskip

\noindent \textbf{Corollary 1.}\textit{\ Deterrence of the entrant for sure
becomes more likely and the probability of a limit wage, }$p^{\ast }$\textit{%
, increases, whenever the cost efficiency or the network efficiency of the
entrant decreases (i.e., }$\Delta $\textit{\ or }$\eta _{2}$\textit{\
increases, resp.) or the network efficiency of the incumbent increases
(i.e., }$\eta _{1}$\textit{\ decreases).}\medskip

Clearly, a bargaining outcome with $\overline{w}\geq \widetilde{w}\,$becomes
more likely for higher values of the entrant's marginal costs ($\Delta $)
and larger (lower) values of the network efficiency parameter $\eta _{2}$ ($%
\eta _{1}$). Inspection of the probability $p^{\ast }$ which solves the
split-the-surplus condition (\ref{indiff_prob}) in expected terms, shows
that $p^{\ast }$ (i.e., the probability of choosing $\widetilde{w}$)
increases as well when entry deterrence for sure becomes more likely.
Interestingly, an increasing value of $\Delta $ and a decreasing value of $%
\eta _{1}$ which both shift the extremum point $R_{1}^{D}-\rho \eta _{1}$ of
the bargaining set outward, induce the bargaining parties to settle on a
higher probability of choosing $\widetilde{w}$ under the lottery solution.
Hence, efforts of the entrant to enhance its cost efficiency would result in
a lower probability of entry (we come back to a similar phenomenon below in
Section 4, where we study the entrant's incentives to invest into the
coverage of its mail delivery network).

We now ask whether entry deterrence can occur for sure even when the entrant
is more efficient. Let us assume for a moment that both firms have the same
network efficiency (i.e., $\eta _{1}=\eta _{2}$). To simplify, let us also
assume that workers' reservation wage takes the value of zero. Entry
deterrence then occurs for sure if 
\begin{equation*}
2\left( \frac{\alpha -2\Delta }{3}\right) ^{2}-\left( \frac{\alpha }{2}%
\right) ^{2}\leq 0\text{ or }\Delta \geq \frac{\alpha \left( 2-3/\sqrt{2}%
\right) }{4}<0\text{.}
\end{equation*}%
Hence, for all $\Delta \in \lbrack \alpha (2-3/\sqrt{2})/4,0)$ wage
bargaining under an extension rule induces deterrence of a more cost
efficient rival.

Let us next assume that both firms have the same cost efficiency (i.e., $%
\Delta =0$) but may differ in their network efficiencies ($\eta _{1}$, $\eta
_{2}$). Again, setting the reservation wage to zero, we then obtain the
following condition for entry deterrence for sure:%
\begin{equation*}
\frac{2\eta _{1}}{\eta _{2}}\left( \frac{\alpha }{3}\right) ^{2}-\left( 
\frac{\alpha }{2}\right) ^{2}\leq 0\text{ or }\frac{\eta _{2}}{\eta _{1}}%
\geq \frac{8}{9}\text{.}
\end{equation*}%
Hence, with an extension rule existing, an incumbent can deter a rival
operator with a more efficient delivery network if $\eta _{2}/\eta _{1}\in
(8/9,1]$ holds. We summarize those results in the following
corollary.\medskip

\noindent \textbf{Corollary 2.} \textit{Suppose }$\rho =0$\textit{. If }$%
\eta _{2}/\eta _{1}=1$\textit{, then a more cost efficient entrant is
deterred from entry for sure for all }$\Delta \in \lbrack \alpha (2-3/\sqrt{2%
})/4,0)$\textit{. If }$\Delta =0$\textit{, then an entrant with a more
efficient network is deterred from entry for sure for all }$\eta _{2}/\eta
_{1}\in (8/9,1]$\textit{. Moreover, when the bargaining parties use a
lottery to share their expected joint surplus, then deterrence of a more
efficient entrant always occurs with some strictly positive probability.}%
\medskip \\[2ex]
\noindent \textit{Comparison of labor market regimes}\\[1.4ex]
Comparing the wage rate agreed upon when no extension rule is in place with
the case where an extension rule obliges the entrant to pay the minimum
wage, we arrive at the following result.\medskip

\noindent \textbf{Corollary 3.} \textit{The (expected) wage rate under a
regime with an extension rule is strictly larger when compared with a regime
where no such rule exists. Moreover, the union's (expected) wage bill and
the incumbent's (expected) profit are both strictly larger under an
extension rule.}\medskip

Corollary 3 shows that the usually assumed conflict of interest between a
firm and its union in wage bargaining may be absent in the presence of
market entry, whenever the wage rate can be used to raise rivals' costs. In
contrast to deterrence models where the deterrence instrument (as, e.g.,
sunk costs in Dewatripont 1987) differs from the rent-sharing instrument, a
minimum wage which combines both functions in a single instrument partly
eliminates the supposed conflict. The reason for this result is that the
firm may wants to deter entry through a relatively large minimum wage which
is also in the interest of the union. However, the conflict of interest does
not disappear completely as the firm tries to pocket as much as possible
from the monopoly rents.

We conclude the analysis of our model with some remarks on overall
productive efficiency as measured by mail unit costs. We compare the labor
market regime without an extension rule with the labor market regime with an
extension rule. We focus on the case that entry is deterred for sure if an
extension is in place. Unit mail cost when no extension rule is in place is
given by%
\begin{equation}
\frac{cx_{1}^{\ast }+(c+\Delta )x_{2}^{\ast }+\eta _{1}\widehat{w}_{1}+\eta
_{2}\rho }{x_{1}^{\ast }+x_{2}^{\ast }}\text{.}  \label{unitcostduop}
\end{equation}%
If an extension rule exists, unit mail costs are equal to%
\begin{equation}
\frac{cx_{1}^{M}+\eta _{1}\overline{w}}{x_{1}^{M}}\text{.}
\label{unitcostmono}
\end{equation}%
Inspection of both expressions (\ref{unitcostduop}) and (\ref{unitcostmono})
reveals the basic trade-off of an extension rule in terms of unit mail
costs. As is well-known duplication of fixed costs under duopoly tends to
make a monopoly outcome more attractive. However, a monopoly outcome under
an extension rule has three main drawbacks: first, it reduces total mail
volume ($x_{1}^{\ast }+x_{2}^{\ast }>x_{1}^{M}$), second, it increases wage
demands by the union of the incumbent firm ($\overline{w}>\widehat{w}%
_{1}>\rho )$, and third, it may deter a more efficient rival from entering
the market. Taking those effects together a duopoly outcome might be very
well more desirable, even in an industry exhibiting features of a natural
monopoly.

To show that overall mail unit cost can be smaller under duopoly in the
absence of an extension rule, let us shortly analyze the case of $\Delta =0$%
, so that $x_{1}^{\ast }=x_{2}^{\ast }$. Using expressions (\ref%
{unitcostduop}) and (\ref{unitcostmono}) we obtain the condition%
\begin{equation*}
\rho \left( \eta _{2}-\frac{1}{6}\eta _{1}\right) <\frac{\alpha ^{2}}{9}
\end{equation*}%
which assures that mail unit costs are smaller under duopoly when compared
with a labor market in which an extension rule allows the union and the
incumbent to settle on an entry deterring minimum wage. Clearly, such an
outcome is more likely the higher the relative network efficiency of the
entrant.

\section{Endogenous coverage}

Until now we assumed that both firms compete head-to-head in the mail
delivery market. Both firms were supposed to provide full coverage and the
efficiency levels of their delivery networks were given exogenously. In
reality, however, the decision about the coverage of a firm's delivery
network should be endogenous (see Valletti et al. 2002). Because of
universal service regulation the incumbent may not have the choice to reduce
its coverage below full coverage. Accordingly, we suppose that the incumbent
must provide a full coverage delivery network. We assume that the entrant
firm, however, can decide freely about the coverage of its delivery network.

We abstract from any efficiency differences between both firms. We assume $%
\Delta =0$ and we suppose that the fixed costs of running the mail delivery
network are a linear function of each firm's coverage, $s_{i}\in \lbrack
0,1] $. The incumbent is assumed to have full coverage with $\eta _{1}=\eta $%
, while the entrant can choose its coverage level, so that $\eta _{2}=\eta
s_{2}$.

We assume that the mail demand schedule $X=a-p$ is the aggregate of a
continuum of symmetric delivery markets with total mass of one. Suppose now
that the entrant serves the fraction $s_{2}$ of all markets. Then the
fraction $s_{2}$ of all delivery markets are served by both the entrant and
the incumbent, while the remaining fraction $1-s_{2}$ is only served by the
incumbent. For expositional purposes, we suppose that the incumbent can
discriminate between the duopolistic delivery markets and the markets where
it holds a monopoly position.

Given the entrant enters the market in the final stage of the game with a
coverage of $s_{2}$, the inverse demand in the duopoly delivery markets is
given by $p^{D}=a-(1/s_{2})(x_{1}+x_{2})$. Accordingly, the inverse demand
in the monopoly segment is given by $p^{M}=a-[1/(1-s_{2})]y_{1}$, where $%
x_{i}$ ($i=1,2$) denotes the firms' mail volume levels in the duopoly
segment and $y_{1}$ stands for the incumbent's mail volume in the
monopolistic segment.

Solving for the optimal quantities in the duopoly segment we obtain $%
x_{1}^{\ast }=x_{2}^{\ast }=s_{2}(\alpha /3)$ which gives rise to net
revenues of $s_{2}R^{D}$ for each firm. Accordingly, we obtain for the
monopoly segment the optimal output level $y_{1}^{M}=(1-s_{2})(\alpha /2)$
which leads to net revenues of $(1-s_{2})R_{1}^{M}$ for the incumbent firm.

We suppose that the entrant firm must incur sunk costs to build up a
delivery network in an initial stage before the above analyzed two-stage
game starts. We specify that the costs to build up a delivery network with
coverage $s_{2}$ are given by the investment function $K(s_{2})=s_{2}^{%
\epsilon }$ with $\epsilon >1$. Note that $1/\epsilon $ measures the
(constant) cost elasticity of coverage. Hence, a one percentage increase of
investment cost leads to a percentage increase of coverage below one percent.

We are now in a position to fully analyze a three-stage game, where the
entrant chooses its coverage in the initial stage while the next two stages
remain the same as before.

We first analyze the case without an extension rule. In this case, the
entrant firm solves the problem 
\begin{equation*}
\max_{s_{2}\in \lbrack 0,1]}\text{ }s_{2}(R^{D}-\rho \eta )-s_{2}^{\epsilon }
\end{equation*}%
from which we obtain the subgame perfect coverage decision of the entrant
firm given by 
\begin{equation}
s_{2}^{\ast }=\left\{ 
\begin{array}{ll}
\left[ \frac{1}{\epsilon }\left( R^{D}-\rho \eta \right) \right] ^{\frac{1}{%
\epsilon -1}} & \text{if }\epsilon >R^{D}-\rho \eta \\ 
1 & \text{if }\epsilon \leq R^{D}-\rho \eta \text{.}%
\end{array}%
\right.  \label{opt_cov_no}
\end{equation}%
Clearly, a full coverage outcome becomes more likely, the larger the
marginal rents of investment, $R^{D}-\eta \rho $, and the larger the cost
elasticity of coverage, $1/\epsilon $.

We next turn to the case when an extension rule makes the wage contract
between the incumbent and the union generally binding. We first observe that
the limit wage is independent of the entrant's coverage decision. As
investments into the build-up of the delivery network constitute sunk costs,
the limit wage fulfills $s_{2}R^{D}-\eta s_{2}\widetilde{w}=0$ which holds
for all $s_{2}>0$ if and only if $\widetilde{w}=(1/\eta )R^{D}$. A
sufficient condition for an entry deterrence outcome is (see Proposition 2)%
\begin{equation}
R_{1}^{M}-\widetilde{w}\eta \geq s_{2}R^{D}+(1-s_{2})R_{1}^{M}-\rho \eta 
\text{.}  \label{deter_endcov}
\end{equation}%
In those instances, the incumbent could realize a larger surplus under an
entry deterring wage than under the duopoly outcome at the workers'
reservation wage if it had all the bargaining power. Such an outcome becomes
the more likely the larger the entrant's coverage becomes as the right-hand
side of (\ref{deter_endcov}) is monotonically decreasing in $s_{2}$. The
condition is, however, never binding, whenever 
\begin{equation}
\rho \eta <2R^{D}-R_{1}^{M}  \label{cond_entry}
\end{equation}%
holds. Incidentally, if Condition (\ref{cond_entry}) holds, then the Nash
bargaining solution always requires to use a lottery to resolve the
negotiations between the incumbent and the union.\footnote{%
By Proposition 2, we know that the Nash bargaining solution chooses a point
on the convexified part of the bargaining frontier if $R_{1}^{M}-\widetilde{w%
}\eta <\widetilde{w}\eta -\rho \eta $ which is equivalent to $\rho \eta
<2R^{D}-R_{1}^{M}$. Hence, if $\rho \eta <2R^{D}-R_{1}^{M}$, then Condition (%
\ref{deter_endcov}) is never fulfilled for all $s_{2}>0$.} We, therefore,
obtained the following lemma.\medskip

\noindent \textbf{Lemma 1. }\textit{If }$\rho \eta \geq 2R^{D}-R_{1}^{M}$%
\textit{, then entry is deterred for sure and the entrant does not invest
into building up a mail delivery network. If, to the contrary, }$\rho \eta
<2R^{D}-R_{1}^{M}$\textit{\ holds, then entry is deterred with probability }$%
p^{\ast }$\textit{\ for all }$s_{2}\in \lbrack 0,1]$\textit{.}\medskip

Lemma 1 highlights the power of minimum wages as a deterrence instrument.
Given that workers' reservation wage, $\rho $, and/or the labor-intensity of
operating the mail delivery network, $\eta $, is relatively high, then an
entrant firm will never build up a delivery network if an extension rule is
enforced. Comparison with the entrant's optimal coverage decision in the
absence of an extension rule (\ref{opt_cov_no}) shows that there can exist
instances in which the entrant would have otherwise build up a full coverage
delivery network.

By Lemma 1, the entrant only invests into a delivery network if Condition (%
\ref{cond_entry}) holds which implies that the incumbent and the union
revert to a lottery to resolve their wage negotiations.

The entrant's maximization problem then becomes%
\begin{equation}
\max_{s_{2}\in \lbrack 0,1]}\text{ }(1-p^{\ast })\left[ s_{2}(R^{D}-\rho
\eta )\right] -s_{2}^{\epsilon }\text{, with }p^{\ast }=\left[ 1+\frac{(%
\widetilde{w}\eta -\rho \eta )-(R_{1}^{M}-\widetilde{w}\eta )}{%
s_{2}R^{D}-\rho \eta }\right] ^{-1}\text{.}  \label{max_cov}
\end{equation}%
Note that $\partial p^{\ast }/\partial s_{2}>0$, so that the probability of
an entry deterring wage increases in the entrant's coverage. Differentiation
of the entrant's profit function (\ref{max_cov}) with respect to $s_{2}$
yields the first-order condition for an interior solution 
\begin{equation}
\left( 1-p^{\ast }-s_{2}\frac{\partial p^{\ast }}{\partial s_{2}}\right)
(R^{D}-\rho \eta )=\epsilon s_{2}^{\epsilon -1}\text{,}  \label{marg_rent}
\end{equation}%
where the left-hand side is the marginal rent of investment. The left-hand
side of Condition (\ref{marg_rent}) is clearly smaller than the marginal
rent of investment in the absence of an extension regulation (which is equal
to $R^{D}-\eta \rho $). Two reasons are responsible for this result: first,
successful entry only occurs with some probability $1-p^{\ast }<1$, and
second, the bargaining parties react to an increase of the entrant's
coverage by increasing the probability of an entry deterring wage (i.e., $%
\partial p^{\ast }/\partial s_{2}>0$).

Denote the solution to the maximization problem (\ref{max_cov}) by $%
s_{2}^{\ast \ast }$ and let us focus on interior solutions, $s_{2}^{\ast }$,
when no extension rules exists. The following proposition is then
immediate.\medskip

\noindent \textbf{Proposition 3. }\textit{If }$\rho \eta \geq
2R^{D}-R_{1}^{M}$\textit{, then the entrant does not invest into building up
a delivery network under an extension rule. If, to the contrary, }$\rho \eta
<2R^{D}-R_{1}^{M}$\textit{\ holds, then the entrant invests strictly less
under an extension rule when compared with the investment level }$%
s_{2}^{\ast }$\textit{\ for }$\epsilon >R^{D}-\rho \eta $\textit{\ in the
absence of an extension rule; i.e., }$s_{2}^{\ast \ast }<s_{2}^{\ast }$%
\textit{.}\medskip

Proposition 3 makes clear that for a large enough reservation wage bill, $%
\rho \eta $, an entrant will never invest into building up its own delivery
network irrespectively of its investment cost function $K(s_{2})$. Moreover,
if investments take place, then the entrant will enter with a network which
entails a smaller coverage when compared with the case without an extension
rule. Overall, having analyzed a richer model with endogenous coverage we
are left with the observation that minimum wage legislation unfolds
additional adverse dynamics effects on the entrant's willingness to invest
into the coverage of its own mail delivery network.

In the next sections we relate our analysis to recent minimum wage
legislation in Germany. We first describe the relevant labor laws which
implement minimum wages at the industry-level. We then examine the Deutsche
Post case which highlights the raising rivals' cost incentives when labor
laws exist which make the collective wage agreement between incumbents
generally binding. Our investigation of that case shows that the main
predictions of our model mirror nicely what actually happened in reality.

\section{Conclusion}

Following from the observations decribed in the previous chapter, in this
chapter we analyzed theoretically how minimum wage legislation in the form
of extension rulings can be used by collective bargaining partners to deter
entry or to drive existing competitors out of the market. Our main
application is the postal service industry where the labor costs of running
a mail delivery network are mainly fixed operating costs.

Both, the Deutsche Post case discussed in detail in chapter 3 and our model
reveal the strong incentives of the incumbent firm and the established union
(which cares only about its organized members employed by the incumbent) to
settle (strategically) on a relative high wage rate so as to harm
competitors. The strategic intention becomes obvious when one considers the
fact that the tariff contract specifying the proposed minimum wages was made
contingent on being declared generally binding by the Federal Government. As
we have shown, both parties retained the right to terminate the agreement
otherwise.

As it is the case in more standard raising rivals' costs models where wages
affect a firm's marginal labor costs directly, wage increases can be used to
monopolize the final product market. However, there are several differences
between raising rivals' marginal costs and raising rivals' fixed labor
costs. Most importantly, when labor constitutes fixed costs, then the
profitability of a raising rivals' costs strategy does not depend on a
sufficient efficiency advantage of the incumbent firm (which engages in the
anticompetitive practice) vis-\`{a}-vis potential competitors.

This observation has several implications. \textit{First}, the alleged
conflict of interest between the firm and its union becomes less pronounced
as it is the case when wages are variable costs. When wages are variable
costs a wage increase not only distributes rents to the union but also tends
to reduce the overall joint surplus available because of the well-known
double mark-up problem. \textit{Second}, when wages are fixed costs then an
incumbent is able to deter entry through strategic wage increases even if
the entrant firm is more efficient. As a consequence, overall productive
efficiency can be reduced under a raising rivals' fixed labor cost strategy.

Furthermore, the model predicted the effects of the introduction of a high
minimum wage for the postal industry in Germany, that the cost increase was
disastrous for the competitors, where not a marginal reduction in output was
the consequence, but also firms were squeezed out of the market entirely,
for example when PIN\ had to file insolvency, although the subsequent legal
dispute of minimum wage declaration was successful in the sense that it has
been declared void.

We also showed that extension regulations may have adverse effects on
competitors' willingness to invest into the coverage of their mail delivery
networks. In the extreme case, entry is completely deterred under an
extension rule while an entrant may build a mail network with full coverage
when no such extension regulation exists.

Therefore, especially minimum wages proposed by established industry players
in industries where wage costs are mainly fixed costs should be treated with
special care, since \textit{i)} unduly high minimum wages are a particularly
effective deterrence instrument when labor constitutes fixed costs, \textit{%
ii)} drastic effects on competitors rather than \textquotedblleft
marginal\textquotedblright effects might result, \textit{iii)} the conflict
of interest between a union and a firm vanishes when the limit wage is
relatively low, \textit{iv)} even more efficient rivals can be deterred and 
\textit{v)} overall productive efficiency may decline.

In the previous chapter, we also described recent legal disputes which
resulted from the Federal Government's minimum wage ruling. The most notable
issue which arises as an insight from this chapter has become the fact that
the incumbent unions (namely, the unions organized in the DGB) lost their
monopoly position in the \textquotedblleft market for collective
contracts.\textquotedblright\ This is a rather new development in the German
labor market, and the labor institutions (which were designed for bilateral
wage negotiations between a monopoly union and a monopolistic employer
association at the industry-level) are still struggling to come to terms
with a competitive labor market.

\clearpage\ifodd\count0\else\thispagestyle{empty} \hbox{}\newpage \fi

\fancyhead[RO]{\rightmark}

\chapter{Modernizing the Postal Universal Service}

\renewcommand{\leftmark}{MODERNIZING THE UNIVERSAL POSTAL SERVICE}

\begin{flushright}
\hangindent=3.6cm \hangafter=0 \textquotedblleft \textit{The two ideas of
reducing the postal service obligation and increasing the electronic service
obligation through broadband are complementary.\textquotedblright }\footnote{%
E. Toime (2009).}
\end{flushright}

\noindent Although this quotation reflects only a small part of the current
issues around postal regulation, it points directly to the postal industry's
challenge how to manage the universal service in times of increasing
electronic substitution and to the idea of considering the interrelation
between the postal and the telecommunications industry.

Increasingly, Europe's postal operators seem to fight an uphill battle
against declining demand for physical mail. In a very difficult overall
economic situation, they face the challenge to master increasing direct
competition from market entrants, indirect competition from electronic
communication alternatives, and rapidly changing senders' and receivers'
needs and expectations.

Despite the fact, that the posts are responding through increased
efficiencies and cost-cutting initiatives as well as adopting strategies to
support longer-term growth, in particular the universal service obligation
(USO), the obligation to provide easily accessible, affordable basic
services (with a certain minimum quality) for the whole population, appears
to be controversially discussed. In many countries, the viability of the
universal service in its contemporary form seems to be questionable and
reductions of the service quality and/or additional funding to be
unavoidable if the postal operators do not find additional revenue streams
that compensate for the burden of providing these services especially in
high-cost/low-margin areas.

Therefore, it appears to be appropriate to examine the USO in its current
form, especially with regard to the high dynamics of the wider
communications market, because the current situation provides also huge
opportunities for postal companies, if the regulation is developed further
in order to account for the new realities. Such an integrated approach
should allow the operators flexibility on their path to their future role in
the information society and should also be in line with the Europe 2020
strategy. This public strategy prioritizes \textquotedblleft
smart\textquotedblright\ and \textquotedblleft sustainable
growth\textquotedblright\ and aims to \textquotedblleft exploit
potential\textquotedblright\ that currently hinders addressing the
\textquotedblleft exposed fundamental issues and unsustainable trends that
we cannot ignore any longer\textquotedblright , insufficient use of
information and communication technologies and encourages the review of
regulations to support the transition of service sectors (EU\ 2010a).

Overall, this chapter aims to contribute to the discussion concerning
appropriate regulation with the aim to provide an option that facilitates
the transition towards an efficient and sustainable universal service
obligation and therefore to contribute to fastening the economic recovery
after the current downturn. Starting from the hypothesis that the current
USO\ setting can be improved to the benefit of all stakeholders, the
incumbent operators, competitors and customers, we discuss and assess
alternative settings based on the relevant literature on the USO\ and on
convergence. We show, that taking the developments of the digital
information society into account, rethinking the universal service should be
on the agenda of policymakers already.

\section{The digital edge}

During the last 25 years, the rapid advancements in information and
communication technologies (ICT) led to far-reaching implications not only
for the industries involved but also transformed the whole society. Prices
have declined rapidly while variety and quality of ICT have been increased
rapidly, with mobile and broadband technologies creating new consumer and
business demands, and influencing the way citizens, businesses and
governments interact if not creating entirely new social structures.
Countries and governments are strategically pushing forward their digital
communications sector because they expect to gain substantial and
long-lasting competitive advantages.

New products emerge every day, and some, such as YouTube and Facebook, are
becoming fixed features on our cultural environment. ICT reach has extended
from international, national and local networks to include networks for
businesses, homes, cars, and individuals. And the internet has gone mobile,
as devices on cellular networks have been internet-enabled and are already
used by more than a billion of individuals around the world (ITU-D IDS\
database, values 2011 eoy). Overall, a vast array of applications for
commerce, government, education, health, and entertainment emerged.

These developments further change consumer and business behaviors and
expectations towards communication and communications technologies,
including letters mail. While innovation \textit{around} the postal sector
focused new services and infrastructures which led to inter-modal
competition, substitution, and mail mix changes, innovation \textit{within}
the postal sector for a long time focused mainly improving the efficiency of
the sorting, transport and delivery processes. However, since broadband
take-up and mobile penetration have reached critical masses, a majority of
the pilot projects of postal operators involves ICT to extend the scope of
their services or to introduce entirely new ones.

\subsection{Consumer trends: New needs and expectations}

Due to generally higher mobility and due to the characteristics of the new
communication technologies, electronic postal innovation enhancing speed,
efficiency and convenience for the customer became center-stage, being
hybrid mail a reference example.\footnote{\textit{Hybrid mail} is sent
electronically by the sender, then printed, enveloped and stamped outside of
the sender's premises, and finally delivered physically. \textit{Reverse
hybrid mail} is the electronic delivery/receipt of physical mail after
having been scanned.} Moreover, people and businesses have many ways to
communicate and now take media choice for granted. Although traditional mail
is a proven and efficient means of communication, yet there is no doubt that
faster, cheaper channels will continue to challenge it (Lesur 2007,
p.\thinspace 3). This challenge is reinforced by the developments of
e-services not only from private companies but also in the area of
e-government services (Capgemini et al. 2009).

Although consumers want to have the flexibility and convenience associated
with mobility, a large majority of two thirds and above often still prefers
to receive mail and paper documents, especially concerning financial
documents like invoices and account statements but also product
announcements (with e-mail being preferred secondly, followed by direct
internet access, short messages (SMS) being least liked, cf.\ Szeto and
Jimenez 2005). Thereby, postal operators are situated at the boundary
between the digital and the physical world, providing ample opportunities
for unified messaging and media preference services (Lesur 2008,
p.\thinspace 48). In consequence, \textquotedblleft what we are seeing now
is that images of envelopes and packages can be delivered electronically,
allowing the receiver to decide what, when and how a mail item is to be
treated.\textquotedblright\ (Toime 2009, p.\thinspace 12).

With many different information transmission channels available, individuals
have to manage this new complexity and handle all their financial (banking,
online and tax payment), communication (traditional phone, mobile phone,
internet provider), and delivery services (post office, home delivery of
goods). Electronic access to these services through computers and mobile
phones certainly eases the task to integrate many transactions remotely and
in a convenient fashion. Accordingly, some postal operators started to
extend their service portfolio \textquotedblleft in a move that harkens back
to the unified services that characterized organizations like the Post,
Telegraph and Telecommunication\textquotedblright\ not only with banking,
but also with consumer phone and broadband services with the aim to become
daily-life services integrators by combining the physical and the electronic
world in a trusted, secured environment for their consumers (Lesur 2007,
pp.\thinspace 9-10).

Not only from the developments in the area of ICT, but also from the full
market opening to competition as envied by the EU legislation, consumers
furthermore expect prices to fall without sacrificing the reliability,
confidentiality, or security of transmission, therefore increasing customer
orientation (Ecorys 2008b, pp.\thinspace 17,\thinspace 27).

\subsection{Availability, take-up and effective use of ICTs}

Key for effective use of ICT is to reach the critical mass needed and to
integrate it with existing systems. In order to make the technology
available to consumers, first, a new technology or application has to be
marketed, where innovation, economies of scale, pricing, and trust are
important aspects, the introduction of mobile phones providing an excellent
example for this. Second, technological developments have to ensure, that
the convergence or integration of different platforms becomes possible; for
example, a smart phone combining a mobile phone with advanced capabilities
concerning the network access speed and a functionality similar to personal
(desktop) computers.

Over the last years, fixed as well as wireless networks followed this
pattern with new applications and services being introduced to the markets
with declining prices and extending their geographic coverage. Even when a
specific technology has been promoted to be universally accessible, the
higher-end services associated with the technology (e.g., higher bandwidth)
took time to reach the more remote areas of a country. Sweden, Finland and
Australia, for example, hope to provide fiber-optic networks for
90\thinspace \% or more of their countries' populations only within the next
ten years. Other technologies such as mobile broadband (4G/LTE) or WiMax
networks take time to reach every corner of the country as well but their
implementation is expected to be only a matter of time due to the high
political priority assigned to it.

Nevertheless, even with many technologies being only partially available
throughout Europe yet, the share of the population using the internet on a
regular basis often exceeds two thirds of a countries population with a
share around or above 90\thinspace \% in the Nordic countries such as
Sweden, Norway or Iceland already. Furthermore, not only due to improvements
in the availability of technology but also due to usage changes of the
younger generations, internet usage can be expected to reach nearly the full
population with the next one or two decades which can bee seen from the
share above 95\thinspace \% in the group of young Europeans between 15 and
30 years of age even today (cf., e.g., Eurostat EPP\ statistics database).

The importance of ICTs is also reflected by the consumer expenditures where
ICTs constitute a large part in the everyday life of many OECD consumers
(cf.~figure 5.1). Although ICT-related expenditures represent a small
percentage of the household budget (2.2\thinspace \% in 2007), this part of
the household budget has grown steadily over the last two decades.
Concerning the figures, additionally it has to be noted, that the \textit{%
monthly} expenditures on telecommunications services per private household
in all European countries exceed the \textit{yearly} expenditures for postal
services.

\bigskip 
%TCIMACRO{%
%\TeXButton{Abb_USO1}{\begin{figure}[!htb] 
%\caption{Monthly household expenditures on ICT\protect\footnotemark}
%\begin{center}
%\includegraphics*[width=0.9\textwidth]{./USO-Grafik1.jpg}
%\label{monthspend}
%\end{center} 
%\end{figure}
%\footnotetext{The figure shows the harmonized indices of consumer prices for the EU25. While the general indices for all items have increased by 19\,\% in the last eight years, the indices for communication have declined by 16.4\,\%.}}}%
%BeginExpansion
\begin{figure}[!htb] 
\caption{Monthly household expenditures on ICT\protect\footnotemark}
\begin{center}
\includegraphics*[width=0.9\textwidth]./USO-Grafik1.jpg}
\label{monthspend}
\end{center} 
\end{figure}
\footnotetext{The figure shows the harmonized indices of consumer prices for the EU25. While the general indices for all items have increased by 19\,\% in the last eight years, the indices for communication have declined by 16.4\,\%.}%
%EndExpansion

In conclusion, although for a complete switch to digital services issues
concerning the security and trustworthiness of network infrastructures and
services have to be solved, one can expect the development towards people
being \textquotedblleft always on\textquotedblright , with smart devices,
virtual smart agents and easy-to-use appliances and applications
automatically assisting the users in their daily activities, filtering
information and serving as personal coaches in the near future (DPAG\ 2009).

\subsection{The impact on postal services and operators}

\begin{flushright}
\hangindent=3cm \hangafter=0 \textquotedblleft \textit{Intermodal
competition from electronic media presents a serious threat to the viability
of postal operators as mail volumes decline. It really is the elephant in
the room when it comes to threats to the traditional postal
business.\textquotedblright}\footnote{%
Crew and Kleindorfer (2010), p.\thinspace 11.}
\end{flushright}

\noindent The national postal operators (NPOs) around the world often
attribute the decreases in their own mail volume growth to electronic
substitution and consider e-substitution and competition with other forms of
electronic business communications as a threat to their core service, or at
least to their operating margins. Nader and Jimenez (2005, pp.\thinspace
6-7) provide an overview over different substitution patterns.

However, the actual effects of e-substitution of postal services are
difficult to estimate due to their dependence on the type of mail, market
developments, and senders' and receivers' preferences (cf.\ Diakova 2005,
Nader and Jimenez 2005, Nader and Lintell 2008, Nikali 2010, Veruete-McKay
et al. 2010). In addition, postal researchers and strategists have found
these terms refer to a host of factors in addition to substitution,
including \textit{i)} cutbacks in business-originated mail volumes due to
economic pressures on mailers, \textit{ii)} market share shifts due to
emerging competition from market liberalization, and \textit{iii)} product
substitution (e.g., to a lower-priced mail class, Nader and Lintell 2008,
p.\thinspace 1).

Although forecasts have proven to be unreliable, the precipitous decline of
total mail volume due to electronic alternatives that has been predicted for
more than a decade and continues to be forecasted for the years to come has
not happened. Some analysts are now suggesting the stagnant growth rates of
addressed letters, delivered by national postal operators, could signal a
\textquotedblleft tipping or inflection point\textquotedblright\ and that,
from this point forward, volumes will begin to decline. The clearest trend
is a decline in First-Class single piece addressed letters in a number of
countries (Nader and Lintell 2008, p.\thinspace 3). In addition, it is
widely expected, that the volumes will not recover, maybe in the area of
promotional mail, but not in transactional mail such as account statements,
invoices and so on.

These views seem to be supported by empirical research about the drivers of
mail, and mail substitution. Diakova (2005) and Nader and Lintell (2008)
find that:

\begin{enumerate}
\item Economic growth no longer is a determinant for mail volumes as strong
as in the past in the developed countries while the relationship in
developing and transition countries is still strong.

\item The effects of population dynamics and income distribution complicate
the analysis due to the resulting demand effects.

\item The share of mail sent by businesses continues to grow, thus clearly
assigning the role of senders to businesses (with the share mail sent by
private and small business mailers being below 15\thinspace \%, in some
countries even close to 5\thinspace \% as, e.g., in Sweden; and more than
half of the total volume being generated by the largest 3000 mailers in most
countries), while private households stay important receivers of mail (with
the share of mail received by private households and small businesses above
two thirds).\footnote{%
Household-to-household mail already in 1987 was only about 5\thinspace \% of
the total volume; cf.\ WIK (2005, p.\thinspace 110).}
\end{enumerate}

Furthermore, it seems safe to assume, that the steep volume declines during
and since the economic downturn in the last years will be recovered only
partially. The decreases in several countries reached double-digit numbers,
with Latvia being an extreme case where mail volumes dropped by 33\thinspace
\% in two years. Figure 5.2 illustrates the average development for the
largest postal operators worldwide.

%TCIMACRO{%
%\TeXButton{Abb_USO2}{\begin{figure}[!htb] 
%\caption{Monthly household expenditure on postal services trend}
%\begin{center}
%\includegraphics*[width=0.9\textwidth]{./USO-Grafik2.jpg}
%\label{toadmvol}
%\end{center} 
%\end{figure}}}%
%BeginExpansion
\begin{figure}[!htb] 
\caption{Monthly household expenditure on postal services trend}
\begin{center}
\includegraphics*[width=0.9\textwidth]{./USO-Grafik2.jpg}
\label{toadmvol}
\end{center} 
\end{figure}%
%EndExpansion

Overall, letter post becomes less a medium for exchanging correspondence,
more for delivering advertisements (more \textquotedblleft one-way
broadcast\textquotedblright , less \textquotedblleft two-way
communication\textquotedblright ), and traditional operators become more
dependent on large mailers (WIK 2005, p.\thinspace 170). Due to the related
shifts in mail volumes and the mail mix, consumer-sent mail loses importance
and the needs of the customers reflect a shift away from the relatively fast
transactional mail delivered in E+1 to low priced products with a lower
service quality level in terms of delivery speed (Capgemini
2007,~p.\thinspace 8). Therefore, to date large mailers have been the
primary (direct) beneficiaries of the development of competition on the
postal markets, with improved quality of service, lower prices, and
innovation, while consumers and small businesses have seen limited change or
improvement (Accenture 2008,~p.\thinspace 7). In addition, the upcoming
competitors are concentrating on the most profitable senders and regions,
which is expected to lead to a reduction of the share of first class mail
from 47\thinspace \% in 2007 to 10-15\thinspace \% until the year 2015,
while the share of the mail that is not time-critical increases from 50 to
over 85\thinspace \%. Taken together, these developments in turn are
estimated to decrease the average prices by 20\thinspace \%, leading to
further pressure for quick response by the postal industry (Capgemini 2007).

Given these facts and observations, the established postal operators have to
react to this rapidly developing environment through the \textit{i)}
optimization of their delivery network according to the new realities, 
\textit{ii)} re-positioning of its services to meet the new market needs, 
\textit{iii)} extending the postal territory to include the internet, 
\textit{iv)} improvement of the range of the postal services offered and 
\textit{v)} web-enabling of their services (Donohoe 2007).

Obviously, all of these issues are directly related to the universal service
for the postal industry, and to the entire telecommunications industry.

\section{The Universal Service}

While the \textit{term} \textquotedblleft universal
service\textquotedblright\ can be attributed to Theodore Vail, the former
president of AT\&T in the United States and his slogan \textquotedblleft one
system, one policy, universal service\textquotedblright\ for the telephone
system (Mueller 1997 cited in Young 2005, p.\thinspace 189), the \textit{%
concept} of universal service in communications had its foundations in the
concept of Rowland Hill and his post office reform known as the \textit{%
Penny Post reform }as described by Coase (1939). Although both approaches
aimed to simplify the respective mode of communication, they both differed
substantially from the universal service of today.

Especially for the telephone service, in the beginning universal service was
not associated with the goal of high penetration rates. At the beginning of
the 20$^{\text{th}}$ century, in the US, competition between competing
telephone networks resulted in fragmented networks that lacked
interconnection. Therefore the need to subscribe to different (fixed line)
telephone networks at the same time arose. During that time, the term
\textquotedblleft universal service\textquotedblright\ can be considered
rather to justify the establishment of the protected monopoly of AT\&T and
therefore the elimination of competition in order to solve these problems
and it did not have the connotation of \textquotedblleft a telephone in
every home, affordability, or government policies to subsidize the
telephone\textquotedblright\ (Mueller 1997, pp.\thinspace 3-4 quoted
according to Young 2005, p.\thinspace 189).

Universal service including the meaning of \textquotedblleft a telephone in
every home\textquotedblright\ as it is commonly understood today returned as
late as in the 1970's to the policy debate in the US, when the
rate-of-return regulation for local services was debated with the emerging
competition for long distance calls. During that period the
\textquotedblleft regulated monopoly [\ldots ] (was) retroactively credited
with making the telephone service universally available and
affordable\textquotedblright\ (Mueller 1997, pp.\thinspace 162, 166 quoted
according to Young 2005, pp.\thinspace 190).

Similarly, for the postal service, the original concept of Rowland Hill's 
\textit{Post Office Reform} of 1840 meant neither the delivery to every home
throughout Britain. Although Hill's concept included a certain amount of
cross-subsidization from urban to rural areas, this element of his reform
proposal was mainly justified by his observation, that even at that time
only a minor share of the \textit{transit cost} was dependent on the
destination. Accordingly, his proposal originally only included the
\textquotedblleft primary delivery\textquotedblright , and neither the
collection nor the local distribution of the mail (Coase 1939, pp.\thinspace
423-424).\thinspace Therefore he concluded that there should be -- despite a
change of the payment mode to pre-payment -- a uniform charge for the
\textquotedblleft primary\textquotedblright\ mail conveyance between all 
\textit{villages} in Britain (which quickly turned out to have a great
influence on the mail volumes), and that a (local) system of
\textquotedblleft secondary distribution has to be found in
addition\textquotedblright\ (Coase 1939, pp.\thinspace 427-428).

Recognizing, that \textquotedblleft by definition, a Universal Service
Obligation mandates a flow of subsidy toward one group of users or
another\textquotedblright\ (Panzar 2001, p.\thinspace 102), Coase proposed
the local delivery to bear an additional charge according to the cost
associated with the service level and regional conditions. Therefore the
issue of redistribution was kept rather limited. He argued that
\textquotedblleft if this plan were adopted, the central authority of the
Post Office would be relieved of nearly all care with respect to the
secondary distribution of letters, the frequency, and, consequently, the
expense of which would in each instance be regulated in exact accordance
with the wants of the district.\textquotedblright\ So \textquotedblleft what
he advocated was not uniformity, but uniformity in so far as it was
justified by its costs\textquotedblright\ and combined it with a
subsidiarity approach for the local delivery (Coase 1939, pp.\thinspace
429-430).

Today, the USO in the postal as well as in the telecommunications industry
is designed to safeguard the public's access to a minimum range of (basic)
services. It is associated with the entitlement of natural or legal persons
to obtain a certain set of services at a specified quality on reasonable
terms at any location within a certain territory and might also include
certain infrastructure requirements. Exceptions normally are only allowed in
cases of extreme geographic, demographic or weather conditions (i.e., if
huge distances, extremely sparse population or, e.g., extreme winter
conditions render \textquotedblleft normal\textquotedblright\ postal service
unfeasible).

From an economic point of view, the justifications for such a policy are
limited and should be carefully considered. The USO hardly can be conceived
as an instrument of the policy set with the goal to improve allocative
efficiency, but merely includes \textquotedblleft very dominant non-economic
dimensions, such as distributional or structural policy\textquotedblright ,
although there are arguments related to externalities and to dynamic
(innovation) efficiency (Hart 1998, p.\thinspace 840).

Basically, the \textit{first} of the two main justification categories are
socio-economic reasons (defined as \textquotedblleft goals to be aspired to
at any given time irrespective of historical context or economic
circumstances\textquotedblright , McNeil 2001 quoted according to Young
2005, p.\thinspace 191). These reasons mainly are based on the idea, that a
basic access to telecommunication services is a necessary prerequisite for
participation in a modern society.

Similarly to utilities like electricity or water, communication services are
considered as \textquotedblleft essential to life\textquotedblright , and
therefore the provision of these services can be considered as \textit{merit
goods} which are \textquotedblleft defined as being a part of a `regulatory
safety net' that is recognized as necessary by the vast majority of
society\textquotedblright\ (WIK 1999, p.\thinspace 32). This argument can be
further supported by the fact, that such essential services might exhibit
indirect externalities, for example, if the access to certain services is a
necessity to be able for education and to participate in the labor market
(Hart 1998, p.\thinspace 845). However, opponents of such arguments find
that \textquotedblleft it is difficult to argue [\ldots ] (that the major
social function) places it beyond the realm of discretionary
consumption\textquotedblright\ and see \textquotedblleft structurally
imposed needs\textquotedblright\ (Young 2005, p.\,193).

The \textit{second} category are (purely) economic justifications such as
considering the communication networks as essential for growth and due to
the involved network externalities. On the one hand, communication service
levels were \textit{correlated} highly with income measurements such as per
capita income and GDP. On the other hand, the \textit{causal direction} is
not fully clear in all situations because a growing economy requires the
growth of its communication infrastructure, which in turn provides not a
justification for a universal service so far (Young 2005, p.\,195).

The most convincing argument therefore seems to be that innovation and
development in a modern information society is cumulative and itinerative
which causes broad network access to invoke innovative use which in turn
expands the network further and so on (Young 2005, p.\,196).

Considering these arguments concerning the \textit{existence} of a USO and
concluding that a certain level of universal service is not only politically
but also economically desirable, the problem of the determination of the
efficient level of the USO still remains.

In contrast to \textquotedblleft purely\textquotedblright\ economic
regulations like price or access regulation, over time, the postal as well
as the telecommunications USOs have been steadily extended concerning their
goals. In this period, the communications revolution has brought significant
transformations to the concept of universal service for communication over
the last 20 years. Universal service has evolved from common carriage (serve
all with no discrimination) to a right to access basic services with full
coverage for reasons of cohesion. Moreover, the universal service is now
discussed as a remedy to an informational divide, as the access to
information and content as opposed to services becomes increasingly
important.

Concerning the scope and exact definition of any USO, an optimum has to be
found which balances cost and utility. Problems arise from public choice
theory where policymakers pursue their interests against the
profit-maximizing interest of the firms, with both being likely to fail to
match the public interest. In consequence, technologies might be chosen that
are not efficient in the long run (structural change might be too early or
too late, consumer preferences might be preempted wrongly, cf.\ Young 2005,
p.\thinspace 200), and on the flipside of the coin, \textquotedblleft high
USOs can be damaging to the economic welfare of a country\textquotedblright\
(WIK 1999,~p.\thinspace 19).

Although it is desirable from a social and from an economic viewpoint to
strive for a certain degree of equity, the egalitarian and social arguments
should be carefully balanced against the economic arguments in order to keep
the solution cheaper than the gains or potential problems without any public
intervention (cf.\ Young 2005, pp.\thinspace 204-205 and WIK 1999,
p.\thinspace 9).

Moreover, the design of any USO should reflect the technological dynamics of
the telecoms, information service, and -- due to the interrelation -- postal
markets, which are sufficiently high to discuss the appropriateness of a
dynamic universal service definition instead of a regular review of a static
definition. For example, this approach which is currently taken by the
current EU regulation involves at least a three-stage policy lag of \textit{%
i)} a recognition lag between market developments or technology changes and
the initiation of the European legislation process, \textit{ii)} a decision
and implementation lag on the European level, and \textit{iii)} an
implementation lag in the member countries. It appears questionable whether
such an approach is able to stay in pace with increasingly dynamic
developments. Therefore, the establishment of a dynamic framework might be
preferable for the future development of the universal service (Hart 1998,
p.\thinspace 839).

Finally, an indirect approach to perceived or actual market deficiencies
using public or industry-funded direct subsidies or tax deduction
possibilities to consumers could be more efficient and effective in
realizing the policy goals, although at the moment there seems to be no
chance to implement such a radical approach allowing to trim universal
services to an absolute minimum. Hart even asks why not to discard national
funding solutions and points to a European fund as a source for all
deficitary services throughout the member states, similarly to the
structural development fund (cf.\ Hart 1998, pp.\thinspace 844, 852).

\section{The information society and the EU 2020 strategy}

The Lisbon Agenda in 2000 asserted that for Europe to remain economically
competitive on a global level, its citizens had to embrace the competencies
required to be able to participate in the knowledge economy and in an
increasingly globalized information society. The \textit{Europe 2020 strategy%
}, which succeeded the Lisbon Agenda, laid out the EU's new strategy for
sustainable growth and jobs. It features plans for high speed internet
access, lower prices and unlocking the potential of unused spectrum waves
for new services.

In order to further secure future economic growth, the combined EU 2020
strategy aims to achieve (EU 2010a, 2010b):

\begin{Itemize}
\item Smart growth

\item Sustainable growth

\item Access to high speed internet by 2013 for all Europeans

\item A resource-efficient Europe and the shift towards a low-carbon economy

\item A shared common sense of urgency
\end{Itemize}

The way to achieve these goals should be to promote innovations, to make
full use of information and communication technologies and to ensure that
innovative ideas can be turned into new products and services in combination
with a focus on user needs and market opportunities. In addition, during the
development of the strategy also structural weaknesses have been exposed.
The main weaknesses were identified to be \textquotedblleft talents and
ideas risk going to waste because of uncertainties, sluggish demand and lack
of funding\textquotedblright\ and insufficient use of information and
communication technologies (EU 2010a, pp.\thinspace 7).

Of special relevance here is also, that the European Commission mentioned,
that some sectors might have to \textquotedblleft
reinvent\textquotedblright\ themselves and that she wants to promote the
restructuring of sectors in difficulty towards future oriented activities
and to support this transition of service [\ldots ] sectors with a review of
regulations (EU 2010a, pp.\,9-10,\thinspace 15).

The main objective of the Information Society is to put the potential of
knowledge and information and communication technologies (ICTs) at the core
of the economic development. Effectively, ICTs are regarded as tools for
achieving development, enabling citizens to participate in society and the
economy and releasing economic potential by improving efficiency and through
the introduction of innovative products and services. ICTs are considered to
connect the three dimensions of e-inclusion, e-services and e-government in
order to reach the highest possible development path. Simultaneously, these
dimensions denote the main fields for policy goals:

\textit{First}, e-inclusion refers to the participation in the Information
Society which is becoming increasingly a prerequisite for the participation
in economic and social development in the digital era. Against this
background, the term \textquotedblleft digital divide\textquotedblright\
refers to the gap between those who have access to ICTs that enable
participation in the Information Society and those who do not. Because
e-inclusion is considered to be key for the social cohesion all over Europe,
it is an issue that remains high on the agenda of national and international
ICT policymakers.

Initially, the e-inclusion and digital divide concept was initially used for
the technical, physical barriers hindering the penetration of ICT tools;
however, the emphasis has shifted towards social barriers and now refers
more to a social divide that develops according to who has and does not have
access, enough competence and experience to benefit from digital services
and modern electronic networks. Internet access is best understood as a
spectrum, ranging from people who have never been online, to those who have
dial-up or sporadic access, to those who have broadband at work, at home and
on the move.

Education and in general the transfer of knowledge is increasingly dependent
on digital technologies. The media literates can access these technologies
without difficulty, which enables them to engage with, and participate in
every level of public life, from social networking to e-government.
Individuals not qualified to use digital technologies are often isolated
from this perspective and are excluded from the benefits of digital
participation or online communication. The digital divide can sometimes be
explained by social, educational, economic or cultural background whereas
the differences in adoption break out prominently along two particular
dimensions, which are not mutually exclusive: education and income.

In order to support the Europe 2020 strategy, the goal is to improve media
literacy and ICT skills to improve e-inclusion. Accordingly, the e-inclusion
Ministerial Declaration of 2006 approved by the leaders of 32 European
countries (EU and non-EU) set definitive objectives (EU\ 2006a): the digital
divide between groups facing exclusion (the elderly, the unemployed, those
living with disabilities) and the majority of the society must be reduced by
50\thinspace \% by 2010 in the EU.

\textit{Second}, e-services and the \textquotedblleft digital
economy\textquotedblright\ as the sum of all economic and social activities
enabled by ICTs such as the internet and mobile networks is an integral part
of the information and communication society.

It is generally agreed that the digital economy is essential to a country's
productivity, global competitiveness and improved social well-being. Indeed,
the European Commission studied how a country could use the digital economy
to maximize its potentials and concluded that according to its base-line
scenario, there is still a potential to generate up to \euro\ 55bn of
additional annual income (EU\ 2011, p.\thinspace 11) and to create up to
700,000 new jobs by 2015 (EU\ 2010c, p.\thinspace 25). While governments are
typically entrusted with filling the gap left by the market, addressing
social inequity, protecting the community and assisting markets to work
fairly and efficiently, in the end, however, transforming the advanced
world's economies into digital economies is appropriately a market-led
phenomenon.

\textit{Third}, e-government services aim to facilitate interaction between
citizens and firms with the government and administrations, thus lowering
the overall transaction cost of the whole economy and fasten the related
procedures in order to save time as a valuable resource. Improvements in the
fields of the available service range, accessibility, usability, as well as
their sophistication concerning, e.g., taxes, registrations, administrative
services, permits, declarations, certificates, public procurement, and
social transfers are considered to have similar effects as the improvement
of private e-services and to increase social welfare (Capgemini et al. 2008).

To improve these services, all governments throughout Europe strive to
improve their e-government services through a wide range of actions, while
the European Commission annually support these efforts with further
activities such as benchmarking.

Additionally, supportive action is also taken either by the countries and/or
telecoms, postal, or specialized operators issuing secure digital identities
in the form of electronic ID cards or by integrating such technology in the
national ID cards. These systems address a large part of the existing
security, trust, authentication, and confidentiality problems existing on
the contemporary internet and can be expected to increase the momentum and
foster the development of the digital economies.

\section{Rethinking the Universal Service}

Given the general market developments, the dynamic progress of ICTs, rapidly
changing customer needs and expectations and the related impact on postal
services and operators as described above, and taking into account the EU
2020 strategy with the recognized necessities for some industries (as the
postal industry) to \textquotedblleft reinvent themselves\textquotedblright\
(EU\ 2010a, p.\thinspace 16)\ and for regulators to review existing
regulations in order to support the transition of these industries, it comes
clear, that the postal USO is one of the regulations that deserve revision
and modernization.

While the advantages of a legal USO include that there exist minimum
standards that are known to all, allowing them to plan accordingly and
reducing the possibility of unequal treatment, it has also a number of
disadvantages. It might limit competitive advantages if competition exists,
and efficiency improvements and entrepreneurial flexibility in general. If
legal, the definition of the USO should reflect a set of minimum services
required by the public interest and it should not introduce everywhere the
maximum achieved anywhere. In many cases, the use of other forms of
communication presumably leads to a decreased importance of the service
under consideration in many areas; therefore the USO requirement
developments should reflect this (Fritschler et al. 2008, app.\thinspace H,
pp.\thinspace 13-14).

Although the regulatory frameworks for telecommunications operators seem to
be at least generally appropriate, the aim for better regulation certainly
would include a special emphasis on the investment possibilities and
incentives for broadband operators, independent of the network they use
(fixed telephony, cable TV, mobile, wireless at fixed locations, or
fiber-optical). Sufficient access to radio spectrum, facilitating
cooperation for the roll-out of new networks, and sophisticated access
regulations preserving the value of investments in combination with
regulatory certainty and considering the consumer interests certainly are
encouraging the development of the information society.\footnote{%
For one approach to dynamically efficient regulation, see Baake, Kamecke,
and Wey (2007).}

Despite that the public sees the merits of universal internet access and
wants it, priority should be given to market-based solutions, and to allow
internet access to be supplied at different speeds and through different
networks, since mandatory broadband supply bears the risk of choosing an
inefficient technology. Broadband USO regulations should be defined with
scrutiny and at speeds that can be accepted as \textquotedblleft
essential\textquotedblright , like basic digital subscriber line (DSL)
connections, although it is likely, that even for remote villages it will be
of prime importance to have an internet connection before seeing a postal
carrier in person.\footnote{%
Examples provide, e.g., France (512 kbps), Switzerland (600 kbps), or
Finland (1 mbps).}

At the same time, increased availability of broadband online access gives
also rise to more possibilities to redesign the postal USO in a way, such
that the long-term viability of the postal industry can be secured without
the need for large amounts of subsidies, neither from redistributional
industry funds, nor from public means.

Since postal services compete not only with parcel and express services (at
the margin), but mainly with electronic communication means, the emergence
and increasing importance of these substitutes create challenging issues for
regulation and the need to react accordingly (OECD 2005b, pp.\thinspace
9-12,\thinspace 119,\thinspace 123).

Thereby, thinking about appropriate levels of universal service puts not the
universal postal service concept under attack, but the design of the USO. An
appropriate postal USO adds the consideration of electronic substitutes to
the regulatory rule set, which largely has not been done so far, as the
following statement underlines: \textquotedblleft The universal postal
services mainly between private persons may be partially substituted by
other text communications services (SMS, e\nobreakdash-mail), but most of
the postal items is business-to-consumer letters. These partial substitutes
have not affected regulation in any ways. [\ldots ] So the postal regulation
tries to help the entry of other postal operators into postal service
market, but the competition from other text communications technologies such
as fax, e\nobreakdash-mail, text messaging and others does not influence the
postal regulation.\textquotedblright\ (OECD 2005b, pp.\thinspace 160,
\thinspace 164: Submission of Hungary).

Generally, the principles of necessity and proportionality of regulation are
valid also for universal service obligations, whereas non-universal service
should be withdrawn from sector specific regulation in order to keep the
total costs low, since the lower the (residual net) cost of providing the
universal service to the (historically) incumbent operators, the lower the
cost for the whole industry and, thus, for the whole society. Also, it
should be kept in mind, that \textquotedblleft while of the state's
activities are unquestionable essential, even well-run liberal democracies
do far more that they can do well and almost certainly than they need to do.
There are strong pressures for government to `do something' where nothing
might be far better\textquotedblright\ (WIK 2005, p.\,186).

Although complete withdrawal of universal service regulation is not an
option from a political point of view, it might well be the case that
keeping up a nationwide postal service would be in the self-interest of the
universal service providers even without the legal obligation (cf.\ also
Baake and Wey 2007a).

The reasons for that include the huge investments in sorting facilities as
well as the role of economic enablers between the physical and the digital
world the postal operators aim to fulfill. Posts already have moved into the
\textquotedblleft multichannel space\textquotedblright , offering a large
variety of services from data services to customer response management and
payment management, and now are expanding further into that space to make
postal services mobile by making them digital -- or even expand their
business through diversification in mobile network services themselves.

For example, in Ireland, An Post has launched the mobile virtual network
operator \textquotedblleft Postfone\textquotedblright\ which is based on
prepaid subscriber identification modules (\textquotedblleft SIM
cards\textquotedblright ) from Vodafone, offering a single simple tariff.%
\footnote{%
hellmail (08. June 2010): An Post Invests In Postfone.
\par
(http://www.hellmail.co.uk/postalnews/anmviewer.asp?a=2232\&print=yes).}
Such a system based on wireless technology could eventually turn out to be
an well-suited platform for universal service transition, since with an own
mobile virtual network operator not only additional revenues could be
obtained, but also postal sites could easily be made accessible for free in
order to increase the acceptance of any digital delivery service or to
provide enhanced services like short message notification in case of
incoming letter mail and parcels.

Another example is e-post, an online service from Canada Post, where private
customers can view, pay and manage also their bills online. Instead of
visiting multiple websites, the consumer receives all his or her bills from
organizations subscribed to the service into one online mailbox. This
mailbox can be accessed via its own URL or at the website of the consumer's
preferred online bank. Secure payment and organization of the bills is
carried out from one virtual location, making the service convenient.

The ability to scan a letter and send the content to a distant customer via
a secured electronic mailbox would significantly decrease the cost of
delivery and offer receivers more choices with their mail. Such services
allow users to manage their mail remotely through a personal electronic
mailbox where they can see their mail and request that the company open it
and scan it for them. Interestingly, very few items sent via Earth Class
Mail end up being delivered physically. In addition to providing customers
with a choice in how to receive their mail, posts can contribute to the
protection of the environment by helping their customers to shift to
electronic transactions when and where this form of communication is
appropriate (Lesur 2007, pp.\,14-15).

More generally, their role as multichannel communication providers (similar
to the former PTTs) could be crucial to adapt to the new market realities:
\textquotedblleft We could see that physical mail volume would drop over the
years and we saw that we would need to offer different things to our
customers. Our strategy is that it shouldn't matter for us if the customer
needs some kind of physical or digital delivery. We are and should be able
to receive any kind of data and handle it physically or digitally. It's just
adapting to market demands and accounting for the strong impact of
technology.\textquotedblright\ (Belli 2010, p.\,45).

With an ongoing USO, nevertheless there are several options worthwhile to be
considered:

\textit{First}, the traditional variants relaxing the obligations in order
to save costs, e.g., centralized PO boxes, reduced delivery frequencies in
remote areas, the outsourcing of rural deliveries, or differentiated
pricing, although political support can be assumed to be lacking today.

\textit{Second}, the service levels required might be made \textit{contingent%
} upon the availability and/or acceptance of convenient alternative means.
For example, a recipient might not insist on a daily delivery if he gets in
turn a workable electronic delivery (thereby ensuring that all requested
items are delivered physically). For reasons of planning security, this also
could be combined with the approach of Hart (1998), where different classes
for the telecommunications services are defined, an where the minimum postal
delivery frequency is made contingent upon the classification of the
according location (\textquotedblleft Class I: Basic high quality services
(Minor League), Class II: State-of-the-art services (Major League), Class
III: Broadband for all (Bandwidth League)\textquotedblright , see Hart 1998,
p.\thinspace 848). Although this system creates a two- or three-tier system,
it might be fully in line with the users' preferences if they gain more from
electronic access than they lose from reduced delivery frequency, and it
might even speed up delivery, if the mail is scanned already in the outward
mail sorting center. According to Itella, their trial tests with a system
like that in Anttila, Finland, had gone very well.

As an orientation for the design of the service quality requirements of the
different tiers, the service charter proposal template from the Strategic
Review of the Canada Post corporation might come in handy: It defines three
percentage values of mail which have to be delivered within two to four
working days, three shares of the population with daily, three-times-a-week
and weekly service, and it contains elements to ensure that only communities
are not served on a daily basis if an appropriate rationale exists in order
to safeguard the citizens interests (Campbell 2008, pp.\thinspace 105-108).
With such an approach, the population density metrics should be considered,
too (Accenture 2008, p.\thinspace 45).

In addition, it can be argued, that postal operators have the interest to
stick to excellence in delivery, since it represents their quintessential
core competence and they should understand the dangers of reducing their
quality which might be \textquotedblleft playing in the hands of their
competitors\textquotedblright\ and may cause further volume declines, both
from end-to-end and access customers (Crew and Kleindorfer 2010,
p.\thinspace 14). This view is confirmed by other authors who estimate the
traffic reduction effect of delivery frequency reduction between 15 and
20\thinspace \%, depending on the initial and the new situation (Pearsall
and Trozzo 2010 and Boldron et al. 2008). This is, although only some
mailers still have to rely on everyday delivery (communications,
newspapers), while others require rather day-definite delivery
(advertisements on Friday). Therefore a varying frequency according to the
mailing patterns and the related volumes, to geographic density, or to
particular content are options that should be open for consideration.

On the receiver side, a survey conducted on behalf of the USPS showed, that
slight decreases in delivery frequency to five days a week to the majority
of the respondents would not affect them at all or very little, while a
reduction to three days a week would be very significant for 42\thinspace \%
of the respondents in rural areas. Interestingly, two thirds of the
respondents would eliminate Saturday delivery, followed by Monday and
Wednesday with about ten\thinspace \% each (Fritschler et al. 2008,
pp.\,9-10). If such service adoptions occur only if broadband services are
made available, even the leaving signals giving up on community or certain
regions is avoided.

One drawback of such an approach is, that, looking at the post offices, it
can be expected that their number is likely to decrease or at least that
they are transferred to franchisees, because in most countries the
distribution of post offices is very different than it would be if post
offices were distributed on the basis of market forces. Arguably, pharmacies
are at least as important to the average citizen as post offices. Comparing
the geographic distribution of a commercial service, like pharmacies, with
the distribution of post offices illustrates what the distribution of post
offices may look like if it would be driven by market forces. It is likely
that the distribution of post offices in most postal administrations is
disproportionately rural (Cohen et al. 2008, pp.\thinspace 325,\thinspace
331,\thinspace 335).

When postal administrations enjoyed strong monopolies, this kind of
non-economic distribution was quite acceptable. The monopoly forced everyone
to pay for various types of non-economic behavior. However, postal
administrations face increasing indirect competition from the internet and
(the prospect of) direct competition from liberalization. It is likely that
bulk mail and not single-piece mail will be subject to direct competition.
If so, it will be difficult to charge the cost of the retail network to
competitive bulk mail, since most mail-related retail activities are for
single-piece mail (Crew and Kleindorfer 2010, p.\thinspace 1).

This problem stems from the fact, that the mechanisms currently financing
universal service are best suited for a regulated market where limits on
competition guarantee economic returns that are sufficient to allow firms to
subsidize their own high-cost consumers.\footnote{%
Report of the US Senate No. 108-318, 108th Congress, 2nd session, 22-23
(August 25, 2004).} In very remote areas revenues from subscribers to the
postal network could be taken into consideration. If such a subscription
would include a certain amount of letter mail to be picked up and sent
without additional charge (similar to a volume plan for mobile subscribers),
this might be an interesting option for regular users of mail.\footnote{%
In the United States and in other countries, rural carriers already provide
retail services to recipients along their route. In this way, they can
obtain virtually every service offered to consumers and small businesses. In
most cases, however, customers of closed offices feel that rural carrier
service is an inadequate substitute. In communities where post offices have
been closed, there are few if any, businesses catering to the residents
(Cohen et al. 2008, p.\thinspace 327).} Alternatively, a price break could
be granted if they opt out for less frequent delivery or for pick-up from a
local retail outlet (Matthews 2004), although since the signing of the deed
of understanding between the postal operator and the government in New
Zealand the postal operators seem to refrain from this funding option.

A less disputable change in pricing is related to the uniformity of tariffs
which can be expected to stay for households and small businesses (single
item mail), but is unlikely to remain for bulk mail (as it is already
differentiated in Germany, the Netherland, New Zealand and Sweden). Uniform
tariffs in combination with network access allow for cherry-picking of
competitors, therefore it should also not be mandated by the regulator (WIK
2005, p.\thinspace 138). In addition, by allowing flexible and zonal access
pricing, subject to transparency and non-discrimination rules, regulators
can help to promote a climate in which access and wholesale operations of
the postal operators can grow, while simultaneously promoting
customer-focused innovations in their end-to-end retail operations to
preserve single-piece volumes (Crew and Kleindorfer 2010, p.\thinspace 14).
On the other hand, due to the fact, that new competitors often serve only
the market for bulk mail, in order to keep the pricing schedule simple, and
due to the little cost differences already observed by Rowland Hill (see
above), uniform pricing is less problematic if it is required for single
items,\footnote{%
As it is the case, e.g., in Austria, Australia, Belgium, Spain, Poland,
France, the Netherlands, Sweden, UK, Finland and the US, cf.\ Accenture
2008,~p.\thinspace 39.} in some countries it is practiced anyhow although it
is not required.\footnote{%
This is the case in Italy, Canada, Germany and New Zealand, see Accenture
2008,~p.\thinspace 39.} Furthermore, such a pricing schemes also in line
with the preferences of the customers, where medium and large mailers would
accept non-uniform rates, while consumers and small businesses are reluctant
to accept such a pricing scheme (WIK 2005, p.\thinspace 109).

\section{Conclusion}

Of all the elements of a nation's infrastructure, the communication
technology infrastructure is the most rapidly evolving one. Because it never
happened that a new communication medium like the telephone or the
television has ever replaced a previous means of communication completely,
and although \textquotedblleft postal services are not part of a sunset
industry, but rather will continue to play a significant role in the world's
economy and information society for years to come\textquotedblright\
(Accenture 2008,~p.~16), the postal sector nevertheless faces its relative
position in the communication mix being challenged.

Therefore there may be a change of the universal service based on the change
of the social and economic status of a service once it passes a certain
threshold. It follows, then, that once a service becomes widely used, access
to the service becomes a definition of economic and societal participation,
or an inclusive right (or, vice versa, the scope of the right is reduced).
The current discussion as whether to widen the definition of universal
service beyond the provision of one specific type of service to encompass a
multi-channel USO concept called the technology-neutral USO or the
communication USO should lead in tendency to a reduction of the
\textquotedblleft classic\textquotedblright\ postal part of the USO. While
such a move could be considered more in line with the changing market
reality, new questions could emerge such as what services should be covered
by the redefined universal service obligation, and on what terms.

For several reasons rethinking, re-evaluating, and re-designing the USO is
appropriate. First, we have moved away from the monopoly approach in
telecommunications and, soon in Europe, postal services. Postal operators
compete not only with each other, but also against other players operating
different modes of conveyance. Second, the rapid progress of
telecommunications technologies and their convergence with other forms of
communication present an opportune time. This is particularly the case given
the extent to which telecommunications such as facsimile, e-mail and
internet access now substitute for postal services. Moreover,
internet-powered technologies might allow us to redefine the letter mail
delivery model. We see evidence of this already when postal consumers in
remote areas opt to accept less frequent mail deliveries in exchange for
improved electronic substitutes. Still, the concerns regarding providing
service in rural and remote areas will remain a significant issue for a long
time. In remote areas, there are relatively more households that have
inadequate access to telecommunications services and that rely more strongly
on the postal service. However, governments are stepping up their efforts to
roll-out high-speed broadband services to every household in the country and
encourage digital inclusion. With these developments, the pressure on posts
increases, but at the same time new windows of opportunity open and possible
synergies between mail and ICT technologies shape the answers to the
question on how the future USO shall be designed.

\clearpage\ifodd\count0\else\thispagestyle{empty} \hbox{}\newpage \fi

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\end{document}
