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Royal Mail Unveils Financial Re-Organisation And Investment Plan PDF Print E-mail
Thursday, 08 February 2007

Royal Mail, operator of Britain’s state-owned mail service and the Post Office network, is today unveiling an ambitious investment plan to strengthen the group’s finances, improve competitiveness and reward its workforce.

The five-year programme, agreed by the Government, will re-position Royal Mail to compete more effectively with commercial rivals and address major funding challenges for the company.

Highlights of the programme include:

• Government agreement for a £1.2bn debt facility, on commercial terms, to modernise Royal Mail operations
• Restructuring of the Post Office network, already approved by Government
• £1bn investment in an escrow account to give security to the pension fund trustees, including £850m from company reserves and a further payment of £150m by Royal Mail
• Royal Mail agreement in principle with the pension fund trustees to fund the pension deficit, currently standing at £6.6bn, over 17 years
• Consultation on how best to safeguard an affordable final salary pension scheme for existing employees
• Consultation on replacing the final salary scheme for newly recruited employees with a defined contributions scheme
• Inaugural "phantom" share scheme to reward Royal Mail’s 190,000 employees, worth up to £5,300 per employee over five years - equivalent to a £1bn dividend distribution.

Alistair Darling, Secretary of State for Trade and Industry, said: "We fully support the business in delivering the programme of reform that it needs to undertake. We recognise that there are a number of difficult changes that need to be made to the way the company operates, including limiting the pension liability going forward, and fully support the business in making them. It is for the management and staff to make the changes necessary to give the company a sound platform on which to build for long-term success in a competitive market."

Allan Leighton, Royal Mail Chairman, said: "Continuing to transform our operations isn’t optional. We will do so while also rewarding our people for their efforts and allowing them to share in our continued transformation."

Adam Crozier, Royal Mail Chief Executive, said: "Our goal is to have a strong and healthy Royal Mail - providing better services than our rivals and with a real chance to compete in the open, competitive market place. We have been talking for some time about how we need to modernise this business to compete. Now we have the means to get on with it."

Financial Performance

Operations have already been transformed under the new management team at Royal Mail. As a result - and with the support of the group’s workforce - losses that were running at £1m a day four years ago have been transformed into a £355m operating profit last year.

However, the cost of servicing the pension fund has continued to be a major drain on the group’s financial performance. The servicing costs of the fund rose by £280m to £730m in 2006-07. As a result, interim profits at Royal Mail fell to £22m from £159m in the first six months of the 2006-07 financial year, in spite of a 1.4% increase in revenue to £4.4bn. Although the decline is in line with management expectations, the £730m annual cost of servicing the pension fund is threatening Royal Mail competitiveness.

Restructuring to Date

The modernisation programme follows significant action by management and all employees to transform Royal Mail. Historic losses have been wiped out following the changes.

The improvements to date have led to:
• Record quality of service
• Improved productivity
• Reduced absenteeism
• Better industrial relations
• Substantial increase in basic pay - 25% over the last four years - and "Share in Success" payments of around £1500 have played an important role in motivating the workforce.

Details of Royal Mail Modernisation

1. Competitive and Regulatory Environment

The sweeping modernisation of Royal Mail, one of Britain’s iconic companies, follows a major shift in the competitive environment for postal services, compounded by structural changes - in the internet age - in the way information is received and consumed.

As a result of these new market forces and stringent regulatory constraints:
• Total volumes in the UK mail market fell by 2 per cent year on year in the first half of 2006-07
• Competitors are expected to handle some 2.5bn items of mail this year out of a total volume of 22bn handled by Royal Mail - currently Royal Mail loses around 2p on every one of these items
• Operating losses at the Post Office have doubled to £4m a week following the loss of Government contracts to handle pensions and benefits business.

Royal Mail cannot compete on commercial terms because of the constraints on its pricing and flexibility imposed by the regulator. In this environment, it will be increasingly difficult to protect volumes and revenues. Royal Mail must respond to these significant market challenges and continued pressure on group finances by accelerating its modernisation programme to improve productivity and cut costs further.

2. Future Modernisation

The Government has agreed a financial package based on a new strategic plan for the next five years. The plan includes:
• Commercial loans to invest about £1.2bn in Royal Mail to modernise the business - these loans need to be repaid out of productivity gains
• £1bn injection to safeguard pensions and address the deficit - including £850m from company reserves and a further payment by Royal Mail of £150m
• Separate funding agreed already for the Post Office network to restructure it over next five years
• Return on the investment will require significant improvements in competitiveness - but will offer a substantial return to Government if plans succeed
• Productivity will need to be addressed across the group
• Employees will be rewarded for their contributions, in addition to pay, through an innovative phantom share scheme.

3. Phantom Share Scheme

Royal Mail and the Government, its shareholder, have agreed to set up a "phantom" share scheme for all employees. In its application, the scheme will be similar to that operated by the John Lewis Partnership, one of the UK’s leading retailers.

Under the terms of the scheme:

• 20 per cent of the value of Royal Mail today will be earmarked for employees
• Shares will be distributed equally to every employee, from board members to frontline delivery staff
• Up to £1bn could be distributed to employees if modernisation targets are reached
• Shares will be distributed free, they will not be paid for
• Employees holding shares will receive an annual profit share, based on Royal Mail’s performance
• The profit share combined with the phantom shares themselves are expected to be worth up to £5,300 per employee over five years, depending on performance.

Allan Leighton, Chairman, said: "The task facing our people is daunting. That’s why we are particularly pleased that the shareholder has agreed to an employee incentive scheme similar to the one run by the John Lewis Partnership. It will underpin the commitment and engagement of our people who, we know, are capable of transforming this vital business on which the whole country depends."

4. Pension Scheme

Given the competitive situation and the pension deficit, Royal Mail is today announcing steps to tackle the issue. After careful consideration, the group management has agreed the following steps to protect the interests of existing employees and provide safeguards for newly recruited staff.

• Consultations will take place on ways to safeguard an affordable final salary scheme for all existing employees
• Separate consultations will begin on replacing the final salary scheme for newly recruited employees with a defined contributions scheme
• Consultations are expected to begin in April and continue for about six months
• Any resulting changes will affect all employees from board members to frontline staff
• Royal Mail has also reached an agreement in principle with the pension fund trustees to fund the pension deficit, currently standing at £6.6bn, over 17 years. Increased payments are already underway, reflecting the company’s commitment to its workforce
• Under the new modernisation programme, £1bn will be held in escrow accounts to provide security for the pension fund trustees.

Adam Crozier, Chief Executive, said: "It is important we safeguard the future of the pension fund for our people, who regard having a final salary pension scheme as a key benefit of working for Royal Mail.

"But the £730m annual cost of servicing the pension fund clearly damages our competitiveness as we need to increase the price of our products and services to pay for it. Around 93 per cent of our mail volumes come from business customers and they should not have to pay for the increased cost of our pensions - and if we ask them to do so more of them will simply go to the competition.

"So to ensure the problem does not get worse for the company or our pension fund members we will now begin a six month consultation on replacing the final salary pension scheme for new recruits with a defined contributions scheme, and on the best way to safeguard an affordable final salary scheme for our existing employees."

5. Management & Government Endorsement

Royal Mail management and Government ministers have agreed the plan following several months of detailed talks and proposals.

Today’s announcements provide clarity and confidence for the Government about the continued prospects of Royal Mail and the Post Office network.

Adam Crozier, Chief Executive, said: "These are enormous challenges but if Royal Mail is to compete and thrive, there is no alternative to change."
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