Royal Mail warns £500m revenue cut would be 'fatal'

Allan Leighton, chairman of loss-making postal monopoly, brands regulator's three-year price curbs as 'mission impossible'

The chairman of the Royal Mail warned last night that it could go bust after the postal regulator announced "shocking" price curbs which will cut the company's revenues by almost £500m.

Allan Leighton, the ex-Asda boss who now runs the postal system, described Postcomm's proposals as a "disaster" and said he would have no option but to appeal to the Competition Commission unless the regulator backed down.

"We are already attempting the turnaround of all time but this has made it mission impossible," Mr Leighton said. "Could we go bust? Well. Every business goes bust when it runs out of cash and it is hard to see how we can find the funds to live with these proposals."

But Graham Corbett, the chairman of Postcomm, dismissed Mr Leighton's apocalyptic warning as the predictable response of a regulated company faced with new price controls. "He is crying wolf very loudly. Frankly, it is absolutely absurd for the Royal Mail to have leapt to the conclusions that it has," Mr Corbett said.

Under Postcomm's proposals, the price of first and second class post will rise by 1p from next April but after that prices will be frozen for three years. In return for the 1p price rise, which is worth about £170m a year to the Royal Mail, it has been given much tougher performance targets and will have to pay compensation to its customers if it fails to meet them.

Domestic customers will be entitled to up to £27 compensation for each letter which gets lost in the postal system and £14 for each letter which is delayed. Bulk mail customers will receive rebates on their bills on a pro-rata basis depending on the amount by which the Royal Mail underperforms its targets.

Since the Royal Mail, on its own admission, loses half a million letters a week and fails to deliver one in 10 letters on time, the compensation payments could soon add up to a big number.

So far, so good. The Royal Mail has no quibbles with the price freeze or the new performance regime. But, says Mr Leighton, the devil is in the regulatory detail. Royal Mail claims that hidden in the 100-page consultation document issued by Postcomm yesterday are some extremely onerous conditions which will cut its revenues by some £460m over the next three years.

First, Postcomm's proposals are based on a calculation of what the average weighted price is of the 21 billion items of mail delivered each year by the Royal Mail. So, the more successful it is in promoting high-value services – such as the £3.65 guaranteed-next day special delivery – the more it will have to cut other prices to keep to its weighted average. It reckons this alone will cost it £300m in revenues.

Second, Postcomm has decided to extend its reach so that virtually everything Royal Mail delivers will be subject to regulation, not just items in the current "monopoly zone" which cost less than £1 to post. Royal Mail estimates this will lead to a further £130m reduction in revenues.

Third, Postcomm describes its proposals as a price freeze but in fact Royal Mail will have to hold prices to the rate of inflation minus 2.5 per cent. Since inflation is well below this level, Royal Mail argues that it is actually facing a price reduction which will knock a further £30m off its revenues.

"The regulator is giving with one hand and grabbing back even more with the other. This is regulation gone mad," Mr Leighton said.

As if that were not bad enough, the Royal Mail is facing the end of its 300-year-old monopoly. From next January, 30 per cent of its market will be opened to competition when rival operators will be able to bid for the business of large bulk mail users – those who despatch more than 4,000 letters at a time. A further 30 per cent of the market will be thrown open from April 2005, when all bulk mail will be opened to competition. And from April, 2007, the entire market will be liberalised enabling anyone to send their post using any operator they want.

Rival national operators such as Deutsche Post and the Dutch post office, with which Royal Mail very nearly merged earlier this year, have already been given licences to start competing in the UK.

In preparation for this the Royal Mail, which is currently losing £1.5m a day, has embarked on a £1.4bn cost-cutting programme which involves 30,000 job losses and the closure of 3,000 post offices – one-sixth of the network.

The cost of the three-year restructuring plan, described by Mr Leighton as the most ambitious turnaround ever attempted by any business organisation, is put at £2.4bn. Of this, £1.8bn will be met by the taxpayer through the National Loan Fund and £600m will be self-financing, paid for by the savings Royal Mail makes along the way. Mr Leighton says the price curbs put forward by Postcomm, requiring Royal Mail to find another £460m from somewhere, amount to "an impossible burden and would fatally damage our chances of recovery".

He says Royal Mail cannot afford to take on more borrowings because it would not be able to repay them. Nor is it in a position to cut into its costs much further since it is already getting rid of 15 per cent of its workforce. "We cannot rule out further job losses but that would not be our first port of call," Mr Leighton said.

He says that he first spelt out to Mr Corbett the disastrous financial consequences of what Postcomm was proposing three weeks ago.

Mr Corbett says Royal Mail's calculations did not reach him until Tuesday night – 24 hours before his proposals were issued under embargo – and even then they took the form of a single sheet of paper.

Pitched battles between regulators and the companies which they police are not unusual. In fact, they have become a familiar part of the economic landscape since the privatisation of industries such as gas, telecoms, water and electricity began in the mid-1980s and the Government created regulators to mimic the competitive forces these state-owned monopolies would otherwise face.

But Royal Mail is different in one crucial respect. It now finds itself regulated and yet still state-owned – the worst of all worlds. As the battle raged in public yesterday between Mr Leighton and Mr Corbett, the one dog that did not bark was the Department of Trade and Industry, the Royal Mail's 100 per cent shareholder.

Behind the scenes ministers are said to have made their unhappiness with Postcomm plain and yet they cannot afford to be seen in public second-guessing the decisions of the independent regulator they set up.

Royal Mail has two months to persuade Postcomm to change its mind before yesterday's consultation paper turns into a set of final price controls. Mr Corbett shows few signs of rolling over. Indeed, he says: "If we had come out with a set of proposals which Royal Mail were happy with I would have been very disappointed."

Mr Leighton seems equally determined not to give ground. "This is an argument we cannot afford to lose. If anything, I am even more determined now to defend the organisation."

Let battle commence.