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United Parcel Service Inc. v. Postal Regulatory Commission

United States Court of Appeals, District of Columbia Circuit

May 22, 2018

United Parcel Service, Inc., Petitioner
Postal Regulatory Commission, Respondent Valpak Franchise Association, Inc., et al., Intervenors

          Argued January 22, 2018

          On Petitions for Review of Orders of the Postal Regulatory Commission

          Jeffrey A. Lamken argued the cause for petitioner. With him on the briefs were James A. Barta, Steig D. Olson, and Sara E. Margolis.

          Bryan N. Tramont and Craig E. Gilmore were on the brief for amicus curiae J. Gregory Sidak in support of petitioner.

          Michael Shih, Attorney, U.S. Department of Justice, argued the cause for respondent. With him on the brief were Michael S. Raab, Attorney, David A. Trissell, General Counsel, Postal Regulatory Commission, and Christopher J. Laver, Deputy General Counsel.

          Morgan E. Rehrig and Eric P. Koetting, Attorneys, U.S. Postal Service, Peter DeChiara, David M. Levy, John F. Cooney, and James Pierce Myers were on the brief for intervenors in support of respondent.

          Before: Tatel, Srinivasan, and Pillard, Circuit Judges.


          Tatel, Circuit Judge:

         The U.S. Postal Service holds congressionally authorized monopoly power over the market for some of its products, like first-class mail delivery, but for other products, like parcel post, it competes with private companies. To promote fair competition, Congress tasked the Postal Regulatory Commission with ensuring that the Postal Service sets competitive products' prices high enough to cover all "costs attributable to [those] product[s] through reliably identified causal relationships." 39 U.S.C. § 3631(b); see also id. § 3633(a)(2). In two 2016 orders, the Commission directed the Postal Service to include among the "costs attributable" to competitive products those costs that would disappear were the Postal Service to stop offering those products for sale. United Parcel Service, Inc., which competes with the Postal Service, petitions for review of both orders, arguing that the cost attribution methodology the Commission embraced is both inconsistent with the statute that gives the Commission its regulatory authority and arbitrary and capricious. For the reasons that follow, we deny the petitions.


         Congress created what is now the Postal Regulatory Commission (the "Commission") in 1970 to oversee the U.S. Postal Service's efforts to set "reasonable and equitable rates of postage and fees for postal services." Postal Reorganization Act, Pub. L. No. 91-375, § 3621, 84 Stat. 719, 760 (1970) (codified as amended at 39 U.S.C. § 404(b)); see also id. § 3601, 84 Stat. at 759 (establishing the Commission). The 2006 Postal Accountability and Enhancement Act (the "Accountability Act"), Pub. L. No. 109-435, 120 Stat. 3198 (2006), provides the framework within which the Commission currently exercises this oversight authority.

         Under the Accountability Act, all Postal Service products are either "market-dominant" or "competitive." See 39 U.S.C. § 3642(b)(1). Market-dominant products are those over which "the Postal Service exercises sufficient market power that it can effectively" raise prices or decrease quality "without risk of losing a significant level of business to other firms offering similar products." Id. To prevent the Postal Service from "improperly leverag[ing]" this market power, U.S. Postal Service v. Postal Regulatory Comm'n, 785 F.3d 740, 744 (D.C. Cir. 2015), the Act requires the Commission to limit rate increases for market-dominant products, see 39 U.S.C. §§ 3622(a), (d)(1); see also 39 C.F.R. §§ 3010.1-3010.66 (implementing this mandate).

         Different concerns attend competitive products-products over which "the Postal Service faces meaningful market competition." U.S. Postal Service, 785 F.3d at 744. For such products, Congress wished to "ensure that the Postal Service competes fairly, " S. Rep. No. 108-318, at 15 (2004) ("Senate Report")-that is, without using revenues from market-dominant products subject to its monopoly power to defray costs competitive products would otherwise have to be priced to cover. The Accountability Act therefore requires the Commission to promulgate regulations that "prohibit the subsidization of competitive products by market-dominant products, " 39 U.S.C. § 3633(a)(1); "ensure that each competitive product covers its costs attributable, " id. § 3633(a)(2), defined as "the direct and indirect postal costs attributable to such product through reliably identified causal relationships, " id. § 3631(b); and "ensure that all competitive products collectively cover what the Commission determines to be an appropriate share of the institutional costs of the Postal Service, " id. § 3633(a)(3).

         In effect, the Accountability Act subjects each competitive product to a "price floor, " U.S. Postal Service v. Postal Regulatory Comm'n, 842 F.3d 1271, 1272 (D.C. Cir. 2016) (per curiam), which must be set high enough to cover both that product's "costs attributable, " 39 U.S.C. § 3633(a)(2), and a portion of the Postal Service's "institutional costs, " id. § 3633(a)(3), which the Commission construes to mean "residual costs, " i.e., all costs that are not costs attributable, see Order Concerning United Parcel Service, Inc.'s Proposed Changes to Postal Service Costing Methodologies (UPS Proposals One, Two, and Three), No. RM2016-2, at 10 (Postal Regulatory Comm'n Sept. 9, 2016) (updated Oct. 19, 2016) ("Order").

         This case concerns the Commission's rules for apportioning postal costs between "attributable" and "institutional" costs. 39 U.S.C. §§ 3633(a)(2), (a)(3). Treating the latter category as "residual" of the former, Order at 10, Commission regulations focus on identifying which costs are "attributable to [a specific] product through reliably identified causal relationships, " 39 U.S.C. § 3631(b). In doing so, the Commission distinguishes (albeit necessarily imperfectly) between "fixed costs, " such as executive salaries, which remain constant regardless of overall product volume, and "variable costs, " such as wage labor or raw materials, which vary with the Service's production levels. Order at 6; see also Responses of the United States Postal Service to Questions 1-4 of Chairman's Information Request No. 2, No. RM2016-2, at 11 n.9 (Postal Regulatory Comm'n Dec. 10, 2015) ("Postal Service Responses") (acknowledging that "fixed costs can be difficult to identify in practice"). Except for certain product-specific costs not at issue, fixed costs are not attributed to particular products and so are considered institutional. See Order at 9 & n.12 (attributing only those fixed costs "that are uniquely associated with an individual product, " id. at 9, such as product-specific advertising costs). The issue here is what portion of the Postal Service's variable costs can be reliably attributed.

         Broadly speaking, the Postal Service, in implementing Commission regulations, attributes variable costs on an activity-by-activity basis. After drawing up a list of the discrete production activities, such as highway transportation, that collectively account for its total variable costs, the Postal Service calculates what share of each activity's costs can be attributed to each product. See Order App'x A at 13-14 (laying out this process); Postal Regulatory Comm'n, FY16 Public Cost Segments and Components Report (2016), (listing production activities). To perform this calculation, it first identifies an activity's "cost driver, " defined as the unit of measurement that best captures the activity's "essen[ce]." Order App'x A at 14. For example, highway transportation is measured in cubic-foot-miles, such that one "unit" of cost driver in this context represents one cubic foot of mail being transported one mile. See id. Then, the Postal Service determines the share of each activity's cost-driver units that each product is responsible for generating, typically by conducting worksite observations in order to produce a "distribution key" that, like a pie chart, illustrates an activity's product-by-product breakdown. See id. at 9; see also Order at 9 n.14; Office of Inspector General, U.S. Postal Service, A Primer on Postal Costing Issues 17-18 (Mar. 20, 2012), (explaining the role of distribution keys).

         The present dispute stems from the uncertainty inherent in translating this product-by-product breakdown of activity quantity into a similar breakdown of activity costs, given the cost savings that accrue as total production volume increases. If every cost-driver unit were equally costly, the distribution keys could be used to apportion all an activity's costs to specific products: a product responsible for 5% of the cubic-foot-miles accrued in highway transportation, for example, could be linked to 5% of that activity's costs. But not all cost-driver units are created equal. Under the principle of diminishing marginal costs, the cost of adding each new unit- in economic parlance, that unit's "marginal cost"-decreases as production quantity increases, due to the efficiency gains that result from scaling up operations. See Order at 35 ("As a result of economies of scale and scope, the marginal cost of individual units of volume . . . decreases with volume."); see also Order App'x A at 2 (defining marginal cost). To transport one cubic foot of mail, for instance, the Postal Service must make an initial outlay to hire a driver and maintain a truck. But throwing a second cubic foot of mail onto the truck carries fewer additional costs, and a third cubic foot carries fewer still. Given this variability, introducing a new product line that increases the Postal Service's total cubic-foot-mileage by 5% may well increase highway transportation costs by something less than 5%. Due to diminishing marginal costs, therefore, the share of cost-driver units a particular product generates might not determine the share of costs that can be reliably linked to that product.

         Historically, the Commission dealt with this uncertainty by directing the Postal Service to attribute to specific products only that portion of an activity's costs that would result if every cost-driver unit cost only as much as the unit with the lowest marginal cost. Put into agency lingo, the Commission had the Postal Service attribute only an activity's "volume-variable cost[s], " defined as the marginal cost of the "last, " i.e., cheapest, cost-driver unit, multiplied by the total number of units accrued. Order at 36 n.56; see also id. at 9. A Commission graph, reproduced below as Figure 1, illustrates volume-variable costs. The downward-sloping curve shows a hypothetical activity's diminishing marginal cost (marked on the vertical axis) as production quantity (marked on the horizontal axis, and measured in cost-driver units) increases. The shaded rectangle represents this activity's volume-variable costs-the $1 marginal cost of the twentieth cost-driver unit, applied to all twenty units.

         (Image Omitted)

         Order App'x A at 15 fig. A-7.

         Given that every cost-driver unit contributes an identical dollar amount to an activity's volume-variable costs, the Postal Service, in attributing only these costs, could securely rely on its distribution keys and assign each product a share of volume-variable costs equivalent to that product's contribution to cost-driver quantity. For example, consider a truck carrying six cubic feet of mail-two cubic feet each of letters, postcards, and parcels-for one mile. Imagine too that the marginal cost of the first cubic-foot-mile is $60, the marginal cost of the second is $50, the marginal cost of the third is $40, and so forth. The activity's volume-variable costs are $60, or the marginal cost of the "final" cubic-foot-mile ($10) multiplied by the total number of cubic-foot-miles (six). Because letters, postcards, and parcels each account for one-third of the cost-driver units, volume-variable costs can be apportioned among them in like manner, with one-third of those costs ($20) attributed to each product.

         As this example shows, the Commission's historic approach left some variable costs unattributed to any one product. Although the volume-variable costs in this example amount to only $60, total highway transportation costs are $210 ($60 plus $50 plus $40 plus $30 plus $20 plus $10). The remaining $150 left unattributed represents "variable costs that are not volume-variable costs." Order at 35. The Commission calls these "inframarginal costs." Id. These costs can be visualized as the white space in Figure 1 that lies between the downward-sloping marginal cost curve and the shaded rectangle that represents volume-variable costs. Historically, the Commission classified all inframarginal costs as institutional costs, only a limited share of which competitive ...

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