Universal Service Obligations in the Postal Sector: The Relationship between Quality

The liberalisation of the postal sector makes necessary to analyse the effect of entry in the maintenance of the universal service obligations. This paper examines the consequences of allowing entry in a postal market where there is an incumbent operator regulated with uniform pricing and quality constraints and with a coverage constraint. I consider that the cost of a unit of mail depends on its quality and on the location of the senders. Senders have inelastic demands and differ in their willingness to pay for quality. The incumbent operator and the entrant play a three-stage game, first choosing the villages they will serve, then the quality of the letters and finally the price. Valletti, Hoernig and Barros (2002) have shown that when an incumbent operator is regulated with a uniform pricing and coverage constraint an entrant can strategically maintain a low level of coverage to increase his profits. Here I show that maintaining a low level of coverage the entrant can also increase the differentiation between his services and the service of the incumbent, and as a result he raises its profits even more. I also analyse the consequences of imposing minimum quality and coverage standards on the incumbent and the entrant. Finally, I show that in presence of network externalities firms use the level of coverage as a quality attribute that substitutes the quality of the service