FTC Staff Comment Before Federal Reserve Concerning Interdistrict Transportation System Price Structure

V910003
COMMISSION AUTHORIZED
BEFORE THE
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
WASHINGTON, D.C. 	20551
Interdistrict Transportation
System Price Structure, 1991 	Docket No. R-0705
COMMENT OF
THE STAFF OF THE BUREAU OF ECONOMICS OF THE
FEDERAL TRADE COMMISSION'
(submitted March 19, 1991)
1 These comments represent the views of the staff of the Bureau of
Economics of the Federal Trade Commission. 	They are not necessarily
the views of the Commission or any individual Commissioner. 	Questions
about these comments may be addressed to James D. Reitzes or John C.
Hilke, Federal Trade Commission, Bureau of Economics, 6th Street and
Pennsylvania Avenue, N.W., Washington, D.C. 20580, telephone: (202) 326-
3349 or 326·3483.

BEFORE THE
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
WASHINGTON, D.C. 20551
In terdistrict Transportation
System Price Structure, 1991 	Docket No. R-0705
COMMENT OF
THE STAFF OF THE BUREAU OF ECONOMICS OF THE
FEDERAL TRADE COMMISSION'
(submitted March 19, 1991)
I. 	INTRODUCTION
The 	staff 	of 	the 	Bureau 	of 	Economics 	of 	the 	Federal 	Trade
Commission [FTC] appreciates the opportunity to submit this comment to
the Board of Governors of the Federal Reserve System [FRS] concerning
proposed changes in the price structure for transporting checks using the
FRS's Interdistrict Transportation System [ITS]. 	As part of the FRS's
check collection service, the ITS network transports checks between pairs
of the FRS's forty-eight check-processing locations. 	The FRS proposes to
amend 	the current ITS 	pricing structure by 	establishing a 	maximum
charge for transporting checks that have been presorted by destination
before delivery to a local FRS office. 	The FRS states that its "objective
of modifying the price structure of ITS surcharges is to ensure that the
price structure reflects the underlying cost function of interdistrict check
transportation." 	Currently, the FRS charges a specific fee per check for
shipping checks on the ITS network . 	Under the new proposal, per-check
1 This comment represents the views of the staff of the Bureau of
Economics of the Federal Trade Commission. 	They are not necessarily
the views of the Commission or any individual Commissioner. 	Questions
about these comments may be addressed to John C. Hilke or James D.
Reitzes, Federal Trade Commission, Bureau of Economics, 6th Street and
Pennsylvania Avenue, N.W., Washington, D.C. 20580, telephone: (202) 326-
3483 or 326-3349.

charges would apply until a maximum charge is attained per shipment.
In effect, per check charges would be reduced for any shipment whose
volume exceeds the ceiling. 	The proposed maximum charge would not
apply to bundles of unsorted checks that are sorted by the FRS and
transported using ITS . 	Unsorted checks are priced separately and are
unaffected by the present proposal.
In 	what 	follows, 	we 	discuss 	ambiguities 	in 	the 	FRS's 	pricing
proposal and go on to consider what effects certain interpretations of its
proposal might have on private firms that provide check transportation
services in competition with the FRS. 	However, before turning to these
topics, the check clearing process and the FRS's role in it are briefly
described .
II. 	EXPERTISE OF THE STAFF OF THE FEDERAL TRADE COMMISSION
The 	FTC 	is 	an 	independent 	regulatory 	agency 	responsible 	for
maintaining competition and safeguarding the interests of consumers.
The 	staff 	of 	the 	FTC, 	upon 	request 	by 	federal, 	state, 	and 	local
government bodies, often analyzes regulatory or legislative proposals that
may affect competition or the efficiency of the economy. 	In the course
of this work, as well as in antitrust and consumer protection research and
litigation, the staff applies economic theory and empirical analysis to
address policy issues that include the determination of the effects on
consumers and competition arising from particular price structures , and
the assessment of the market in which sellers compete.
2

The staff of the FTC has commented previously on various issues
before the Board of Governors of the Federal Reserve System. 2 The staff
also 	has 	commented 	before 	the 	Postal 	Rate 	Commission 	on 	issues
involving 	rates 	for 	transportation 	services, 	competition 	between
government 	and 	private 	industry, 	and 	the 	regulatory 	advantages 	of
government suppliers .3 In the area of transportation regulation, the staff
has prepared several reports and provided numerous comments to state
and national regulatory agencies."
2 Comments have been submitted in: Docket R-0687, The Matter of
Truth and Lending; Home Equity Disclosure and Substantive Rule (April
20, 1990); Letter from Acting Chairman Calvani, dated December 23,
1985, concerning application of margin requirements to takeover bids;
Docket R-0545, Amendments of Regulation Z (July 19, 1985); Docket R-
0541, Revision of Regulation B (June 21, 1985). For additional discussion
of instances. in which government enterprises compete with private firms,
see 	Statement 	of 	Timothy 	J. 	Muris, 	Director, 	Bureau 	of 	Consumer
Protection 	Concerning 	The 	Provision 	of 	Telecommunications 	and
Information Serv ices By the Federal Government in Competition with the
Private 	Sector, 	submitted 	to 	the 	House 	Committee 	on 	Government
Operations (February 25, 1982).
3 These matters include: (l) discussion of competition issues inherent
in 	proposed 	rate 	and 	classification 	changes 	related 	to 	electronic
computer-originated mail, ECOM (PRC Docket No. R83-1 , filed June I,
1983); (2) drawbacks to a proposed modification of the test period for
cost recovery in ECOM (PRe Docket No. R83-1, filed June 16, 1983); (3)
advantages of setting ECOM rates to cover full costs (PRC Docket No.
RM-l, filed December 23, J983); (4) expedited procedures in reviewing
proposed rate changes for E'X.pres~ Mail (PRC Docket No. RM88-2, filed
October 14, 1988); (5) a complaint urging a study of the potential public
benefits of exempting addressed third-class mail from the private express
statutes (PRC Docket No. C89-1, filed February 28, 1989); and (6) recent
developments in monopoly theory (PRC Docket RM89-4, filed September
I, 1989 and related testimony published in Monopoly Theory Inquiry,
Washington, D.C.: PRC , November 1989, pp. 357 - 390).
4 See, for example, Ogur, J., et al., The Deregulated Airline Indu'stry;
A 	Review 	of 	the 	Evidence, 	Washington, 	D.C.: FTC, 	1988; 	"Pricing
Practices of Motor Common Carriers of Property Since the Motor Carriers
Act of 	1980, Ex Parte 	No. MC-l66," 	before the 	Interstate Commerce
Commission (January 19, 1983); Breen, D., Regulatory Reform and the
Trucking Industry: An Evaluation of the Motor Carriers Act of 1980,
submitted to the Motor Carrier Ratemaking Study Commission (March
1982); "Economic Deregulation of Trucking," submitted to the Washington
Sta te Legislature, March 1985; FTC staff com men ts to Congress in the
Railroad 	Antimonopoly 	Act of 	1986, submitted May 	and 	June, 	1986;
(continued ...)
3

III. BACKGROUND
A. 	The Check Clearance Process
The FRS has operated the ITS check-transportation system as part
of 	its 	check 	collection 	services 	for 	many 	years .s 	Check 	collection
includes a series of steps whereby a financial institution that receives a
check, known as a bank of first deposit [BFD], returns that check to the
payor bank for payment of funds. 	As illustrated in Figure I, the check
collection process typically requires the services of check sorting, check
transport a tion, and check presen tmen t. 	In Figure 1, providers of these
services within the check collection process are denoted by boxes; all
providers of a given service are located in the same column. 	Note that
once the customer uses an FRS service, such as sorting or transportation,
that customer 	must 	use 	FRS services 	for 	the remaining steps 	in 	the
clearance process.
Figure 1 indicates that the BFD must obtain sorting services prior
to transportation . 	Sorting is required to determine the location of the
payor bank, and, in some instances, to separate checks for large amounts.
Sorting can be conducted directly by the BFD, or obtained for a fee from
a correspondent bank or 	the FRS. 6 	When a bank leaves an unsorted
4(... continued)
Frankena, 	M, 	and 	Pautler 	P., 	An 	Economic 	Analysis 	of 	Taxicab
Regulation, 	Washington, 	D.C.: 	FTC, 	1984; 	"Possible 	Restrictive 	and
Anticompetitive Practices in South Carolina's Public Service Commission
Statutes," submitted to the Legislative Audit Council of South Carolina,
1987; and, Reitzes, J., Mathies, A., and Daniel, T., An Analysis of the
Maritime Industry and the Effects of the 1984 Shipping Act , FTC Report
to Congress, 1989.
S This section relies heavily on the GAO Report No. GAO/GGD-89-
61., 	Check 	Collection: 	Competitive 	Fairness 	Is 	an 	Elusive 	Goal,
Washington, D.C.: 	May 1989.
6 The FRS has 48 offices throughout the United States, each of
which is a drop-off point for sorting services .
4

Fig. 1 CHECK CLEARING PROCESS: INTER-DISTRICT CHECKS
Corree-
pondent
~ 	I I 	I	Private 	Private
Bank 	Courier 	1'\ 	I 	Preaentment
of Flret 	BFD
\1 I 	Payor
Depoelt 	Sort 	Bank
(BFD) 	... .	. 	.. ITS 	FRS
I Preaentment
FRS
VSort
Not •• :
F RI • F.d.r.' R••• r va Iy.t...
D.c'.'on poInt. occur .t ttl. br.nctl ••• t ttl •• nd. 0' ttl.
ttllCk lin ••.

bundle of checks at the FRS, that bundle is considered a "mixed sort."
If the 	FRS sorts 	the check, it 	then 	requires 	that 	the check 	also 	be
transported and presented by the FRS . 7 If, instead, a correspondent bank
performs the sorting services, that bank typically arranges transportation
and presentment services as well. 	The correspondent bank then charges
the BFD for the performance of all these steps.8
If 	sorting 	services 	are 	furnished 	by 	a 	non-FRS 	supplier , 	that
supplier has the option of using private transportation services or the ITS
service to transport the check to the payor bank. 	Private transportation
services are available from couriers that operate 	their own fleets 	of
planes, or 	from 	freight 	forwarders 	that 	typically 	rent 	freight 	space
aboard commercial airlines . A presorted bundle of checks, which is then
given to the FRS for transportation [and presentment], is considered a
"consolida ted sort."
Once a 	check 	reaches 	its 	destination, 	it 	is 	then 	presented 	for
payment. 	If presented by the FRS, immediate payment is required by
law, and the FRS need not pay a presentment fee . 	If presented by a
private bank, however, then that bank must typically pay a fee in order
to 	receive 	immediate 	payment. 	Hence, the 	FRS enjoys an 	apparent
regulatory ad vantage in the presentment of cnecks." 	Unless there are
7 The existence of private providers of sorting, transportation, and
presentment services implies that this requirement, by itself, is unlikely
to be inefficient.
8 BFDs 	that use the FRS or correspondent banks for sorting and
subsequent check-processing steps may do so in part because they prefer
"one-stop shopping."
9 See the GAO Report, Chec t' Collection: Competitive Fairness Is an
Elusive Goal, supra note 	5. The 	report states 	that, "The inability of
[private] 	collecting 	banks 	to 	match 	Reserve 	bank 	collection 	terms,
especially obtaining same-day payment without incurring bank fees, has
constrained the collection options open to collecting banks; the collection
services they may sell; and, in turn, the potential efficiencies they may
(continued ...)
5

economies from vertical integration, however, this advantage should not
necessarily affect competition in the transportation segment of the check
clearance 	process. 	Correspondent 	banks 	can 	also 	obtain 	immediate
payment upon presentment of checks without paying a fee if the private
bank sorts and bundles the checks and delivers them to the appropriate
FRS office for presentment.
Of 	the 	bundle 	of 	services 	that 	comprise 	check 	collection, 	the
proposed fee change concerns only charges related to check transportation
through the ITS system. 	Further, the proposed ceiling on transportation
charges affects only checks that have been presorted by destination when
they arrive at an FRS office. 	These consolidated sorts will be assessed
a standard fee per check that varies based on the origin and destination
until the ceiling on charges is reached.l?
V. 	FRS Presence In the Check Clearance Process
Until 1980, the FRS provided check-collection services, including
transportation, as a "free" service to member banks." 	The Monetary
Control Act of 1980, and subsequent FRS regulations , established that the
FRS should price these services using pricing principles that consider
9(...con tinued)
bring to the market . 	GAO found no evidence that the check collection
system would be damaged if the differences in basic check presentment
abilities of collecting and Reserve banks were narrowed or eliminated .
In fact , the system might be improved by such a change." See pp. 2 and
3.
'0 Mixed 	sorts 	are 	typically 	assessed 	a 	standard 	fee 	per 	check
regardless 	of 	the 	destination 	of 	each 	check. 	The 	transportation
component of this fee is not subject to any ceiling, based on the new FRS
ra te proposal.
" 	The costs of these services were effectively paid by interest the
FRS earned on the reserves that member banks were required to deposit
with 	the FRS . 	Member 	banks received 	no 	return on 	these reserves.
Nonmember banks could utilize the FRS's check collection services by
using a member bank as a correspondent bank.
6

costs that would be borne if the FRS operated as a private organization.V
Other 	goals 	of 	the 	pricing 	policy 	are 	to 	foster 	private competition,
improve the efficiency of the payments mechanism, and lower the costs
of check-processing services to society at large . 	The FRS seeks these
goals within the context of its overriding mission of maintaining public
confidence 	in 	the 	integrity 	and 	safety 	of 	the 	nationwide 	payments
system. 13
After "1980, the FRS's check-collection system was opened to all
banks on a fee-for-service basis. 	Partially as a result of its fee structure,
FRS check-collection volume apparently declined six percent from 1980
to 1981. 14 	Since then, however, FRS check-collection volume has grown:
14.6 billion checks in 1983, 16.0 billion checks in 1985, 17.0 billion checks
in 1987, and 18.0 billion in 1989. 15
The FRS's market share of check-collection services differs based
on the size of the bank of first deposit. 	A study by the Association of
Reserve City Bankers indicates that smaller banks are less likely to use
12 FRS Transmittal 45, Nov. 1984, p. 7.53 and 7.54.
13 FRS Transmittal Ill, May 1990, pp. 7.85 - 7.87.
14 	See 	GAO 	Report 	No. 	GAO/GGD-89-61, 	Check 	Collection:
Competitive Fairness Is an Elusive Goal, supra note 5, p. 71.
15 The FRS estimates that 55 billion checks will be written in 1990.
Of these, 25 percent are "on us" checks, i.e., those for which the BFD and
the payor are the same bank. 	Another 	11 percent of the checks are
presented through local clearinghouse arrangements. 	The remaining 64
percent include checks presented directly between banks [either locally
without 	the 	aid 	of 	clearinghouses 	or 	interdistrict), 	checks 	collected
through 	correspondent banks, checks collected 	through Federal Home
Loan 	Banks, and 	checks collected 	through 	the FRS. 	(See, 	Board 	of
Governors of the Federal Reserve, 	Annual 	Report, Washington, D.C.:
1983-89.) 	Unlike correspondent banks and the FRS, Federal Home Loan
Banks can only offer check-collection services to thrift institutions. 	For
diagrammatic simplicity, this source of check-collection services 	was
omitted from Figure 1.
7

the FRS directly for check-collection services. 16 	Overall, however, the
FRS's share 	of check-collection services has 	increased 	over 	the 	past
several 	years 	according 	to 	survey 	data 	from 	the 	American 	Bankers
Association and the Association of Reserve City Bankers. 17
Historically, the FRS's revenue from check collection has exceeded
its reported costs. 	Between 1983 and 1989, FRS revenue from commercial
check collection rose from $383 million in 1983 to $549 million in 1989.
During this same period, the FRS reported that its real and imputed
costs 18 associated with FRS check collection rose from $358 million to
$538 million. 19
16 The following table presents the proportion of checks collected
(exclusively) through the FRS and through correspondent banks (CBs) in
1987 for various size categories of BFDs. 	Percentages in each row do not
sum to one hundred because some checks were collected in other ways
(e.g., clearinghouses and holding company affiliates). 	In addition, checks
that reach correspondent banks may subsequently be given to the FRS for
some check-collection services.
BFD Assets
($ millions)
25-100
100-500
500-750
over 750
Percent of checks
collected by FRS
36%
41
44
43
Percent of checks
collected by CBs
51%
44
32
20
Source: GAO Report No. GAO/GGD-89-61, Check Collection: Competitive
Fairness Is an Elusive Goal, Appendix II.
17 This survey indicates that 	from 	1983-87, the market share of
correspondent banks dropped 10-16 points for depository institutions in
the $25-$100 million asset range, 13-23 points in the $100-$500 million
asset range, 12-18 points in the $500-$750 million asset range, and 2-7
points in the over $750 million asset range. 	These data also indicate that
the FRS has gained market share in the smaller asset ranges [below $750
million]. 	See 	GAO 	Report 	No. 	GAO/GGD-89-61, 	Check 	Collection:
Competitive Fairness Is an Elusive Goal, Appendix II.
18 This category includes f'loat costs and charges that would accrue
to a private firm involved in crieck collection [such as sales taxes and
any finance charges that would normally be associated with the private
acquisition of assets used in check collection].
19 See "Pro Forma Income Statement for Federal Reserve Priced
Services, by Service," contained in the Board of Governors of the Federal
Reserve System, Annual Report, Washington, D.C., 1983-89.
8

IV. THE PRICING PROPOSAL
The 	FRS 	proposes 	a 	pricing 	schedule 	that 	would 	establish 	a
maximum charge for shipping bundles of presorted checks between two
FRS banks. 	Once the maximum charge is reached, larger bundles would
not lead to higher total charges. 	A major effect of the FRS proposal
would be to lower shipping costs to large shippers . 	There is nothing
necessarily 	wrong 	with 	such a 	result. 	Shippers of 	large 	bundles of
presorted checks may impose less cost per check on the ITS system than
shippers of small bundles of presorted checks. Costs per check may be
lower 	for 	a 	great 	many 	reasons 	which 	we 	do 	not 	here 	attempt 	to
articulate . If the cost per check of transporting checks declines as a
shipper's volume increases, it would be efficient to esta blish a pricing
schedule that reflects such declining costs. 	We are concerned , however,
that the reasons given by the FRS in support of its 	proposal do 	not
demonstrate that large shippers impose lower costs per check than small
shippers. 	The FRS notes;
ITS 	network 	costs 	are 	essentially 	fixed. 	Of 	total 	1990
network costs, more than 90 percent do not vary with volume.
Once the Federal Reserve enters into multi-year contracts
with 	the 	couriers 	to 	provide 	aircraft, 	pilots, 	ground
operations, and other components of the network, those costs
are fixed ....Thus, the Federal Reserve uses an entirely variable
price 	structure 	to 	recover 	largely 	fixed 	costs....A 	price
structure with some fixed element would enable depository
institutions, and particularly shippers of large volumes, to
enjoy the benefits of the largely fixed cost ITS network. 20
The foregoing description of ITS network costs paints a picture in
which total costs and total capacity are relatively fixed over the life of
the FRS's multi-year contracts . While such a situation may mean that the
20 Federal Reserve System, Docket No. R-0705. pp. 3-4.
9

FRS's total short-run costs are more or less the same regardless of the
total volume of checks shipped by all shippers, it does not necessarily
mean that large shippers should be charged a lower average price per
check than small shippers . 	If the cost per check of transporting checks
declines as a shipper's volume increases, a fee schedule that rises less
than proportionately with shipper volume would be desirable . 	But the
FRS does not express why or how the shippers of large volumes impose
less cost per check than do shippers of small volumes. 21
A second potential difficulty with 	the FRS proposal is that it
assumes not only that large shippers impose lower costs per check than
small shippers, but also that costs per shipper do not increase at all with
any volume larger than that eligible for the ceiling or maximum charge .
Although this could be true, the FRS proposal does not indicate why or
how 	this 	might be so. 	As the 	FRS notes, total costs may 	not 	vary
substantially with total volume while contracts are in place in the short
run . 22 	However, 	over 	a 	longer 	time 	horizon, 	the 	zero 	charge 	for
shipment volumes larger than the ceiling volume could induce a larger
proportion of shipments of such sizes. 	When contracts are renegotiated,
it seems to us unlikely that an increase in shipments of this size would
impose no cost on 	the FRS. 	If they do impose additional cost, then
charging zero for such shipment sizes as suggested by the FRS proposal
21 We assume that transportation costs and prices can be considered
independently of the other steps in the check clearance process (sorting
and presentment). 	This assumption appears consistent with the 	FRS's
approach 	to 	this 	issue. 	It 	is 	possible 	that 	cost 	and 	demand
interrelationships exist between transportation and these other services.
Accounting for these interrelationships would complicate the development
of a cost-based price structure . See Baumol, W., Panzar, J., and R. Willig,
Contestable Markets and the Theory of Industry Structure. New York :
Harcourt Brace Jovanovich, 1982.
22 The FRS believes that as much as 10 percent of its costs vary with
volume even when contracts are fixed and in place.
10

would not reflect costs accurately. 	If costs are imposed by an increase
in larger shipment volumes, then the FRS might account for this by an
increase in the ceiling charge during the next contract period. 	We note
however 	that 	this 	implies 	that 	shipment 	volumes 	above 	the 	current
ceiling 	would 	impose costs on 	the FRS 	rather 	than 	zero cost as 	the
pricing proposal suggests. 	It may well be that larger shipment volumes
do not impose as much cost as do smaller shipment volumes. 	But again,
the reasons why this might be so are not discussed in the FRS proposal.
It is true that the FRS might be able to align its price structure
more closely with costs by using flexible fee ceilings. 	In fact the FRS
has suggested that it might ultimately adopt ceilings that vary as origins
and destinations vary.23 	Nonetheless, geographically flexible fee ceilings
may Dot accurately reflect variations in costs due solely to shipment
volume. 	We note that if large shipment volumes are priced below cost,
efficient private competitors could be disadvantaged. 	This is discussed
in greater detail in the following section.
It is possible that a price structure with a maximum charge is
easier 	to 	administer 	than 	alterna ti ve 	pricing 	structures 	that 	more
accurately reflect ITS costs in relation to shipment volume. If the FRS
believes that such administrative simplicity will save costs, then the FRS
may then 	wish to consider more explicitly whether any reduction in
administrative costs due to a price ceiling offsets the benefits from a
closer relationship of prices to costs.
The FRS supports its fee ceiling proposal, in part, by noting that
private couriers purportedly charge their customers a fixed fee 	that is
independent of volume. 	The FRS notes that a price structure with some
fixed element, "would also bring the Federal Reserve closer to prevailing
23 See Docket No. R-0705, p. 6.
11

market practice ....,,24 	If private couriers actually do 	set 	a 	maximum
charge, then the FRS proposal may well 	be appropriate. 	Some of the
comments submitted 	to the FRS suggest otherwise, however. 	Private
couriers may assess a flat charge plus a fee that increases at various
volume increments. 25 Under the FRS proposal, a flat fee is charged only
to shippers of bundles equal to or larger than the size eligible for the
ceiling charge. 	All other shippers are charged a fee that varies directly
in proportion to bundle size. 	This seems quite different from the fee
structure used by private couriers .
By establishing a price schedule that reflects its 	costs, the FRS
would 	encourage competition 	by 	promoting 	the 	entry or 	survival of
efficient providers of check -transportation services.26 	The FRS would
24 See, Federal Reserve Docket No. R-0705, pp, 4-5. Discussions with
FRS staff indicate that their information concerning industry pricing
practices was not based on a detailed investigation of the market. 	These
discussions suggested that more information was being gathered .
25 For example, comments of 	First 	Wisconsin 	National 	Bank 	of
Milwaukee, submitted October 8, 1990 [p , 3], state, "We currently have
contracts that charge per pound, and we have a base rate with additional
chargers] when the weight exceeds a determined amount." Similarly, First
Fidelity 	Bancorporation, comments as 	follows [submitted October 26,
1990, p, 2]: "... we are not aware of any private courier company that
prices 	for 	check 	shipments 	in 	the 	manner 	proposed 	by 	the 	Federal
Reserve. 	The majority of prices quoted to FFB by private couriers asks
for a minimum price per endpoint which varies upward as certain weight
limits are reached ."
Our conversations with industry sources and review of industry
comments also indicate that ITS pricing behavior differs from that used
by 	private 	providers. 	Private couriers 	tend 	to 	negotiate 	rates 	with
customers, whereas the FRS does not.
26 The policy guidelines of the FRS require that as part of its cost
adjustments, the FRS include an allowance for sales and income taxes.
After 	these 	adjustments, the 	FRS 	then 	compares 	its 	"net" 	return 	on
capital with the "normal" return on capital earned by a private firm
engaged in similar activities.
Although these "private sector" adjustments are not normally part
of the accounting costs of government enterprises, we believe that they
allow the FRS to assess more accurately the efficiency of its provision
of check-collection services. 	Without the tax adjustments, the FRS might
overinvest in the provision of check-clearing services.
12

also 	encourage efficient 	provision 	of 	related 	services such 	as 	check
sorting and check presen tmen t.
If the FRS sets a price schedule that recovers its costs, but charges
certain banks (larger shippers) less than the costs they directly impose,
then smaller shippers will pay more than the cost of providing their
check-transportation services if the ITS is their only shipping option. 	It
would seem that this effect should be avoided. Competition from private
couriers may ·preven t FRS prices from significantly exceeding the cost of
providing check-transportation services to smaller shippers. 	If so, the
FRS could not charge some banks (large shippers) less than the costs they
directly impose without also subsidizing ITS operations. 	The FRS may
also wish to avoid this possibility.
V. COMPETITION WITHIN THE RELEVANT MARKET
The proposed change in the ITS fee structure will likely influence
the demand faced by private couriers and the quantity of checks they
ship. 	In most markets, staff would not suggest that firms should be
constrained from 	lowering price 	because 	their 	competitors 	would 	be
injured. 	Similarly, 	staff 	would 	suggest 	that 	the 	effects on 	private
couriers be given little consideration if ITS prices reasonably follow the
costs 	that 	its 	services impose. 	So long as 	prices reflect costs, more-
efficient 	[or 	equally-efficient] 	private 	providers 	of 	transportation
services will compete successfully with ITS. 	Furthermore, pricing by the
FRS that reflects its costs will 	be more likely to induce the FRS to
adjust the quantity of its services to an efficient level. 	However, if the
FRS chooses a pricing structure that does 	not recover ITS costs, and
maintains 	the 	structure 	by 	subsidizing 	the 	ITS 	network 	with 	funds
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derived from other sources (such as other sources of FRS income), then
potentially 	more-efficient 	providers 	of 	check 	transportation 	services
might exit the market or curtail their service.
In its initial review of the competitive impact of the proposed fee
change, 	the 	FRS 	concluded 	that 	it 	should 	improve 	the 	competitive
position of correspondent banks [that provide check-collection services]
because the ITS transport price to large shippers may be lower. 	The FRS
acknowledges that the ITS rate change may shift demand to ITS from
private air networks, but concludes:
The modified ITS price structure may induce a shift in
volume 	from direct-sent arrangements through 	private air
couriers 	to 	consolidated 	shipments 	on 	ITS. 	The 	Federal
Reserve does 	not 	compete directly with private sector air
couriers. 	The ITS network transports only checks that are
accounted for on the books of the Reserve Banks and other
Federal 	Reserve 	materials 	between 	Federal 	Reserve 	Bank
offices. 	Thus, 	ITS 	is 	an 	integral 	part 	of 	the 	Federal
Reserve's 	check 	collection 	service. 	Private 	air 	couriers
provide 	a 	broad 	range 	of services, 	including 	delivery 	of
checks to correspondent banks and transportation of many
other types of cargo.
Even if the Federal Reserve were perceived to be in
competition with private air couriers, the proposed ITS price
structure would not have a direct and material adverse effect
on the ability of air couriers to compete effectively. 	The
proposed price structure is consjstent with the current pricing
practices of most air carriers.f
Our examination of the FRS's request for comments, comments and
interviews 	with 	private 	couriers 	and 	banks,28 	GAO 	reports,29 	and
27 Docket No. R-0705, pp. 8-9.
28 Thirty-six 	comments 	were 	received 	in 	response 	to 	the 	initial
request for comments due on October 19, 1990. This initial deadline was
subsequently extended for ninety days.
29 See 	GAO 	Report 	No. GAO/GGD-90-17 	The 	Federal 	Reserve:
Information on the System's Check Collection Servjce, Dec. 1989, and
GAO Report No. GAO/GGD-89-61 Check Collection: Competitive Fairness
Is an Elusive Goal. May 1989.
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publicly available market information 30 suggest that private air courier
services do compete with ITS. 	The FRS seems to conclude that because
the FRS integrates sorting, transportation, and presentment activities into
a single service offering, private couriers do not compete with the FRS.
The 	FRS 	may 	wish 	to 	reexamine 	this 	interpretation. 	A 	vertically
integrated 	supplier [such as 	the 	FRS) does compete 	with 	firms 	that
supply one stage of the vertical process whenever single-stage suppliers
can be linked with suppliers at other stages to provide a close substitute
for the integrated serv ice. 	Our current understanding is that customers,
in fact, have such alterna ti ves.
Of particular relevance is that the FRS offers ITS transportation
services to banks that do not purchase sorting services from the FRS.
Correspondent banks are welcome to presort and then deliver checks to
either 	the 	ITS 	or 	a 	private 	courier 	for 	transportation 	prior 	to
presentment. Faced with these alternative sources of transportation, some
correspondent banks may be expected to switch toward ITS services when
the price of ITS services declines and away from ITS services when the
price of ITS services increases.31
Further, 	the 	fact 	that 	non-ITS 	private 	couriers 	provide
transportation services to many other industries need not mean, as the
FRS appears to conclude, that these couriers would therefore experience
little, if any, impact if forced to cease or curtail the provision of check-
transportation 	services. 	The 	ability 	to 	shift 	resources 	to 	serve 	the
transportation 	requirements 	of 	other 	industries 	reduces 	the 	risk 	of
30 Public references that provide information on air courier services
include Moody's Transportation 	Manual. U.S. Industrial Outlook, and
filings by air couriers to the Securities and Exchange Commission.
31 The FRS also expressed this expectation in the passage previously
cited in this section.
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providing transportation services to any given industry . 	Nevertheless, it
may be, although we do not know this as a fact, that non-ITS private
couriers bear significant expenses, some perhaps specified in 	long-run
contracts, particular to the provision of check-transportation services. 	If
so, 	then 	a 	reduction 	or 	cessation 	of 	these 	services 	may 	imply 	that
insufficient revenues are generated to offset these costs. 	Hence, losses
may be experienced .
While the impact on 	firms from a 	rival's 	pricing policy would
generally reflect the procompetitive workings of market forces -- and
thus 	not 	warrant 	regulatory 	scrutiny 	-- 	the 	FRS's 	proposed 	pricing
change, were it not to 	reflect costs reasonably, may adversely affect
efficiency. 	This 	would 	be 	so 	if 	the 	FRS's 	pricing 	proposal 	caused
private competitors to curtail their service or leave the market when they
would not curtail their service or leave if the FRS's proposal reasonably
reflected its costs.
VI. CONCLUSION
The pricing 	schedule 	proposed 	by 	the 	FRS 	would 	establish 	a
maximum charge for shipping bundles of presorted checks. 	The effect
of the maximum charge would be not only to reduce per-check prices to
shippers of large bundles , but also to establish a ceiling above which
total charges would not vary with volume. 	We would encourage the FRS
to explore the relationship between bundle size and cost. 	Although it
may be that large bundles impose lower costs per check on the FRS, we
do not believe that the FRS has demonstrated that this is so. 	Moreover,
our analysis suggests that a rate ceiling may not appropriately consider
the relationship between cost and volume .
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