Dear USPS: Consider privatizing

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NEW YORK (Fortune) -- The U.S. Postal Service is losing money so quickly you'd think it somehow got mixed up in the subprime mortgage business. It's on track this year for an operating loss of between $6 billion and $12 billion, debt surpassing $10 billion, and a $1 billion cash shortfall. For any business, those are some ugly numbers.

And yet the USPS is not quite a typical business, and therein lies the problem.

Contrary to what many people might guess, the USPS is not a government agency. It hasn't received direct subsidies since the early 1980s. Aside from a miniscule fraction of its budget for free mail services for the blind and Congress' franking privileges, the Postal Service pays its own way with postage revenues, which in fiscal year 2008, reached $75 billion.

But here's how the USPS is not treated like everyone else: It's exempt from taxes and antitrust law. No one else is allowed to deliver first-class mail. Those are advantages, but on the other hand USPS is subjected to constant meddling from Congress -- for instance, the postmaster general Jack Potter has to ask Congress for permission to reduce a six-day delivery schedule to five in order to save money. And these same politicians get an earful from constituents anytime a local post-office branch, no matter how unprofitable for the USPS, is threatened with closure.

It's a bad time for the Postal Service to be hamstrung, because its entire business model is under threat. Mail use is in epic decline. It peaked in 2006 with 213 billion pieces of mail and the Postal Service projects it will fall to 170 billion in 2010. The Internet has presented a structural change in the way people communicate and do business (for example, the rise in online bill payments), but the recession has also eaten into profits since companies have been cutting back their direct-mail advertising budgets.

To its credit, the Postal Service has said it will achieve a record $6 billion in savings this year, mainly through consolidating retail stations and branches. It's also making city carrier routes more efficient. "Productivity has improved, probably faster than any time in its history," says Michael Crew, director of the Center for Research in Regulated Industries at Rutgers. "The problem is, it's not enough."

Any solution has to address the fact that the USPS is still functioning on a scale far larger than the demand for mail. Last week the Government Accountability Office released a report with several recommendations for what the USPS should do. Among the solutions: speed up the streamlining. There are about 400 major mail processing facilities, far more than the USPS needs given that it has 50% excess capacity for processing first-class mail alone.

The Postal Service also needs to scale back its workforce, most likely through attrition. (The USPS has never had layoffs.) In March, about 150,000 out of 646,000 workers were offered early retirement. That process will speed up as more workers approach retirement age.

But many experts argue that true reform requires the Postal Service to privatize, which would include opening up the first-class mail business to competition. Privatization has worked in many other countries. Germany's Deutsche Post, which runs the DHL brand, has been private since 2000 and is now the world's largest logistics group. The European Union is in the midst of privatizing the postal services of all its member nations. And in 2005, Japan approved the privatization of its postal service, Japan Post.

Even a former U.S. postmaster general has come out strongly in favor of the idea. Shortly after stepping down from his post from 1998 to 2001, William Henderson wrote an op-ed in the Washington Post advocating privatization: "Privatization may seem far-fetched, but it's not. For all intents and purposes, the U.S. Postal Service is already a [giant] corporation."

Henderson went on to suggest the Postal Service could be largely publicly owned so the government retained a "golden share." Or the USPS could be employee-owned through a stock ownership plan.

The troubles at the Postal Service have been chronic. Back in 2002, President George W. Bush appointed a commission to study the USPS and recommend reforms. The commission did not recommend privatization, but four years later, Congress passed the biggest changes to the USPS in three decades with legislation that capped postage-rate increases at the rate of inflation and called for the Postal Service to cut its infrastructure. This was before the recession hit, though, and the downturn has only accelerated the changes that need to happen.

There's money to be made in the delivery business. FedEx (FDX, Fortune 500) and UPS (UPS, Fortune 500), while hurting from the recession, have proved to be world-class competitors. Suggests Dan Ortwerth, analyst at Edward Jones: "If FedEx and UPS's management team took over the Postal Service and were truly given free rein, man, I think they could probably do a lot to whip it into shape and take advantage of the Postal Service's unique internal strength. But that's not how it is. Jobs are protected, routes are protected, and that's just the nature of it."