Postal Service favored Netflix, regulators rule

Four years after inspectors found that the cash-strapped U.S. Postal Service could save tens of millions of dollars by charging Netflix for hand-sorting its DVD mailers, postal executives have refused to make the change. Now, regulators are calling the Postal Service’s treatment of Netflix discriminatory.

At issue is a system in which postal workers hand-sort Netflix DVDs because the company’s return envelopes jam the Postal Service’s automated sorting equipment.

But Netflix hasn’t been charged the 17-cents-per-envelope fee for manual processing, and with millions of Netflix return envelopes sent through the mail system, the labor costs alone from hand-sorting add up to as much as $20 million per year, according to a 2007 review by the Postal Service’s Office of Inspector General.

After inspectors issued their report on the problem, GameFly Inc., which rents video games recorded on DVDs, filed a formal complaint with the Postal Regulatory Commission accusing the Postal Service of unlawfully discriminating against the company by giving special preferences to Netflix and, to a lesser extent, Blockbuster.

The Postal Service disputed the accusation, arguing it wasn’t fair to compare Netflix and GameFly. Postal lawyers said GameFly’s return DVD envelopes weren’t as recognizable as the Neflix red envelopes, and so they were harder to distinguish and hand-sort. The Postal Service also said it didn’t make a commitment to Netflix or Blockbuster for a minimum level of hand-processing, arguing that mail-processing decisions are made at the local level.

But postal regulators disagreed in a ruling last week, saying the Postal Service “unlawfully discriminated” against GameFly. The video-game rental company had argued it incurred about $700,000 in increased postal expenses per year because of the practice.

“The Postal Service separated and hand-processes a substantial proportion of Netflix’s returns without imposing a non-machinable surcharge,” the commission ruling stated, adding that Postal Service headquarters officials knew about the practice for years.

“Internal Postal Service communications between local operators and headquarters personnel make it abundantly clear that the forms and extent of special processing were known to headquarters personnel and were both tacitly and expressly condoned,” the commissioners wrote in a 129-page ruling.

A spokesman for Netflix declined to comment Tuesday, saying the company doesn’t comment on other companies’ lawsuits. Still, Netflix has kept a close watch on the GameFly complaint and proceedings.

In the company’s 2010 annual report filed with the Securities and Exchange Commission (SEC), Netflix disclosed that “a by-mail game-rental company filed a complaint with the Postal Regulatory Commission alleging that the U.S. Postal Service unreasonably discriminated against it in favor of Netflix and Blockbuster.

“To the extent this proceeding was to result in operational or regulatory changes impacting our mail processing, our gross margins and business operations could be adversely affected.”

The Postal Service also declined to comment on the ruling, as did an attorney for GameFly.

The commission gave the Postal Service 60 days to fix the “unreasonable preference.”

GameFly wanted the Postal Service to offer every DVD-rental company manual processing at the same level currently given to Netflix, but the commission said there were drawbacks, including “potentially significant administrative costs.” Instead, the commission called for the Postal Service to offer a reduced rate for round-trip, flat-shaped DVD mailers weighing up to two ounces.

“The rate is designed to ameliorate the disparate treatment in the Postal Service’s current application of the rate schedule to Netflix’s and GameFly’s mailpiece designed,” the commission ruled

The commission’s ruling came nearly two years to the day that GameFly first filed a complaint about the hand-sorting practice.

Postal Regulatory Commissioner Tony L. Hammond wrote in a concurring opinion that he “reluctantly” joined in the decision. He said his reluctance stemmed from concern that the Postal Service and its customers could misinterpret the commission’s finding.

“The Postal Service worked with a customer, Netflix, to help its business thrive through the use of the mail,” he wrote. “The Postal Service should work with current and potential customers. Netflix explained to the Postal Service what treatment would be most helpful to it. There is nothing wrong with that.”

But Mr. Hammond added that in the “lengthy and complex case,” the Postal Service’s arguments appeared “at best, strained. He stated he was “not convinced that management is powerless to stop local officials from following unnecessarily expensive operating practices.”