The financing of universal service provision in the postal sector has traditionally relied on granting the universal service provider a reserved area. Together with growing
electronic substitution, current liberalization policies promoting competitive entry may put the traditional universal service at risk. Hence, there is an increased interest in knowing the cost of universal service provision. The third EC postal directive proposes a calculation approach to separately determine the net cost of a universal service obligation and to compensate the universal service provider (USP). This paper discusses the interaction between universal service costing and financing and shows that the EC approach may result in distorted results. It also quantifies the effects based on a model
calibration with Swiss data. The results show that separate costing and financing leads to a considerable under-compensation of the USP if there is a compensation fund to
which every operator contributes. The USP is over-compensated if it is exempt from contributing to the fund (pay or play mechanism). The problem of under- or
overcompensation can be resolved by an integrated computation of the net cost that includes the competitive effects of the financing mechanism. Such an integrated
approach results in a fair compensation of the USP.