Inside his office high above L'Enfant Plaza, Postmaster General William J. Henderson juggles the present and the future. He estimates he will need to chop U.S. Postal Service costs by $1 billion this year to avoid red ink. But he also needs to find a strategy, at whatever cost, to expand the agency into the new world of e-mail and e-commerce.

He has a bundle of e-ideas. The Postal Service, for instance, could develop an electronic mailbox, giving American households an Internet address to match up with their physical address. If a home did not have a computer link to the Internet, the agency would print out the electronic messages, put the paper into an envelope and hand-deliver it.

The Postal Service could also set up an Internet auction site to help retailers dispose of surplus goods. Or even help Americans pay their bills electronically.

"We're in no different a position than every company in America . . . and that is to figure out what this new channel means to you," Henderson said. "How is it going to hurt you and how is it going to help you?"

But the Postal Service has come late to the Internet game and faces numerous hurdles: It is a classic bricks-and-mortar, labor-intensive business, fighting to control costs. It must live within constraints dictated by Congress and the federal bureaucracy. It operates against tough competition from private-sector delivery companies.

Perhaps more important, critics contend that the Postal Service is neither fast, flexible nor innovative--the chief characteristics of the Internet economy.

"You have to wonder if the days are not numbered," said Donna Hoffman, co-director of eLab, an electronic commerce research center at Vanderbilt University.

"I think they have real challenges," said Bill Whyman, an Internet strategist for the Legg Mason Precursor Group. "Just look at instant messaging. America Online's service delivers more messages than the U.S. Postal Service by 50 percent every day."

Historically, increases in mail volume have helped the agency cover its costs. But Postal Service projections show that first-class mail volume will decline at an average annual rate of 2.5 percent from 2003 to 2008. "Such a decline would be unprecedented in the service's history and would likely create financial and performance challenges," the General Accounting Office said in a recent report.

The Postal Service fears it could lose as much as $17 billion worth of first-class mail to e-commerce competition in coming years. That would represent a substantial loss for the agency, which takes in about $63 billion in revenue each year.

Banks and "bill presentment" companies, for example, are increasingly offering consumers online choices for paying monthly bills. For the Postal Service, that means less use of first-class stamps and the loss of easy-to-sort envelopes with pre-printed addresses and bar codes.

Henderson believes "the key to that erosion is going to be the consumer, not the company that bills you. You're not going to subscribe to an e-payment proposition company until it is cheaper and easier for you to use than to use the mail."

Still, Henderson knows the question is not when he loses a large share of first-class mail but at what speed. And so he is trying to prepare the Postal Service for the age of the Internet.

To move the Postal Service into e-commerce, Henderson has launched a reorganization of agency headquarters, naming a vice president for e-commerce, Bob Krause. Four postal officials--chief financial officer M. Richard Porras, treasurer and e-payments vice president Stephen M. Kearney, president for expedited packages services John Kelly and controller John H. Ward--join Krause as Henderson's e-braintrust.

Senior postal officials do not rule out the possibility of creating a subsidiary or splitting the Postal Service into two parts--one focused on traditional mail and the other on e-commerce--if it proves necessary to better compete against providers of Internet-based services. That step, though, would likely require congressional approval.

Top postal officials expect that any Internet-based ventures will require partnerships with the private sector in order to succeed. They have met with a number of companies, including America Online.

Some postal officials think the agency could serve as a go-between for consumers and companies if the public begins to migrate to the Internet as a way of paying bills. The Postal Service would help protect consumers from fraudulent schemes and provide a buffer against "data mining" aimed at invading a person's privacy, the officials said.

Officials also want to launch a nationwide experiment this spring that would let smaller companies send electronic documents to printers at various places across the country. By printing near the point of delivery, small companies would be able to obtain discounted mail rates.

But some of the Postal Service's best electronic bets probably involve old-fashioned delivery of packages. Last year, the agency struck up partnerships with the giant Internet bookseller Amazon.com, Eddiebauer.com and eToys.com to run cooperative advertising campaigns. Officials hope the campaign will lead consumers to choose the Postal Service as their preferred shipper, rather than UPS or Federal Express.

The Internet, Henderson said, is lowering profit margins on many products, and that, in turn, puts pressure on shippers. "You're not going to buy a CD for $7 and pay $9 for the shipping. . . . The Postal Service is positioned in the right spot for people who are shopping out of their homes and doing business out of their homes," he said.

Kelly, who oversees package services, expects that Internet retailers will increasingly look for new methods of dealing with returns--clothes and other items consumers order but later decide they do not want. To handle rejected merchandise, the Postal Service is studying whether it could run an auction site, perhaps in coordination with an Internet company, or a donation site that accepted goods for charity. The agency might even set up "an e-commerce drop point right in your neighborhood," Henderson said.

Henderson bets that the massive reach of the Postal Service--letter carriers deliver the mail to 130 million households six days a week--will give him an Internet edge.

"We are there. We can do it. No one can do it as inexpensively as we can and no one goes there, everywhere, every day," he said.

But skeptics see the Postal Service in retrenchment, not expansion, in the Internet era. Continued increases in first-class postage will drive more Americans toward e-mail and e-commerce transactions, they believe. The Postal Service also may find that its competitors have picked off the most profitable routes, leaving it with the most expensive low-volume, probably rural, routes.

"They are going to be left with a smaller portion of the pie, and they are going to be left with the least attractive market segments and customers," said Whyman of Legg Mason.

The Postal Service also faces political restraints, he noted. "The U.S. government is not going to compete with its own private sector. The post office to some extent will have its hands tied," he said.

But the post office survived the advent of the telegraph, telephone and fax and will likely come to terms with the Internet. Ulric Weil, a senior technology analyst at Friedman, Billings, Ramsey Group Inc. in Arlington, does not think the Postal Service's future need be full of gloom.

"Not everybody has a computer with a modem. We have the great digital divide. . . . The 50 percent who do not have computers with modems still depend on first-class mail," Weil said.

Postal officials need to look to banks, which replaced tellers with automated cash-dispensing machines, and automakers, who turned to robotics, as models for the future, he said.

In particular, Weil said, the Postal Service cannot go on thinking it will maintain its work force of more than 800,000 people. Henderson, he said, "can't have all those people feeding off the trough. He can't support all those people, no matter what he does. . . . He has to downsize."

Henderson must start educating his unions, Congress and the Postal Rate Commission, which approves postage increases, "in the realities of the Internet age and lay the cards on the table," Weil said.

Despite an uncertain future, the Postal Service can draw on some strengths. It has racked up five consecutive years of profit. If ranked as a corporation, the Postal Service would place in the top 10 in terms of revenue and third in the number of employees.

Henderson sees the Internet as an opportunity, not an obstacle, for the Postal Service to meet its mandate of providing "universal service" to Americans, regardless of where they live. "This is just moving mail from hard copy to electronics. . . . It's just an extension of creating the universal service," he said.

New Deliveries From USPS

Here is a sampling of current or planned electronic products from the U.S. Postal Service:

PC Postage: Computerized postage that can be downloaded from a personal computer onto an envelope or label. The service, which began in August 1999, is provided through two companies, E-Stamp and Stamps.com; other companies also have requested certification to offer the product.

Digital Certificate: Provides proof that all parties in an electronic transaction are who they say they are. Offered at start of PC Postage.

Delivery Confirmation: Allows customers to verify delivery of parcels and priority mail by logging on to www.USPS.gov. Launched in March 1999.

Priority Mail: Describes postage rates at www.USPSPriorityMail.com for shippers and shoppers. Launched in August 1999.

Merchandise Return: Accessible through the Priority Mail site where postage-paid, plain-paper Priority Mail labels can be downloaded to return merchandise to participating online merchants. Also called Returns@ease. Started in October 1999.

Electronic Postmark: Verifies when an electronic message was sent. Scheduled to start this year.

PosteCS: Post Electronic Courier Service will serve as an international Internet-based service that provides privacy for electronic messages, receiver and sender authentication, and proof of delivery. To start this year.

Shipping Online: Offers electronic access to expedited services, such as creation of shipping labels, pickup schedules and delivery confirmation, that can be paid for with a credit card. To start early this year.

Mailing Online: Allows mailers to electronically transmit documents and mailing lists to the Postal Service, which will ensure that documents are printed, stuffed in envelopes and transported to the nearest post office for delivery. Expected to receive approval of the Postal Rate Commission for a three-year, nationwide test starting this year.

CAPTION: Postmaster General William J. Henderson has reorganized the U.S. Postal Service's headquarters to help ease it into Internet commerce ventures.