Royal Mail's first-class delivery rate for the first nine months of 2007 was 83%, which was 10 percentage points below its target of 93%. Four of those months were blighted by rolling industrial action by workers over pay, pensions and working conditions.
Postwatch said the results would likely result in Royal Mail missing out on 10 of its 12 annual licence targets by the end of the year, which would make it the worst annual performance by Royal Mail since 2003-2004, when the company missed all 12.
The watchdog warned that 2007 and 2008 could be "the pivotal year" in Royal Mail's decline unless it could modernise itself.
The company has responded that its performance was affected by strike action, resulting in a fall in first-class delivery targets between September and December to 80%, and second class post dropping to 91.4%.
Royal Mail said the figures contrasted sharply with its "target-beating performance" across all operations over the 12 months leading up to the strike.
Postwatch also criticised Royal Mail for its service levels over the Christmas period, which fell outside the annual target, and resulted in only 55.1% of first-class post being delivered the next day. The figure for standard retail parcels was 83%.
Millie Banerjee, chair of Postwatch, said: "Royal Mail is having a difficult year. It has let customers down and driven many of them into using alternative means of communicating; it is doubtful that those customers who moved away from mail will return."
Ninian Wilson, operations director at Royal Mail, said: "With the strike behind us and a wide-ranging agreement on modernisation in place, we are now focused on delivering once again consistent, high quality of service to all our customers."