Management of Transportation

Chapter 9Costing and

Pricing

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Market Considerations Cost-of-Service Pricing Value-of-Service Pricing Rate Making in Practice Special Rates Pricing in Transportation Management

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In post-deregulation period, transport prices largely determined by market-based forces

Market structure modelsEvolve from conventional economic price theory

Attempts to explain the pricing behavior of a collection of firms faced with particular market characteristics (number of competitors, degree of product differentiation, barriers to entry, etc.)

Does not do well in predicting pricing behavior of individual firms

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Market structure models, cont’dPrincipal market structures

Pure competition Many sellers with same products

Monopoly One seller

Oligopoly A few large sellers with substitutable products

Monopolistic competition Many small sellers, some product differentiation

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Market structure models, cont’dFew markets are either perfectly

competitive or totally monopolistic All modes encounter some form of

oligopolistic competition In pricing and output decisions, sellers consider

potential reactions of competitors (mutual interdependence)

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Theory of contestable markets Instead of many sellers, substitutes “threat of

entry” from new competitorsNecessary conditions:

No barriers to entry No economies of scale Consumers able and willing to switch Carriers are not able to respond to new entrants’ prices

In some time periods, theory applies well to airline industry, other times it does not

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Relevant market areasNo single market structure model correctly

describes competitive environment of transport or even a single mode in transport

Classification of competitive environment should be: Mode-specific Route-specific Commodity-specific Shipment size-specific

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An approach to setting prices on the basis of the cost of providing the service

Principal assumptionsService is homogeneousOne group of customersCustomers must cover all costsSeller sets prices to maximize profits

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Two variations of cost-of-service pricingAverage cost approachMarginal cost approachCost of service as price floor

Impact of common costsThe cost-price circular argument

Problem of decreasing cost industriesSubsidies and tax policy

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Alternative definitions and terminologySimilarity is that all consider demand

characteristics (as well as costs) in pricing Pricing according to product value

Charging higher prices on higher value productsCost-based reasons (liability) for such pricingValue is indicator of ability to bear prices, but

other demand factors may dictate price elasticity

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Third-degree price discriminationDef: Seller sets separate prices for separate

groups of buyers of essentially same serviceThree necessary conditions

Must be able to segment buyers into sub-markets defined by price elasticity

Seller must be able to prevent transfer of sales between sub-markets

Seller must possess some degree of monopoly power

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Differential pricingSimilar definition as 3rd degree price

discriminationSame 3 conditions applyMeans of segmenting buyers

By commodity By time By place By individual person

Legal limitations

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Sets a ceiling on pricesCan also be price floor in certain circumstances

Useful if high % of costs are fixed or common Enables carrying of traffic that might be lost if

average cost-based prices are chargedSome prices < ave. costs can be profitable

Keys to successful value-of-service pricingKnowing how costs behaveGood estimates of price elasticity

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Some initial terminologyRates and tariffs

Individual tariffsRate bureaus and bureau tariffs

General ratesClass , exception, and commodity rates

Each designed to simplify the potential complexity of trillions of possible rates

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Class rate systemProvides a rate for any commodity between any

two pointsThree simplification steps

Geographic: rate basis points and numbers Commodity: commodity classification, class ratings Rate structure: national scale of rates, cwt-based

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Commodity classification factorsProduct characteristics that impact carrier costs

Product densityHigher densities mean lower carrier costs per cwt

Stowability Handling Liability

Considers product value and susceptibility to damage

Individual carriers may establish commodity exceptions

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Determining a class rateDetermine rate basis points for origin/dest.Determine rate basis no. (rate basis no.

tariff)Determine commodity classification ratingDetermine rate from class rate tariffMultiply class rate by shipment weight in

cwt

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Exception ratesModification to national classification Instituted by individual carrierUsed when transport characteristics for an

item in a particular area differ from other areas Ex: large volume movements Ex: intense competitive conditions

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Commodity ratesConstructed on variety of bases

Most common: specific rate on a specific commodity between specified points via specific route and direction

Not part of commodity classification system If available, takes precedence over class and

exception ratesTypically offered for regular, large volume

moves

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General rate structures were principal basis of rates published by rate bureaus

Post-deregulation eraDiminished role of rate bureaus in rate matters Increased number of individual carrier tariffsExpanded use of shipper-carrier negotiationsPortions of general rate systems still used in LTL

Commodity classification useful simplification Class rates serve as benchmark for new types of rates

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Post-deregulation era, cont’dSome new rate type examples

Zip code based rates published as part of carrier specific class and commodity rate structuresMany carriers offer web-based zip-code tariffs

as variations of class rate system Mileage-based rates

Variation of commodity tariff systemRates quoted per mile, regardless of weight

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Rate forms that evolved due to special cost features or to induce certain shipment patterns

Character-of-shipment ratesLTL/TL ratesMultiple-car rates Incentive ratesUnit-train ratesPer-car and per-truckload ratesAny-quantity ratesDensity rates

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Area, location, or route ratesLocal rates Joint ratesProportional ratesDifferential ratesPer-mile ratesTerminal-to-terminal ratesBlanket or group rates

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Time/service rate structuresContract rates

Contract services common in rail, trucking, water, and some air transport

Rates and services negotiated between shipper, carrierRates not governed by published tariffsObjectives of the negotiations

identify service and cost factors critical to each party set rate inducements and penalties based on

performance on those factors Contracts allow for a great deal of tailoring of

services to particular needs of the shipper and carrier

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Contract rates, cont’d Examples of optional features

Volume-based: reduced rates in exchange for volume commitment over specified period

Equipment-based: variations in rate depending upon type of car supplied (car-supply charge)

Transit-time based: variations in rates by transit-time

Variety of services-based: menu of logistics-related services

Deferred delivery Lower rate for flexibility in delivery time Common in air transport Enables higher vehicle utilization

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Other rate structures (each is designed for a particular cost or service purpose)Corporate volume ratesDiscountsLoading allowancesAggregate tender ratesFAK rates

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Other rate structures, cont’dReleased ratesEmpty haul ratesTwo-way or three-way ratesSpot-market ratesMenu pricing

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Factors affecting pricing decisionsRole of the market (customers)

Relative power of customers vs. carrier Price elasticity (sensitivity) Availability of substitutes

Governmental controls Surface Transportation Board: economic reg. Justice Dept.: antitrust

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Factors affecting pricing decisions, cont’d Involvement of other channel members

Carriers involved in interline movements Revenue split issuesPrice change interdependency

Influence of competitors’ pricing Price leader influences

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Major pricing decisions (strategic)Setting prices on new service

Often little info on price elasticity or actual costs Too high a price might attract competitors or not

enough trafficModification of prices over time

Response to market, service, or operating change Timing of change can be important

Initiating/responding to price leader changes

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Establishing the pricing objectiveGeneral considerations

Should reflect corporate objectives May vary during product/service life-cycle May vary by market

Alternative objectives Survival-based pricing

Increase cash flow through low prices that attract volume

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Alternative objectives, cont’d Unit volume pricing

Set prices to maximize utilization of existing capacity

Ex: pickup allowances (LTL), space available prices (air freight, multiple-car prices (rail)

Profit maximizationAttractive to carriers focused on returns on

investment Skimming

High price designed to attractive traffic focused on service quality, uniqueness and insensitive to price

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Alternative objectives, cont’d Penetration pricing

Often follows skimming Sales-based pricing

Lower price to attract mass market and increased sales

Used in later stages of life cycle Market share pricing

Lowering price to gain market share from competitors

Attractive in stagnant or declining industries Social responsibility pricing

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Estimating demand Important, but difficult, especially for new serviceFor price changes, price elasticity estimates are

made Similar market comparisons (cautions)

Role of surveys and market tests Estimating costs

Determination of what costs to includeCost variation at different levels of output

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Price levels and price adjustmentsGiven demand and cost estimates, actual

price can now be setAlternative methods of setting actual price

Demand-based Cost-based Profit-based Competition-based

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Discounts and allowances (price adjustment) Def: reduction from published price in exchange

for buyer doing something beneficial to supplier Examples

Lower prices for larger shipments (TL vs. LTL)Lower prices on low-demand seasonsCash discounts for quicker payment of bills

Federal regulation of discountsDiscount must result from carrier cost savings

due to action of shipperSize of discount should not exceed cost

savings

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Most common mistakes in pricingOver-reliance on costsSlow reaction to market changes Ignoring marketing mixPrices not tailored to services and marketsNeed to price according to strategic plan

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Management of Transportation

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