Download Chapter 11: Costing and Pricing

Chapter 4: Costing and Pricing
rate vs. price
price is more general, for example:
Price = rate * weight
Market Structure Models (Review of economics basics)
Monopoly (one seller) vs. pure competition (many sellers, buyers and sellers small
so no one influences prices or supply, homogeneous products, unrestricted entry)
Oligopoly and monopolistic competition
Relevant Market Area: Depending on the market area, examples of all 4 market
structures may be found.
For deregulation to work, the ideal structure was pure competition. Question was
market entry. "Theory of contestable markets" compared participation of many
sellers (of air transport) with "potential competition" (if there were no barriers and
no economies of scale).
Pages 103-4: Cost of service pricing: average cost, marginal cost, marginal
revenue; Figures 4-1 and 4-2 are not on the test. Figures 4-3 and 4-4 are OK.
Price at point where marginal cost = marginal revenue. Why? (Only if all costs
are variable)
Cost of Service Pricing
Cost vs. activities:
Separable costs: Directly assignable to activity (unit of output)
Example: fuel and driver's time used on a single household moving van trip.
Other examples: (from school, work, home)?
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Common costs: Not obviously assignable to one activity, but may be allocated on
some "reasonable" basis: dollars per mile, % of separable costs, % of sales.
Common costs may be joint or nonjoint.
Joint (if one unit of output is made, a by-product is also made which might incur
more costs): spending 10 gallons to drive a truck from Ames to Des Moines
actually means what? Providing one output means that a second output will also
be provided. The example is the back-haul.
Nonjoint: what portion of the airplane fuel and crew's time is accounted for by my
suitcase? (None.) Yet all the passengers and luggage, combined, is moved by the
common costs of fuel and crew.
For budgeting, divide costs into fixed (over the short run--which means what?)
and variable (those that increase with output).
Note: there is some cross-over between fixed vs. variable and separable vs.
common costs. We generally use fixed vs. variable.
Examples of fixed costs: annual property taxes, salaries, interest on long-term
loans, annual maintenance (due to time, not amount of use).
Examples of variable costs: fuel, labor time, supplies used up by providing an
output, replacement parts that wear out with increased use.
Other examples of variable costs: renting facilities or equipment for a particular
use (vehicle, ship, public warehouse); paying a freight bill; paying a garage for
maintaining our vehicles.
To "know your costs" for performing a given activity, would you prefer fixed or
variable (or both) costs?
Two more kinds of separable costs: marginal and out-of-pocket.
Marginal: change in total costs for one more unit of output.
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Out-of-pocket: as it sounds--costs incurred for a given unit of output--but may
be applied too narrowly (what is the output-of-pocket cost of one more 10-lb.
package) or too broadly (what is the out-of-pocket cost of one more trailer-load) to
be useful. But is a reasonable, very short-term measurement of variable costs, and
may be used to forecast cash flows.
Railroads and pipelines: up to 50% of costs are fixed; would need to be paid
regardless of number of railcars hauled.
Motor carriers: 10% of costs are fixed.
Water carriers: use public right-of-way, keeping fixed costs lower, but equipment
investment is high. Similar to motor carriers.
Airlines: public right-of-way and terminals. More like motor carriers.
Value of service pricing = differential pricing (different prices for similar but
different needs); Figure 4-5.
Headhaul vs. backhaul; Figure 4-6. Figure 4-7 combines previous graphs into one.
Cost Concepts (based on Appendix 4-A, pp. 140-148)
1. Money cost or accounting cost:
a. Cash paid
b. Allocated fixed costs
2. Economic costs: futuristic
a. Opportunity costs
b. Sunk costs
3. Social costs
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Easiest to use?
Example of cost calculations: Railroad from ISU to Boone
Fixed costs
Track, locomotive
$10,000,000
Variable cost (per year)
Car rental @ $400 per year:
option 1: 50 cars per year
option 2: 500 cars per year
option 3: 1,000 cars per year
option 4: 10,000 cars per year
requires 2nd locomotive @ $2,000,000
What are (& graph each):
1. total costs
2. average costs
3. marginal costs
Rate Making in Practice
Tariffs: the publication showing the rates; a price sheet or rate sheet.
General rates (for a variety of products) vs. Specific rates (as it sounds, for a
particular haul or service)
Older rate system: product classification, formerly published by Rate Bureaus
(sometimes still used within states)
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Now discounts from class rates, or exceptions to class rates, or separate
commodity rates (for higher volumes, repeated shipments).
Background:
What if we had a general rate of $.05 per ton-mile? Is that more equitable than a
rate of $250 per haul? (The latter is an example of a blanket rate, one type of
specific rate.)
Consider differences between points of service (33,000 shipping points in the
U.S.), and in commodities being shipped (grain, flour, Ho-Ho's), and in demands
for products. If all these differences were accounted for by individual shipping
rates, there could be trillions of rates published (in a tariff). OK but awkward.
Therefore, simplify:
1. Shipping and receiving points from 33,000 to only the most important; use a
grid system.
a. Measure distance from square to square (using the major shipping point
as the basis in each); call this number the rate basis number.
2. Substitute "rates" for individual prices. A rate is expressed in dollars (or cents)
per hundredweight (cwt).
3. Compare each commodity being shipped with a so-called "average"
commodity, in terms of density, stowability, handling, liability. The average
product gets a rating of 100 (or 100% of the normal or first-class rating). What
would you say about a product with a rating of 45? How about 200?
Examples:
1. You have a 10,000 pound shipment of Personal Effects of a Navy Admiral,
with a released value between $.50 and 2.00 per pound (what does this mean?) to
be shipped from Flint, Michigan to Columbus, Ohio.
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a. What is the rate basis number (and what does this mean)? Use Table 4-2, p.
115.
b. What is the class (and what does this mean)? Use Table 4-3, p. 116.
c. What is the rate? Use Table 4-5, p. 119.
d. What is the "price" (the amount of the freight bill)? What if you had 14,000
pounds of this item?
Now you have plastic materials meeting the item 156300 description, in rolls
measuring 9 feet in length 2 feet in diameter, to be shipped between two points
525 miles apart. The weight is 40,000 pounds. What is the freight bill? Use
Table 4-3 and Table 4-5.
You now have 4,000 pounds of reclaimed rubber, to be shipped from Akron, Ohio
to Warren, Michigan. How much will you be charged? Use Table 4-6, p. 120.
Rates under deregulation (p. 120)
Rate bureaus, status of.
Quote from p. 122: The product classification feature of the former class rate
system will no doubt survive for some time to come. This system of describing
and classifying products simplifies the entire product description processes for all
carriers.
Zip-code based rates.
Mileage rates (example of $1.25)
Special Rates (begins p. 122)—depends on character of shipment
LTL, TL vs. weight groupings
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Incentive rates: higher rate for the first 40,000 lb., lower rate for the remainder of
a TL or CL
multiple-car rates (RR) and Unit-train rates ($100,000)
Per-car; per-truckload; per-containerload rates (e.g., $3,500)
AQ similar to above
Rates based on product density, or physical volume filled (air carriers)
Similar: linear foot rule (motor carriers)
Exempt shipment rates (piggyback, fresh fruit, air freight).
Area, location, or route rates
Local vs. Joint
Proportional rates
Differential rates (water-compelled (RR)—not much used
mileage rates; (see p. 122)
Terminal-to-terminal; ramp-to-ramp
Blanket, group rates
Time/service rate structures
Contract rates: guaranteed minimum tonnage or percentage of total tonnage; also
car-supply charge (may be monthly).
Deferred delivery
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Other rate structures
Corporate Volume rates
Discounts (e.g., 25-50% off class rates)
Loading allowance
Aggregate tender rates
FAK
Released value rates
Two-way, 3-way rates (explain as back-haul rates)
Spot market rates
Menu pricing (pricing for “value-added” services)
Pricing in Transportation Management
Factors affecting (p. 128); “what market is forced to pay (in monopolistic
situations).” ?! Why?
Consider influence of other channel members, competitors, environment.
Major pricing decisions--examples:
1. Specific pricing decisions:
new service (FedEx)
2. modifying existing prices
3. responding to competitors (i.e., price leaders in an oligopoly).
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How much to charge for transportation? If based on costs, use average or
marginal costs.
Pricing objectives:
survival (airline examples--but marginal cost?)
unit volume pricing (multiple cars, space available)
profit maximization (but how do you know?)
Demand curve
skimming price (Concorde)
market penetration (Ryan Air)
sales-based pricing (follows life-cycle stages)
market share objective
social responsibility pricing objective (Cy-Ride).
Estimating Demand and Costs:
Consider price elasticity, economies of scale
Surveys, test markets
Pricing mistakes:
prices too reliant on costs
prices not revised with market changes
ignore interaction with marketing variables (e.g., promotion)
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one price for all.
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