Transport Management & Theory Practices (10)

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Management of Transportation

Seventh Edition Coyle, Novack, Gibson & Bardi

© 2011 Cengage Learning

Chapter 10Costing and Pricing

Issues



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Chapter 10 Topics

• Market Considerations

• Cost-of-Service Pricing

• Value-of-Service Pricing

• Rate Making in Practice

• Special Rates

• Pricing in Transportation Management



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Market Considerations

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

• Market structure models– Evolve 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 Considerations, cont’d

• Market structure models, cont’d– Principal 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’d– Few 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 competitors– Necessary 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 areas– No 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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Cost-of-Service Pricing

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

• Principal assumptions– Service is homogeneous– One group of customers– Customers must cover all costs– Seller sets prices to maximize profits


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Cost-of-Service Pricing, cont’d

• Two variations of cost-of-service pricing– Average cost approach– Marginal cost approach– Cost of service as price floor

• Impact of common costs– The cost-price circular argument

• Problem of decreasing cost industries– Subsidies and tax policy


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Figure 10-1


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Figure 10-2


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Value-of-Service Pricing

• Alternative definitions and terminology– Similarity is that all consider demand

characteristics (as well as costs) in pricing

• Pricing according to product value– Charging higher prices on higher value products– Cost-based reasons (liability) for such pricing– Value is indicator of ability to bear prices, but

other demand factors may dictate price elasticity


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Figure 10-3


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Value-of-Service Pricing, cont’d

• Third-degree price discrimination– Def: Seller sets separate prices for separate

groups of buyers of essentially same service– Three 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 pricing– Similar definition as 3rd degree price

discrimination– Same 3 conditions apply– Means of segmenting buyers

• By commodity

• By time

• By place

• By individual person– Legal limitations


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Figure 10-5


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• Sets a ceiling on prices– Can 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 charged– Some prices < ave. costs can be profitable

• Keys to successful value-of-service pricing– Knowing how costs behave– Good estimates of price elasticity


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Figure 10-6


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Rate Making in Practice

• Some initial terminology– Rates and tariffs

• Individual tariffs

– Rate bureaus and bureau tariffs

• General rates– Class , exception, and commodity rates

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


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Rate Making in Practice, cont’d

• Class rate system– Provides a rate for any commodity between any

two points– Three 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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Figure 10-8


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Table 10-1


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Table 10-2


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Table 10-3


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• Commodity classification factors– Product characteristics that impact carrier costs

• Product density– Higher 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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Table 10-4


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• Determining a class rate– Determine rate basis points for origin/dest.– Determine rate basis no. (rate basis no. tariff)– Determine commodity classification rating– Determine rate from class rate tariff– Multiply class rate by shipment weight in cwt


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Figure 10-9


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Table 10-5


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• Exception rates– Modification to national classification– Instituted by individual carrier– Used 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 rates– Constructed 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 rates– Typically offered for regular, large volume

moves


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Table 10-6


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

• Post-deregulation era– Diminished role of rate bureaus in rate matters– Increased number of individual carrier tariffs– Expanded use of shipper-carrier negotiations– Portions 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’d– Some new rate type examples

• Zip code based rates published as part of carrier specific class and commodity rate structures

– Many carriers offer web-based zip-code tariffs as variations of class rate system

• Mileage-based rates– Variation of commodity tariff system

– Rates quoted per mile, regardless of weight


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Special Rates

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

• Character-of-shipment rates– LTL/TL rates– Multiple-car rates– Incentive rates– Unit-train rates– Per-car and per-truckload rates– Any-quantity rates– Density rates


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Special Rates, cont’d

• Area, location, or route rates– Local rates– Joint rates– Proportional rates– Differential rates– Per-mile rates– Terminal-to-terminal rates– Blanket or group rates


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• Time/service rate structures– Contract rates

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

• Rates and services negotiated between shipper, carrier– Rates not governed by published tariffs– Objectives 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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Special Rates, cont’d Time/service rate structures, cont’d

– 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 rates– Discounts– Loading allowances– Aggregate tender rates– FAK rates


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• Other rate structures, cont’d– Released rates– Empty haul rates– Two-way or three-way rates– Spot-market rates– Menu pricing


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Pricing in Transportation Management

• Factors affecting pricing decisions– Role 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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Pricing in Transport Mgmt, cont’d

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

• Carriers involved in interline movements – Revenue split issues

– Price 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 traffic

– Modification 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 objective– General 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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Pricing in Transport Mgmt, cont’d Establishing the pricing objective, cont’d

– 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 maximization– Attractive 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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Pricing in Transport Mgmt, cont’d Establishing the pricing objective, cont’d

– 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 service– For price changes, price elasticity estimates are made

• Similar market comparisons (cautions)

– Role of surveys and market tests

• Estimating costs– Determination of what costs to include– Cost variation at different levels of output


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• Price levels and price adjustments– Given demand and cost estimates, actual price

can now be set– Alternative methods of setting actual price

• Demand-based

• Cost-based

• Profit-based

• Competition-based


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Pricing in Transport Mgmt, cont’d Price levels and price adjustments, cont’d

– 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 seasons– Cash discounts for quicker payment of bills

• Federal regulation of discounts– Discount must result from carrier cost savings due to

action of shipper– Size of discount should not exceed cost savings


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• Most common mistakes in pricing– Over-reliance on costs– Slow reaction to market changes– Ignoring marketing mix– Prices not tailored to services and markets– Need to price according to strategic plan

Business

Transport Management & Theory Practices (10)