Melanie Limpangug

Market-Based Pricing Practices in the United States Railroad Industry White Paper The purpose of this paper is to provide a historical background of the railroad industry in the United States (US) and its influence on the market-based pricing practices of companies in the industry. Background Railroads exercise a significant pricing power in the rail market. The maximization of economic welfare is attainable where an economically efficient pricing strategy is applied to make “the marginal social costs of railway services” at par with prices based on pure economic theory [1]. However, such postulation has become infeasible in railway management as the application of market-based pricing practices is uncommon for railway operations [1]. This makes vital the role of rail consultancy firms to helping realize railway infrastructure projects taking into account the significant pricing power of railroads in the rail market [2]. The economic and environmental benefits of railroads are essential considerations for shippers, who want to take advantage of railroads for their freight. History of the US Railroad Industry The development of railroads was instrumental to the growth of the US economy. The railroad industry served as a catalyst for growth during the nineteenth century [2]. Between the 1930s and 1950s, America developed railroad systems, including an intercity railroad that spanned across Baltimore and Ohio [3]. The Interstate Commerce Act 1887 was enacted to establish the Interstate Commerce Commission that subjected the railroads to an across the board federal economic regulation. This was prompted by the increasing influence of rail prices on individuals and businesses during the nineteenth century. Railroad operators acquired vast power and wealth that had to be regulated implement a reasonable and just pricing system. Freight railroads were introduced and developed further after the first World War [3]. However, the industry declined as a result of the increasing competition among highways, waterways, and railroads following the world war [3] [4]. Railroad operators encountered setbacks and challenges early in history as the increasing demand for railroad routes caused towns to convince ​ companies to build rail lines in their areas. The ​Railroad Revitalization and Regulatory Reform Act of 1976 (4R Act) was implemented to enable the regulatory reorganisation of the railroad industry. The law was enacted following the bankruptcy of the Penn Central Transportation Company. The US Government enacted the ​Staggers Rail Act of 1980 to instigate a regulatory balance that would help save the railroad industry. This led to an increase in production, a reduction in rates, and billions of dollar worth of reinvestments from private entities, which helped restore the foremost freight retail system in the world [3]. Deregulation had a positive impact on rail prices in the rail freight industry as shippers benefitted from an improvement in the railroads, which allowed to them to also pass the benefit to the consumers [4]. The impact of price deregulation on rail prices then helped revive an entire rail freight industry. Cash flows improved as rail prices reduced and allowed rails to compete with different modes of freight transportation. The Rail Renaissance of the 21st Century Today, the US freight rail industry is an epitome of a successful a comeback. The industry competes in the world rail market through its provision of a “safe, reliable, and cost-effective transportation for goods and services” [5]. The US Government worked towards the deregulation of the industry to provide a solution that would benefit the railway operators, shippers, and consumers. Technological advancements enabled railway operators to develop further the mechanisms to successfully deliver freight. The level of productivity also increased as shippers gained access to better railroad infrastructure. The result is the revitalization of the freight rail industry. US freight railroads now take a multifaceted approach to fuel conservation. The volume of railroads have increased in the past year compared to how it was in the 1980s but fuel consumption has lowered as a result of technological innovations, additional investments, and adoption of operating practices [6]. Consequently, the US freight railroad industry has increased its ability to compete with the railroad industries in the world in all aspects of railroad operations, from the miles of freight railroad, rail infrastructure and equipment, and volume of freight carried by rail [6: 1]. This has made the US railroad industry a first class freight rail system. Market-Based Pricing Railroad operators are involved in a large business, but often times conduct business as monopolies, which makes it difficult for an individual shipper to acquire as many information or have a leverage to effectively negotiate with these transportation service providers. Cost effectiveness is at the heart of the US freight railroad industry. On average, the freight rail rates (on a per ton mile revenue) is almost fifty percent lower in 2016 compared to the 1980s [7]. The low rates benefit consumers as this provides them with an opportunity ship twice the volume of freight at a relatively lower price compared to the price that they had to pay 37 years ago. In relation to cost effectiveness is the practice of market-based pricing in the US railroad industry. In general, market-based pricing appertains to the pricing of a product or service relative to the market. That is based on the cost that an individual shipper is able to carry and not according to the actual costs. Regulators in the US have demonstrated their support for the adoption of a market-based approach in the industry [8]. This has substantially helped the US freight rail industry to maximise revenue opportunities. More revenues also meant opportunities for rail operators to improve the efficiency and safety of the railroads. A market-based approach in rail pricing has contributed largely to the continued growth of the industry. This has allowed for the balancing of governmental role in the operations of railroads for freights across the country. The impact of deregulation has become more evident as investments coming from the private sector helped not just to stabilize the industry but also to keep the revenue adequate. This has also encouraged healthy competition in the industry that resulted in economic efficiency and innovation. The implementation of the ​Staggers Rail Act was also instrumental to this development as this enabled the rail operators to conduct their business in a manner that was similar to any type of business organization [8]. Thus, the deregulation of the industry resulted in the adopted of a market-based approach that benefited all key stakeholders. Railroads help alleviate highway congestion at the same time lowering its economic costs. That is in terms of the difference in the volume of freight that can be shifted through rail than through trucks. Economic costs are lowered as the freight gets to its destination on time as compared to when it is being shifted through trucks that may get stuck in traffic and cause the business to lose money. Contrastingly, there are key players in the railroad industry that are lobbying for the regulation of the railroads in the country. This could impose a limitation on the ability of the railroads to maintain the same quality of rail infrastructure that consumers have taken advantage of for the last three decades since the deregulation. This could also limit the ability of the railroads to impose a price that is contingent upon the forces in the market that affect the development of rail infrastructure and thus affect the costs of delivery of freight across the country. The calls to regulate the freight rail industry may be due to the increasing demand for freight transportation as more and more shippers rely on freight to transfer goods. Thus, the expansion of the US rail infrastructure has become increasingly important [9]. However, the regulation of the industry could threaten its cost-effectiveness as this may lead to more government intervention and cause US freight railroads to pass the burden to consumers or affect their freight service. Rail Costing and The Uniform Rail Costing System (URCS) The Uniform Rail Costing System (URCS) is the rail costing methodology that is applied to establish a projection of the variable and total unit costs associated with the transfer of goods through the US Class 1 railroads [10]. The pricing and operational decisions of railroads are based on a URCS that is used to gauge the shipment-level costs [11]. The rail costing process determines the eligibility of the rates of a shipment and the reasonableness of the rate [11]. There are consulting firms that use cost-based price consulting methods in providing advice to clients. However, this method is inconsistent with the reality of rail prices as they may fall short at providing a realistic comparison of the rail rates and then leave the shipper in a disadvantaged position in price negotiations. Additionally, the railroads, although under an obligation to provide transportation services to shippers that requests services are not held accountable to imposing unreasonable rates to consumers. There are Rate-Reasonableness Standards that may apply in these scenarios. The reasonableness of a rate is determined according to the market dominance of a movement. A reasonable rate must not exceed 180 percent of the costs. The rate of the movement should be beyond 180 percent of the variable cost designated by the URCS and not be subject to an effective competition for it to be qualified for review by the agency that administers the rate relief process [11]. However, in practice, railroads usually impose rates at 350 percent of the cost. Under the circumstances, the shipper may file with the Surface Transportation Board and undergo with the whole rate relief process to obtain a rate relief, i.e. lower rates, within a prescribed period. A shipper may need to spend at least $2,000,000 to file and win a rate case. Railroads, on the other hand, vigorously defend rail rate cases as what is at stake is the amount of money that they might lose, and the impact of a losing a case on the other shippers, such that they will also expect their rates to be reduced. Recommendations Based upon the history, facts, and arguments about the US freight railroad industry, railroads exercise a significant pricing power in the rail market. The following call to action is put forward to recognize the value of consulting services to shippers and consumers. Shippers should recognize how commodity mixes are also sensitive to market-based prices. The shippers need access to information about the relationship between commodity mixes and the price of transport modes. The uneven distribution of commodity mixes may have an impact on market-based prices. Essentially, there are movements in the economy that has an impact on commodity prices which could have an effect on the capacity of the shippers to transfer these through railroads. The choice of a transport mode may then be affected. Railroads undergo freight transportation planning to address the demands of railroads a strategic, tactical, and operational level [12]. As such the changes in the price of commodities may have implications on demand and on demand estimation involved in the freight transportation planning process. Shippers should gain a good understanding of what their market-based rates should be to help minimize the transportation cost expenses An analysis of transportation costs is crucial for shippers to benefit from the cost-effectiveness of railroads. However, this has to begin with their recognition of the different types of costs associated with transport, such as the internal costs, fixed and variable costs, and the costs of economic transfers and taxes [13] [15]. This could help to better understand the benefits of railroad transportation projects for the shippers in comparison with the other modes of transport. Conclusion A new regulation for the US rail industry would only derail the “the rail renaissance of the 21st century.” The Government should not put an end to the adoption of a market-based approach in rail pricing. This could have a significant impact on the economy and railroads may be restrained from earning efficient revenues [16] [17]. Market freedom should be given emphasis [18]. Rail pricing must still be consistent with the URCS [19]. Railroad regulations should encourage investment for innovation [20]. For the shippers, the goal must be to step up to the challenge and lobbying for the present policies to remain unchanged as this would help maintain the quality of the railroads in the country. Company Info The company offers professional services such as rate consulting services, which are provided by former railroad executives, who have extensive technical knowledge of rail pricing, and experience in rate evaluation. These experts provide clients with a advice on the reasonable rates and abuse or excessive rates (bid packages) offered by rail operators. References [1] The World Bank. (2017). Pricing [Online]. Available: https://ppiaf.org/sites/ppiaf.org/files/documents/toolkits/railways_toolkit/ch2_2.html [2] Donaldson D. (201). Railroads of the Raj: Estimating the impact of transportation infrastructure. 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