And!, And! And! one reason Pennsylvania steel mills have closed.
The involved railroads, the Pennsy and the L&N, could make money (create wealth) hauling the ingots from Pennsylvania to Kentucy. But the dang government wouldn't let 'em. You see, it would take the business away from the truckers and the barges and the government just couldn't allow that, now could they.
The steel mills would have reduced their logistics costs by using rail, but the government wouldn't allow that either.
So we got a bankrupt railroad and shuttered steel mills.
This is one of the stupidest things I've ever read. Never let a lawyer or a judge set a price. They don't know what they are doing.
http://en.wikisource.org/wiki/American_Commercial_Lines,_Inc._v._Louisville_%26_Nashville_Railroad_Company/Opinion_of_the_Court
.....Steel Mills: Badly damaged mills in Johnstown from the {latest}, flood back in 1977 didn't help the situation there for Bethlehem Steel.
Quentin
Basically, the steel mills were already outdated. Newer mills in Japan and Germany (replacing those destroyed in the war) could do the work more efficiently. You can walk up and down the tracks from Philadelphia to Chicago and find empty, abandoned factories. The buildings are old, and can not be fixed: they must be torn down and new buildings built. But for what reason? Nobody has ever had a reason to do so. Electricity is more costly in the north east than elsewhere, There are labor unions in the north east, why deal with them when you can build in a right-to-work state just as easily.
There is a steel fabricating plant in New England, North Dakota. I saw it there and wondered what the heck it was doing here. There are no steel mills there, there are no railroads there, and there are for dang sure no customers there, yet there they are fabricating steel! Better deal on labor? Well maybe a few years ago, but now with the oil boom out here nobody can get enough help, although an oil boom does mean customers for steel.
Pay your dime and pick your reason.
The Route of the Broadway Lion The Largest Subway Layout in North Dakota.
Here there be cats. LIONS with CAMERAS
It appears to me the ICC was dead wrong given the fact that barge traffic in particular was, and still is, heavily subsidized. Same for trucking. They do not pay their fair share of damage to roads.
Thank heaven for the demise of the ICC, and the creation of the STB. The Staggers Act at least gave the railroads a fighting chance by giving private enterprise a fighting chance to compete with those that are subsidized.Sure, water transportation is the less costly option but only at taxpayers expense.
Had the ICC had some foresight perhaps those Pennsylvania would still be in business.
Oh, the joys of the interference of government.
Norm
We're all subsidized...the railroads are too. Who eats more at the public trough is a subject for debate.
There are many reasons why the Pennsy and others ran into trouble. Sure, the regulatory straightjacket they were in was a big part of it. But there were other reasons as well that persist even to this day in any large organization. Large organizations generally are slow to react to changes in the market or in response to problems. That gives smaller organizations a distinct competitive advanage... This is why small transportation companies exist and indeed dominate the transportation industry. Speaking from experience, I can quote a price and have the load picked up and enroute before my larger competitor even sees the "request for a quote" from the shipper. Those of us who run small carriers realize that our only competitive advantage lies in the speed of execution. Take that away and we become redundant. The bureaucratic nature of large organizations like Pennsy had as much to do with their demise as anything else did.
Trucking continues to exist only because customers are willing to pay more, in some cases much more, for better faster service. We in the trucking industry could never compete successfully with rail on price alone. The railroads today realize that and are closing the gap on this service level disparity.
......And imported steel from the far east and perhaps other countries, undercut companies here in price. Now their labor costs too have risen, and no doubt continue to rise as well....Who knows, what the next big surprise in steel may be.
The city of Johnstown, at one time had upwards of 25,000 employees in those steel mills of Bethlehem, and U S steel there.
My home was 20 miles from there and one could see the red glow at night under the right weather conditions, from blast furnaces.....It was a valley of much activity, with employment from the mills and all the supporting industries to them in the area....Including the C & B L railroad serving the valley of plants....Much of which still stands.
Trivia: A city of streetcars all over the area, and reaching out to extended Boros. Before one of the floods, had extended {interurbans}, out to Windber, Pa., and Jerome.
greyhounds [snipped - PDN] . . . Never let a lawyer or a judge set a price. They don't know what they are doing. http://en.wikisource.org/wiki/American_Commercial_Lines,_Inc._v._Louisville_%26_Nashville_Railroad_Company/Opinion_of_the_Court
Actually, it wasn't the lawyers or judges who set or decided the price - it was the ICC Commissioners, after review of the claims of each side, pursuant to the amendments from the 1958 Transportation Act, which was enacted by Congress. All the judges did was decide whether the ICC got the process right in accordance with that law, or not - and the lawyers only argued each side, according to who was paying them.
But the real irony here is that it appears that the railroads "were hoist on their own petard" (Old English or Scottish version of "shooting yourself in the foot"). From the U.S. Supreme Court's opinion at the link above (emphasis added - PDN):
"The enactment of § 15a(3) in 1958 was due primarily to complaints by the railroads that the ICC had maintained rates at artificially high levels in order to protect competing modes from being driven out of business by railroad competition."
I also want to study further the quoted rates and their attributes as stated by the opinion - something seems odd to me there.
- Paul North.
Given the fact that steel mills all over the East, Midwest closed down for a wide variety of reasons (new technologies, imports, labor), to cite this decision (even if it was wrong) as one reason (with a strong implication that it was a major factor - "so we got a bankrupt railroad and shuttered steel mills") for the demise of the mills and PRR, seems a bit of a stretch, or more likely someone's pet theory looking for evidence.
C&NW, CA&E, MILW, CGW and IC fan
The government term would be "PROGRESS"
There are many, many reasons why the Pennsylvania Railroad went broke, the same as the New York Central, the Lackawanna, the New Jersey Central, and a number of Northeastern roads. Ever hear of the "Rust Belt"? The phenomenon affected them all. Rising taxes and labor costs, tougher environmental laws (not necessarily a bad thing) all lead to plant closings and the subsequent loss of shippers.
Also remember that in railroads were over-built in the Northeast in the sense there were too many of them. When the area was a big manufacturing center there was enough business to go around, but as those shippers disappeared the over-building became apparant. Also, with the post World War Two highway construction trucks came on the scene offering faster and more versatile "door-to-door" service. They couldn't win.
schlimm Given the fact that steel mills all over the East, Midwest closed down for a wide variety of reasons (new technologies, imports, labor), to cite this decision (even if it was wrong) as one reason (with a strong implication that it was a major factor - "so we got a bankrupt railroad and shuttered steel mills") for the demise of the mills and PRR, seems a bit of a stretch, or more likely someone's pet theory looking for evidence.
Thanks to Chris / CopCarSS for my avatar.
Murphy Siding schlimm: Given the fact that steel mills all over the East, Midwest closed down for a wide variety of reasons (new technologies, imports, labor), to cite this decision (even if it was wrong) as one reason (with a strong implication that it was a major factor - "so we got a bankrupt railroad and shuttered steel mills") for the demise of the mills and PRR, seems a bit of a stretch, or more likely someone's pet theory looking for evidence. I believe that's the reason the thread title is One reason the Pennsylvania Railroad went broke, not the only reason. It seems a little harsh to jump all over greyhounds based on your inference of what you think he meant. From your post, I can make the same kind of inferences, I guess, and ask you why you think over regulation and stiffling of competition and progress was a good thing for the PRR, the steel mills, the transportaion industry, and the American economy in general? Do you still hold those same opinions now?
schlimm: Given the fact that steel mills all over the East, Midwest closed down for a wide variety of reasons (new technologies, imports, labor), to cite this decision (even if it was wrong) as one reason (with a strong implication that it was a major factor - "so we got a bankrupt railroad and shuttered steel mills") for the demise of the mills and PRR, seems a bit of a stretch, or more likely someone's pet theory looking for evidence.
I believe that's the reason the thread title is One reason the Pennsylvania Railroad went broke, not the only reason. It seems a little harsh to jump all over greyhounds based on your inference of what you think he meant. From your post, I can make the same kind of inferences, I guess, and ask you why you think over regulation and stiffling of competition and progress was a good thing for the PRR, the steel mills, the transportaion industry, and the American economy in general? Do you still hold those same opinions now?
Well that is certainly making a quantum leap in inference! If you read more carefully, you would have noticed he said, "so we got a bankrupt railroad and shuttered steel mills" which clearly goes way beyond the title of the thread. So do you actually believe you know about my beliefs? Where is the evidence I ever said "over-regulation and stifling of competition and progress was [were] a good thing for the PRR, the steel mills, the transportation industry, and the American economy in general?' Apparently you like to engage in a straw man argument. Let's try the converse. Do you believe "over-regulation and stifling of competition and progress" were the main reasons for the failure of the PRR, the steel mills, the transportation industry, and the American economy in general? " The point is that the problems of the PRR and steel (which were the industries addressed) were far more complex than that court decision or even over-regulation.
So now you're flip flopping on your enthusiasm for over-regulation and competition stifling?
Murphy Siding So now you're flip flopping on your enthusiasm for over-regulation and competition stifling?
I guess you don't read.
Paul_D_North_Jr Oh yeah - the "Ingot Mold' case (1968). (To/ from Steelton in Kentucky ? - and why there ? - were they being moved anyway ? But I digress . . . ) Actually, it wasn't the lawyers or judges who set or decided the price - it was the ICC Commissioners, after review of the claims of each side, pursuant to the amendments from the 1958 Transportation Act, which was enacted by Congress. All the judges did was decide whether the ICC got the process right in accordance with that law, or not - and the lawyers only argued each side, according to who was paying them. But the real irony here is that it appears that the railroads "were hoist on their own petard" (Old English or Scottish version of "shooting yourself in the foot"). From the U.S. Supreme Court's opinion at the link above (emphasis added - PDN): "The enactment of § 15a(3) in 1958 was due primarily to complaints by the railroads that the ICC had maintained rates at artificially high levels in order to protect competing modes from being driven out of business by railroad competition." I also want to study further the quoted rates and their attributes as stated by the opinion - something seems odd to me there. - Paul North.
Oh yeah - the "Ingot Mold' case (1968). (To/ from Steelton in Kentucky ? - and why there ? - were they being moved anyway ? But I digress . . . )
Actually, there's an interesting sidebar to this incredibly asinine decision.
Remember Harry C. Ames (1890-1966), the ICC lawyer who basically caused the commission to order rail container rates increased to a non-competitive level in 1931. (Why would the government order corporations to increase their prices? Durring a depression!)
Well, in 1913 Harry C. begat a son. The son was named Harry C. Ames Jr. (1913-2008) Harry C. Jr. followed his father into the legal profession. Harry C. Sr. left government employment and joined with his son in the formation of the Washington, DC law firm of Ames, Hill and Ames in 1939. They naturally specialized in "Transportation Law."
Harry C. Jr's obituary states that he represented over 287 trucking and barge firms. With not a railroad mentioned.
http://www.legacy.com/obituaries/timesdispatch/obituary.aspx?n=harry-c-ames&pid=116670837
The kicker is that Harry C. Jr. was one of the lawyers representing the trucking/barge interest in the "Ingot Molds" case. Both he and his father seem to have specialized in getting government edicts that forced railroads to not compete for profitable freight This not only hurt the railroads, it hurt the US economy and the US people.
I've got a letter from Harry C. Jr. He wrote it to me after I was published in Trains in 1994. In the article I identified his father as the one who caused the demise of the budding rail intermodal system in 1931. He wanted to know what case I was talking about. I replied with the requested information and offered to supply any more information he wanted. I never heard from him again.
I should have been more agressive. He could have been a gold mine of information.
greyhounds - That's a bit of quite worthwhile history, personality, research, analysis, addition to the scholarship on the subject, and trivia factoid ! Thanks for sharing, and having the motivation to write that letter. I can now even accept that the lawyer complaint above was well-grounded. You've always been a credible commentator to me (even though we do disagree on a few issues), and this enhances your reputation with me.
OK, let me try to explain this to you.
You see, these regulator types and legal folks have this thing they call a "Precedent". They put great stock in these "Precedent" things. You pretty much have to buy Satan breakfast to get a "Precedent" changed. This case wasn't just about some steel being floated down the Ohio River from Pennsylvania to Kentucky. It was a challenge to a precedent established by the ICC regulator types that caused rail rates to be held high by the government so as to intentionally force the freight over to barge movement.
Look at the work the railroads did on this. They got a law through congress (probably involving several satanic breakfasts) and then fought the regulatory decision to the Supreme Court. The railroads would not have done all this if it was not an issue critical to their survival.
Railroads have high fixed costs due to their ownership of their own right of way. Barges and trucks don't have these high fixed costs because they use a government provided right of way. (Even if the truckers and barges pay fees to use the government right of way, it's a variable, not a fixed, cost) In an industry producing only one output (i.e. a Tootsie Roll plant) the sum of fixed and variable costs divided by the output would be called the "Average Costs". Since railroads produce more than one output, as they haul anything and everything from anywhere to everywhere, there is no possible "Average". What replaces the average in railroading is "Fully Allocated." In railroading the fixed costs can be summed up and then divided by any number you want to use to produce a magic number called the "Fully Allocated Cost.". The denominator in this calculation can be gross ton-miles, revenue ton-miles, train crew use of toilet paper, whatever you want. It's an ALLOCATION of FIXED costs that can't be assigned to any specific transportation event.
Since fixed costs, by definition, don't change with the volume of freight handled by a railroad they play no rational role in pricing rail service. That's why the railroads brought all those economists in to testify in the "Ingot Molds" case. They were demonstrating that the government regulators were using a totally bogus standard to protect the barge lines. Why would the regulators do this? I don't know. Maybe some cash was finding its way in to their pockets? Maybe the Washington, DC law firm of Ames, Hill and Ames knew the right buttons to push? Maybe the regulators were just ignorant? Maybe they didn't want to rock the boat?
Anyway, this important case set the "Precedent" that the ICC regulators could use fully allocated rail costs as a means to protect truck and barge lines from rail competition. If it wasn't a death sentance for the Pennsylvania Railroad it was gosh darn close to one.
As to the steel mills, they had tremendous costs bringing in vast amounts of raw materials and distributing vast amounts of finished products. Anything that inhibited the mills' ability to reduce their logistics costs also inhibited their ability to modernize and compete with imported steel. Again, it may have not been the ultimate death sentance by government. But it sure made things worse.
Finally, ask yourself why the government was even involved in this situation. They really had no role to play. Other than sticking their nose in.
Thanks for the explanation. I am no cost accountant, but I seem to recall that fixed costs (overhead) have to be allocated to the price of goods or services in some way or else a company loses money if it only covers the variable costs. Fully allocated costing is one such method, which I do recall is often disliked by the sales departments and can create some internal tension with the accounting department of a company.
The Men Who Loved Trains by Rush Loving Jr. contains some helpful insights into the demise of the PRR, as well as the other Northeastern roads, and the emergence of Conrail. I recommend it.
schlimm Thanks for the explanation. I am no cost accountant, but I seem to recall that fixed costs (overhead) have to be allocated to the price of goods or services in some way or else a company loses money if it only covers the variable costs. Fully allocated costing is one such method, which I do recall is often disliked by the sales departments and can create some internal tension with the accounting department of a company.
No, fixed costs (overhead) doesn't have to be allocated. It has to be covered, but it can't rationally be allocated in diverse output enterprises such as a railroad (Or a McDonalds). People can, and have, come up with formulas for such allocations. But just because there is a formula that produces a number doesn't mean the number is meaningful. Again, in railroading and other lines of trade, overhead cost has to be covered but it can't be rationally allocated to specific units of sale.
Pricing is much more complex than crunching a bunch of numbers. In the subject situation the railroads involved couldn't set the price. The price was being set by competition. In this case a truck-barge movement of ingots. The maximum rail price that would get the business was above the rail variable cost but below the contrived fully allocated rail cost. So should the railroads want business at a maximum price that is above variable but below fully allocated cost?
Of course they would want such business. They would be better off with the business as it would make some contribution to covering their fixed costs. When the government regulators rulled that they could not price at such a level they seriously hurt the Pennsylvania Railroad and other railroads. Not only did such a rulling hurt the railroads, it hurt the nation because it prevented the US from receiving maximum benefit from its railroads.
In 1967 the Pennsylvania Railroad had precious little traffic that was not subject to truck and/or barge competition. When the dang government greatly restricted their ability to compete for such business, it was, by in large, a death sentance for the railroad. (See "In the Matter of Container Service" for another inane government decision that helped kill the Pennsy.)
Again, can you explain why the government needed to even be involved in this situation, or any other such situation where the pervasive intermodal competition existed. They only screwed things up and hurt the country.
Greyhounds or Mr North: A question
If Al Perlman had run Penn Central after the merger could he have pulled it off. With or without Blevens (the CFO or treasurer I think) money support?
Try to remember he started the Rio Grande to out hustle UP. And he was starting to do that at the New York Central.
Thx IGN
Precedent is as important in court decisions as in regulatory decisions. Dismissing it out of hand would leave the door open for capricious decisions.
The various regulatory bodies at both the state and federal level came into existence because there was a general desire for it. Also, there is still a strong undercurrent of distrust for Big Business so the issue of regulation is not going to go away.
Ken: I really don't know what would be exactly the best method to allocate fixed costs. But to "cover" them means to allocate them into the pricing of services so that the revenue stream in toto will cover those costs. If you only price a service with a margin above the variable (operating) costs, you will either not cover the fixed costs if they are high, as in a railroad, or you will end up with no profit. What you will end up doing by default is allocating that share of the fixed costs to some other service you offer, sort of a loss leader. There's no getting away from it. Perhaps the rationale for the ICC decision was that the PRR was operating a service below the true cost to eliminate competition, and once that was done, would have priced it at whatever they wanted? That sort of thing has happened in many modalities (retailing comes to mind), but it is uniquely grievous when unlike retailing, especially grocery stores, the limited competition is eliminated.
narig01 Greyhounds or Mr North: A question If Al Perlman had run Penn Central after the merger could he have pulled it off. With or without Blevens (the CFO or treasurer I think) money support? Try to remember he started the Rio Grande to out hustle UP. And he was starting to do that at the New York Central. Thx IGN
If you research this farther, you will find that Penn Central forced Perlman and his associates out. The reasons involved were complex to say the least, but it seems that there were a number of utterly incompetent managers in Penn Central whose real motivation was to set up the golden handshake/nest egg for themselves. By attempting to run the railroad the way it probably should have been run, he was screwing up their plans, so they forced him out. Trains ran a highly detailed article a couple years back on Alfred Perlman.
Some loved him; some did not--but he did know how to run a railroad.
My uncle was a high ranking employee within Melon Bank and at least moderately active within the Pittsburgh society circles. He and my aunt contended that a lot of dirty behind the scenes money grabbing went on at Penn Central during the late 1960's, as various managers were motivated to line their own pockets at the expense of the railroad. Prior to her death, my aunt had said the truth of the alleged financial misdeeds may never fully see the light of day--but that's really all I know.
John
schlimm Ken: I really don't know what would be exactly the best method to allocate fixed costs. But to "cover" them means to allocate them into the pricing of services so that the revenue stream in toto will cover those costs. If you only price a service with a margin above the variable (operating) costs, you will either not cover the fixed costs if they are high, as in a railroad, or you will end up with no profit. What you will end up doing by default is allocating that share of the fixed costs to some other service you offer, sort of a loss leader. There's no getting away from it.
Ken: I really don't know what would be exactly the best method to allocate fixed costs. But to "cover" them means to allocate them into the pricing of services so that the revenue stream in toto will cover those costs. If you only price a service with a margin above the variable (operating) costs, you will either not cover the fixed costs if they are high, as in a railroad, or you will end up with no profit. What you will end up doing by default is allocating that share of the fixed costs to some other service you offer, sort of a loss leader. There's no getting away from it.
UP 4-12-2 narig01: Greyhounds or Mr North: A question If Al Perlman had run Penn Central after the merger could he have pulled it off. With or without Blevens (the CFO or treasurer I think) money support? Try to remember he started the Rio Grande to out hustle UP. And he was starting to do that at the New York Central. Thx IGN If you research this farther, you will find that Penn Central forced Perlman and his associates out. The reasons involved were complex to say the least, but it seems that there were a number of utterly incompetent managers in Penn Central Some loved him; some did not--but he did know how to run a railroad. John
narig01: Greyhounds or Mr North: A question If Al Perlman had run Penn Central after the merger could he have pulled it off. With or without Blevens (the CFO or treasurer I think) money support? Try to remember he started the Rio Grande to out hustle UP. And he was starting to do that at the New York Central. Thx IGN
If you research this farther, you will find that Penn Central forced Perlman and his associates out. The reasons involved were complex to say the least, but it seems that there were a number of utterly incompetent managers in Penn Central
Could he have made it work? Try to remember some of the talent he would have had. Jim Hagen(I think) Mike Flanery, Jim McClellan to name a few.
Murphy Siding I imagine there's some of this same thing going on in most every industry. How do they price things to make a profit in your industry schlimm?
I imagine there's some of this same thing going on in most every industry. How do they price things to make a profit in your industry schlimm?
Quite different in healthcare, as so much is determined by insurance. In academia it's a different world. But years ago in retail, it was a running battle for us buyers with the cost accountants, who always wanted to be sure we were allocating overhead, and like most folks in that field, when it is a big operation, they had specific formulae. Hardly anyone outside the accounting division much likes accountants, but they are an essential ingredient in any successful operation. One of the biggest reasons start up businesses fail is they underprice (hardly ever overprice) their services or products by seat of the pants calculations, aka, intuition, hunches, business acumen or plain guessing.
narig01 UP 4-12-2: narig01: Greyhounds or Mr North: A question If Al Perlman had run Penn Central after the merger could he have pulled it off. With or without Blevens (the CFO or treasurer I think) money support? Try to remember he started the Rio Grande to out hustle UP. And he was starting to do that at the New York Central. Thx IGN If you research this farther, you will find that Penn Central forced Perlman and his associates out. The reasons involved were complex to say the least, but it seems that there were a number of utterly incompetent managers in Penn Central Some loved him; some did not--but he did know how to run a railroad. John My original question was what if Al Perlman had run the combined Penn Central, Could he have made it work? Try to remember some of the talent he would have had. Jim Hagen(I think) Mike Flanery, Jim McClellan to name a few. Thx IGN
UP 4-12-2: narig01: Greyhounds or Mr North: A question If Al Perlman had run Penn Central after the merger could he have pulled it off. With or without Blevens (the CFO or treasurer I think) money support? Try to remember he started the Rio Grande to out hustle UP. And he was starting to do that at the New York Central. Thx IGN If you research this farther, you will find that Penn Central forced Perlman and his associates out. The reasons involved were complex to say the least, but it seems that there were a number of utterly incompetent managers in Penn Central Some loved him; some did not--but he did know how to run a railroad. John
My original question was what if Al Perlman had run the combined Penn Central,
Loving addresses the Perlman issue in The Men Who Loved Trains, which I referenced earlier. It has been approximately a year since I read the book, but I believe he concluded that Perlman would have had a dramatic impact on the combined Central/PRR, but in any case regional economics as well as two extremely different corporate cultures were working against the merger. Making the Central and Pennsy merger work would have been a daunting task.
Perlman, if I remember correctly, wanted to merge the Central with the C&O, which he believed would be a better fit.
greyhounds schlimm: Thanks for the explanation. I am no cost accountant, but I seem to recall that fixed costs (overhead) have to be allocated to the price of goods or services in some way or else a company loses money if it only covers the variable costs. Fully allocated costing is one such method, which I do recall is often disliked by the sales departments and can create some internal tension with the accounting department of a company. No, fixed costs (overhead) doesn't have to be allocated. It has to be covered, but it can't rationally be allocated in diverse output enterprises such as a railroad (Or a McDonalds). People can, and have, come up with formulas for such allocations. But just because there is a formula that produces a number doesn't mean the number is meaningful. Again, in railroading and other lines of trade, overhead cost has to be covered but it can't be rationally allocated to specific units of sale. Pricing is much more complex than crunching a bunch of numbers. In the subject situation the railroads involved couldn't set the price. The price was being set by competition. In this case a truck-barge movement of ingots. The maximum rail price that would get the business was above the rail variable cost but below the contrived fully allocated rail cost. So should the railroads want business at a maximum price that is above variable but below fully allocated cost? Of course they would want such business. They would be better off with the business as it would make some contribution to covering their fixed costs. When the government regulators rulled that they could not price at such a level they seriously hurt the Pennsylvania Railroad and other railroads. Not only did such a rulling hurt the railroads, it hurt the nation because it prevented the US from receiving maximum benefit from its railroads. In 1967 the Pennsylvania Railroad had precious little traffic that was not subject to truck and/or barge competition. When the dang government greatly restricted their ability to compete for such business, it was, by in large, a death sentance for the railroad. (See "In the Matter of Container Service" for another inane government decision that helped kill the Pennsy.) Again, can you explain why the government needed to even be involved in this situation, or any other such situation where the pervasive intermodal competition existed. They only screwed things up and hurt the country.
schlimm: Thanks for the explanation. I am no cost accountant, but I seem to recall that fixed costs (overhead) have to be allocated to the price of goods or services in some way or else a company loses money if it only covers the variable costs. Fully allocated costing is one such method, which I do recall is often disliked by the sales departments and can create some internal tension with the accounting department of a company.
Allocation of overheads and fixed costs to product lines is a complex subject. It is beyond the scope of these forums. Having said that, a business can determine the cost of goods sold, which includes an allocation of overheads, to determine its operating profit, and then look to cover the fixed costs with the combined product operating profits.
In the case of the electric utility business in Texas, upon deregulation, we determined that we needed to allocate some of the fixed costs, i.e. depreciation, interest, taxes, etc. by product line and by segments, e.g. generation, transmission, distribution, retail, etc. Actually, the regulator required us to do it. We were able to come up with fixed cost allocation models that were acceptable to management, the regulators, and perhaps most importantly our external auditors.
Allocations contain heaps of estimates. The key question is whether they are logical and can be supported.
schlimm Murphy Siding: I imagine there's some of this same thing going on in most every industry. How do they price things to make a profit in your industry schlimm? Quite different in healthcare, as so much is determined by insurance. In academia it's a different world. But years ago in retail, it was a running battle for us buyers with the cost accountants, who always wanted to be sure we were allocating overhead, and like most folks in that field, when it is a big operation, they had specific formulae. Hardly anyone outside the accounting division much likes accountants, but they are an essential ingredient in any successful operation. One of the biggest reasons start up businesses fail is they underprice (hardly ever overprice) their services or products by seat of the pants calculations, aka, intuition, hunches, business acumen or plain guessing.
Murphy Siding: I imagine there's some of this same thing going on in most every industry. How do they price things to make a profit in your industry schlimm?
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