Saving the Railroad Industry TO Death - The Evil of Economic Freight Rate Regulation

[MichaelSol]

The 180 rev/lrvc thing is only a legal thng.  The Law Deparment thinks about it but it has virtually nothing to do with how the railroad and it's customers do business with one another.  In negotiating dozens of contracts with margins over 180% in never came up.  Not once in 23 years!

This is misleading all the way around. 

It is an important economic concept, written into law. The concept was designed by the economists who forcefully and successfully advocated deregulation but who also felt it was of utmost significance to have a marginal price formula to restrict monopolistic behaviors.

This was a regulatory alternative to placing railroads under the general jurisdiction of the Justice Department where general anti-trust law is enforced. The alternative to a straightforward marginal price constraint is constant re-examination on a case by case basis using the Herfindahl-Hirschman Index, or other more generalized measures of market control or market share, and imposing standard anti-trust remedies that other businesses in the United States are subject to.

In the case of railroads, the economists who devised the concept recognized the dangers of captive shippers and potential monopoly under deregulated conditions and advocated -- in all cases of deregulation, not just railroads -- a marginal price formula to ensure that, within a broad range of economic conditions, businesses could engage in differential pricing subject to an approximation of market restraints under those circumstances where genuine markets did not exist.

The 160% R/VC ratio was recommended based on economic studies. The rail industry successfully lobbied for the higher threshold of 180% R/VC.

The number of litigated cases involving shippers and railroads where the subject of the 180% R/VC threshold "came up" in the course of discussions -- resulting in outright litigation -- is lengthy.

Outside of litigation, the number of pages of shipper testimony regarding their difficulties in negotiating with railroads over the significance of that threshold fills many, many volumes.

 

[bobwilcox]

The 180 rev/lrvc thing is only a legal thng.  The Law Deparment thinks about it but it has virtually nothing to do with how the railroad and it's customers do business with one another.  In negotiating dozens of contracts with margins over 180% in never came up.  Not once in 23 years!

[greyhounds]

Could someone provide me with a definition of cross subsidization as it applies to railroad pricing?

In my mind, a LOB is only being cross subsidized if revenue is less than variable costs.  From the posts on this thread, it appears that there are other definitions being used.  Anyone?

The STB standard is 180% of revenue to variable cost.  Thus, in the railroad context any rate structure which results in an R/VC of less than 180% is probably being cross subsidized by the rate structure in which revenues exceed variable costs by more than 180%.  Compare that to your statement above, where you believe cross subsidization only happens when revenues are less than 100% of variable costs.  For the record, the lowest R/VC ratio that I know of is 108%, so by your definition there is currently no cross subsidization taking place.

Whether the 180% measure itself is too arbitrary is another discussion altogether.

You're right, there is no cross subsidization taking place.

The 180% figure is just a political compromise benchmark.  A study found 61% of rail business to be priced below that figure.  If a rail freight rate is below 180% of variable cost the traffic is deemed to be in a competitive situation and the rail customers have no legal standing to make a complaint about their rates.

If the rate exceeds 180% the customers may file with the Surface Transportation Board, which then could conduct an investigation.  The shipper is "potentially" captive.  But the rate may be well over 180% of variable cost and still be the result of competive factors. 

It has nothing to do with cross subsidies. 

[greyhounds]

Here we go again, a personal attack about personal attacks.... the topic is an interesting discussion, keep your announced personal vendettas that you keep dragging into these threads, and what you "are never going to forget," to yourself. Back to the regularly scheduled economic discussion ....

You aren't in charge and you're not going to tell me what I can or can not say.

[Datafever]

[This was subsequently modified to 180% and then not implemented as a cap.  If it had been implemented as a cap, then by what you said, no railroad could ever be revenue adequate.

?

Well, fix my math if I am misunderstanding you.

A hypthetical railroad named BNSF has $10 billion in operating expenses. Historically, that breaks out to roughly $7.4 billion in variable costs and $2.6 billion in fixed costs.

If the BNSF is charging an average of 160% R/VC, its revenue will be $11.85 billion, showing a net profit of $1.85 billion. That is a 15.63% rate of return on revenue which is substantially above the WACC of the BNSF over the past ten years. At 180%, it would be a 25% rate of return.

If that is not revenue adequate, there is not a Fortune 500 corporation that is going to make it. They're all doomed.

I fear that you have taken my quote out of context.  I was responding to a post that declared that 180% R/VC was the standard by which the STB determines if a railroad is revenue adequate. 

[MichaelSol]

[This was subsequently modified to 180% and then not implemented as a cap.  If it had been implemented as a cap, then by what you said, no railroad could ever be revenue adequate.

?

Well, fix my math if I am misunderstanding you.

A hypthetical railroad named BNSF has $10 billion in operating expenses. Historically, that breaks out to roughly $7.4 billion in variable costs and $2.6 billion in fixed costs.

If the BNSF is charging an average of 160% R/VC, its revenue will be $11.85 billion, showing a net profit of $1.85 billion. That is a 15.63% rate of return on revenue which is substantially above the WACC of the BNSF over the past ten years. At 180%, it would be a 25% rate of return.

If that is not revenue adequate, there is not a Fortune 500 corporation that is going to make it. They're all doomed.

 

[MichaelSol]

Here we go again, a personal attack about personal attacks.... the topic is an interesting discussion, keep your announced personal vendettas that you keep dragging into these threads, and what you "are never going to forget," to yourself. Back to the regularly scheduled economic discussion ....

[greyhounds]

Groan,  Well here we go again.  Greyhounds started with his model assinging $1000 per car load of coal to fixed costs.  Now he comes along and says, "(You can not allocate fixed cost to any specific movement - you have to cover them with your entire traffic base, but you can not allocate them.  The only way the ethanol shows a loss is through the impossible allocation of fixed costs to the movement.)"  So which is it, can you assign fixed costs to reveue cars or not?  You cannot have it both ways.

So here is my plan.  I will not read any more of your posts and thus will not be tempted to reply to any more of them.  Perhaps that way you can keep a straight line of thought instead or bouncing around the spectrum in order to be contravailing.

Also, please note.  Though containers have the potential to be loaded bidirectional the reality is the loaded movements eastward with imports far exceeds the loaded westbound boxes loaded with export or domestic product.

You know, these personal attacks out of Montana got old a long time ago. 

I intentionally set up a simple situation where a rail line had only one movement.  In that scenario, that one movement obviously had to carry the entire cost of the line, both fixed and variable cost. 

I then introduced a second movement of freight that had to be sold below average cost to demonstrate that such a movement could be sold at a profit to the railroad company as long as it exceeded variable costs.

You now falsely accuse me of "assigning" the fixed cost in the initial situation.  No, I didn't "assign" them - but since there was just that coal business on the line, nothing else was there to carry those cost.  

You evidently can't/won't understand this so you resort to personal insults.  And I'm not ever going to forget your attack on me for my involvement in Greyhound racing.  That's something I'm very proud of.  And it's something else you know nothing about.  But your lack of knowledge didn't stop you then either.   

[Datafever]

The 180% standard is used to determine revenue adequecy.  Thus, any rate structure below 180% R/VC supposedly does not cover all costs (variable, fixed, etc.) of the move, so we presume such would have to be made up for by someone else's rate structure which exceeds the standard.

You seem to be throwing things my direction that I have never run across before.  That doesn't mean that you are wrong, it just means that my research hasn't encountered what you are saying.  Could you provide a reference or two to back this up?

From what I have read, revenue adequacy is determined by return on investment.  Further, it is my understanding that when Staggers was originally proposed, 160% R/VC was going to be the cap.  This was subsequently modified to 180% and then not implemented as a cap.  If it had been implemented as a cap, then by what you said, no railroad could ever be revenue adequate.

The fact that the GAO uses this standard for the totally unrelated purpose of *determining* captive shipper status just means that some ivory tower beauracrats are too lazy to use the more logical method of determining captivity, aka the physical limitation to one Class I service provider.

The GAO does not use the 180% R/VC as a method for determining captive shipper status as an arbitrary measure.  Staggers defines a "potential captive shipper" as one whose rate exceeds 180% R/VC.  In other words, the term is a legal definition.  For the GAO to willy-nilly use a different definition would be silly.

In so far as your definition being a more logical method, I am not convinced.  Perhaps we could run through some scenarios and you could elaborate.

[Anonymous]

Could someone provide me with a definition of cross subsidization as it applies to railroad pricing?

In my mind, a LOB is only being cross subsidized if revenue is less than variable costs.  From the posts on this thread, it appears that there are other definitions being used.  Anyone?

The STB standard is 180% of revenue to variable cost.  Thus, in the railroad context any rate structure which results in an R/VC of less than 180% is probably being cross subsidized by the rate structure in which revenues exceed variable costs by more than 180%.  Compare that to your statement above, where you believe cross subsidization only happens when revenues are less than 100% of variable costs.  For the record, the lowest R/VC ratio that I know of is 108%, so by your definition there is currently no cross subsidization taking place.

Whether the 180% measure itself is too arbitrary is another discussion altogether.

I am aware that the STB uses the 180% value to determine potential captive shippers (per Staggers), but I have not read anything that would indicate that the 180% value is used to define cross subsidization.  Would you happen to have any links to information that would validate that?

If one shipper pays 181% R/VC and another shipper pays 179% R/VC, would you say that cross subsidization has taken place?  If that were a valid criteria, then any shipper that paid a higher R/VC percentage would be cross subsidizing any other shipper that paid a lower R/VC regardless of the actual percentage.

I wouldn't say that what I stated was a definition, per se.  It just kind of "makes sense" to me.  After all, if an LOB is actually losing money (not covering the variable costs) then I think that it is inarguable that such LOB is being cross subsidized by the rest of the business.

The reason that I brought it up is because the various posts that have been made seem to indicate that not everyone is on the same wavelength as to what cross subsidization really means in this context.

The 180% standard is used to determine revenue adequecy.  Thus, any rate structure below 180% R/VC supposedly does not cover all costs (variable, fixed, etc.) of the move, so we presume such would have to be made up for by someone else's rate structure which exceeds the standard.

The fact that the GAO uses this standard for the totally unrelated purpose of *determining* captive shipper status just means that some ivory tower beauracrats are too lazy to use the more logical method of determining captivity, aka the physical limitation to one Class I service provider.

[oltmannd]

Groan,  Well here we go again.  Greyhounds started with his model assinging $1000 per car load of coal to fixed costs.  Now he comes along and says, "(You can not allocate fixed cost to any specific movement - you have to cover them with your entire traffic base, but you can not allocate them.  The only way the ethanol shows a loss is through the impossible allocation of fixed costs to the movement.)"  So which is it, can you assign fixed costs to reveue cars or not?  You cannot have it both ways.

So here is my plan.  I will not read any more of your posts and thus will not be tempted to reply to any more of them.  Perhaps that way you can keep a straight line of thought instead or bouncing around the spectrum in order to be contravailing.

Also, please note.  Though containers have the potential to be loaded bidirectional the reality is the loaded movements eastward with imports far exceeds the loaded westbound boxes loaded with export or domestic product.

Any box moving in either direction, loaded or empty, is a revenue move except for RR controlled equipment, which is a shrinking piece of the pie.

[Datafever]

Could someone provide me with a definition of cross subsidization as it applies to railroad pricing?

In my mind, a LOB is only being cross subsidized if revenue is less than variable costs.  From the posts on this thread, it appears that there are other definitions being used.  Anyone?

The STB standard is 180% of revenue to variable cost.  Thus, in the railroad context any rate structure which results in an R/VC of less than 180% is probably being cross subsidized by the rate structure in which revenues exceed variable costs by more than 180%.  Compare that to your statement above, where you believe cross subsidization only happens when revenues are less than 100% of variable costs.  For the record, the lowest R/VC ratio that I know of is 108%, so by your definition there is currently no cross subsidization taking place.

Whether the 180% measure itself is too arbitrary is another discussion altogether.

I am aware that the STB uses the 180% value to determine potential captive shippers (per Staggers), but I have not read anything that would indicate that the 180% value is used to define cross subsidization.  Would you happen to have any links to information that would validate that?

If one shipper pays 181% R/VC and another shipper pays 179% R/VC, would you say that cross subsidization has taken place?  If that were a valid criteria, then any shipper that paid a higher R/VC percentage would be cross subsidizing any other shipper that paid a lower R/VC regardless of the actual percentage.

I wouldn't say that what I stated was a definition, per se.  It just kind of "makes sense" to me.  After all, if an LOB is actually losing money (not covering the variable costs) then I think that it is inarguable that such LOB is being cross subsidized by the rest of the business.

The reason that I brought it up is because the various posts that have been made seem to indicate that not everyone is on the same wavelength as to what cross subsidization really means in this context.

[Murphy Siding]

    What does LOB stand for?  Thanks

Line Of Business

     Thanks Datafever.

[Anonymous]

Could someone provide me with a definition of cross subsidization as it applies to railroad pricing?

In my mind, a LOB is only being cross subsidized if revenue is less than variable costs.  From the posts on this thread, it appears that there are other definitions being used.  Anyone?

The STB standard is 180% of revenue to variable cost.  Thus, in the railroad context any rate structure which results in an R/VC of less than 180% is probably being cross subsidized by the rate structure in which revenues exceed variable costs by more than 180%.  Compare that to your statement above, where you believe cross subsidization only happens when revenues are less than 100% of variable costs.  For the record, the lowest R/VC ratio that I know of is 108%, so by your definition there is currently no cross subsidization taking place.

Whether the 180% measure itself is too arbitrary is another discussion altogether.

[Datafever]

Could someone provide me with a definition of cross subsidization as it applies to railroad pricing?

In my mind, a LOB is only being cross subsidized if revenue is less than variable costs.  From the posts on this thread, it appears that there are other definitions being used.  Anyone?

[MichaelSol]

 

oltmannd wrote:

Or, perhaps rates are a function of capacity.  In the real world, when something gets too crowded, you raise the price.

If a line goes from A to B to C and is at or near capacity, any shipper wanting a ride from A to B or B to C better expect to pay the A to C rate - or better!

My problem with this statement is that there seems to be a facile generalization for every scenario by which the posters propose how the "real world" works, then when faced with contrary evidence, an opposing facile generalization is substituted. The real world must be more elusive than alleged.

In this instance, congestion and capacity problems are undeniably on the intermodal corridors. Is that a reasonable test of the statement? Well, it ought to be -- it represents a big chunk of business, the evidence is strong, and it ought to fit the proposition, in a rational world that is authentically market driven.

Yet, since the year 2000 the rail price index has increased approximately 25.7%, while intermodal rates have increased only 11.5%, among the lowest of all categories. Real growth in intermodal rates has represented a decline in the rates over the time period, even as costs have increased, and particularly both variable and fixed costs associated with the traffic.

With a declining rate even at capacity, will an increase in fixed costs to create additional capacity generate greater profit? Can an econometrician make a reasonable claim that the company will increase its profits? Well, according to your proposition, if capacity is increased -- if a line has excess capacity -- rates will be lower .... yet rates are declining, even though at capacity, contrary to the proposition that rates should have increased because of the specific constraint of capacity as you specifically proposed.

Whew, you may have a logic in there somewhere, but perhaps the theory proposed doesn't actually match reality very well -- and intermodal is "Exhibit A." The good question, then, is, why doesn't intermodal follow your theory?

This is my problem with your statement; it seems to be a statement of convenience that is, in fact, contrary to what is happening. Transparently false in a large, compelling context, it is unlikely to suddenly become a profound truth in a narrower context of captive shippers.

Where the proof of your proposition fails, is that evidence then that the circumstance is not market driven? Not a lot of options there, it either is or it isn't. And I agree with you, if truly market driven, intermodal prices would have gone up relative to costs, not down.

But they didn't. If they are not following genuine market pricing as I think you accurately propose the theory, is that evidence of cross-subsidization, since cross-subsidization is the plausible alternative explanation when the market pricing explanation fails?

I think it is.

 

[Datafever]

    What does LOB stand for?  Thanks

Line Of Business

[arbfbe]

Groan,  Well here we go again.  Greyhounds started with his model assinging $1000 per car load of coal to fixed costs.  Now he comes along and says, "(You can not allocate fixed cost to any specific movement - you have to cover them with your entire traffic base, but you can not allocate them.  The only way the ethanol shows a loss is through the impossible allocation of fixed costs to the movement.)"  So which is it, can you assign fixed costs to reveue cars or not?  You cannot have it both ways.

So here is my plan.  I will not read any more of your posts and thus will not be tempted to reply to any more of them.  Perhaps that way you can keep a straight line of thought instead or bouncing around the spectrum in order to be contravailing.

Also, please note.  Though containers have the potential to be loaded bidirectional the reality is the loaded movements eastward with imports far exceeds the loaded westbound boxes loaded with export or domestic product.

[Murphy Siding]

    What does LOB stand for?  Thanks

[oltmannd]

"Rail transportation companies [have] carload rail prices standing 31.0% higher than they were five years ago. ... In contrast, intermodal service prices were [only] 13.1% higher than they were in 2001."

Elizabeth Batz, "Pricing Across the Transportation Modes," Logistics Management, 5/1/2006.

"Seems" like rates ought to be a function of capacity -- problem is in offering a rational explanation why they obviously aren't -- and why other freight is paying the cost -- cross-subsidizing -- of the enormous investment required for intermodal.

There is no cross subsidy.

Investment decisions by companies are made using projections of the discounted (for risk and time value of money) cash flow into the future.  Cash flow is a function of margin (revenue less cost) and volume.  Intermodal produces less margin but much more volume.  A 240 container stack train will produce gross revenue of around $120 for every mile it moves.  And if it's loaded with international containers, the railroad will have no equipment ownership expense outside the locomotives.  (they will pay per diem and mileage on the well cars.)

And those containers will produce that revenue in both directions, unlike a grain car.  A grain car goes back empty at no revenue.  The containers can be revenue loads both ways.

No rational firm will cross subsidize any line of business (exception: start up lines of business that are projected to produce positive cash flows in the future.)  To maintain otherwise is to maintain that railroad management is acting irrationally.  They're not.

To maintain they are is what is irrational.  There is no cross subsidy.

...and, them may purposely wring a dying LOB dry in order to support a more lucrative LOB.  That is not cross subsidization, either.  It's just good business.

You MIGHT be able to make the case the the the RR holding companies used other businesses they owned to prop up the RR in the 50s, 60s and 70s.  That may have been bad business - or altruism.

[oltmannd]

Capacity, in this case, is constrained by equipment.

And, obviously, it doesn't pay to invest in more.

Or it does, if the capacity constraint is something different. My point is, your generalization was one of those generalizations that is true or isn't true, depending on [fill in the blank].

Don't know how it is in your part of the country, but the BNSF grain fleet is utilized almost continuously. You may not think that 20 year old (average), paid-for equipment, operating at between 15 and 20 cycles annually is good business -- and ag generates the highest carload revenue of any marketing group.

Asset productivity is very good in this instance on this railroad. Compared to the labor intensive handling required for intermodal, a shuttle grain train is almost an entirely automated process.

Well, sure, all generalizations fail somewhere.  If they didn't we'd call them laws. 

Conversion of grain from loose car to unit shuttles and/or large blocks is certainly a good thing as is BNSF's capacity management scheme for grain. 

I'm not so sure why you think intermodal is labor intense.  The terminals are capital intense but the gate, inspection, positioning and loading are not labor intensive -15 to 20 man minutes per box total.

[MichaelSol]

Capacity, in this case, is constrained by equipment.

And, obviously, it doesn't pay to invest in more.

Or it does, if the capacity constraint is something different. My point is, your generalization was one of those generalizations that is true or isn't true, depending on [fill in the blank].

Don't know how it is in your part of the country, but the BNSF grain fleet is utilized almost continuously. You may not think that 20 year old (average), paid-for equipment, operating at between 15 and 20 cycles annually is good business -- and ag generates the highest carload revenue of any marketing group.

Asset productivity is very good in this instance on this railroad. Compared to the labor intensive handling required for intermodal, a shuttle grain train is almost an entirely automated process.

[oltmannd]

Or, perhaps rates are a function of capacity.  In the real world, when something gets too crowded, you raise the price.

If a line goes from A to B to C and is at or near capacity, any shipper wanting a ride from A to B or B to C better expect to pay the A to C rate - or better!

Except, that's the theory, not the real world. Look at intermodal.

It has been demanding the most capacity and growth resources. Nearly all new construction goes to meeting intermodal demand. Enormous resources are being required, compared to, say, wheat. Yet, wheat pays the highest prices, and is one of the few categories of freight rates that GAO found had increased, rather than decreased, since Staggers.

"Rail transportation companies [have] carload rail prices standing 31.0% higher than they were five years ago. ... In contrast, intermodal service prices were [only] 13.1% higher than they were in 2001."

Elizabeth Batz, "Pricing Across the Transportation Modes," Logistics Management, 5/1/2006.

"Seems" like rates ought to be a function of capacity -- problem is in offering a rational explanation why they obviously aren't -- and why other freight is paying the cost -- cross-subsidizing -- of the enormous investment required for intermodal.

You seem to be insinuating that RR mgt has no idea what their the ROI is for their capital projects.  That they'd "steal" huge sums of money from profitable LOBs to sink into marginal intermodal business.  As if they have no idea of their margins.  Really!

To state the obvious:

Wheat is lousy business.  It only moves when the price is right and then EVERYBODY wants their wheat moved.  Asset productivity is lousy.  BNSF has the right idea with their capacity auctions.

Intermodal is steady, growing, very profitable business, on the whole.  Asset productivity is terriffic.  BNSF is investing quite a bit trying to make their carload business perform like intermodal - lots of transload terminals and the like, integrated into new and expanded intermodal terminals.

Well, if you propose that "at capacity" means raise rates, and an example is shown -- the biggest example possible -- where that clearly does not happen, then obviously there is a different reason why rates are not raised, isn't there?

That's my point, exactly.

The fact that there is or might be does not mean that both your contentions, proposing opposite rationales, can be true .... or, as you say, it is "obvious."

Capacity, in this case, is constrained by equipment.

And, obviously, it doesn't pay to invest in more.

[MichaelSol]

Or, perhaps rates are a function of capacity.  In the real world, when something gets too crowded, you raise the price.

If a line goes from A to B to C and is at or near capacity, any shipper wanting a ride from A to B or B to C better expect to pay the A to C rate - or better!

Except, that's the theory, not the real world. Look at intermodal.

It has been demanding the most capacity and growth resources. Nearly all new construction goes to meeting intermodal demand. Enormous resources are being required, compared to, say, wheat. Yet, wheat pays the highest prices, and is one of the few categories of freight rates that GAO found had increased, rather than decreased, since Staggers.

"Rail transportation companies [have] carload rail prices standing 31.0% higher than they were five years ago. ... In contrast, intermodal service prices were [only] 13.1% higher than they were in 2001."

Elizabeth Batz, "Pricing Across the Transportation Modes," Logistics Management, 5/1/2006.

"Seems" like rates ought to be a function of capacity -- problem is in offering a rational explanation why they obviously aren't -- and why other freight is paying the cost -- cross-subsidizing -- of the enormous investment required for intermodal.

You seem to be insinuating that RR mgt has no idea what their the ROI is for their capital projects.  That they'd "steal" huge sums of money from profitable LOBs to sink into marginal intermodal business.  As if they have no idea of their margins.  Really!

To state the obvious:

Wheat is lousy business.  It only moves when the price is right and then EVERYBODY wants their wheat moved.  Asset productivity is lousy.  BNSF has the right idea with their capacity auctions.

Intermodal is steady, growing, very profitable business, on the whole.  Asset productivity is terriffic.  BNSF is investing quite a bit trying to make their carload business perform like intermodal - lots of transload terminals and the like, integrated into new and expanded intermodal terminals.

Well, if you propose that "at capacity" means raise rates, and an example is shown -- the biggest example possible -- where that clearly does not happen, then obviously there is a different reason why rates are not raised, isn't there?

That's my point, exactly.

The fact that there is or might be does not mean that both your contentions, proposing opposite rationales, can be true .... or, as you say, it is "obvious."

 

 

[oltmannd]

Or, perhaps rates are a function of capacity.  In the real world, when something gets too crowded, you raise the price.

If a line goes from A to B to C and is at or near capacity, any shipper wanting a ride from A to B or B to C better expect to pay the A to C rate - or better!

Except, that's the theory, not the real world. Look at intermodal.

It has been demanding the most capacity and growth resources. Nearly all new construction goes to meeting intermodal demand. Enormous resources are being required, compared to, say, wheat. Yet, wheat pays the highest prices, and is one of the few categories of freight rates that GAO found had increased, rather than decreased, since Staggers.

"Rail transportation companies [have] carload rail prices standing 31.0% higher than they were five years ago. ... In contrast, intermodal service prices were [only] 13.1% higher than they were in 2001."

Elizabeth Batz, "Pricing Across the Transportation Modes," Logistics Management, 5/1/2006.

"Seems" like rates ought to be a function of capacity -- problem is in offering a rational explanation why they obviously aren't -- and why other freight is paying the cost -- cross-subsidizing -- of the enormous investment required for intermodal.

You seem to be insinuating that RR mgt has no idea what their the ROI is for their capital projects.  That they'd "steal" huge sums of money from profitable LOBs to sink into marginal intermodal business.  As if they have no idea of their margins.  Really!

To state the obvious:

Wheat is lousy business.  It only moves when the price is right and then EVERYBODY wants their wheat moved.  Asset productivity is lousy.  BNSF has the right idea with their capacity auctions.

Intermodal is steady, growing, very profitable business, on the whole.  Asset productivity is terriffic.  BNSF is investing quite a bit trying to make their carload business perform like intermodal - lots of transload terminals and the like, integrated into new and expanded intermodal terminals.

 

[greyhounds]

"Rail transportation companies [have] carload rail prices standing 31.0% higher than they were five years ago. ... In contrast, intermodal service prices were [only] 13.1% higher than they were in 2001."

Elizabeth Batz, "Pricing Across the Transportation Modes," Logistics Management, 5/1/2006.

"Seems" like rates ought to be a function of capacity -- problem is in offering a rational explanation why they obviously aren't -- and why other freight is paying the cost -- cross-subsidizing -- of the enormous investment required for intermodal.

There is no cross subsidy.

Investment decisions by companies are made using projections of the discounted (for risk and time value of money) cash flow into the future.  Cash flow is a function of margin (revenue less cost) and volume.  Intermodal produces less margin but much more volume.  A 240 container stack train will produce gross revenue of around $120 for every mile it moves.  And if it's loaded with international containers, the railroad will have no equipment ownership expense outside the locomotives.  (they will pay per diem and mileage on the well cars.)

And those containers will produce that revenue in both directions, unlike a grain car.  A grain car goes back empty at no revenue.  The containers can be revenue loads both ways.

No rational firm will cross subsidize any line of business (exception: start up lines of business that are projected to produce positive cash flows in the future.)  To maintain otherwise is to maintain that railroad management is acting irrationally.  They're not.

To maintain they are is what is irrational.  There is no cross subsidy.

 

[MichaelSol]

Or, perhaps rates are a function of capacity.  In the real world, when something gets too crowded, you raise the price.

If a line goes from A to B to C and is at or near capacity, any shipper wanting a ride from A to B or B to C better expect to pay the A to C rate - or better!

Except, that's the theory, not the real world. Look at intermodal.

It has been demanding the most capacity and growth resources. Nearly all new construction goes to meeting intermodal demand. Enormous resources are being required, compared to, say, wheat. Yet, wheat pays the highest prices, and is one of the few categories of freight rates that GAO found had increased, rather than decreased, since Staggers.

"Rail transportation companies [have] carload rail prices standing 31.0% higher than they were five years ago. ... In contrast, intermodal service prices were [only] 13.1% higher than they were in 2001."

Elizabeth Batz, "Pricing Across the Transportation Modes," Logistics Management, 5/1/2006.

"Seems" like rates ought to be a function of capacity -- problem is in offering a rational explanation why they obviously aren't -- and why other freight is paying the cost -- cross-subsidizing -- of the enormous investment required for intermodal.

 

 

[oltmannd]

And now back to reality......

 

 

It is absolutely fair to the original shipper.  He is harmed not one iota by the "new" traffic.

But....

In this example, once the coal mine plays out and all that's left is that ethanol traffic, what would be "fair"?  The RR can no longer afford to move the ethanol at $2400/car load.  So the RR raises rates to cover fixed costs which causes the consingee to switch to an alternate source of supply - at greater cost to him.  The RR abandons the line, since it has a negative economic value.  The ethanol consumer has higher costs and winds up at a disadvantage in the market he serves since his competitor haslower costs (lets assume exactly similar circumstances except his RR line didn't lose it's base load traffic) and he goes belly up.  It this because of some "unfairness" on the part of the RR with regard to the shippers?  Or, is it just "life in big city"?

And, this is EXACTLY where the RRs found themselves in the regulated environment.  Other modes came and stole big chunks of the base load traffic (often with the gov't assistance) and the RRs were not free to adjust to the new conditions.  Rates were set entirely by calculated costs with no respect to the value of the service provided.   The notion that there is "fairness" in prices being set in relation to calculated costs is nuts.  Nobody runs their household that way.  Nobody sells things on Ebay that way (wanna buy a PS3?).  And nobody would ever run a small business that way.  So why should a RR be any different? 

The thread was about cross subsidization of traffic, in effect the railroad "taxing" one shipper with higher rates to cover more of the fixed costs to allow another shipper a lower rate to attract the business to the line.  I am sure the higher rate shipper would find the situation unfair, the subsidized shipper would be happy with the situation and would look for some way to justify the tarrif on the other shipper.  The railroad would be happy since they could make more money with the non-equal tarrifs.

Regulation was perhaps not good for the railroads and marginal lines.  The same happens today without regulation.  One customer closes shop or is bought out by another entity which moves production elsewhere and the line is forced to close since there is not enough business left to cover fixed and variable costs.  Regulation has nothing to do with that, business cycles and decisions do.  The railroads can keep the line open if they choose by raising rates to shippers on other lines to cover the fixed costs on the line they want to remain open. 

It's all about how you define your terms.  Cross subsidization is basic fact of life in the US. People without kids cross subsidize the schooling of those who have'em.  States with few interstate highways and lots of vehicle miles travelled (like NJ) cross subsidize those that many Interstate miles and few vehicle miles travelled (like Montana).  Once upon a time, residents on a steam loop got their heat subsidized by electic consumers (it ain't "waste heat" if it's keeping your toes warm) 

Fair and Unfair are highly subjective terms.  New neighbors move in and set up a virtual junk car lot on their front lawn, killing the value of your house.  Is that fair to you?  Don't they have property rights, too?  Is it fair to keep them from using their land the way they want to?  Is it fair for you to lose value just because you have new neighbors?

The whole economic system functions as a whole and always has some level of regulation.  How much, in what manner and to what end are what's variable and they all effect the rules of the game that producers and consumers operate under.  The rules will always have winners and losers but the goal is to maximize the efficiency of the whole system.  Once you start to draw boundaries around this chunk or that and set up special rules to try to optimize that part, you lose the whole.

Back to that example.  A RR is moving coal at $3000 a car load and is covering all their costs.  Then, they find through inovation that they can reduce their operating cost 50%.  Are they under any obligation to pass along some of the savings or is the value of the service still $3000 a car load?  Is it fair that the shipper should get to share in the value of the RRs inovation?  Wouldn't that be the RRs inovation going to cross subsidize the shipper, who did nothing to earn the savings? 

What if that $3000 a carload coal was going to plant A.  The mine wanted to ship to plant B that was further down the main line, but the RR cost for that was $3500 and they were being undercut by another mine that was short haul trucking the coal there for $3100 (car load equivalent).  But, now with reduced costs, the RR can do $2900 to Plant B and win the business.  $3000 for the shorter haul and $2900 for the longer haul on the same line by the same RR.  Worse yet, let's say that because the RR did the hard work to reduce their costs that the $3000 load is now over the STBs magic 180% mark.  Where is the cross subsidization?  Who did the cost savings work?  Who is gets to reap the benefit?

 

[greyhounds]

Well, sort of close but your model fails to mention a couple of points concerning fixed costs.  Fixed costs are more related to costs per mile

No they're not.  They're not specifically related to anything.  Cost per mile of what?

  Going with your example of assigning $1000 per car in fixed costs for the original traffic that will pay the fixed costs for the line at the given traffic level.  Now when you add the new ethanol traffic and increase the number of cars on the line you should reduce the fixed cost charges per car.  If the fixed charges divided by the original number of cars came out to $1000 then the same fixed charges divided by the higher number of cars will give a number lower than $1000.  Now if this new lower figure of fixed costs per car comes in at $400 then your ethanol business pays it's own way.  If the new number is say $600 per car and the variable costs remain at $2000 per car then you are losing $200 per car with the new traffic.  But wait, since you are still charging your original customer $3000 per car they are paying ALL the fixed costs for the line.  The new customer is contributing $400 per car towards those fixed costs but these costs have already been met by the original shipper.  So this contribution goes right to the bottom line, pure profit!  Nice for the railroad but the original shipper is cross subsidizing the new customer account the new shipper cannot meet the charges fully for his share of fixed costs.  Now say the new fixed costs per car do work out to $400 per car.  The ethanol guys are now paying $2000 per car to cover variable costs and $400 per car to fully cover their share of fixed costs.  All is  well, right?  No, since no railroad in their right mind will call the original shippers who are willing to pay $3000 per car for a move which is $2000 in variable costs and $400 in fixed costs.  That leaves $600 per car which the railroad takes to the bottom line.  So if the original shipper does not find out about the new $2400 per car price structure he still ends up subsidizing the new traffic.

This is the kind of false reasoning one has to use if one is trying to show there is a cross subsidy that doesn't exist.  In our example, the railroad is running along without the ethanol traffic.  Then it gets the ethanol at a price of $2,400/car.  It's additional cost is only $2,000/car.  It's $400 ahead for every car of ethanol it handles.  But this somehow becomes a $200 loss.  And that "loss" has to be made up by other shippers.  This is the so-called cross subsidy.  But there is no such "loss".  Again, the railroad is $400 ahead on each car.  There's nothing to be made up.  There can't be any subsidy.  There's nothing to subsidize.  (You can not allocate fixed cost to any specific movement - you have to cover them with your entire traffic base, but you can not allocate them.  The only way the ethanol shows a loss is through the impossible allocation of fixed costs to the movement.)

Now is that fair to the original shipper?  What does the Railroad care about fair? 

The original shipper hasn't been affected at all.  And he's had nothing to do with the ethanol traffic.  I don't see how it's "unfair". 

Is your proposed solution:

1) everytime a railroad develops new business it has to give an across the board rate reduction to all existing shippers?  There will be precisous little new business.

2) prohibit the railroad from moving the ethanol at $2,400/car and deny the receiver the opportunity to use his low cost supplier

Differential pricing, which does not involve cross subsidization, seems to be the best answer to the situation.  I haven't heard a better one from you.

 

[arbfbe]

And now back to reality......

 

 

It is absolutely fair to the original shipper.  He is harmed not one iota by the "new" traffic.

But....

In this example, once the coal mine plays out and all that's left is that ethanol traffic, what would be "fair"?  The RR can no longer afford to move the ethanol at $2400/car load.  So the RR raises rates to cover fixed costs which causes the consingee to switch to an alternate source of supply - at greater cost to him.  The RR abandons the line, since it has a negative economic value.  The ethanol consumer has higher costs and winds up at a disadvantage in the market he serves since his competitor haslower costs (lets assume exactly similar circumstances except his RR line didn't lose it's base load traffic) and he goes belly up.  It this because of some "unfairness" on the part of the RR with regard to the shippers?  Or, is it just "life in big city"?

And, this is EXACTLY where the RRs found themselves in the regulated environment.  Other modes came and stole big chunks of the base load traffic (often with the gov't assistance) and the RRs were not free to adjust to the new conditions.  Rates were set entirely by calculated costs with no respect to the value of the service provided.   The notion that there is "fairness" in prices being set in relation to calculated costs is nuts.  Nobody runs their household that way.  Nobody sells things on Ebay that way (wanna buy a PS3?).  And nobody would ever run a small business that way.  So why should a RR be any different? 

 

The thread was about cross subsidization of traffic, in effect the railroad "taxing" one shipper with higher rates to cover more of the fixed costs to allow another shipper a lower rate to attract the business to the line.  I am sure the higher rate shipper would find the situation unfair, the subsidized shipper would be happy with the situation and would look for some way to justify the tarrif on the other shipper.  The railroad would be happy since they could make more money with the non-equal tarrifs.

Regulation was perhaps not good for the railroads and marginal lines.  The same happens today without regulation.  One customer closes shop or is bought out by another entity which moves production elsewhere and the line is forced to close since there is not enough business left to cover fixed and variable costs.  Regulation has nothing to do with that, business cycles and decisions do.  The railroads can keep the line open if they choose by raising rates to shippers on other lines to cover the fixed costs on the line they want to remain open.