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What is Avoidable Cost?

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What is Avoidable Cost?
Posted by wanswheel on Wednesday, June 4, 2014 11:06 AM

Excerpts from Methodology for Determining the Avoidable and Fully Allocated Costs of Amtrak Routes (2009)

http://www.fra.dot.gov/Elib/Document/2744

The term “Avoidable Cost” has been employed by the Surface Transportation Board (STB) and its predecessor Interstate Commerce Commission (ICC) for many years in deliberations regarding abandonment of rail lines and discontinuance of railroad service. The definition and usage of the term in this study largely follows this precedent.

Avoidable Costs are defined as costs that cease to exist when a route is no longer operated. When a service stops being provided, some activities that were required to provide it can be eliminated or reduced to a smaller scale. The costs of the resources they previously consumed are avoidable. The portion of a company’s costs that may be considered avoidable clearly depends on the time horizon involved. In a sense, all costs are avoidable in that if a company discontinued all productive activities and liquidated, then it would have avoided all its costs of operation because it would not be operating. Short of liquidation, however, a company may avoid certain support activity costs and capital costs for certain facilities and equipment by reducing its volume of productive activity, although a lower scale of operations may not allow the same efficiency in the application of direct labor or materials to production. However, a company’s Avoidable Cost of producing a product is understood to mean the costs that the company would not incur, after a period long enough to make appropriate adjustments in direct production labor and purchases of materials and business services, if it discontinued some part of its production without changing the scale of those parts of the enterprise that support rather than perform direct production activity.

Procedures to estimate Avoidable Costs for STB and ICC deliberations include the recognition of lost revenues on connecting services. By including these effects, a more complete measure of the financial impact of service termination on the enterprise is provided. These lost revenue effects will exist to varying degrees if Amtrak routes are terminated, but have not been included in this methodology for regular reporting of Avoidable Costs and should be considered as part of follow-on development efforts. As Amtrak’s trains function as a network and changes to individual or multiple trains likely result in changes to revenue not just on the affected trains but on other trains, calculating the avoidable revenue is a difficult exercise.

Distinctions exist between Avoidable Costs as used in this methodology and the similar concepts of variable costs, incremental costs, and marginal costs that are used elsewhere for other purposes:

Variable costs are those that fluctuate directly with the level of output, in contrast to fixed costs which do not vary. Total costs are the sum of fixed and variable costs.

Incremental costs are the costs that vary, either positively or negatively, as output changes from a baseline level.

Marginal costs are the differential costs of (only) the last unit of production, either added or subtracted.

Avoidable Costs refer to the specific case in which output is reduced or eliminated. Because it is used in conjunction with specific time horizons, it can include what are referred to as fixed costs in the other cost concept definitions. This gives rise to the succinct statement: “All variable costs are avoidable, but not all Avoidable Costs are variable.”

All variable costs of operating a route can be immediately avoided if that route is terminated. Other resources and activities that support a route may require some time to eliminate or adjust when a service is eliminated, so that their costs are only fully or partly avoidable after that time has elapsed. The avoidability of costs for Amtrak services is estimated over two different time horizons:

(1) short run - costs that no longer will be incurred one year after a route is eliminated,

(2) long run - costs that no longer will be incurred five years after a route is eliminated.

In the short run, some costs, mainly the direct costs of operating trains, such as fuel expenses, wages and other direct labor, and certain materials, can be eliminated relatively quickly when a route is terminated. Other cost savings in the first year occur as a result of operational adjustments and lags in the accounting system. In the long-term, other costs can be avoided as Amtrak’s scale of operations is reduced in certain areas, such as at stations and equipment maintenance ResCens [Responsibility Centers]. Also, costs can be avoided as facilities dedicated to a specific route are “retired” and sold, thereby avoiding any operating and capital charges associated with their ownership. Rolling stock employed on a specific route is treated as partly avoidable in the long term. This is true because in the long run a reduced need for cars and locomotives due to cessation of a particular Amtrak service is expected to translate into a reduced need for capital outlays to renew and rehabilitate its fleet.

The actual estimates of Amtrak’s avoidable costs necessarily are reduced by the expected labor protection payments provided for in its collective bargaining agreements covering certain categories of workers. Under current agreements, these payments are phased out over five years, therefore, such labor protection payments are 100 percent avoidable in the long run.

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Posted by Anonymous on Wednesday, June 4, 2014 3:46 PM

I largely agree with the piece on avoidable costs.  I presume that you copied this from the source cited.

Without access to Amtrak's books, determining the avoidable costs associated with discontinuance of the long distance trains is impossible, or it is a highly speculative exercise.  

Based on my experience, an aggressive business would be able to shed avoidable costs quicker than a government agency.  And Amtrak is a government agency. A competitive business must shed itself of unproductive product and/or service lines quickly or go under. A government agency is under no such time pressure. But at the end of the day, we don't really know.

Based on FY13 operating results, if Amtrak could get rid of the long distance trains, it comes close to being able to cover all of its costs, or at least it positions itself to do so in a few years. It would need to tweak its remaining services' revenues and labor costs.

Depreciation is Amtrak's second largest expense. I have submitted an FOIA request to determine how much of it is worn by the NEC, Short Distance...and Long Distance Trains.  Once I have that number, assuming that I get it, I'll post the 2013 financial results with depreciation included, which is key to knowing how close the NEC is to being self-sustaining.

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Posted by V.Payne on Wednesday, June 4, 2014 10:21 PM

It's funny in this country we have commuter and intercity infrastructure provisions exactly opposite from the rest of the developed world. Which makes sense when you think of the ratio of train miles. Here we provide commuter infrastructure through the intercity operator funding in the NEC where elsewhere the commuter infrastructure is used by the intercity operators at incremental cost.

There was an ICC case from three decades ago that set the rates for commuter access to the NEC low and stuck Amtrak with the costs IIRC. Maybe that case would answer the questions? I do not have the Docket number but someone might. Why not just ask for the avoidable costs and then add depreciation on a current replacement value by a hand calculation knowing the consists?

I am just curious, what capital has been spent in the last 20 years on intercity routes (since 1994 Superliner II and GE diesels) that could even still have significant depreciation? Rebuilds on cars are only about $400k every million miles. The only thing is the yet to be accepted Viewliners, which shouldn't have depreciation yet.

When I talk of short term avoidable costs I do not figure any capital. When I talk of long term avoidable costs I figure equipment capital and facility recapitalization..

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Posted by Anonymous on Thursday, June 5, 2014 9:58 AM

Without access to Amtrak's books, it is impossible to know how much depreciation is worn by the three product lines, i.e. NEC, State Supported and Other Short Distance Trains, and Long Distance Trains. This is why I have asked for it as opposed to speculate about it.

If the FRA, as per its December 2013 document cited previously, does not have Amtrak's avoidable costs by train route, I don't have any reason to believe that Amtrak would make the information available to me or anyone else.  In any case, projecting avoidable costs is a dicey exercise as made clear above. 

Amtrak depreciates it rolling stock over a period ranging up to 42 years. It does not tell us how long it depreciates the long distance equipment. If it is 42 years, then depreciation is still running on most of the long distance equipment. Again, without access to the depreciation schedules, one does not know how much depreciation is worn by the long distance trains.

The differentiation between short term avoidable costs and long term avoidable costs is artificial.  It is an arbitrary line drawn in the sand. All or most costs, as noted in the opening post, are avoidable in the long run.

Depreciation is a non-cash item.  If the long distance trains were to be discontinued, the equipment that could not be sold or re-positioned would be junked.  I doubt that there is a market for it. It would be taken off the books. Since Amtrak leases most if not all of its rolling stock, the on-going capital costs associated with the equipment would run for the remainder of the lease terms.  Most leases have an early termination clause, with an accompanying penalty.  If Amtrak was on top of its game when it negotiated the leases, disposal of the equipment would include a one time charge to earnings for the lease buyout charges.  

If a company is dropping a product line, replacement costs are not a factor.  It is not going to replace anything associated with that product line.  The biggest challenge with regard to avoidable costs is to determine how the remaining shared costs would be redistributed.  Without access to Amtrak's books, the redistribution is pure speculation.

In FY13 Amtrak had capital expenditures of $1,050,527,000.  Of this amount, $363.8 million may have been associated with the rebuilding or upgrading of long distance equipment.  Most of these expenditures would have been capitalized, and the depreciation schedules would have been adjusted to reflect the changes in the expected service life of the equipment.  Without access of Amtrak's depreciation schedules, one does not know how much of the aforesaid amount was spent on the long distance equipment or the impact it had on the long distance depreciation schedules.

Even if only half of the costs associated with the long distance trains is avoidable, which probably understates the realizable amounts, the FY13 costs would, if invested in the Treasury 10 Year Note, at today's quoted interest rate, would generate a return of $773.9 million.  For each subsequent year of avoidable losses on the long distance trains, the savings increases dramatically.

Only those who have no concept of business or don't care would argue that Amtrak should continue running long distance trains because discontinuance of them would only produce avoidable costs of approximately 50 per cent of the published costs. If the long distance trains are a must for social reasons, lets call them for what they are: a welfare program!

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Posted by wanswheel on Thursday, June 5, 2014 1:10 PM

Avoidable Cost, as I understand it, is an imaginary pile of dollars, some more of it flying out the window every day the trains are running. Or it’s a mild sedative. But it doesn’t actually exist, not in the present anyway, unless the cost of running a train today can be avoided. Avoidable Cost is expected to come into existance in the future, though, after a decision is made to stop incurring it.

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Posted by henry6 on Thursday, June 5, 2014 1:34 PM
I've always been led to believe avoidable costs were costs which a freight railroad had to add or endure which they would not otherwise encounter if a passenger train were added. Thus, higher speed track, a signal system if not in place, stations, personnel above and beyond those needed for freight operations, lost time by freight trains having to be held or to take siding while passenger trains had the right of way, interlockings and control points to manage traffic, insurance, and anything else freight railroad management, their accountants, their insurance gurus, and lawyers could conceive of to prevent passenger service to happen.

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Posted by Anonymous on Thursday, June 5, 2014 3:23 PM

wanswheel

Avoidable Cost, as I understand it, is an imaginary pile of dollars, some more of it flying out the window every day the trains are running. Or it’s a mild sedative. But it doesn’t actually exist, not in the present anyway, unless the cost of running a train today can be avoided. Avoidable Cost is expected to come into existance in the future, though, after a decision is made to stop incurring it.

An avoidable cost is any cost that could be shed if the activity that drives it is terminated.  It is as you point out a future happening.  

If Amtrak killed the long distance trains, the cost of the consumables, i.e. fuel, water, food, beverages, etc. would go away quickly.  It would be avoided.  Other costs, such as direct labor, rents, leases, overheads, etc. would take longer. Some costs, however, associated with an operation (long distance trains) might not go away, at least directly, and would have to be allocated over the remaining product lines.This is the tricky part of the equations.

Presumably Amtrak, which owns Chicago's Union Station, allocates or charges a user fee for the trains using the station.  Some of the station's costs are worn by the long distance trains that use it.  How much?  Without access to Amtak's books, we don't know.  

In any case, if the long distance trains were discontinued, the costs of the station, assuming they are not scale-able quickly, would remain.  They cannot be avoided simply by discontinuing the long distance trains.   However, if discontinuing them freed-up track space, and more State Supported and Short Distance Trains could be accommodated in the station, then costs formerly allocated to the long distance trains could be allocated to the new trains running into and out of the station. 

People who try to make a business case for the long distance trains will attempt to turn the avoidable cost exercise into as tricky an exercise as one can imagine. However, if Amtrak were a real business that had to respond to markets and at least break even, it would have been out of business decades ago.  And a major drag on it would have been the long distance trains, which made no sense when it was formed and make even less sense today.

If the long distance trains are a critical component in the nation's transportation portfolio, they should be cut loose from Amtrak, which has a reasonable probability of at least breaking even in the next few years.  That could work a variety of good things for the company's employees, customers, and other stakeholders.  The new company could be called the USA Passenger Trains - A Government Agency. Not hard to figure where I am coming from.

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Posted by blue streak 1 on Thursday, June 5, 2014 3:25 PM
Henry -- How about station costs, crew costs ( some which may not disappear for up to 5 years due to union agreements ), fuel, agents, wear & tear and maintenance, etc ? Now we need to admit that many of these items would reduce per train if there were more trains on a route due to efficiencies of scale.
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Posted by henry6 on Thursday, June 5, 2014 3:43 PM
blue streak 1
Henry -- How about station costs, crew costs ( some which may not disappear for up to 5 years due to union agreements ), fuel, agents, wear & tear and maintenance, etc ? Now we need to admit that many of these items would reduce per train if there were more trains on a route due to efficiencies of scale.
I thought I covered all that... if you don't run passenger trains you don't have crew costs, stations and station agents, fuel costs for trains not run, wear and tear nor maintenance on wear and tear not committed. What does a union have to do with it if there are no jobs? I guess, I don't understanding what you are trying to say but I think I was perfectly clear.

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Posted by Anonymous on Thursday, June 5, 2014 3:58 PM

If Amtrak's management negotiated reasonable contracts with the labor unions, they probably contain a severance clause that guarantees union employees who cannot be reassigned to another like kind of job some or all of their pay for a period of time.  Anything beyond two or three years would be extreme. However, without access to the terms of Amtrak's labor contracts, the severance terms are not known.  

In the case of long service employees who are within XX years of normal retirement, the contracts may include provisions for bridge financing of compensation and benefits until the employee qualifies for full retirement benefits. This is a practice followed by many if not most companies. Irrespective of whether the company's employees belong to a union, the day of just cutting people loose, i.e. treating them unfairly, at least by well managed companies, is over.

The costs associated with helping long service employees over the retirement line could be classified as unavoidable.  But unless one has access to the company's books, labor contracts, management discussions, etc., none of this is knowable by outsiders. 

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Posted by henry6 on Thursday, June 5, 2014 4:26 PM
But Sam, you are addressing Amtrak's costs not the avoidable costs of the host railroad. Or any railroad that eliminates passenger or other service.

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Posted by schlimm on Thursday, June 5, 2014 5:00 PM

henry6
But Sam, you are addressing Amtrak's costs not the avoidable costs of the host railroad. Or any railroad that eliminates passenger or other service.

We were talking about the avoidable costs associated with Amtrak, specifically LD services.   If you are referring now to the host railroad, that cost should be fairly close to what Amtrak pays it for running its LD services on the host's rails.  I suspect it is actually more than the rent received, which would explain why the freight lines do not treat Amtrak as a priority customer.

C&NW, CA&E, MILW, CGW and IC fan

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Posted by Anonymous on Thursday, June 5, 2014 6:01 PM

schlimm

henry6
But Sam, you are addressing Amtrak's costs not the avoidable costs of the host railroad. Or any railroad that eliminates passenger or other service.

We were talking about the avoidable costs associated with Amtrak, specifically LD services.   If you are referring now to the host railroad, that cost should be fairly close to what Amtrak pays it for running its LD services on the host's rails.  I suspect it is actually more than the rent received, which would explain why the freight lines do not treat Amtrak as a priority customer.

I agree. 
A good example is found in the case of the BNSF hosting the Southwest Chief.  It has been maintaining its line from Dodge City or thereabouts to Albuquerque or thereabouts to a higher standard than it requires to support the Chief.  If the Chief goes away, the incremental line cost would go away also.      
If the BNSF won't maintain the track for passenger train speeds, and Amtrak won't compensate it for the incremental costs of doing so, the cost goes away unless the on-line communities absorb it. Last I heard the affected on-line communities were still debating whether they wanted to absorb the cost of maintaining the Chief through their communities.
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Posted by V.Payne on Thursday, June 5, 2014 7:51 PM

"Of this amount, $363.8 million may have been associated with the rebuilding or upgrading of long distance equipment."

May? there is no way this is possible. Most of the cars and engines are rebuilt every three years, so this would represent rebuilding 2700 pieces of equipment at $400k each on a three year cycle, about twice the entire NRPC fleet. Maybe some turnaround costs are getting counted. Here are the cost families from 2007 in APT.

I still don't get the demand to run the NRPC as a business when the House leadership has proposed to fill the gap in the HTF by eliminating the possibility of future bailouts of the USPS from Saturday mail cost delivery on the books to offset the real financial loses, forgetting the leveraging off the local road system.

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Posted by henry6 on Thursday, June 5, 2014 8:51 PM
When the phrase "run like a business" is thrown around in political venues, it really means nothing but rhetoric. Businesses don't work like political organizations and vice versa. It all sounds good, but only makes the speaker feel better. When push comes to shove, reality sets in and it's politics as usual.

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Posted by Anonymous on Saturday, June 7, 2014 9:47 AM

For FY13 the Capital Expenditures Program (CEP) included the following items that have had or will have a direct or indirect impact on long distance trains, either in whole or in part.  The information can be found in the September 2013 Monthly Operating Report. 

Most of the CEP items represent overhauls or facilities projects that extend the life of the equipment and/or facilities.  Amtrak capitalizes expenditures that significantly increase asset values or extend their useful lives, which is in compliance with Generally Accepted Accounting Principles (GAAP).  This includes all major overhauls. The capital amounts shown do not include the cost of debt financing, which would be capitalized for any CEP projects funded by external debt, and would be embedded in the final capitalization amounts. 

Unless stated otherwise, the CEP expenditures that benefit the long distance trains is unknown.  However, for each category shown below, it is likely that the long distance trains had or will have a flow through benefit from the capital spend, either directly or indirectly and in whole or in part.  For example, some of the locomotive overhauls were for locomotives that probably pull long distance trains.  And many of the station improvements, if fully allocated, probably benefit the long distance trains.  

In FY13 Amtrak spent $55.3 million to overhaul Superliners and $7.4 million to overhaul Viewliners.  Presumably there is no question that these capitalized overhauls benefited the long distance trains.

Amtrak spent $153.9 million overhauling and/or upgrading locomotives and $71.6 million on the AmFleet Program.  Some of the locomotives (AEM -7, P42) are used to pull long distance trains, and some of the cars can be found in the Silver Service trains, Crescent, and Lake Shore Limited. 

Amtrak spent $64.9 million on capital acquisitions, $3.1 million on facilities improvements, $3.6 million on general safety and reliability projects, and $28.2 million on the Safety and Security Program.  Some of these CEP spends ultimately will have a flow through benefit for the long distance trains.  For example, all the trains, including the long distance trains, benefit at least indirectly from the Safety and Security Program.

In addition to aforementioned expenditures, the Engineering Department racked up $88.7 million CEP spends for station structures.  All of Amtrak’s stations, with the exception of those north of Boston, host at least one long distance train, which probably benefits from the planned or implemented station improvements. 

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Posted by V.Payne on Monday, June 23, 2014 9:42 PM

So the Direct Costs are Avoidable from a snip of the April 2014 NPRC 5-year financial projection (Long Distance) below. The Shared Costs are only partially avoidable. Note that system shared "Police/Environmental and Safety" is more than the "Station-Route" expenses! This is typical of NRPC where the costs that are fixed relative to production outweigh the costs of the production of transportation.

I am going to point out some inconsistent assignments of shared costs for the other business lines shortly (SD and NEC). When NRPC reports Total Cost numbers they are including costs that will not be saved if a route is dropped which is why they need to report long-term and short-term avoidable cost numbers as required by law.

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Posted by oltmannd on Wednesday, June 25, 2014 8:00 AM

VPayne-

That GAO AutoTrain report from 1985 had a nice definition of avoidable cost in it in the appendix

www.gao.gov/.../208863.pdf

It matches up pretty well.  I wonder how the normalized 1985 numbers, adjusted for inflation, match the 2014 numbers?  For example, is car maintenance cost per car mile similar, better or worse?

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Posted by V.Payne on Monday, August 11, 2014 9:24 PM

The 1985 Total Costs of $31.690 million would be $70.20 million today. NRPC claims the Total Costs now are $103.7 million (48% higher), but as this topic is pointing to, the Avoidable Costs are the ones to watch as the Total Costs seem to have become inflated with non-variable costs. Even back in 1985 if you read the PDF above NRPC was assigning costs, though the Auto Train was unique in having clean cost centers from the prior private operation.

The 1985 Revenue of $25.131 million would be $55.67 million today (though according to the note below the chart in 1986 it increased rapidly), while the current revenue is $75.4 million. I don't believe there is anywhere near a proportionate change in ridership, but I might be wrong.  Things were different, of course the consist was single level and I believe buffets were used, along with full domes.

In a few days I hope to post the recent Financial report from NRPC that shows assignment of more G&A costs to the LD network than even the NEC is assigned. I am sure it will be startling and affect all of 12 people or so.

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