transport management & theory practices (10)
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© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Management of Transportation
Seventh Edition Coyle, Novack, Gibson & Bardi
© 2011 Cengage Learning
Chapter 10Costing and Pricing
Issues
© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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Chapter 10 Topics
• Market Considerations
• Cost-of-Service Pricing
• Value-of-Service Pricing
• Rate Making in Practice
• Special Rates
• Pricing in Transportation Management
© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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Market Considerations
• In post-deregulation period, transport prices largely determined by market-based forces
• Market structure models– Evolve from conventional economic price theory
• Attempts to explain the pricing behavior of a collection of firms faced with particular market characteristics (number of competitors, degree of product differentiation, barriers to entry, etc.)
• Does not do well in predicting pricing behavior of individual firms
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Market Considerations, cont’d
• Market structure models, cont’d– Principal market structures
• Pure competition – Many sellers with same products
• Monopoly – One seller
• Oligopoly – A few large sellers with substitutable products
• Monopolistic competition – Many small sellers, some product differentiation
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Market Considerations, cont’d
• Market structure models, cont’d– Few markets are either perfectly competitive or
totally monopolistic – All modes encounter some form of oligopolistic
competition• In pricing and output decisions, sellers consider
potential reactions of competitors (mutual interdependence)
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Market Considerations, cont’d
• Theory of contestable markets– Instead of many sellers, substitutes “threat of
entry” from new competitors– Necessary conditions:
• No barriers to entry
• No economies of scale
• Consumers able and willing to switch
• Carriers are not able to respond to new entrants’ prices
– In some time periods, theory applies well to airline industry, other times it does not
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Market Considerations, cont’d
• Relevant market areas– No single market structure model correctly
describes competitive environment of transport or even a single mode in transport
– Classification of competitive environment should be:
• Mode-specific• Route-specific• Commodity-specific• Shipment size-specific
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Cost-of-Service Pricing
• An approach to setting prices on the basis of the cost of providing the service
• Principal assumptions– Service is homogeneous– One group of customers– Customers must cover all costs– Seller sets prices to maximize profits
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Cost-of-Service Pricing, cont’d
• Two variations of cost-of-service pricing– Average cost approach– Marginal cost approach– Cost of service as price floor
• Impact of common costs– The cost-price circular argument
• Problem of decreasing cost industries– Subsidies and tax policy
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Figure 10-1
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Figure 10-2
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Value-of-Service Pricing
• Alternative definitions and terminology– Similarity is that all consider demand
characteristics (as well as costs) in pricing
• Pricing according to product value– Charging higher prices on higher value products– Cost-based reasons (liability) for such pricing– Value is indicator of ability to bear prices, but
other demand factors may dictate price elasticity
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Figure 10-3
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Value-of-Service Pricing, cont’d
• Third-degree price discrimination– Def: Seller sets separate prices for separate
groups of buyers of essentially same service– Three necessary conditions
• Must be able to segment buyers into sub-markets defined by price elasticity
• Seller must be able to prevent transfer of sales between sub-markets
• Seller must possess some degree of monopoly power
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Value-of-Service Pricing, cont’d
• Differential pricing– Similar definition as 3rd degree price
discrimination– Same 3 conditions apply– Means of segmenting buyers
• By commodity
• By time
• By place
• By individual person– Legal limitations
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Figure 10-5
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Value-of-Service Pricing, cont’d
• Sets a ceiling on prices– Can also be price floor in certain circumstances
• Useful if high % of costs are fixed or common
• Enables carrying of traffic that might be lost if average cost-based prices are charged– Some prices < ave. costs can be profitable
• Keys to successful value-of-service pricing– Knowing how costs behave– Good estimates of price elasticity
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Figure 10-6
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Rate Making in Practice
• Some initial terminology– Rates and tariffs
• Individual tariffs
– Rate bureaus and bureau tariffs
• General rates– Class , exception, and commodity rates
• Each designed to simplify the potential complexity of trillions of possible rates
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Rate Making in Practice, cont’d
• Class rate system– Provides a rate for any commodity between any
two points– Three simplification steps
• Geographic: rate basis points and numbers
• Commodity: commodity classification, class ratings
• Rate structure: national scale of rates, cwt-based
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Figure 10-8
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Table 10-1
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Table 10-2
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Table 10-3
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Rate Making in Practice, cont’d
• Commodity classification factors– Product characteristics that impact carrier costs
• Product density– Higher densities mean lower carrier costs per cwt
• Stowability• Handling• Liability
– Considers product value and susceptibility to damage
– Individual carriers may establish commodity exceptions
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Table 10-4
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Rate Making in Practice, cont’d
• Determining a class rate– Determine rate basis points for origin/dest.– Determine rate basis no. (rate basis no. tariff)– Determine commodity classification rating– Determine rate from class rate tariff– Multiply class rate by shipment weight in cwt
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Figure 10-9
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Table 10-5
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Rate Making in Practice, cont’d
• Exception rates– Modification to national classification– Instituted by individual carrier– Used when transport characteristics for an item
in a particular area differ from other areas• Ex: large volume movements
• Ex: intense competitive conditions
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Rate Making in Practice, cont’d
• Commodity rates– Constructed on variety of bases
• Most common: specific rate on a specific commodity between specified points via specific route and direction
– Not part of commodity classification system– If available, takes precedence over class and
exception rates– Typically offered for regular, large volume
moves
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Table 10-6
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Rate Making in Practice, cont’d
• General rate structures were principal basis of rates published by rate bureaus
• Post-deregulation era– Diminished role of rate bureaus in rate matters– Increased number of individual carrier tariffs– Expanded use of shipper-carrier negotiations– Portions of general rate systems still used in LTL
• Commodity classification useful simplification
• Class rates serve as benchmark for new types of rates
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Rate Making in Practice, cont’d
• Post-deregulation era, cont’d– Some new rate type examples
• Zip code based rates published as part of carrier specific class and commodity rate structures
– Many carriers offer web-based zip-code tariffs as variations of class rate system
• Mileage-based rates– Variation of commodity tariff system
– Rates quoted per mile, regardless of weight
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Special Rates
• Rate forms that evolved due to special cost features or to induce certain shipment patterns
• Character-of-shipment rates– LTL/TL rates– Multiple-car rates– Incentive rates– Unit-train rates– Per-car and per-truckload rates– Any-quantity rates– Density rates
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Special Rates, cont’d
• Area, location, or route rates– Local rates– Joint rates– Proportional rates– Differential rates– Per-mile rates– Terminal-to-terminal rates– Blanket or group rates
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Special Rates, cont’d
• Time/service rate structures– Contract rates
• Contract services common in rail, trucking, water, and some air transport
• Rates and services negotiated between shipper, carrier– Rates not governed by published tariffs– Objectives of the negotiations
» identify service and cost factors critical to each party » set rate inducements and penalties based on performance
on those factors
• Contracts allow for a great deal of tailoring of services to particular needs of the shipper and carrier
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Special Rates, cont’d Time/service rate structures, cont’d
– Contract rates, cont’d• Examples of optional features
– Volume-based: reduced rates in exchange for volume commitment over specified period
– Equipment-based: variations in rate depending upon type of car supplied (car-supply charge)
– Transit-time based: variations in rates by transit-time– Variety of services-based: menu of logistics-related services
– Deferred delivery• Lower rate for flexibility in delivery time• Common in air transport • Enables higher vehicle utilization
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Special Rates, cont’d
• Other rate structures (each is designed for a particular cost or service purpose)– Corporate volume rates– Discounts– Loading allowances– Aggregate tender rates– FAK rates
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Special Rates, cont’d
• Other rate structures, cont’d– Released rates– Empty haul rates– Two-way or three-way rates– Spot-market rates– Menu pricing
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Pricing in Transportation Management
• Factors affecting pricing decisions– Role of the market (customers)
• Relative power of customers vs. carrier
• Price elasticity (sensitivity)
• Availability of substitutes
– Governmental controls• Surface Transportation Board: economic reg.
• Justice Dept.: antitrust
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Pricing in Transport Mgmt, cont’d
• Factors affecting pricing decisions, cont’d– Involvement of other channel members
• Carriers involved in interline movements – Revenue split issues
– Price change interdependency
– Influence of competitors’ pricing• Price leader influences
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Pricing in Transport Mgmt, cont’d
• Major pricing decisions (strategic)– Setting prices on new service
• Often little info on price elasticity or actual costs
• Too high a price might attract competitors or not enough traffic
– Modification of prices over time• Response to market, service, or operating change
• Timing of change can be important
– Initiating/responding to price leader changes
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Pricing in Transport Mgmt, cont’d
• Establishing the pricing objective– General considerations
• Should reflect corporate objectives• May vary during product/service life-cycle• May vary by market
– Alternative objectives• Survival-based pricing
– Increase cash flow through low prices that attract volume
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Pricing in Transport Mgmt, cont’d Establishing the pricing objective, cont’d
– Alternative objectives, cont’d• Unit volume pricing
– Set prices to maximize utilization of existing capacity
– Ex: pickup allowances (LTL), space available prices (air freight, multiple-car prices (rail)
• Profit maximization– Attractive to carriers focused on returns on investment
• Skimming– High price designed to attractive traffic focused on service
quality, uniqueness and insensitive to price
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Pricing in Transport Mgmt, cont’d Establishing the pricing objective, cont’d
– Alternative objectives, cont’d• Penetration pricing
– Often follows skimming
• Sales-based pricing– Lower price to attract mass market and increased sales
– Used in later stages of life cycle
• Market share pricing– Lowering price to gain market share from competitors
– Attractive in stagnant or declining industries
• Social responsibility pricing
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Pricing in Transport Mgmt, cont’d
• Estimating demand– Important, but difficult, especially for new service– For price changes, price elasticity estimates are made
• Similar market comparisons (cautions)
– Role of surveys and market tests
• Estimating costs– Determination of what costs to include– Cost variation at different levels of output
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Pricing in Transport Mgmt, cont’d
• Price levels and price adjustments– Given demand and cost estimates, actual price
can now be set– Alternative methods of setting actual price
• Demand-based
• Cost-based
• Profit-based
• Competition-based
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Pricing in Transport Mgmt, cont’d Price levels and price adjustments, cont’d
– Discounts and allowances (price adjustment)• Def: reduction from published price in exchange for
buyer doing something beneficial to supplier• Examples
– Lower prices for larger shipments (TL vs. LTL)– Lower prices on low-demand seasons– Cash discounts for quicker payment of bills
• Federal regulation of discounts– Discount must result from carrier cost savings due to
action of shipper– Size of discount should not exceed cost savings
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Pricing in Transport Mgmt, cont’d
• Most common mistakes in pricing– Over-reliance on costs– Slow reaction to market changes– Ignoring marketing mix– Prices not tailored to services and markets– Need to price according to strategic plan