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Management of
Transportation
Seventh Edition
Coyle, Novack, Gibson & Bardi
© 2011 Cengage Learning
Chapter 10
Costing and Pricing
Issues
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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
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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