Market Considerations :Coyle/Bardi/Novack Transportation 6e © 2006 1 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
Market Considerations, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 2 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
Market Considerations, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 3 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)
Market Considerations, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 4 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
Market Considerations, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 5 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
Cost-of-Service Pricing :Coyle/Bardi/Novack Transportation 6e © 2006 6 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
Cost-of-Service Pricing, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 7 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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Value-of-Service Pricing :Coyle/Bardi/Novack Transportation 6e © 2006 10 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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Value-of-Service Pricing, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 12 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
Value-of-Service Pricing, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 13 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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Value-of-Service Pricing, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 15 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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Rate Making in Practice :Coyle/Bardi/Novack Transportation 6e © 2006 17 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
Rate Making in Practice, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 18 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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Rate Making in Practice, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 23 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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Rate Making in Practice, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 25 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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Rate Making in Practice, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 28 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
Rate Making in Practice, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 29 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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Rate Making in Practice, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 31 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
Rate Making in Practice, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 32 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
Special Rates :Coyle/Bardi/Novack Transportation 6e © 2006 33 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
Special Rates, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 34 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
Special Rates, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 35 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
Special Rates, cont’d Time/service rate structures, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 36 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
Special Rates, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 37 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
Special Rates, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 38 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
Pricing in Transportation Management :Coyle/Bardi/Novack Transportation 6e © 2006 39 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
Pricing in Transport Mgmt, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 40 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
Pricing in Transport Mgmt, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 41 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
Pricing in Transport Mgmt, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 42 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
Pricing in Transport Mgmt, cont’d Establishing the pricing objective, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 43 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
Pricing in Transport Mgmt, cont’d Establishing the pricing objective, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 44 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
Pricing in Transport Mgmt, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 45 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
Pricing in Transport Mgmt, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 46 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
Pricing in Transport Mgmt, cont’d Price levels and price adjustments, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 47 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
Pricing in Transport Mgmt, cont’d :Coyle/Bardi/Novack Transportation 6e © 2006 48 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