Cost Allocation in Transportation Assigning Costs on Cause-Effect Basis
Efficient pricing requires that costs be allocated correctly to the service or customer that is creating the cost (i.e., on a cause-effect basis). • Not all costs are easily traceable to a given service or customer. • Separable costs: costs that can be directly assigned • Common costs: “shared” costs
Costs that are separable for one type of transportation service may not be separable for another. • Transportation example of a separable cost? • Transportation example of a common cost? • What is the backhaul cost (or cost of deadhead miles) and who should pay for it?
Activity Based Costing: determining the activities that are required to perform a given service and attaching a cost to each activity. • Determining the appropriate unit of measure for costing and pricing in transportation is also complicated by the nature of transport costs.
How do TL firms price? LTL firms? Railroads? • How do the following costs vary (i.e., what unit of measure would be best for allocating these costs)? • Fuel • Driver/crew • Equipment maintenance • Equipment capital cost (financial expense) • Parts • Dock labor
As you can see, transport costs vary on different bases. In theory, a multiple factor (or multi-tiered) costing and pricing method would be best. In practice, shippers prefer a one-tier price because it removes uncertainty. How?
One last cost concept needs to be discussed: variable vs. fixed cost. • Variable costs –vary with volume of output • Fixed cost – firm incurs cost whether or not there is output • In transportation competing firms often have different cost structures: e.g., railroads vs. TL – railroads have higher FC • Public sector affects modal cost structures: infrastructure ownership and taxes
Cost structure affects pricing • Railroads utilize price discrimination (value of service pricing) • Railroads have few or no competitors in some markets • Different products have different price elasticity of demand for transportation service • Railroads charge higher “mark-ups” above VC (and thus recover more of their FC) from shippers in non-competitive markets and from high value products
Trucking firms and air freight carriers face rigorous competition in nearly every market. • Thus, trucking and air freight carriers utilize cost-based pricing across the board while product demand factors and transportation competition play a major role in railroad pricing. (This is why competitive access issue is so important to shippers.)