Pricing of transport activities Lecture 7

On completion of this topic you should
be able to:
• Explain why pricing of transport services is different to
other economic wants
• Identify price discrimination in the pricing of transport
• Recognise reasons for predatory pricing & price fixing
• Outline pricing of transport services & costs incurred,
including transfer pricing
• List cost structures of modes of freight transport
7032maa – Lecture 7 1
Importance of price
7032maa – Lecture 7 2
Price determinants
• Price is determined
by market conditions
• Price should also be
based on recognised
costing methods
such as:
7032maa – Lecture 7 3
Price determinants
• Transport is often paid for in different ways:
• In advanced (bus train fares etc)
• After consumption of transport service
• Within the price of another good
• Directly (fuel) or indirectly (taxes etc)
7032maa – Lecture 7 4
Price discrimination
• Price depends on what the market will bear
• Transport markets do not have homogenous consumers
• Time, flexibility & speed of transport services affect price
7032maa – Lecture 7 5
Price discrimination
• A situation where price charged is higher for the
same goods or services for reasons unrelated to
cost
• Not just relating to actual price of transport services,
related goods also affected eg Parking fees
• Price discrimination is a way to increase total
revenue & earn higher profits by reducing consumer
surplus
• Consumer surplus is the difference between actual
price & what consumers are willing to pay
7032maa – Lecture 7 6
Perfect price
discrimination
Consumer surplus
7032maa – Lecture 7 7
Price discrimination
Possible to divide market up into different segments such
as:
•Some markets monopolistic, others competitive
7032maa – Lecture 7 8
Express parcel
delivery at set times
more expensive
Economy service
delivers any time on
any day
Destination expensive when
geographically remote
Peak travel
more
expensive
Conditions of consumer
surplus
Seller must have the following conditions
• Possess a degree of market power
• Able to divide market into segments such as
delivery & booking time, geography
• Possess inhibitors that stop consumers down
trading to other substitute services
• Each segment have different elasticities of
demand
• Able to sell each unit of a transport service
separately
7032maa – Lecture 7 9
Predatory pricing
Occurs when a firm:
• Has market power in more than one market
• Reduces price below cost in the short run to obtain
abnormal profits in the long run
Purpose of predatory pricing is to:
• Achieve or maintain a monopoly position
• Attempt to bankrupt competitors or encourage them to
merge or collude
• Encourage market power to raise barriers to entry
Predatory pricing practices are illegal in most countries
7032maa – Lecture 7 10
Price fixing & collusion
• Firms in oligopolistic markets such as
airlines & shipping lines, sometimes
choose to collude
• Seen as better than competing by
reducing price & losing profit
• This is good for the firms, but bad for
consumers
7032maa – Lecture 7 11
Price fixing & collusion
Benefits of price fixing
and collusion include:
• Reduces level of
uncertainty
• A cartel means the
oligopoly acts as a
monopoly
• Removes price
competitiveness
7032maa – Lecture 7 12
Pricing: Cost of a transport
journey
Source: COWIE, J., (2010) The Economics of Transport, Routledge p191, fig8.7
Don’t
forget
profit!!
7032maa – Lecture 7 13
Taxes & price
• In UK and other developed nations, tax
structures do not reflect usage of the transport
infrastructure
• An opportunity to “nudge” the market towards
fairer taxes based on usage & environment
7032maa – Lecture 7 14
External pricing decisions
Dyson,2011 Accounting for Non-Accounting Students, 8th Ed Pearson fig 18.4 p407
7032maa – Lecture 7 15
Transfer pricing decision
Dyson,2011 Accounting for Non-Accounting Students, 8th Ed Pearson fig 18.5 p410
7032maa – Lecture 7 16
Setting transfer prices
• Market price: Power of the market sets the price
• Adjusted market price: Market price reduced
due to recognition of lower cost of internal trading
• Total cost or total cost plus: Transfer price
based on direct cost & share of overheads or all
overheads plus profit
• Can encourage sub optimisation, as no incentive
to control costs
7032maa – Lecture 7 17
Setting transfer prices
• Variable cost : Does not encourage internal
trading, as no profit incentive
• Variable cost plus: Profit incentive as long as
based on standard variable cost
• Negotiated price: Striking a bargain based on
a combination of market price and costs
• Danger from powerful negotiators, must be
mutually agreed
• Opportunity cost: Base on standard variable
cost & opportunity cost resulting from deal
7032maa – Lecture 7 18
Transfer pricing problems
Businesses selling internally & setting prices
• For one section of business its revenue, for the
other it is an expenditure
• Can be used to artificially boost costs for tax
purposes
• Also hide poor sales by selling internally
• Has to be comparable with external market price
• Pressures of supply / demand are avoided if buy
internally, could encourage inefficiency
7032maa – Lecture 7 19
Cost structures found in
freight transport
Road haulage:
• Cost structures related to acquisition, periodic
costs and fixed/variable running costs
• Depot & terminal costs are high & long term
• Variable costs include fuel & wages
• In less than truck load markets (LTL) fixed costs
are even higher
• Profitability is based on volumes of traffic moved
7032maa – Lecture 7 20
Cost structures found in
freight transport
Economies of density:
• Relates to road vehicle carrying capacity & size
• Longer and taller trailer can carry more
• Marginal cost of adding extra “less than truck load”
consignment very low
• Price as cost per tonne or cost per km?
– Cost per tonne is fine if vehicle fully laden
– Cost per km is dependent on distance
• Scope to reduce average costs through economies
of density
7032maa – Lecture 7 21
Cost structures found in
freight transport
Rail freight:
Form and structure vary around the world
• Often state run (Europe, Asia)
• Mix passenger trains with freight trains
• Some have separated track infrastructure from rail
operators (UK)
• North America is predominantly private and mainly runs
freight operations owning own track
• Track gauges different (Spain, Russia)
• Age of trackside infrastructure restricts usage (UK)
7032maa – Lecture 7 22
Cost structures found in
freight transport
Rail freight:
• Very high level of capital costs
• High barriers to entry, both legislative & investment cost
• Operating costs, especially fixed are also high
• Variable and marginal costs low, due to economies of
density (eg double stacked containers, long trains)
• This means that rail freight has a high break even point
• Economies of scale and scope need to be exploited to
maximise high capital and fixed costs
• Result is few firms operating in rail freight markets
7032maa – Lecture 7 23
Cost structures found in
freight transport
Air freight:
Three types of freight operators:
• Line haul, between airports
– All cargo operators
– Combination passenger and cargo operators
– Passenger only operators
• Integrated operators, provide a door to door service that
included land transport (often known as Integrators such as
DHL, Fed Ex, UPS, TNT)
• Niche operators, such as heavy air transport
7032maa – Lecture 7 24
Cost structures found in
freight transport
Air freight:
• Goods in joint supply – most passenger aircraft
have ample cargo space below the floor
• Enables airlines to sell freight space at the same
time as passenger seats
• When passenger capacity increases, so does
freight capacity
• Not all airlines carry additional freight, such as
budget airlines, because of handling costs
7032maa – Lecture 7 25
Cost structures found in
freight transport
Air freight:
Barriers to entry are high due to:
• High capital cost of aircraft & high maintenance fixed
cost
• Airport docking spaces at geographical desirable
locations
• Airfreight operators are in competition with passenger
operators for airport access
• High capital costs means risk of merges and collusion
7032maa – Lecture 7 26
Cost structures found in
freight transport
Air freight:
• Non price competition such as speed and reliability
important in air freight
• Prices are very competitive, but low due to marginal cost
• Yield management of freight capacity is crucial & can be
categorised as:
– Uncertain capacity, difficult to predict freight volumes
– 3 dimensional capacity, weight, volume & quantity
– Itinerary control, freight can go any route
– Allotment of pre booked slots
– Unequal freight flows & imbalances
7032maa – Lecture 7 27
Cost structures found in
freight transport
Maritime shipping:
• Inland shipping – navigable rivers and canals
• Coastal shipping – port to port on same coast
• Short sea shipping – ferries, small cargo ships
• Deep sea shipping – Intercontinental container ships
• High capital costs associated with ports and ship
acquisition
• Economies of scale and low marginal cost , so ships keep
getting bigger!
• Liner conferences are a form of legal collusion on prices
7032maa – Lecture 7 28
Summary
• Explained why pricing of transport services is different to
other economic wants
• Identified price discrimination in the pricing of transport
• Recognised reasons for predatory pricing & price fixing
• Outlined pricing of transport services & costs incurred,
including transfer pricing
• Listed cost structures of modes of freight transport
7032maa – Lecture 7 29

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