Posts Tagged pricing

Unit Trains and Railroad Pricing Versus Mobile Operators

In my background, I used to manage the product marketing for chemicals shipped on the Southern Pacific railroad (now the Union Pacific).  While railroads are not known for their cutting edge business skills, it is instructive to see how another capital-intensive, network business dealt with pricing.

So how might you think railroad price their services?  By the carload?  In some cases, yes.  But not all cars are the same size.  Frequently, they priced freight by weight.  And they would give shippers incentives for loading as much in a car as possible. For example, $30 per Net Ton (this excludes the weight of the car) with a 70 ton minimum, and $28 per Net Ton with a 80 ton minimum. Three scenarios:

Weight

Price

Total Charge

Under 70 tons

$30/Net Ton, 70 ton min

$2,100

72 tons

$30/Net Ton, 70 ton min

$2,160

82 tons

$28/Net Ton, 80 ton min

$2,296

At some point, it makes sense for the shipper to pay the “next minimum” – between 74.6 and 80 tons.

In some ways, this rail model is similar to the “buckets” (e.g. $60 for 1000 minutes) offered by mobile operators, but with some differences.  Both collect a minimum revenue.  However, in the rail pricing, there are incentives to load more and generate even more revenue.  In contrast, most mobile carriers penalize a user for going beyond his “bucket” size by charging an overage charge. 

The rail pricing model and incentives make sense relative to the capital investments. For a rail carrier, the capital investment is two assets. First the fixed rail network itself.  Second is the locomotive(s) required to pull the train. 

The rail network is a fixed item that has a capacity that is rarely maxed out (requiring double-tracking to expand). The more likely capacity constraint is in the switchyards.  Switching locomotives in a “hump” yard is a time-consuming and serial process.  The “minimum” of pricing model serves to cover the cost of the rail network.

Locomotives are an asset that is modular and mobile enough that additional locomotives can be added if the cars need it.  Plus, there are economies of scale for longer trains – most of the power is to get going and braking.  So it makes sense to price to attract incremental weight and revenue.  Every additional car on the train has a lower marginal cost.

A different rail scenario to consider is the “unit” train.  Unit trains typically involve high volume commodities like coal.  The entire train is made of ~100 coal cars plus a locomotive set that is efficiently matched to the weight of the entire train.  For rail carriers, unit trains are a beautiful use of capital.  They generate a lot of revenue via their volume.  They are constantly moving, meaning the investment is constantly producing a return.  They are efficient, not wasting locomotive power. And, perhaps most importantly, they do not require any switchyard time.  They can go from point A to B, bypassing the costs and time of switchyards which represent the “nodes” of the network.  Because of these efficiencies, unit trains receive very low prices.   Why?  Because of lack of variability in unit train movement and their low impact on the overall sizing of the network.  Unit trains represent a “baseload” of traffic that rail carriers need to survive.

In next post, I will talk a little more about how this relates to telecom, mobile networks.  Then we will look at the electric power industry.

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