Thursday, March 31, 2011

New rate tools for short lines

Written by  Roy Blanchard, Contributing Editor

Short line operators proposing new moves or trying to renegotiate rate divisions on old moves can be at a competitive disadvantage with their Class I counterparts.

The Class I market managers are armed with legacy costs for just about every commodity origin-destination pair, they know what the competition is charging for the same move, and they can tell with one click of a computer mouse whether the ratio between potential revenue and legacy costs meets muster.

Moreover, accounting rules say short lines have to be paid out of revenue and their fees do not belong under operating expense. So a marketing manager evaluating a proposed move with thin margins may see the short line fee cutting into the desired revenue-cost ratio and reject it. Or he could boost his revenue to cover the fee and potentially make the rate non-competitive. In any event, the short line manager never knew what was in the rate unless his Class I counterpart offered it.

And unless the Class I was feeling helpful, the short line manager either went along with the proposed rate or the traffic didn’t move. If he wanted to drill down for some estimates of costs, the best approximation was always the STB’s Uniform Rail Costing System (URCS). But that’s always six months to a year or more out date, hardly helpful in trying to price profitably for moves as much as two years out.

The good news is that short lines now have access to two particularly helpful tools for sanity-checking Class I railroad rate proposals and seeing if they are profitable for the short line: EyeProfit® from Eyeris, Inc., and the railroad costing and market intelligence database from USRail.desktop.

Some stage-setting is in order. First, URCS is not really designed for rate-making. Its primary use is helping STB in estimating variable and total unit costs in rate cases involving past events on Class I railroads. The URCS numbers are derived from each Class I’s annual report (the “R-1” submitted to the STB) as adjusted by certain movement data. The R-1s due March 31 reflect the prior year’s costs and it takes the STB until the fourth quarter to build the URCS data.

Thus the URCS data in use, say in June 2011, are based on the 2009 reports and are 18 months old. To address some of this time lag, the STB has developed an internal indexing system to calculate more up-to-date cost estimates. While the Board adjusts the URCS per-car data in hand with publicly available indices from sources such as the Association of American Railroads and the Bureau of Labor Statistics, the STB indexed data still lag real-time data by four months. Moreover, the indexed data may or may not be available to the public at the time of need.

To see how much URCS data can lag the present case, compare Union Pacific operating expense for 2009 with the 2010 numbers and 2011 projections. Total 2010 operating expense increased just 11% over 2009 while revenue units increased 13%, lowering the per-unit expense. The 2010 operating ratio was 70.6, down nearly six points from 2009, and UP says it expects to do even better in 2011.

The outlook is the same across the entire Class I community: revenues up by double-digit percentages, operating incomes up by multiples of that, and lower cost-per-revenue unit. The Class I's are getting better every day at making fixed costs variable and matching variable costs to the volume at hand. Real-time costs are replacing legacy costs.

This is where the first new tool, USRail.desktop, comes in. Desktop, as it’s colloquially known, is a computer program that gives users the power to see actual railroad costs and margins by commodity OD pairs, car type, whether unit train or single car, transit times, the best routing options, and the commodity carloads already moving in each lane. All one need do is enter the usual movement data and the software returns a cost breakdown—car-hire, fuel, etc.—that includes the short line costs.

The short line manager looks at the market data section to see what’s moving in the lane under consideration and at what revenue per unit. Desktop has already provided the costs, so determining an appropriate revenue-cost ratio is easily done. The next step is sitting down with the customer to design the service: annual carloads of what in and out, car type, leased or railroad-owned, service frequency, and so on.

EyeProfit® shows how each operating activity affects a specific financial outcome. Using this, the short line manager can allocate the right amount of expense (car hire, diesel fuel, labor, track and equipment maintenance, etc.) to each specific customer-related task. Armed with the actual service design costs, one can go back to the Desktop model, refine the short line costs, and come up with a target rate. When the Class I prices move, the short line has a way of sanity-checking the rate and knowing if the short line rate division will yield the desired profit level.

These two tools in combination gives the short line owner a competitive advantage by understanding current Class I costs by commodity O/D pair, what it costs to provide the service the customer wants, and a starting point for negotiating Class I rate divisions. The desired outcome is making customers smile. With short lines using Desktop and EyeProfit®, everybody—shipper, short line, and Class I—can smile. And make money doing it.