Can and will Railroads continue to raise prices in the future?

Implications: Railroads are producing record profits resulting from their raising average real prices nearly 25% over the last four years. Railroads are transitioning from a simplistic Pricing Strategy -- "raise them" -- to a sophisticated Yield Managemetn Strategy Railroads will maintain price discipline to AT LEAST offset inflation on all freight   Less desirable shipments will continue to see annual increases in the 7% to 9% range as railroads use price to rationalize capacity and balance flows.

Analysis: Railroads have been raising prices.  Over the last four years, revenue per thousand ton miles of freight has increases from $26 to $32 in current dollars.  This measure indicates how much money shippers are paying to move one ton of freight, one mile.  It is a meaningful year over year comparison, even as the mix of commodities, length of haul, and tons per car may be changing.

Railroads have been able to raise prices for three reasons:

1) Their truck competitor has been raising prices to offset cost increases related to driver shortages, equipment cost increases stemming from more expensive emissions controls and highway congestion, and increased fuel costs.

2) The Railroad service product is improving.  Mergers have created more direct routes, less delay at interchanges, and more fluid “one way” running on parallel corridors.  Computer technology has enabled more real time monitoring and more intelligent network management.  Shippers are willing to pay more for better service.

3) Some railroad corridors and some railroad terminals have reached capacity (either continuously or at least during busy seasons) and the railroads are rationalizing demand for that scarce capacity by raising prices.

Historically, since deregulation in 1980, railroads lowered prices in order to attract more volume and increase density on their tracks.  Because railroads have a very high fixed cost structure, they gain significant economies of scale by running more traffic on a given amount of infrastructure; as the fixed cost is spread over more and more shipments, the average cost per shipment goes down and profits will go up.  But, this phenomenon only works until the rails are filled up.  Once the network volume begins to exceed “fluid maximum capacity”, incremental traffic will actually increase costs.  Trains are delayed, car and locomotive cycle times lengthen, and overtime costs go up as it takes train crews longer to operate a train over their respective crew district.

One reason recent prices have jumped so much in such a short amount of time is that many shipments were under long term contracts that constrained the ability of the railroads to raise prices during the term of the contract.  As these contracts come due, the price points are being "re centered" and dramatically stepped up to reflect the accumulation of changing market conditions that occured during the contract period.  So as prices stabilize around this new equilibrium, what is the expectation for the futre?  Will railroads revert to small, incremental annual price increases, or will they be able to maintain substantial price increases over and above inflation?

Currently, the industry is transitioning from a period of “simplistic” pricing strategies (marked by broad decisions to “lower them”, “raise them”, “charge more for heavy cars and less for lightweight cars”) to an era of “sophisticated” pricing strategies.  The challenge is to use price to manipulate market responses such that traffic density closely matches the fluid-maximum capacity of the network; at that point, railroad profits are maximized. 

In general, we expect all rail prices to continue to rise.  However, as railroads use price to manage their yield and increase balance on their networks, shippers should expect to see some prices rise more rapidly than others.  For example, we expect that shipments moving on congested corridors will likely see annual price increases in the 6% to 8% range.  While shipments moving on fluid corridors may enjoy minimal price increases in the range of 3% to 5%, as railroads encourage traffic growth but at the same time look to offset inflation. 

In a similar fashion, we expect the railroads to continue to raise prices faster on short haul moves versus long haul moves.  This makes economic sense as railroads try to maximize the revenue they can extract from a network bottleneck.  For example, say a railroad has a key terminal where fluid maximum capacity is 30 trains per day.  The railroad has to decide how to allocate those limited number of slots.  A short haul train (say 100 cars moving 400 miles) may only produce $200,000 of revenue, while a long haul train (say a 100 cars going 800 miles) may produce $300,000.  But, both trains use one slot at the congested terminal.  The railroad will raise prices on the short haul trains to drive them off to other corridors or to encourage shippers to tender shipments on off-peak days in order to free up space to take on additional long haul trains.  

We have combined these findings with other analyses dealing with carload versus unit train movements and backhaul versus head haul movements to deveop a simple model for postulating annual railroad price increases in the future. 

Examine four critical attributes of any shipment:  

- Is it a long haul (> 600 miles)? 
- Is it traversing a fluid corridor? 
- Is it in the back haul direction?  
- Is it a unit train?  

If the answer to all four of these questions is “yes” then the shipment will likely see price increases in the 3% to 5% range.

If the answer to any three of these questions is “yes” and one is “no” then the shipment will likely see price increases in the 4% to 6% range.

If the answer to any two of these question is “yes” and two are “no” then the shipment will likely see price increases in the 5% to 7% range.

If the answer to any one of these questions is “no” and three are “yes” then the shipment will likely see price increases in the 6% to 8% range.

Finally, the least desirable rail shipments are those that have none of these attributes, i.e. the answer to all of the question is “no”.  These least desirable shipments will continue to see annual price increases in the range of 7% to 9%.