School of Enterprise

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School of Enterprise

• Financial Pricing Strategies
• Lecture 3
• Kim HASSALL
• April 2008

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Three areas of Logistic and Transport Pricing for
Examination

• Regulatory
• Economic
• Operational

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Some 110 Transport and Logistic Pricing
Strategies have been Isolated as at January
2007.We will examine some 21 key strategies in
some detail

• Regulatory R
• Economic E
• Operational O

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1. Marginal Cost Pricing E

• The cost of producing one extra unit of output
  taking into account the direct costs of
  production.
• Note Full overheads and direct costs may not be
  recovered

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2. Full Cost Recovery E

• The cost of allocating all direct and overhead
  costs to the producing of an item. Overhead
  allocation may be done via a set of business
  rules.
• Note Full cost recovery may not be possible
  where Sunk Costs have been incurred and
  competition is intense.

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3. Sunk Cost E

• The cost of establishing a tool, a piece of
  software, or a piece of infrastructure that
  allows the operator to compete in a market. If
  the market is competitive enough recovery of the
  development costs may not be possible. The setup
  investment is essentially sunk.
• Note The occurrence in sunk costs is common in
  both software development and e-business
  applications. In essence the allocated overhead
  margins will only bear no more than a fractional
  contribution to their development.

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4. Joint and Common Costs E

• Joint Costs are costs that need to be allocated
  across two or more types of product. This is
  done through the use of a devised allocation
  rule. Remember allocation rules can be changed
  and improved.
• Common Costs are by definition not separable. An
  example would be allocating the costs of traffic
  light operations across cars, trucks and
  cyclists. The allocative split is done via the
  development of a business rule with may or may
  not be efficient or equitable.
• Activity. Discuss a Distribution Centre operating
  cold store, vegetables and fruit. What are the
  joint and common cost considerations?

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5. Separable and non-Separable Costs E

• Separable costs can be allocated by some
  separation rule, (hopefully efficient), whereas
  non separable costs have no such natural
  separation rules.
• Economists have examined types of rules that are
  effective for separating non separable costs.
  These will differ with the type of operation.
• Eg taxes on entry to a market may be hard to
  split over various operations, but corporate
  accounting or Product Costing areas may devise
  such Rules.

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6. Fixed and Variable Costs E

• Fixed costs .. Costs that do not vary with use,
  eg Truck registration fees, Third party
  comprehensive insurance, some access fees,
  association fees. A proportion of these costs may
  be apportioned differently depending on the
  number of clients using the service. Eg, truck
  deliveries, hours, tonnes etc
• Variable CostsCosts that do vary with service or
  activity. Eg truck kilometers, fuel use, tyre
  use, depot hours

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7. Direct and Indirect Costs E

• Direct costs .. Costs that reflect the service
  levels that a customer may demand. Eg, truck
  services or deliveries per day. These costs can
  be directly calculated with specific allocation
  rules.
• Indirect Costs.Costs are perhaps not allocated
  to the client eg, accidents and emissions costs.
  These may be allocated evenly across the business
  or not costed at all.
• Note Many Indirect costs perhaps should be
  allocated to being attributable to activities
  associated with particular clients. Indirect cost
  should be reviewed from time to time.

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8. Attributable and Non Attributable Costs. E

• Attributable costs are those costs that are
  attributable to a particular client, service,
  product or commodity. When assessing the
  resourcing and pricing for particular services or
  goods all areas of attribution should be charged
  for. Knowing what the market will bear and what
  opposition prices are offered are useful pieces
  of information before allocating full cost
  attribution.
• Non Attributable costs are may not be directed
  attributed to a customer or product. Eg, some
  license fees, permits and taxes may not be
  attributed to any one customer or service.
  However, other business allocation rules may be
  implemented to achieve cost recovery. Particular
  Information Technology Systems may not be
  attributed to any particular client but are a
  necessary hurdle into that business line.

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9. Avoidable and Non Avoidable Costs E

• Avoidability is a very powerful costing and
  pricing concept especially in conjunction with
  Activity Based Costing principles. Avoidability
  has many principles in common with attribution,
  although some attributed costs may not be
  avoidable at least in the short term. Eg,
  attributing half a warehouse to a customer does
  not make the costs avoidable if the customer is
  lost.
• Non Avoidable costs are perhaps infrastructure or
  Information Technology costs that are necessary
  for entry into a market. How they are allocated
  is up to the business rules of each company.

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10. Access Cost/Pricing R

• Access pricing is a common regulatory charging
  mechanism in which a particular group of
  operators seeks access to a network or to a
  market.
• Common Examples of an access price, is car
  registration charges, train network access
  payments, congestion charging, tollway entrance
  charging etc the access charge should be levied
  via efficient business rules. Often it is not.

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11. Slot Pricing R

• Slot pricing is an access pricing regime that
  allows operators to connect to a network or
  service through a pre arranged timeslot. This
  timeslot possibly has a different charge
  associated with the slot (eg, peak capacity
  charging). The slot allocation mechanism is
  intended to benefit overall system or network
  throughput.
• Common Examples of slot pricing, can be seen at
  container ports, airports, rail terminals, air
  freight hubs etc.

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12. User Pays/Paygo Pricing R

• Paygo or pay as you go is a full cost recovery
  pricing mechanism that requires the users of a
  service or network to fully recovery their share
  of that network or services over an agreed
  period.
• In Australia Paygo for roads was written into the
  truck cost recovery program for road usage. This
  process is managed by the National Transport
  Commission.

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13. Congestion Pricing R

• Congestion pricing is an access pricing
  arrangement intended to balance generally road
  supply with traffic demand. It has been
  implemented in London central cordon in February
  2003 and had an immediate impact. Many countries
  are examining Congestion pricing, including
  Australia.
• The pricing system should be levied by trip
  origin-destination by time of day, otherwise the
  access price may be equivalent to a flat toll
  price.
• Implementation difficulties can revolve around
  the types of technology chosen for the traffic
  management/collection system. There are wide
  ranging differences in overhead costs that result
  from the associated technology.

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14. Transfer Pricing O

• Transfer Pricing was developed in the early 1990s
  and became fashionable for examining the
  efficiency of between centre, divisions, or
  operations, often within a company. Usually the
  focus of at least one division was that it was
  non revenue generating and needed to be compared
  often with divisions that were revenue
  generating. The mechanism establishes a quasi
  cost or service based revenue stream that can
  allow for notional cost and profit reporting.
• TP is a powerful technique that dispels the
  notion of a free service from one division to
  another and can show the misuse of a free good or
  service between divisions.

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15. Corridor Pricing O

• Corridor prices are a common feature of Road,
  Rail, Aviation and Shipping markets where direct
  origin to destination services are required.
  Generally speaking origin cities that have the
  greatest freight generating potential have the
  highest ex origin freight rates. Prices for
  freight despatched from these cities can also be
  termed as forward-leg prices, and return prices
  can be termed backhaul prices or rates.
• Corridor pricing is a natural market feature that
  often reflects available freight capacity to
  price relationships.

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16. Backhaul Pricing O

• Backhaul Pricing is the reverse of forwardleg
  pricing. By definition backhaul prices are lower
  than forward-leg prices unless particular
  origin-destination pairs are of similar sizes
  with similar freight despatch capacities.
• Often Corridor operations have forward leg prices
  cross subsidizing the return or backhaul prices.
  The sum of both directions on a corridor will
  generally allow for a profit across the forward
  and backhaul operations.
• Certain operations, eg, Manufacturers can often
  attain cheaper transport costs by availing
  themselves of backhaul rates.

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17. Transaction Cost Pricing O

• The costs of purchasing, billing, verifying, etc
  have an associated cost.
• Often booking fees and transaction fees also form
  components of a client price for a particular
  service.
• In e-Business particularly listing prices for
  catalogue display, listing items for auction,
  currency exchanges fees and a transaction
  commission, are all common pricing mechanisms
  that operators or sellers need to examine when
  contracting services or products.

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18. Activity Based Costing O

• The Concept for Activity Based Costing (ABC)
  became prevalent in the mid 1990s and has
  remained high in the analysts arsenal of pricing
  strategies. Full ABC recovery is a full cost
  recovery approach but restricted to the
  recovering the resources that have been applied
  to a particular service or good.
• In a full ABC approach, overheads are also
  allocated to costs of services or goods.
• Note One important consideration in using ABC
  analysis is what level of avoidability exists
  within the cost allocations of a product or
  service, such that if a product or service is
  withdrawn then what is really avoidable.

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19. Network Density Pricing O

• Often economys of scale and scope are
  considerations for expanding products or services
  within an existing business base. What is not
  often discussed is a third economy of scope which
  is an economy of network density.
• Economys of density often apply to transport
  networks and conceptually can be thought of, in a
  marginal way, as adding an extra link in a
  network. The cost of servicing such a link may be
  totally different to the pricing and costings for
  the existing network, and if excess transport
  capacity can be utilized then significant saving
  may be achieved.
• Note How new network links are incorporated into
  an existing transport operators or customers
  network is an important issue for overall network
  pricing, and should be reviewed often.

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20. Open Book Pricing O

• Open Book pricing relationships require all
  nominated costs between operator and customer to
  be captured for examination from both parties on
  an agreed, regular basis. Open book agreements
  and contracts may be for a particular transport
  operation or even for a total distribution centre
  operation. They may apply to both third and
  fourth party logistic operations.
• Costs, service performance measures, and
  escalations as well as bonuses can be brought
  into the open book relationship. Profit margin is
  shown and the full operation or centre accounting
  for the open book relationship can even be
  externally audited.
• Within the open book relationship a custom er may
  pay directly for a subcontracted service arranged
  by the operator, or the customer may reimburse
  the prime contractor for subcontractor dealings.
• Where a 3PL or a 4PL operator may bring
  significant sectoral expertise to a customer then
  Open Book relationships should be considered.
• Note Trust is a prime imperative for open book
  relationships Also the open book needs to be the
  object audited and shared with the customer. The
  aim of the partnership is for a best outcome and
  the achievement of best practices in achieving
  this end.

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21. Factory Gate Pricing O

• Factory Gate Pricing (FGP) was introduced into
  the UK in the early 2000s generally from a retail
  perspective. FGP or more specifically ex Factory
  Gate Pricing is a way to restructure transport
  costs, for example, to a retail Distribution
  Centre. FGP can even separate transport costs
  from the service and product package offered by
  the incumbent transport or 3PL operators or
  manufacturers themselves.
• Many areas from where goods are sourced, be it
  farm or factory gate, the actual kilometer cost
  equation can be restructured from any corridor or
  partial market corridors that exist currently. In
  essence FGP can create new market prices from
  particular supply nodes within an inbound
  logistics network. Inbound transport can even be
  paid for separately under new contract
  arrangements and not be included as a total
  inbound goods and transport cost.
• Note From the perspective of a transport
  operator capacity utilization is important. If a
  major customer pays for deliveries on a tonne or
  partial truckload basis then other customers need
  to be included in delivery runs. Should several
  companies be serving one major client then
  co-operative cross dock arrangements should be
  considered ex that locality.
• Activity Electronics Factory Gate price
  Operator considerations