Rail Costing and Regulation:
The Uniform Rail Costing System
Wesley W. Wilson and Frank A. Wolak
University of Oregon
Stanford University
Motivation
• Staggers Act significantly expanded pricing discretion
of railroads
– Complete pricing freedom for movements deemed to be
“effectively competitive”
– Freedom to negotiate contract rates subject to constraint
that contract does not harm common carrier service
– Tariff rates can be subject to regulatory review if they are
set by a “market dominant” shipper
• Staggers Act and preceding legislation set two major
goals for new regime
– Protect captive shippers from excessive prices
– Ensure revenue adequacy necessary for long-term
financial viability of railroads
Motivation
• “Variable cost” of shipment calculated using
Uniform Rail Costing System (URCS) is a major
input to meeting both of these goals
– Input to market dominance test
– Input to determining excessive prices
• URCS “variable cost” is computed using 15
accounting-based cost activities by allocating a
portion of the total costs for each category to
each shipment based on a variability ratio of each
activity
– Predicted percent of activity-specific costs that vary
with output of activity
Motivation
• Implication--URCS “variable cost” of a shipment is
an “allocated cost” concept that bears little
relation to railroad costs caused by shipment
– Incremental cost of shipment
• Ratio of revenue for shipment (R) to URCS
“variable cost” (VC) is used as a basis for
determining market dominance of shipment
• R/VC greater than 180 percent is necessary for
shipper to have possibility for regulatory relief
from STB
Purpose of Paper
• Evaluate current approach employed by STB to
provide rate relief to shippers subject to market
dominance
– Assess economic foundation for using URCS “variable
cost” as basis for allowing shipper access to regulatory
relief process
• Evaluate economic foundation for using URCS
‘variable cost” to determine a reasonable price
• Discuss market efficiency consequences of using
URCS to set maximum reasonable price for a
shipment
• Evaluate need for continued collection and
production of railroad cost data
Outline of Presentation
• Background on railroad industry post-Staggers
• Review of Staggers Act mandate and how it is
implemented by STB
• Describe of basic features of URCS procedure
• Present simplified model of railroad costs and
pricing
– Determining incremental cost of shipment
– Setting profit-maximizing shipment prices
• Need for and use of railroad cost data going
forward
Background
• Partial deregulation of railroads to place greater
reliance on the market mechanisms to set rates
• Staggers Act was intended to “[strip] away needless
and costly regulation in favor of marketplace forces
wherever possible” (Carter 1980).
• Rate regulatory oversight was significantly changed
– No price regulation for shipments deemed “competitive”
by STB
– Negotiated contracts between shipper and railroads
allowed
– Regulation only over movements where a rail carrier was
deemed market dominant
• Eased and streamlined merger reviews and rail line
abandonments and sales reviews
Background
• Dramatic changes post-Staggers Act
– A massive consolidation movement (from 40 Class
I carriers to 7, most through mergers)
– Reduction in rates from 6.46 cents/ton-mile in
1980 to 3.29 cents/ton-mile in 2013 (2009$)
– Reduction in size of network held by Class I
carriers from 164,822 miles in 1980 to 95,391 in
2013.
– Increases in average length of haul from 615 to
973 miles
Background
– Many shippers now have only one railroad option
and many face high prices for rail shipments
– Some shippers cannot negotiate “reasonably
priced” contracts with railroad
– Rail networks are smaller but they are moving
significantly more tonnage over the network.
• Allocation to higher-priced traffic
• Service issues
• Network congestion
Figure 1
1800
800
120
Miles of Road (in 000)
160
130
140
150
1000 1200 1400 1600
Revenue Tonmiles (in bil)
170
Revenue Tonmiles and MOR
1980
1990
2000
2010
year
Miles of Road (in 000)
Revenue Tonmiles (in bil)
Figure 3
0
2
4
6
8
Average Revenue Tonmiles and Miles of Road (relative to 1983)
1980
1990
2000
year
rel_mor
rel_rtm
2010
Figure 4
500
Average Length of Haul
600
700
800
900
Average Length of Haul
1980
2000
1990
year
2010
Figure 5
20
25
weighted_ut
30
35
40
45
Unit Train Percentage
1980
2000
1990
year
2010
STB Regulatory Oversight Process
STB Regulatory Oversight
• Contract rates are not subject to regulatory review (some
limited review of agricultural commodity contracts).
• Some car types/commodities exempted because STB has
determine these shipments have competitive alternative
• Remaining rates, “tariff” rates, are subject to regulatory
review for reasonableness if provider of movement is deemed
“market dominant”
– Market dominance means that R/VC>180 percent and there is a lack
of competitive options (intramodal and intermodal).
– Notably if R/VC<180, the rate is not market dominant and the finding
cannot be rebutted.
• VC of a movement is calculated using URCS
Rate Reasonableness Process
• If market dominance is found by STB, then the level of rate
can be scrutinized by three alternatives
– SAC (Stand-Alone Cost)
• Seeks to determine the lowest cost at which a hypothetical, efficiently
operating carrier could provide service.
• Docket 715: “the rate at issue cannot be higher than the rate a
hypothetical efficient railroad would need to charge to serve the
complaining shipper while fully covering all of its costs, including a
reasonable return on investment. In other words, we judge the
challenged rate against a simulated competitive rate a captive shipper
would enjoy if a competitive transportation market existed.”
– Pittman (2010) documents significant time and financial costs of
this procedure ($5 million) and argues that its application to the
railroad industry is inappropriate
– Shippers complain SAC process is too complex and expensive
Rate Reasonableness Process
• Simplified SAC:
– Limits evidence that can be submitted to
streamline process
– Find the replacement cost of the existing facilities
used to serve the captive shipper and the return
on investment a hypothetical railroad would
require to replicate those facilities
– $5 million limitation on relief from excessive rates
that a shipper can collect
Rate Reasonableness
• Three benchmark: An examination of three
benchmarks are used to evaluate the reasonableness
of the rate.
– 1. The average markup above VC that a carrier would
need to charge all of its potentially captive traffic (i.e.,
those with ratios greater than 180 percent) to recover all
of its non-variable costs;
– 2. The average markup above variable costs that a carrier
receives on its captive traffic (R/VC) greater than 180
percent); and
– 3. The average markup assessed on other potentially
captive traffic involving the same or a similar commodity
moving similar distances
• $1 million cap on relief that shipper can receive
Rate Regulation and URCS
• URCS is used to
– Determine jurisdiction of the STB to initiate
rate review process
– Determine the reasonableness of rates
using all three tests
• SAC
• Simplified-SAC
• Three benchmarks
Uniform Railroad Costing System
URCS
• Adopted in 1989 after years of development
• Replaced Rail Form A which was introduced in
1939.
• It is the STB’s general costing program
• Used by STB to compute “variable cost” (VC)
of a shipment
URCS Modeling Process
• Three phases of URCS modeling procedure:
– 1. Compiles massive amounts of raw data collected
from the carriers, the American Association of
Railroads (ARR), the Waybill Data Sample, and special
studies. The data are audited and costs components
are allocated to 15 different activity groups, which are
linked to output and capacity variables through linear
regressions
– 2. Transform the URCS master file cost data using
regression results into unit costs
– 3. Generates variable cost for shipment, based on
“relatively” modest user inputs (commodity, railroad,
number and types of cars, and length of haul).
URCS Modeling Process
• Activity groups are defined in terms of similarities
of costs, judgements and generally accepted
accounting practices.
• The calculation of URCS “variable costs”
– Rhodes and Westbook (1986): “… shipment variable
costs are weighted averages of total costs from
individual cost categories that comport with cost
categories defined in railroad accounting practices.”
– The weights used to compute VC are proportional to
the variability ratios of each activity
• Variability ratio = Fraction of total costs that activity-level
regression predicts are “variable”
URCS Properties
• No reason to expect that this VC has any relationship to
the incremental cost of the rail movement (cost caused
by movement) in the sense defined by Panzer (1989)
– IC(qj|Q-j) = C(qj,Q-j) – C(0.Q-j),
• Q-j is the (J-1)-dimensional vector of tonnages associated with the
other J-1 movements by the railroad
• C(qj*,Q-j*) is total cost of railroad producing the J-dimensional
output vector (qj*,Q-j*’)’.
• Note: A profit-maximizing railroad would not price
below average incremental cost of providing shipment
– Doing so would imply a reduction in railroad’s profits
URCS Properties
• Christensen Associates (2009) found
– 22 percent of ton-miles have R/VC values less than 100
(2000-2001)
– 29 percent of ton-miles have R/VC values less than 100
(2005-6)
• Findings are not surprising given that URCS shipment
VCs are based on arbitrary accounting-based cost
allocation methodology
– Different allocated cost methodologies would yield
different frequencies of violation of this “rational pricing”
constraint
– Different cost allocation methodologies will produce
different sets of shipments violating R/VC > 180 test
Other Properties of URCS
• URCS methodology does not account for any input
substitution in production in response to changes in level of
output
• URCS costs are based on linear relationship between
activity-level measures of cost and output
– Greatly simplifies, but is likely to be inconsistent with how rail
costs are actually incurred (Griliches, 1988)
• Activity-level relationship approach to cost allocation does
not allow for economies density in providing rail service
• Christensen Associates (2009) also found that R/VC
relationships are only weakly correlated with measures of
competition they construct.
Other Properties of URCS
• URCS uses information for special studies
conducted in the 1930s
• Some of the activity-level cost/output
relationships did not produce sensible regression
results and were assigned an ad hoc default
variability ratio
• Conclusion—URCS measure of “variable cost” of
shipment based on arbitrary cost allocation rules
that are likely to be unrelated to causally related
costs of shipment that determine shipment price
Profit-Maximizing Pricing
• Profit-maximizing multi-product firm (railroad) serving independent
demands sets prices for each of J (j=1,2,…,J) goods (shipments) to
satisfy
–
–
–
–
(P(j) – MC(j))/P(j) = -1/η(j)
P(j) is price of jth good (shipment)
MC(j) = ∂C(qj,Q-j)/∂qj is marginal cost of jth good (shipment)
η(j) is own-price elasticity of demand for jth good (depends on
competition railroad faces from competitors for jth shipment)
• Implications of profit-maximizing pricing
– Prices can differ across shipments for same origin and destination pair,
depending on differences in marginal costs and demand elasticities for
shipments
– Markups, (P(j) – MC(j))/P(j), can differ across shipments for same
origin and destination pairs depending on elasticity of demand for
shipment
The Usefulness of Cost Information
• Large portions of total cost of railroad do not vary
with tonnages or even its composition
– Railroads therefore must price above average
incremental costs on most if not all shipments to
recover total costs
• Even perfect estimate of railroad cost function,
C(qj,Q-j), would not solve the problem of what
constitutes an unreasonable rate for shipper
– Just changes problem from setting “minimal excessive
price” to that of setting “minimal excessive markup”
Challenge of Setting Maximum Markups
• Setting a single maximum markup for all
shipments would likely produce significant
shipper and railroad welfare losses
– Total welfare maximizing prices subject to zero
economic profit constraint (Ramsey Prices) set
markups inversely related to demand elasticities
(similar to profit-maximizing firm)
– (P(j) – MC(j))/P(j) = -λ/η(j) where 0< λ< 1
• This logic argues for focusing regulatory process
on setting maximum price for shipments, based
on shipment characteristics, rather than
maximum markup for shipment
Should STB Collect Cost Information?
• Strong reasons to discontinue to use of URCS to
determine excessive prices and set regulated prices
• STB still needs railroad cost and output data to meet
other aspects of its regulatory mandate
– Re-focus data collection efforts to serve these goals
• Areas where cost data is needed
–
–
–
–
Service quality regulation
Infrastructure adequacy
Operating and maintenance adequacy
Safety effort and expenditure adequacy
• Cost and output data can be used to benchmark
railroads to enhance ability of STB to achieve these
regulatory mandates
Conclusions
• URCS “variable costs” are the result of an arbitrary cost
allocation mechanism that bears little relation to cost
constructs that determine pricing decisions of profitmaximizing railroad
• Estimates of railroad cost function only changes
regulatory challenge from setting maximum price to
setting maximum markup over “economically relevant”
measure of cost (marginal cost) of shipment
• Focusing on setting maximum price avoids needs to
perform massively complex task of estimating railroad’s
cost function
• Cost data collection process should be streamlined to
focus on where cost data is needed to meet STB’s
regulatory mandate
Questions/Comments?