How Railroads Price

Railroads will tell you they “price to the market.” But, whose market is it, yours or theirs?

The Revenue-to-Variable Cost Ratio (RVC) is an important metric for understanding how the railroads compare any given rate to another, and consequently how they price. The RVC is simply the rail rate divided by the railroad’s operating cost.

In the example below, the total rail revenue (rate plus fuel surcharge) is $7,856 and the railroads operating cost is $4,043. This means the railroads have a combined margin of $3,812 with a RVC of 1.94.

Rail freight cost showing RVC

 

How many times have you questioned how reasonable a rail rate was? How do you compare the rate for one lane to the rate in another lane? RVCs provide an objective way to benchmark and compare your rates across lanes and carriers.

Of course when setting rates, carriers consider factors other than cost including risk/liability, modal competition, and rail competition. They will estimate what the market will bear and pricing managers often have a desired return for each commodity.

A railroad’s targeted profit level will often be based on what it currently obtains from other similar traffic. For example, if a railroad has existing rates for a given commodity that produce an RVC of 2.0, the carrier is likely to require that same return on a new rate request, especially if new traffic would displace existing business.

The railroads will strive to protect existing operating margins. When negotiating a rate, the railroad will consider how the traffic will affect their entire portfolio. Is it totally new volume, or does it displace other business? Railroads will offer rates ensure that they receive the same or better profit margin than they currently receive. If a carrier is moving a commodity in one lane, and you request a rate for a new lane that would take volume away from their current business, they are likely to quote a rate that is equal or greater than their current margin. This can be viewed as margin-plus pricing. Other factors such as traffic patterns and equipment utilization may also come into play.

Understanding the RVCs that the railroads desire, coupled with an estimate of their cost for any given lane, provides insight into their pricing structure. In an environment where there is a significant amount of confidential contract pricing, it provides a way to evaluate rail rate reasonableness. RSI’s USRail Impact software makes it easy to obtain accurate RVCs based on RSI’s proprietary cost model.

Shipper's Guide to Rail Freight Rates