Ports & Harbors - Publications

     Port pricing in North America often owes more to politics and to artistry than to repeatable scientific logic. Even when the pricing process seems to be carefully thought out. a concentration on internal factors, a neglect of external factors or a tendency to adopt a 'short run' time frame may bring unwanted results. To shed light upon an arena which seems to be constantly in the shadows, we offer in this paper an overview and a guide to effective port pricing practices based on US and Canadian observations.

1. Introduction
     Public port authorities provide services and lease facilities at a range of prices. The application of these prices generates the operating revenues of a Port. Operating revenues are the major income source at virtually every public port authority in North America. Thus, the success or failure of a Port's pricing strategy is a major determinant of a Port's viability.
     When most US public port authorities were initially established, they relied on some form of subsidy (e.g. tax revenue, monetary grants and/or allocations, land grants, general obligation bonding authority) to cover capital and/or operating expenses. Today, some of those subsidies have been eliminated, some have been or are being reduced and many, if not most, of those that remain are under threat of reduction or elimination. This has forced public port authorities to pay close attention to the commercial viability of their operation and to keep a closer rein on the bureaucratic extravagancies sometimes associated with public agencies. An increasing emphasis on the 'business side' also means a much greater reliance on operating revenues and an inclination to price services and facilities to generate a profit or, at least, to break even.
     A major challenge for public port authorities in the 1990s will be to act more like businesses. For some Ports, this means adopting more carefully constructed pricing policies.

2. The environment
     Over the years a number of basic changes have affected the environment for North American Port pricing.
     Port pricing is no longer as effective a means to influence the actions of either carriers or shippers. Items out of the Port's control such as system-wide intermodal considerations, single bill of lading documentation, in-port time for vessels, labour work rules, and carriers' strategic considerations have become high priorities on carrier and shipper agendas. Today the pricing of Port services or facilities is not a high enough priority item on these agendas to influence decisions significantly. The cost of transiting a port represents a rather small fraction of total voyage cost for most long-distance intermodal movements today.
     Port pricing has undergone a series of significant market-driven changes that have altered the way that Ports price their services/facilities. For example, wharfage, dockage and demurrage used to be the major components of a Port's tariff and major revenue sources, but today these have been replaced by terminal rents and time/volume payments. In some ports, wharfage and dockage charges exist primarily as a funding mechanism for terminal leases and other agreements.
     Customer relationships within the Port have changed dramatically. The Port as lessor courts the steamship line as lessee; the commodity shipper is the carrier's customer, not (directly) the Port's customer. Long-term agreements between Port and carrier have replaced the ship-by-ship arrangements at common berth facilities. Long-term agreements have actually limited pricing options and alternatives for many Ports.
     Thus, the last decade has seen changes that have altered very significantly the effect of Port pricing on carrier and shipper decisions, the ways in which Ports relate to their now-redefined customers, the tools that Ports use to price services and facilities, and the options available in Port pricing.

3. The players
     Pricing should not be the sole responsibility of the Port's marketing department, nor the sole responsibility of the accounting department or any other single department or person. Each department, the executive director, and the Board should have some level of input into the Port pricing arena. By involving these players early in the game, conflicts can be recognized and dealt with. The relative weight given to inputs from each department in the ultimate pricing decision depends on a number of internal and external factors.
     At a micro-level, and in the short run, if capacity is not a constraint and the Port has significant excess capacity, it might be very appropriate for the marketing department to exercise a major influence on the pricing of a service or facility. Conversely, if capacity is constrained, input from the marketing department might be less significant. In effect, some very basic conditions of supply and demand should determine the relative strength of the various players in the Port pricing arena.
     At a macro-level, it is virtually impossible for any public port authority to do effective pricing without policy guidelines. The Board must provide leadership by formulating these guidelines and making them pan of the strategic planning process. The process should include the identification of target customers and target business sectors and indicators should be provided for appropriate return on investment (ROI) ra~e levels. Without such guidelines virtually every project or customer is of equal importance, which would force the Board to make all the ultimate pricing decisions. Additionally, without appropriate policy direction from the Board, the executive director and Port staff would be forced to waste time and resources following up every prospect with equal effort. Thus, a clearly articulated pricing strategy is a prerequisite to the success of a public port authority.

4. Pricing strategy
     Port pricing can not be dealt with in isolation, since pricing is a major factor in the implementation of a Port's strategic plan. Pricing must be viewed as one element in a much broader Port management concept. This concept has three elements. The first is the Port's planning and development philosophy and the Port's goals or objectives. The second is the Port's investment criteria and policies. The third is the Port's pricing policies and techniques. These three elements are closely interrelated. Significant change in anyone of these three elements affects the other two elements directly. This means that a Port's pricing approach should be supportive of the Port's overall objectives, be consistent with the Port's development and planning philosophy, and be a logical extension of the Port's investment criteria and policies.
     There are three basic approaches that Ports consider in formulating their pricing policies. The first is a purely economic approach, which argues for marginal cost pricing. The second is a financial approach, which argues for prices to be set to recover fixed and variable costs and provide an adequate rate of return. The third approach is a public enterprise approach which argues for prices to be set to recognize the need for the Port to be a means to foster local development and existing local, regional and/or national economic activities. The third approach usually requires subsidies by taxpayers or other Port customers.
     The economic approach would be used by Ports that are primarily concerned with being self-supporting (breaking even). The financial approach would be used by Ports that want to maximize profit as their main Port goal. The public enterprise approach would be used by Ports that are primarily concerned with maximizing throughput and can afford to subsidize certain operations and functions in order to capture cargo.
     Each of these approaches has its own strengths, but the basic objectives differ. The resolution of this question of objective-recognizing that there may have to be compromises-is the first step toward formulation of a pricing policy that is each Port's foundation for pricing facilities or services rationally.
     Clearly there is no single pricing approach that is accepted and applied uniformly by all Ports. Nor can it be said that there is a 'best approach,' given the diversity in port characteristics, types of ownership, philosophies of management. specific goals, etc. These differences are reflected in the pricing approach or combination of approaches that they use, and, of course, there are always cases of mismanagement and misguided policies!
     There is nothing inherently desirable or undesirable in this diversity and lack of uniformity in pricing. The essential thing for a successful Port pricing policy is that it be supportive of the Port's planning and development philosophy and objectives and the Port's investment policies and criteria. As simple as this may sound. it is one of the most complex challenges for Port managers.

5. Port pricing process
     Before making any pricing decision on new Port business, it is necessary to answer the question: 'Does this piece of business fit into the Port's strategic plan?' If the answer ~ yes, the Port can proceed. If it is no, then the Port must determine if the strategic plan should be changed to accommodate the new prospect or whether the business should be rejected. Unfortunately, many Ports have not felt sufficiently confident of their strategic plan to make a rejection decision when objective analysis calls for it.
     There are three phases in the Port pricing process: the internal examination, the external examination or 'reality check', and the determination.

5.1. Internal examination
     The internal examination is the first phase of the Port pricing process. It provides a valid method of calculating the internal cost-based price or price range. The outcome of the internal investigation phase is a benchmark price.
     The benchmark price is a price that would generate sufficient gross revenue to cover all direct and indirect costs associated with the delivery of a service or facility to the customer.
     There are four elements of the benchmark price formula: historical costs, imputed costs, return on investment, and sensitivity analysis.

(a) direct depreciation expenses on existing facilities and equipment and depreciation or amortization      expenses on facilities and equipment to be constructed or acquired;
(b) direct maintenance expenses for facilities and equipment including amortization of contingency funds;
(c) direct tax and insurance expenses;
(d) direct and indirect terminal operating expenses; and
(e) administrative and general expenses including indirect depreciation, maintenance, taxes and      insurance as well as some share of the Port's general and administrative expenses.

5.1.2. Imputed cost. The second step is the calculation of imputed costs. Imputed costs are unreimbursed and often unrecorded benefits provided by an outside entity (e.g. fire, police, computer, or other services).

5.1.3. Return on investment. The third step involves computation of return on investment (ROI) for both land and facilities and equipment.
     It seems sensible to base these ROI computations on market or replacement value rather than book value, even though establishment of market or replacement value may not be easy for the Port.

5.1.4 Sensitivity analysis. The calculation of historical cost, imputed cost, and return on investment requires that certain assumptions be made about various cost elements. These assumptions take the form of estimates or educated guesses about the applicable amounts or percentages of certain costs and whether or not to include a certain cost item in the benchmark price formula at all.
     Despite the fact that the analyst bases these assumptions on the best available information, these assumptions may lead to understatement or overstatement of costs. Thus, it is important for the analyst to state clearly the critical underlying assumptions used to calculate the cost estimates and to test how sensitive each is to the calculation of the benchmark price.
     The price per unit of cargo or the normal published tariff rate is the benchmark price incorporating historical cost, imputed cost, return on investment, tempered by the sensitivity analysis, less any applicable usage revenue (e.g. dockage, wharfage, storage charges) divided by the throughput volume.
     A major controlling factor in the successful execution of the internal investigation phase of the Port pricing process is the Port's own accounting system. In order to gain the maximum benefit from this first phase a Port must have a fairly sophisticated cost accounting system. The system must be able to identify the various cost computation components (e.g. costs by line of business. function and facility)- For many Ports the absence of or lack of sophistication in the cost accounting segment of their accounting system may make it difficult to establish a benchmark price accurately.

5.2. External examination or reality check
     The first phase of the Port pricing process produces the 'benchmark price', a specific number or numerical range that. if used. would ensure that the Port will cover all direct. and indirect. depreciation and debt service expenses and earn a profit. Ideally the Port would charge the customer the benchmark price and prosper. Since Ports must contend with a real rather than an ideal world the next phase is designed to subject the benchmark price to a series of tests that will determine its applicability and usefulness.
     This series of tests can be called the 'reality check'. Just as the first phase of the Port pricing process concentrates on internal factors (e.g. various actual and anticipated expenses and a target ROI), the second phase concentrates on external factors (e.g. strategic goals and objectives of the Port. some of which may be non-economic. inter-port competition. general business conditions and trends. etc.).
     There are two steps in the 'reality check': consideration and negotiation.

5.2.1. Consideration. This step involves identifying, listing and prioritizing the various elements that might affect the Port's ultimate pricing decision.
     These factors would include at least the following: need to find business to match excess terminal capacity; need to stay abreast of the competition and cultivate/accommodate important customers; need to respond to external economic and political pressures (e.g. regional and national economic and social objectives); need to address growth management impacts (e.g. utility, road, rail, and mass transit concerns) and environmental implications of prospective new business and port growth.
     It is necessary to weigh these elements and prioritize them. Prioritization allows the Port to move into the next step in this phase. negotiation.

5.2.2. Negotiation. This step is the most difficult one for most Ports. It requires that representatives of the Port and potential client meet to discuss the Port's proposed price or the benchmark price modified by the appropriate external factors.
     In any event, the potential customer may reject the initial Port price offered or make a counter offer. At this point, the Port enters negotiation with the customer. The possible tactics and strategies for price negotiation are numerous. and the specific situation will dictate which the Port will employ.
     However, prior to each round of negotiation, the Port should examine the priorities of the various external factors as well as the potential effect that the new price offer may have on the Port's other customers and pricing arrangements. and the Port's overall financial condition.
     Negotiation should be a rational process resulting in a reasonable intersection of interests.

5.3. Determination
     This phase involves approving the negotiated price. Normally, if the Port has a well-articulated pricing policy, the ultimate decision on most prices can be approved at the executive director level.
     However, if the Port lacks such a policy or is faced with a reservation of price approval power on certain or all ultimate price decisions. these decisions may need to be made at the commissioner level.
     If the ultimate pricing decisions will be made by the Commission, it is, of course, necessary that a fonnal staff recommendation and supporting documentation be made available to the members prior to their vote.

5.4. The tariff rate
     There is a general but often incorrect assumption that the rates published in the Port's official tariff apply to all customers. At best, a published tariff rate is the benchmark price, less usage revenues (e.g. preferential berthing charges), divided by estimated throughput. At worst, it is a random number, arrived at without any study of expense data, that appears to be in line with the tariff rates published by competing Ports.
     In fact, published tariff rates are an effective and flexible marketing tool. These rates are often a starting point for the negotiation of a time/volume agreement or of a first or last port of call status agreement. Tariff rates are the starting point for any analyses of profit potential from scale economies or of contracted time/volume effects on expense levels.
     It is extremely important to remember that, if at all possible, any deviation from a published tariff rate should be allowed oni.\' if there is a written agreement between the Port and carrier or'shipper spelling out exactly what guarantees of additional throughput or other considerations are being made to justify such a deviation. Ports must recognize that any deviation from a published tariff rate is a valuable consideration that should be traded but not given away.

6. Conclusions
     Ports need to go beyond their own internal workings and short- term economics before they can perfect their pricing techniques. Ports need to understand among many other things the 'Port vs Port' negotiating tactics employed by some carriers and shippers. In North America, port competition is a fact of life and cannot be ignored. And in many cases, carriers, shippers and other customers of the Port use this competitive situation to their own maximum advantage. Playing one Port against another seems to be a normal negotiating technique. Unfortunately, in many instances, this tactic makes Ports lose sight of their previously-stated goals and objectives. An appreciation of actual costs from the Port pricing decision agenda is obscured by the fear of losing a customer. When this happens, Ports bid blindly in order to get a specific customer and the customer usually gets the services and facilities at a subsidized rate. Is the Port that eventually obtains the business the winner or the loser?
     The process outlined in this paper should facilitate the Port's pricing of both services and facilities. It should help Ports to price in a logical and economically sound manner as part of an overall strategy. It should provide a framework for consideration of both internal and external factors that impinge on the pricing process. Perhaps also it points towards more business-like and less impulsive decision-making.

Acknowledgments
The cooperation and support of the American Association of Port Authorities (AAPA), especially the AAPA's Finance and Commerce Committees, and numerous Canadian and US public port authorities in this Washington Sea Grant-funded research project are gratefully acknowledged.