Costing



Use of Service Costing and Profit Measurement Systems

Service Costing and Profit Measurement Systems (SCPM) provide detailed cost and profitability information for railways service provision. Typically, railways fixed costs are substantial and shared broadly by all traffic groups. So most SCPMs calculate variable costs, and measure service profitability by how much the service contributes to the railway’s fixed costs (e.g., contribution = revenue - variable costs).

Railways use SCPMs to provide information for the following activities:

  • Commercial pricing
  • Prioritizing use of scarce resources
  • Identifying opportunities for cost reduction
  • Investment analysis
The primary purpose of any SCPM system is to support commercial pricing decisions. The general principle of commercial pricing is to maximize profit (the services’ contribution to the railway’s fixed costs), knowing both the costs and the market. This principle is sometimes expressed as “price to the market, not to costs...but price above costs.”



To make the best pricing decisions, railway marketing staff must know both their customers and their competition—whether, for example, a small price reduction is likely to cement existing client loyalty and perhaps lure clients from competitors. The SCPM role is to ensure that marketing staff know the price level that is viable in the face of the railway’s variable costs of providing the service. At prices below variable costs, the railway would lose money.

SCPM system information is used prospectively for pricing and retrospectively for evaluating marketing department staff performance. The system’s costing methodology must be applied consistently for both purposes.

Commercial railways use SCPM systems to allocate scarce resources. For example, during a period of locomotive shortage, a U.S. freight railway used its SCPM system to determine the profitability of each traffic type and prioritized locomotive allocation to trains hauling the most profitable traffic. Similarly, commercial railways use SCPM’s profitability measurement to allocate capacity on crowded railway lines. When capacity is oversubscribed, the railway may increase the contributions required from all traffic. This prices the least profitable traffic off the railway, freeing up capacity for the more profitable traffic.

The SCPM system also provides information for cost reduction by relating railway activities to costs. The system provides a structured view of costs, allowing the railway to benchmark service cost components and identify those that are too high. The SCPM also specifies cost variability, thus identifying costs that are too inflexible, leading to efforts to rectify this. For example, during the 1990s, the U.S. railways transformed most labor costs from fixed to variable, a major effort that required renegotiating crew contracts, modifying train planning, and altering management practices.

Finally, the SCPM provides information for investment analysis by providing baseline (“before investment”) costs to compare with the after-investment scenario. When railways management is considering line upgrades, sales, or closure, they can use data from the SCPM to analyze revenues and costs for all traffic handled on the line segment. If management is considering a new service, they can use SCPM information for projecting costs, based on data from similar services.

To satisfy all these uses, the SCPM system must have the following characteristics:

  • Timely: Data must be available immediately when needed.
  • Accurate: Results depend on accurate underlying data, without which cost calculations will seem unreasonable to users, who will then ignore system results.
  • Specific: The value of the system is providing costs specific to services provided.
  • Unbiased: Users must view the system as impartial since it may be used to evaluate staff performance, allocate resources, and make investment decisions.
  • Multi-dimensional: The system must provide short-, medium-, and long-term costing for decisions with multiple time horizons.
  • Easy and flexible: Being user-friendly will facilitate broad use.


    
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