Arbitrary pricing plagues the industry
Fair and profitable pricing comes down to basic business principles
By Carmen Daecher
EDITORS NOTE: Recent discussions and comments from owner-operators and industry professionals prompted this rerun of an archived column by Carmen Daecher (BUSRide, September 2009) on this seemingly timeless topic.
For years, too many bus and motorcoach operators have practiced underpricing as a means to remain competitive. Such single-minded competitive pricing as a standard operating procedure has plagued the motorcoach industry. This is happening because a great number of coach operators do not fully understand how to price their services. The fair and profitable approach to pricing comes down to some very basic business principles.
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The fixed costs
Successful business owners know the fixed costs — the costs to stay in business even if the company does not produce one dollar in revenue. Fixed costs include employee salaries, principle and interest on loans, rent and leases, property and vehicle payments.
An established budget
Successful business owners operate within an established budget. Whether or not it draws on historical records of all past fixed and variable expenditures, a well-defined budget reveals the most realistic picture of the level of service the company can expect to deliver based on its current size and resources.
The budget holds the company to only the most reasonable expectations as it lays out goals and objectives, such as whether to stabilize the current operation or make plans to expand and grow the business.
The variable costs and asset utilization
Variable costs are the expenses that ultimately produce revenue; i.e., the money expended to put a motorcoach on the road and deliver the service.
Asset utilization monitors the number of days in the year each vehicle is in service. Asset efficiency monitors the number of sold seats or the mileage the vehicle travels in the delivery of service. These principles are the key factors in the profitable management of costs and pricing.
The assessment begins with the break-even level of service; the point at which business revenue is equal to the total costs to deliver the service — zero net income.
Profit does not just happen. An operator must calculate the reasonable profit the business will yield based on the use of the available assets, the fixed and variable costs compared to level of sales and service required to return a plausible net gain. Profits should be reasonable and fair, and allow the business to remain competitive.
To meet the desired profit goal depends on the strategy in place to manage costs and cash flow.
Pricing concerns specific to bus and motorcoach operations include the issue of recording full-time driver salaries as a fixed or variable cost, or whether fuel purchased in bulk is fixed or variable.
The basic unit for variable costs determines realistic and profitable pricing. Operators deal with these costs every day, but too often fail to assess costs strategically as they relate to break-even expenses and profits.
Do the math
The variable cost unit directly influences the established price for service whether it is the price per passenger, per trip or per mile. The unit measure of variable costs and delivered service determine its price.
For example, the cost per unit of service delivery must reflect the cost of fuel per mile of service.
The pricing plan is a matter of utilization and efficiency, and is the same for all other variable costs. To arrive at an equitable service cost, spread the fixed costs over the number of units delivered during the budget cycle.
(Fixed costs per unit + variable costs per unit) + desired profit per unit = service price per unit. $1000 in fixed costs for 1000 variable cost units (i.e. passengers, trips or miles) equals a fixed cost per unit of $1.00.
The breakeven point is critical
The breakeven point is a critical step in a successful pricing strategy. A business cannot cover its fixed costs until earned revenue equals the volume of its delivered service. The higher the fixed costs, the higher the variable costs and the longer it will take to reach a breakeven point before the company can enjoy a profit. Even though the profit model forecasts a certain amount of income based on delivery of service per unit, of an operator cannot expect one dollar of profit until this happens.
Many operators have difficulty understanding that even with lower variable costs, higher fixed costs mean the company has to bring more revenue, perhaps over a longer period of time before the company turns its first dollar of profit.
Cash flow is not profit
Cash flow and profit are not the same— and they are altogether separate from fixed and variable costs.
For example, fuel purchased in bulk is an asset until it is used. But in establishing the price for service and calculating potential revenue, it is better to consider fuel costs associated with operating the vehicle as a variable expense.
Depreciation of equipment is a fixed cost that has more to do with the purchase of an asset than its use. From a pricing point of view, an operator can build both equipment depreciation and future vehicle replacement into the cost structure. However, doing this can drive up the cost and possibly make the operation less competitive.
The more prudent approach is to determine if the current depreciation level will increase with future vehicle purchases.
The winning edge
The advantage goes to the operator who clearly understands all associated costs and prices the delivery of service accordingly. He knows how to structure his costs and uses the most accurate data available to establish a pricing strategy that is both fair to his customers and to the company. This leaves him in a position to be able to respond and adapt to changing market conditions throughout the year.
The financially astute operator also knows to figure in costs associated with running the safest possible organization, which includes all costs involved in risk management, staff training, vehicle maintenance, as well as safety-related equipment and technology. A proper and profitable pricing strategy for a bus and motorcoach operation must never compromise any safety aspect.
The benefit of a detailed pricing model that fully supports a fiscally sound business plan far outweighs any inconveniences. It also helps the prudent operator deliver the safest and most reliable service possible at a profit regardless of what the next guy is charging.
Carmen Daecher, chairman emeritus of the Daecher Consulting Group, Camp Hill, PA, is dean of the UMA/College of Southern Maryland Bus and Motorcoach Academy, La Plata, MD. He holds a Masters of Science degree in Transportation Engineering from Villanova University, Villanova, PA.