3.3 – Transport Costs

Authors: Dr. Jean-Paul Rodrigue and Dr. Theo Notteboom

Transport costs are a monetary measure of what the transport provider must pay to produce transportation services.

1. Transport Costs and Rates

Transport systems face requirements to increase their capacity and reduce mobility costs, an objective that has seen continuous improvements in the last century. Users, such as individuals, corporations, institutions, or governments, must negotiate or bid for the mobility of passengers and freight. Capacity, distribution systems, tariffs, wages, locations, marketing, as well as fuel costs vary across geographies and in time. There are also costs involved in gathering information, negotiating, and enforcing contracts and transactions, often referred to as the cost of doing business. Trade also involves transaction costs, including customs duties, insurance and currency exchange, that all agents attempt to reduce since transaction costs account for a share of the resources consumed by the economy.

Frequently, corporations and individuals must decide how to route passengers or freight through the transport system. For passengers, this choice has been considerably expanded in the context of rising incomes and the availability of modes. For freight, the production of light and high-value consumer goods, such as electronics, and less bulky production techniques have expanded the locational choice of production and distribution. It is not uncommon for transport costs to account for 10% of the total cost of a product. This share also roughly applies to personal mobility, where households spend about 10% of their income on transportation, including automobile ownership, which has a complex cost structure. Thus, choosing a transportation mode to route passengers and freight between origins and destinations is an important decision, which depends on several factors such as the nature of the goods, the available infrastructures, origins and destinations, technology, and their respective distances. Jointly, they define transportation costs.

Transport costs are the costs internally assumed by the providers of transport services. They come as fixed (infrastructure) and variable (operating) costs, depending on conditions related to geography, infrastructure, administrative barriers, energy, and how passengers and freight are carried. Three major components, related to transactions, shipments, and the friction of distance, impact transport costs.

Transport costs have significant impacts on the structure of economic activities as well as on international trade. Empirical evidence underlines that raising transport costs by 10% reduces trade volumes by more than 20%. The general quality of transport infrastructure can account for half of the variation in transport costs. In a competitive environment where transportation is a service that can be bid on, transport costs are influenced by the respective rates of transport companies, the portion of the transport costs charged to users.

Rates are the price of transportation services paid by their users. They are the negotiated monetary cost of moving a passenger or a unit of freight between a specific origin and destination. Rates are often visible to the consumers since transport service providers must provide this information to secure transactions. They may not necessarily express the real transport costs.

The difference between costs and rates for the service provider results in a loss or a profit. Rate-setting is a complex undertaking subject to constant change concerning the components defining transport costs. For public transit, rates are often fixed, and the outcome of a political decision where a share of the total costs is subsidized. Rate increases can be subject to the approval of the regulatory agency. The goal is to provide affordable mobility to the largest possible segment of the population, even if this implies a recurring deficit (public transit systems rarely make any profit). It is thus common for public transit systems to have rates that are lower than costs and targeted at subsidizing the mobility of social groups such as students, the elderly, or people receiving public assistance.

For freight transportation and many forms of passenger transportation (e.g. air transportation), rates are subject to competitive pressure. This means that the rate will be adjusted according to the complex interactions between supply and demand. They either reflect costs directly involved with shipping (cost-of-service) or are determined by the value of the commodity (value-of-service). Since many actors involved in freight transportation are private, rates vary significantly, but profitability is paramount, as transportation service providers cannot remain in service otherwise.

2. Components of the Transport Market

Transportation offers a spectrum of costs and service levels, which results in substantial differences across the world. The cost of a transport service includes the direct out-of-the-pocket money costs to the user, time costs, and costs related to possible inefficiencies and risk (e.g. unexpected delays). However, economic actors often base their choice of transport mode or route on only part of the total transport cost. For example, motorists are biased by short-run marginal costs. They might narrow down the price of a specific trip by car to fuel costs only, thereby excluding costs such as tolls, depreciation, insurance, and vehicle tax.

Many shippers or freight forwarders are primarily guided by direct monetary costs when considering the cost factor in the modal choice. The narrow focus on direct money costs is, to some extent, attributable to the fact that time costs and costs related to possible inefficiencies are harder to calculate and often can only be fully assessed after the cargo has arrived. There are significant conditions affecting transport costs and thus transport rates.

a. Distance and time

The impacts of geography mainly involve distance and accessibility. Distance is commonly the most basic condition affecting transport costs. The more it is difficult to trade space for a cost, the more the friction of distance is important. It can be expressed in terms of length, time, economic costs, or the amount of energy used. It varies significantly according to the type of transportation mode involved and the efficiency of specific transport routes. Landlocked countries tend to have higher transport costs, often twice as much, as they do not have direct access to maritime transportation. The impact of geography on the cost structure can be expanded to include several rate zones, such as one for local, another for the nation, and another for exports.

The transport time component is also an important consideration as it is associated with the service factor of transportation. They include the transport time, the order time, the timing, the punctuality, and the frequency. For instance, a maritime shipping company may offer a container transport service between several North American and Pacific Asian ports. It may take 12 days to service two ports across the Pacific (transport time), and a port call is done every two days (frequency). To secure a slot on a ship, a freight forwarder must call at least five days in advance (order time). For a specific port terminal, a ship arrives at 8 AM and leaves at 5 PM (timing), with the average delay being six hours (punctuality).

b. Type of product

The mobility of freight is cargo-dependent. Many bulky or perishable products require packaging and special handling. Coal is a commodity that is easier to transport than fruits or fresh flowers as it requires rudimentary storage facilities and can be transshipped using rudimentary equipment. Insurance costs are also considered and are commonly a function of the value to weight ratio and the risk associated with the movement. As such, different economic sectors incur different transport costs as they each have their own transport intensity. With containerization, the type of product plays a limited role in the transport cost since rates are set per container, but products still need to be loaded or unloaded from the container.

For passengers, comfort and amenities must be provided, especially if long-distance travel is involved. These amenities have a cost but can also be a source of revenue, such as for retail and restoration. Product differentiation takes the form of a segmentation of amenities and levels of comfort during travel. For instance, air travel is often segmented, in its simplest form, into business and economy classes.

c. Economies of scale and energy

The larger the quantities transported, the lower the unit transport cost. Economies of scale or the possibilities to apply them are particularly suitable for bulk commodities such as energy (coal, oil), minerals, and grains if they are transported in large quantities. A similar trend applies to container shipping, with larger containerships involving lower unit costs. For the transportation of passengers, economies of scale are salient for public transit systems. However, they are limited by the demand as the maximum-sized transport unit that can be assigned on a route cannot exceed the available demand without impairing its profitability.

Transport activities are large consumers of energy, especially oil. About 60% of all global oil consumption is attributed to transport activities. Transport typically accounts for about 25% of all the energy consumption of an economy. The costs of several energy-intensive transport modes, such as maritime and air transport, are particularly susceptible to fluctuations in energy prices since energy accounts to close to half their operating costs.

d. Empty backhauls

Many transport interactions involve empty backhauls since it is uncommon to have a perfect match between an inbound and a return trip. Commuting patterns involve imbalanced flows and empty return trips. For international trade, imbalances between imports and exports impact transport costs. This is especially the case for container transportation since trade imbalances imply the repositioning of empty containers that must be considered in the total transport costs. Consequently, if a trade balance is strongly negative (more imports than exports), transport costs for imports tend to be higher than for exports. Significant transport rate imbalances have emerged along major trade routes. The same condition applies at the national and local levels, where freight flows are often unidirectional (e.g. from a port terminal to a distribution center), implying empty backhaul movements.

e. Infrastructures and modes

The efficiency and capacity of transport modes and terminals directly impact transport costs. Poor infrastructures imply higher transport costs, delays, and adverse economic consequences. More developed transport systems tend to have lower transport costs since they are more reliable, connected, and can handle more movements.

Different transport costs characterize different modes since each has its own capacity limitations and operational conditions. A core aspect concerns the suitability of modes according to the distance involved and the nature of what is being carried. When two or more modes are directly competing for the same market, the outcome often results in lower transport costs and the development of niches. Containerized transportation significantly reduced freight transport rates worldwide by allowing relatively small transport units (containers) to be carried in massified loads.

f. Competition, regulation, and subsidies

Transportation involves a complex competitive and regulatory environment. Transport services taking place over highly competitive segments tend to be of lower cost than in segments with limited competition (oligopoly or monopoly). International competition has favored concentration in many segments of the transport industry, namely maritime and air modes. Regulations, such as tariffs, cabotage laws, labor, security, and safety impose additional transport costs, particularly in developing economies.

If the infrastructure is expensive to develop and maintain, this cost should be reflected in fares to cover the amortization of the asset. Publicly available roads are a form of cross-subsidy since they offer their users free infrastructure. Still, freedom of access can be misleading as sales and fuel taxes are paid by users and these funds are used for road infrastructure construction and maintenance. If a government or a corporation uses other sectors of its activities to subsidize the full costs of transport infrastructure, then this cross-subsidy is having an impact on its costs. Taxes and tolls are commonly used to cross-subsidize public transit.

g. Surcharges, taxes and tolls

Surcharges refer to an array of fees, often set in an arbitrary fashion, to reflect temporary conditions that may impact the costs assumed by the transporter. They also take place when fares are regulated, leaving the operator to find alternative sources of revenue. Fuel surcharges, security fees, geopolitical risk premiums, and additional baggage fees are most common. The passenger transport industry, particularly airlines, has become dependent on a wide array of surcharges as a source of revenue for operators. Yield management is another form of surcharge where a transport service provider changes its rate according to fluctuations in demand.

Transport activities are often taxed, such as vehicle sales taxes and registration fees. Fuel taxes are the most significant form of taxation levied by governments, with revenues often used to cover maintenance and infrastructure investment costs. Tolls are also commonly levied on the usage of transportation assets, particularly at bottlenecks such as bridges and tunnels.

3. Types of Transport Costs

Mobility is influenced by transport costs. Empirical evidence for passenger vehicle use underlines the relationship between annual vehicle mileage and fuel costs, implying the higher fuel costs are, the lower the mileage. At the international level, the doubling of transport costs can reduce trade flows by more than 80%. The more affordable mobility is, the more frequent the movements and the more likely they will take place over longer distances. Empirical evidence also underlines that transport costs tend to be higher in the early or final stages of a movement, also known as the first and the last mile. A wide variety of transport costs can be considered.

Terminal costs. Costs that are related to loading, transshipment, and unloading. Two major terminal costs can be considered; loading and unloading at the origin and destination, which are unavoidable, and intermediate (transshipment) costs that can be avoided. For complex transport terminals, such as ports and airports, terminal costs can involve various components, including docking/gate fees, handling charges, and pilotage/traffic control fees.

Linehaul costs. Costs that are a function of the distance over which a unit of freight or passenger is carried. Weight is also a cost function when freight is involved. They include labor and fuel and commonly exclude transshipment costs.

Capital costs. Costs applying to the physical assets of transportation, mainly infrastructures, terminals, and vehicles. They include the purchase or major enhancement of fixed assets, which can often be a one-time event that can be amortized over several decades. Since physical assets tend to depreciate over time, capital investments are required on a regular basis for maintenance.

Transport providers make various decisions based on their cost structure, a function of all the above transport costs. This involves the transmission of information that takes the form of documents and terms for transactions involving the transportation of passengers and goods. Specific commercial transportation terms have been set to simplify transactions and identify the respective responsibilities. While the transport rate plays an important role in the modal choice, firms using freight transport services are not always motivated by cost minimization. They often show “satisfying behavior” whereby the transport costs need to be below a certain threshold combined with specific requirements regarding reliability, frequency, and other service attributes. Such complexities make it more difficult to assess the role of transport rates in the behavior of transport users, particularly for supply chains where transport costs are a small share of the market value of the end product.

The role of transport companies has increased in the general context of global commercial geography. Maritime shipping companies, air carriers, and logistics service providers have become multinational corporations. However, the nature of this role is changing due to a general reduction of transport costs but growing infrastructure costs, mainly due to greater flows and competition for land. Each transport sector must consider variations in the importance of different transport costs. While operating costs are high for air transport, terminal costs are significant for maritime transport. Several indexes, such as the Baltic Dry Index, have been developed to convey a pricing mechanism useful for planning and decision making, particularly concerning future expectations. Relations between terminal operators and carriers have thus become crucial, notably in containerized traffic. They are needed to overcome the physical and time constraints of transshipment, notably at ports.

Technological improvements and their associated decline in transport costs have weakened the links between transport modes, terminals, and economic activities. With lower transportation costs, there is more locational flexibility as long as transportation networks remain accessible. There is less emphasis on heavy industries and more importance given to manufacturing and transport services such as warehousing and distribution. Indeed, new functions are being grafted to transport activities facilitating logistics and manufacturing processes. The standard notion of transportation costs is being expanded towards logistics costs, which are more extensive to include inventory carrying costs as well as the combination of modes necessary for a complex movement to occur.

The requirements of international trade gave rise to the development of specialized and intermediary firms providing transport services. These are firms that do not physically transport the goods but are required to facilitate the grouping, storage, and handling of freight, as well as the complex paperwork and financial and legal transactions involved in international trade. Examples include freight forwarders, customs brokers, warehousing, insurance agents, and financial institutions. Recently, there has been a trend to consolidate these different intermediate functions. A growing proportion of global trade is now being organized by multi-national corporations that are offering door-to-door logistics services. They are defined as third-party logistics providers.


Related Topics

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