Transport Costs

Authors: Dr. Claude Comtois, Dr. Jean-Paul Rodrigue and Dr. Michael Kuby

1. Transport Costs and Rates

Transport systems face requirements to increase their capacity and to reduce the costs of movements. All users (e.g. individuals, enterprises, institutions, governments, etc.) have to negotiate or bid for the transfer of goods, people, information and capital because supplies, distribution systems, tariffs, salaries, locations, marketing techniques as well as fuel costs are changing constantly. There are also costs involved in gathering information, negotiating, and enforcing contracts and transactions, which are often referred as the cost of doing business. Trade involves transactions costs that all agents attempt to reduce since transaction costs account for a growing share of the resources consumed by the economy.

Frequently, enterprises and individuals must take decisions about how to route passengers or freight through the transport system. This choice has been considerably expanded in the context of the production of lighter and high value consuming goods, such as electronics, and less bulky production techniques. It is not uncommon for transport costs to account for 10% of the total cost of a product. Thus, the choice of a transportation mode to route people and freight within origins and destinations becomes important and depends on a number of factors such as the nature of the goods, the available infrastructures, origins and destinations, technology, and particularly their respective distances. Jointly, they define transportation costs.

Transport costs are a monetary measure of what the transport provider must pay to produce transportation services. They come as fixed (infrastructure) and variable (operating) costs, depending on a variety of conditions related to geography, infrastructure, administrative barriers, energy, and on how passengers and freight are carried. Three major components, related to transactions, shipments and the friction of distance, impact on 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%. In a competitive environment where transportation is a service that can be bided 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 providers must provide this information to secure transactions. They may not necessarily express the real transport costs.

The difference between costs and rates either results in a loss or a profit from the service provider. Considering the components of transport costs previously discussed, rate setting is a complex undertaking subject to constant change. For public transit, rates are often fixed and the result of a political decision where a share of the total costs is subsidized by the society. The goal is to provide an 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.  For freight transportation and many forms of passenger transportation (e.g. air transportation) rates are subject to a competitive pressure. This means that the rate will be adjusted according to the demand and the supply. 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 tend to vary, often significantly, but profitability is paramount.

2. Costs and Time Components

Among the most significant conditions affecting transport costs and thus transport rates are:

• Geography. Its impacts 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. The friction of distance can be expressed in terms of length, time, economic costs or the amount of energy used. It varies greatly 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.
• Type of product. Many products require packaging, special handling, are bulky or perishable. Coal is obviously 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 to be 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. For passengers, comfort and amenities must be provided, especially if long distance travel is involved.
• Economies of scale. Another condition affecting transport costs is related to economies of scale or the possibilities to apply them as the larger the quantities transported, the lower the unit cost. Bulk commodities such as energy (coal, oil), minerals and grains are highly suitable to obtain lower unit transport costs if they are transported in large quantities. For instance, moving a barrel of oil over 4,000 km would cost $1 on a 150,000 deadweight tons tanker ship and $3 on a 50,000 deadweight tons tanker ship. A similar trend also applies to container shipping with larger containerships involving lower unit costs.
• Energy. Transport activities are large consumers of energy, especially oil. About 60% of all the global oil consumption is attributed to transport activities. Transport typically account for about 25% of all the energy consumption of an economy. The costs of several energy intensive transport modes, such as air transport, are particularly susceptible to fluctuations in energy prices.
• Trade imbalances. Imbalances between imports and exports have impacts on transport costs. This is especially the case for container transportation since trade imbalances imply the repositioning of empty containers that have to be taken into account 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, implying empty movements.
• Infrastructures. The efficiency and capacity of transport modes and terminals has a direct impact on transport costs. Poor infrastructures imply higher transport costs, delays and negative economic consequences. More developed transport systems tend to have lower transport costs since they are more reliable and can handle more movements.
• Mode. Different modes are characterized by different transport costs, since each has its own capacity limitations and operational conditions. When two or more modes are directly competing for the same market, the outcome often results in lower transport costs.
• Competition and regulation. Concerns the complex competitive and regulatory environment in which transportation takes place. Transport services taking place over highly competitive segments tend to be of lower cost than on 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.

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 shipper may offer a container transport service between a number of 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). In order 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 8AM and leaves at 5PM (timing) with the average delay being two hours (punctuality).

3. Types of Transport Costs

Mobility tends to be 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, 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. A wide variety of transport costs can be considered.

Freight on board (FOB). Is a transport rate where the price of a good is the combination of the factory costs and the shipping costs from the factory to the consumer. In the case of FOB, the consumer pays for the freight transport costs. Consequently, the price of a commodity will vary according to transportation costs and distance.

Costs-Insurance-Freight (CIF). Is a transport rate that considers the price of the good, insurance costs and transport costs. It implies a uniform delivered price for all customers everywhere, with no spatially variable shipping price. The average shipping price is built into the price of a good. The CIF cost structure can be expanded to include several rate zones, such as one for local, another for the nation and another for exports.

Terminal costs. Costs that are related to the 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.

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. Since physical assets tend to depreciate over time, capital investments are required on a regular basis for maintenance.

Transport providers make a variety of decisions based on their cost structure, a function of all the above types of transport costs. The role of transport companies has sensibly increased in the general context of the global commercial geography. However, the nature of this role is changing as a result of 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.

Technological changes and their associated decline in transport costs have weakened the links transport modes and their terminals. There is less emphasis on heavy industries and more importance given to manufacturing and transport services (e.g. warehousing and distribution). Indeed, new functions are being grafted to transport activities that are henceforward facilitating logistics and manufacturing processes. 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.

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 included freight forwarders, customs brokers, warehousing, insurance agents and banking, etc. Recently, there has been a trend to consolidate these different intermediate functions, and a growing proportion of global trade is now being organized by multi-national corporations that are offering door to door logistics services.