Pricing policy of Indian railways

Abstract

Transport is a defacto barometer of economic progress of any nation. With around 1.4 million employees and 1.1 million pensioners, one of the world largest railway networks – over 63,000 kilometers of routes – running approximately 13,000 trains each day, including 9,000 passenger trains, the Indian Railways (IR) transports 2 million tons of freight and some 17 million passengers between 7,000 railway stations each day and can be said to be the lifeline of the country. The IR has its own interesting story in the past decade where it graduated from near bankruptcy in 2001 to US $6 billion annual cash surplus in 2008, counter-intuitively, under populist leader Mr. Lalu Prasad, the then Minister of Railways. All this was done under a populist political mandate that did not allow conventional policy prescriptions – no privatization, no retrenchment and no fare-hike – the finances of Indian Railways as well as the quality of service provided, transformed. In 2001, both operating ratio and revenue to the capital at charge ratio were at their worst positions and as told by the Rakesh Mohan Committee IR was heading towards a bankruptcy, post which it did a ?U? turn becoming the 2nd largest profit making PSU after ONGC. Study of this turnaround story is of huge importance for our project in light of the fact that Railways ?claim? to have not increased the freight and the passenger fares in the last 9 years of operation, i.e. 2001-09. So where did the money come from? Pricing in Indian Railways has always been an issue due to social considerations and as inferred from the budget speech railways play a dual role by taking a social factor too during price considerations. As more than 70% of the passengers are suburban and the second class travelers any hike in price would directly affect them and make the incumbent government unpopular. There were multiple reasons for the turnaround but it can be primarily attributed to the fact that there was no increase in the fares in the passenger and freight segment both of which showed an increase in demand elasticity. IR took note of the increased competition starting 2001. For example, today freight rates are not based on the value of goods but are fixed after taking into account railway‘s competitiveness and elasticity of demand. In our analysis we found that there was a clear rise in upper class demand post 2000, a period where there was no increase in AC fare prior to which there was a high increase (10% to 20%) in fares in all the budgets from 1990 to 1999. Hence, a competitive pricing adopted by the railways with respect to the upper class fares led to capture of the market share. Also, around 2/3rd of the revenue for railways comes from freight. Freight can rightly be said to be the lifeline for railways which is subsidizing the losses incurred in the second class passenger, suburban railway and the essential commodities in the freight segment. Freight cargo transportation jumped to 7.67 percent in 2007 as against 1.4 percent in 2001 and there was a constant growth in the period 2000-2004 followed by a steep growth in the period 2004-09. The incremental loading achieved was about 170 million tons, which exceeded the total incremental loading of the 1990‘s by 120 percent. There has been a huge rise in the freight revenue from the year 2004 onwards which was in turn due to the higher tonnage, a major reason for the same was the decision by the MoR to increase the axle load limits from 6 tons to 10 tons which caused an increase in the capacity and hence the capacity utilization leading to the reduction in cost (due to economies of scale). Other reasons for freight rise were reduced turnaround time and market oriented tariffs schemes. While the first two actions increased IR‘s capacity to move higher volume of goods, the third action — market oriented tariffs and schemes — helped raise the per unit revenue from freight. Indian Railways have also been churning out schemes after schemes in freight over the past 5 years. A whole lot of schemes have been put in place to attract the freight customer, since July 2005. Also, other pricing schemes like mini rakes for the small customer, incentives at terminals like engine on load and construction of sidings, wagon investment scheme etc added to the customer focused strategy for railways. Overall, the turnaround story seems to be quite impressive, but if we see the tenure of Mr. Lalu Yadav it was also a time when the GDP growth was quite high and it could also have been a major contributor to the railway‘s increased revenue. Other critical factors that led to this turn around can be grouped as cost cutting initiatives, revenue raising initiative, change in pricing, rationalization of freight, organizational culture improvement, decentralization in decision making, human resource initiative, product innovation, product differentiation, outsourcing and environmental factors. With respect to pricing we concluded that from 2000-2009 presence of competition in upper class passenger and the road segment led to a competitive pricing being adopted by railways in upper class segment and commodities where earlier there was competition. Also, railways adopted monopolistic pricing in commodities where there was no competition. Hence 2000-2009 was an era where pricing outlook of the railways had an additional economic angle to it, led by price rationalization (of both passenger and freight segment), adoption of innovative dynamic pricing and differential pricing. On analyzing the budgets from 2000-09 we found that though IR claimed to have not increased the fares there were hidden increases which we term as disguised pricing like extension of ?Tatkal‘ scheme to 5 days, up gradation of trains to superfast category, levy of surcharge on congestion, increased demurrage rates, up gradation in classes of commodities. Railway in India plays the dual role of adopting a capitalist and socialist strategy by not increasing the passenger fares but still maintaining its commercial viability by cross subsidization from freight. We further found that cross subsidization of passenger segment losses through freight indirectly affects the common man as was seen that in 70% of the cases freight hike led to an increase in WPI for the following quarter, though the analysis was not conclusive. Also, enough evidences are there to ascertain that there is a lot of political motivation behind actions of almost all Railway Ministers; be it during decentralization (creation of railway zones), set up of new rail coach factory or launch of new trains. Pricing decision which directly affects the common man is no different. On mapping the pricing decision with the election data we found that there was not a single instance in which freight and fare charges were increased when there was a general election scheduled in that year (last budget of the incumbent government). Overall, IR does not follow cost based pricing neither in passenger nor in freight since freight has very high operating margin and passenger pricing most of the times is motivated by social and political reasons thus running at a loss. According to ?OECD Economic surveys: India‘, cross subsidy hampers India‘s industrial development also and there is a scope of freight reduction up to 32%. To recommend a holistic approach for pricing in IR we studied the pricing in US (capitalistic economy), Russia (socialistic approach) and other countries and concluded that the pricing in IR is better than most of countries with measures taken off-late. Also, there were attempts to adopt Ramsay pricing in US which obviously cannot be done for Indian Railways because of socialistic and political considerations. Indian Railways today is facing competition for many quarters; low cost airlines in passenger upper class segment, road transport in passenger lower class, pipelines in petroleum and oil related products, road in cement etc. The pricing policy which IR should adopt should not only be in line with its vision and mission but should also consider customer demand and competition. In view of this report, IR should examine its current portfolio to examine which activities it wants to keep and which ones it wants to spin-off and continue to price its product competitively except in segments where it cannot do so for social and political reasons. Keeping this is mind; some recommendations have been made for pricing policy that IR should adopt. IR is still a monopoly in certain passenger segments (like general for certain distances); however due to social and political constraints their fares cannot be increased. Barring these passenger segments IR should look at adopting a cost related pricing policy. In passenger segment this can be done by having a base price below which the fares cannot go (even for social and political reasons) and clear division of fixed and variable cost. Apart from this, Railways could also implement time-of-day convenience pricing and can look at adopting a dynamic pricing policy for this. Railways can also look at segmenting the passenger market based on various parameters – (1) price/demography (2) distance (3) time of travel (4) comfort of travel. Analyzing the passenger traffic flow based on these parameters would lead to identification of segments where Railways have monopoly or face competition and adopt their pricing policy accordingly. For freight, based on analysis of traffic of data in terms of their origination (port/mines/industry/collection center) and destination (distribution center/port/industry), commodities can be segregated in terms of their demand being inelastic, marginally elastic, relatively elastic and completely elastic. Based on this data, IR can charge monopoly or competitive pricing. In segments where it has to charge competitive pricing, it can also look to work with the client and explore ways to provide customized solution. Indian Railways should remove disguised pricing, as this will hurt it in the long run. Announcing in the Railway Budget that the freight fares for a particular category are unchanged and then adopting disguised pricing is a strategy which might have worked till now but if Indian Railways have to compete and build a sustainable customer base this may not be the right idea. IR can also consider auctioning of vacant seats and berths in passenger trains as well as empty returning freight trains to increase utilization and occupancy rates. The pricing policy of IR was a huge problem which was due to the fact that decisions taken were politically motivated rather than the commercial reasons. Railways needed to develop market oriented and customer friendly outlook due to emerging competition within the transport sector. Today with an increased commercial orientation, aggressive marketing and economy measures, the Railways have been continuously working towards further improving their financial performance. However, the latest budget speech by the new railway minister Mamata Banerjee in 2009 indicates towards increased inclination towards socialistic approach to pricing. If these indications are to go by, we can expect more stress on socialistic policy and less on capitalistic policy in terms of pricing for Railway services.