POLI 100K, Railroads and American Politics: Topic 6, The Nature of Railroad Competition

Price Discrimination By The Railroads

1. Discrimination against types of traffic: Examples
   
   
   1. Value Based Pricing – One of the earliest realizations of railroad managers was that they could not charge a flat ton-mile freight rate. If they did so, the cost of shipping high value added finished goods would be too cheap and the cost of shipping bulk freight would be too expensive. If the rates were too high then lumber, coal, and minerals would not be produced since it would too expensive to ship them. If the rates were too low, then manufacturers of finished goods would be getting a "free" ride. Consequently, detailed categories of freight quickly evolved and value based pricing became the standard.
      
      
   2. Asymmetric Traffic – Traffic on many railroads was asymmetric, more freight was shipped in one direction than the other. Consequently, since some empty cars had to be pulled in one direction, then almost anything at any price to fill those empty cars was profitable. So it could cost less to ship an identical item from city A to city B than from city B to city A. That is:

                  PAB < PBA
      

   3. Volume – Because moving a full as opposed to a partially full car was approximately the same cost, lower rates were charged on carload lots.
      
      
2. Discrimination against Places: It was very common for freight rates to be higher between towns along a railroad’s main line – especially if it was a monopoly provider – than the rates between major cities at the ends of railroad’s main line. For example, freight rates between, say, Greensburg, PA, and Altoona, PA, on the Pennsylvania RR could be higher than rates from Pittsburgh to Philadelphia. It was cheaper to ship oil from Cleveland, OH to New York City than it was to ship oil from Pittsburgh, PA to New York City. Cleveland had multiple rail lines and Pittsburgh only had the PARR (the B&O’s line into Pittsburgh could not handle enough traffic to bother the PARR).
   
   
   
   Given 4 cities, A, B, C, D, in order along a Railroad line, it was often the case that

   
             PAD + PDC  < PAC
   

   1. Oyster Example – Not every case of discrimination against places stemmed from monopoly conditions. A group of oystermen from a town on the Delaware coast went to the railroad (I believe it was the PARR) that had a branch line from Philadelphia to the coastal town and offered the railroad a deal. If the railroad would add an extra freight car to its regularly scheduled train to the coast and back the oystermen would supply enough oysters to fill the car. This would allow the oystermen to get their product to the Philadelphia fish market. The railroad looked at the costs and decided that at $1 per 100 pounds and a full car it would make money so they agreed to provide the car.
      
      
   2. However, the railroad then discovered that the oystermen could only provide a half carload and the railroad was losing money. Rather than end the service, the railroad went to the oystermen in a second Delaware town down the coast from the first town and offered to ship their oysters at $.75 per 100 pounds. It cost about $.25 per 100 pounds to get the oysters from the second town to the first town. The result was that the railroad filled its freight car ½ at $1.00 and ½ at $.75 which allowed it to break even.
      
      
   3. Is this fair? The oystermen who live further away are getting a cheaper freight rate! But any other arrangement would result in the railroad losing money and no oysters being shipped!
      
      
   4. The moral of the story is that the railroads were not necessarily evil, money grubbing, exploiters of local business!
      
      
3. Discrimination against Persons – Rebates and Drawbacks
   
   
   1. Because of the competitive nature of the railroad business, large shippers early on insisted upon, and got, price breaks – rebates – from the railroads. These rebates varied with the number of railroads available to the shipper and the market power of the shipper.
      
      
   2. A good example of this was the Standard Oil. Cleveland, Ohio was served by three railroads – the New York Central, the Erie, and the Pennsylvania. The prevailing rate in 1867 was $.42 a barrel to ship from the Oil Regions in PA to Cleveland where it was refined by the Standard. Henry Flagler, Rockefeller’s capable partner, negotiated a secret rebate of at least $.15 per barrel from the railroads (needless to say, no records survive of these transactions!). Given its volume, this gave the Standard a big competitive advantage.
      
      Henry Flagler (1830 - 1913)
      
      
      Railroads in the Pennsylvania Oil Regions 1865-73
      
      
      
   3. Drawbacks – In some situations shippers were powerful enough to force the railroads to give them drawbacks on competitors. For example, in one instance the Standard Oil got a rebate of $.25 per barrel on the published rate of $.40 so its true cost was $.15 a barrel. It then forced the railroads to charge its competitors the published rate of $.40 and refund $.25 of the $.40 directly to Standard Oil. This was known as a drawback and note that it was a capital transfer from the competitors!
      
      
   4. William H. Vanderbilt admitted to the Hepburn Committee (an investigation by the New York State Senate) in 1879 that all large shippers who applied for special rates normally received them. In the first six months of 1880 the New York Central system granted 6,000 special rates.
      
      William H. Vanderbilt (1821 - 1885)