\ “' l;Ilire %‘ 4 190 9805 _. . . 312 1 himgzu: ‘ J13 Universu'y __—A ‘——.— --= . This is to certify that the thesis entitled AN ECONOMIC ANALYSIS OF A GRAIN LOGISTIC SYSTEM: A MICHIGAurcASE STUDY presented by A." Clyde Vollmers has been accepted towards fulfillment of the requirements for Economics Major professor (:EQS:}7149 Ag ::[j/;ég§3:r/ /// 0-7839 ‘ OVERDUE FINES: ‘LK “-4, 25¢ per day per min ‘\\\“.;I L mumfi LIQRARY MATERIALS: F Place in book return to move change from circulation "cords r ~.J WNW AN ECONOMIC ANALYSIS OF A GRAIN LOGISTIC SYSTEM: A MICHIGAN CASE STUDY BY A. Clyde Vollmers A DISSERTATION Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Agricultural Economics 1980 ABSTRACT AN ECONOMIC ANALYSIS OF A GRAIN LOGISTIC SYSTEM: A MICHIGAN CASE STUDY BY A. Clyde Vollmers This research effort evaluated the impact that alternative organi- zations of the logistics system would have upon the cost of marketing grain for the Thumb region of Michigan. This problem was addressed because of the continuing concern farmers have displayed over the costs of processing and distributing food products. Economic theory suggests that the farmers' concern is well-founded because the supply function is less elastic than the consumer demand function. Thus, farmers incur a larger share of the marketing margin. Because the logistic function is a major component of the marketing margin, any technological or institutional inefficiencies it contains can have a significant impact upon farm income. A mathematical model was used which first simulated the existing organization of the grain flow in this 3500 square mile region. Sub- sequent runs minimized the logistic cost assuming varying institutional and technological parameters. The specific activities that were modeled included: 1) the collection of grain from farms to elevators; 2) processing and handling of the grain by elevator and subterminal; and 3) distribution by rail, water, or truck. The commodities that were examined included corn, wheat, and oats for the 1976 marketing year. A. Clyde Vollmers The cost of marketing the corn, oats, and wheat that were produced in Michigan's Thumb region was estimated to total $19,177,105 or $0.665 per bushel for the 1976 marketing year. This estimate included costs that were imposed upon the distribution activity by the suboptimal organization of: distribution patterns; distributional patterns come pounded by ownership patterns; transshipment patterns; and modal selection. In total, subOptimal organization was estimated to impose a cost of $581,000. Sixty-five car unit train rates requiring eight consecutive train- loads were in effect during the test period.. If these rates were eliminated, while the physical infrastructure remained intact, costs incurred by the Thumb's market channel would increase more than $3.2 million. Twenty of the sixty elevators serving the Thumb region had less than 100,000 bushels of storage capacity and ten of these could store d)(7 50,000 bushels or less. Should the smallest ten elevators exit, the estimated marketing cost would decline $270,952, while the exit of all twenty would reduce costs byuigiingg. After spatial equilibrium has been reestablished, the costs imposed by the abandonment of the individual branch lines serving the Thumb region were estimated to total: C 80's Croswell to Bad Axe Line $179,528 3 C 50's Port Huron to Saginaw Line 66,070 f GTW's Imlay City to Caseville Line 58,567i Entire Tuscola and 21,015i In conjunction with abandonment, institutional and technological changes were evaluated. The introduction of competitive ten-car rates on nearby lines retaining rail service could be used to reduce the A. Clyde Vollmers negative impacts imposed by abandonment on all lines. On two lines, the costs could be virtually eliminated. The model suggested that water rate reductions would have sig- nificant impacts upon the land locked subterminals, and if the reduc- tions are large enough, water movement could replace unit trains. However, competitive strategies make this outcome unlikely. The cost borne by those receiving the largest negative impact could be effectively reduced by institutions designed: 1) to encourage market transactions and collective action among channel participants; and 2) to increase and improve the information available to channel participants. Further, the most effective policy will be directed towards modifying the allocation of impacts considered to be inequitable, rather than modifying the source of the impact. ACKNOWLEDGEMENTS The completion of my graduate program required the assistance and support of many individuals. I am especially indebted to my dissertation committee, Dr. James Shaffer, Dr. Stanley Thompson, Dr. Frank Mossman, both for their guidance during the development of the dissertation and for concepts conveyed in their classrooms. I also appreciated the opportunity to study under other Michigan State University faculty. The financial support provided by the Agricultural Economics Department was invaluable in completing my program. Without the help of Thumb area elevator managers and rail users this research effort would have been impossible and their assistance is greatfully acknowledged. I am eternally thankful to the Lord for this experience and the Christian fellowship He provided to encourage and support me. The greatest cost involved in this research was borne by my wife, Kathy, and our children, Stacy and Michael, and in appreciation for their love and support, I dedicate this dissertation to them. ii TABLE OF CONTENTS AcmOWIJEDGEMENTS O O O O O O O O O O O O O O O O O O 0 LI ST OF TABI‘E S O O O O O O O O O O O O O O O O O O O 0 LIST OF FIGURES O O O O O O O O O O O O O O O O O O O 0 CHAPTER I. III. THE PROBLEM, SCOPE OF THE RESEARCH EFFORT, AND ANALYTICAL FRAMEWORK . . . . . . . . . . . . . . The Problem. . . . . . . . . . . . . . . . . . Scope of the Research Effort . . . . . . . . . Research Objective . . . . . . . . . . . . . Research Approach. . . . . . . . . . . . . . . Mathematical Solutions to Logistics Problems Institutional Approach to Logistics Problems LITERATURE REVIEW. . . . . . . . . . . . . . . . Introduction . . . . . . . . . . . . . . . . . Administrative Procedures Literature . . . . . Abandonment Impact Literature. . . . . . . . . Agricultural Impacts and Adjustments . . . . Rationalization Literature . . . . . . . . . . CHANNEL MEMBER BEHAVIOR. . . . . . . . . . . . . Introduction . . . . . . . . . . . . . . . . . Geographic and Demographic Characteristics . . The Region . . . . . . . . . . . . . . . . . Population and Employment in the Thumb . . . Agricultural Population in the Thumb: The Derived Demand for Transportation Services . . Elevators in the Thumb Region. . . . . . . . . Ownership and Capacity of Thumb Elevators. . The Evolution of Elevator Competition. . . . The Structure of the Elevator Subsector in the Thumb . . . . . . . . . . . . . . . . The Transportation Network . . . . . . . . . . The Rail System. . . . . . . . . . . . . . . Rail Service . . . . . . . . . . . . . . . . Exempt Trucking Subsector. . . . . . . . . . The Water Transport System . . . . . . . . . iii vi viii 45 45 45 45 47 50 52 55 58 63 69 69 76 77 83 CHAPTER The Public Sector. . . . . . . . . . . . A WOrd on Theory . . . . . . . . . . . Policy Impacts and Opportunity Sets. . The Performance of One Agency. . . . . IV. THE MATHEMATICAL MODEL . . . . . . . . . . Development of the Theory. . . . . . . . Location Theory. . . . . . . . . . . . The Early Models . . . . . . . . . . . The Stollsteimer Model . . . . . . . . Modifications of the Stollsteimer Model The Mathematical Model . . . . . . . . . Assumptions. . . . . . . . . . . . . . Data Required for Model. . . . . . . . . Questionnaire. . . . . . . . . . . . . Grain Requiring Logistical Services. . Assembly Costs . . . . . . . . . . . . Grain Processing Costs . . . . . . . . Distribution Costs . . . . . . . . . . V. RESULTS OF THE SIMULATION AND POLICY IMPLICATIONS . . . . . . . . . . . . . . . Introduction . . . . . . . . . . . . . . Model Highlights . . . . . . . . . . . . Model Results. . . . . . . . . . . . . . System Slack . . . . . . . . . . . . . Marketing Costs Before Unit Train Rates Elevator Exit. . . . . . . . . . . . . Rail Line Abandonment. . . . . . . . . Changes in Vessel Rates. . . . . . . . Summary of Simulation Results. . . . . . VI. SUMMARY, CONCLUSIONS, AND RECOMMENDATIONS. Summary. . . . . . . . . . . . . . . . . Problems and Objectives. . . . . . . . Theoretical Framework. . . . . . . . . The Current System . . . . . . . . . . Conclusions. . . . . . . . . . . . . . . Recommendations. . . . . . . . . . . . . General Policy Recommendations . . . . Specific Policy Recommendations. . . Suggested Areas of Additional Research . APPENDIX A Ques tionnaire I O O O O C O O O O O O O O O O 0 iv 87 87 88 90 95 95 95 96 97 98 102 106 107 107 108 114 118 124 129 129 130 131 132 147 149 162 187 194 197 197 197 198 200 201 204 204 208 209 211 APPENDIX B Collection Costs . Introduction . Farm Truck Costs Fixed Costs. Variable Costs APPENDIX C Institutional Factors. Institutional Limitations. "There Ought to Be a Law". Public Provision of Transportation Some Long-Term Economic Impacts. The Rail Abandonment Hearing: An Equipment: Institutionalized Adversary Proceeding . Implication and Institutional Limitation . BIBLIOGRAPHY O 214 214 214 214 217 222 222 222 224 249 260 262 3-1 3-7 LIST OF TABLES Population of Huron, Sanilac, and Tuscola Counties . Distribution of Employment in Huron, Sanilac, and Tuscola Counties, 1970 . . . . . . . . . . . . . Normal Precipitation and Temperature for Flint, MiChigan' 1941-1970. 0 o o o o o o o o o o o o o o 0 Farm Size: Number and Trends, 1974. . . . . . . . . Acres of Planted Crops for 1959 and 1975, Huron, Sanilac,and Tuscola Counties . . . . . . . . . . . . County Rank for Production of Selected Agricultural Products and County Production as a Percentage of MiChigan . 8 Total ' 1975 O O O O O O O O O O O O O O 0 Characteristics of the Elevators in the Thumb Region of Michigan . . . . . . . . . . . . . . . . . Capacity Distribution of Grain Elevators Serving the Thumb Region in Michigan . . . . . . . . . . . . Truck Tariff, Exempt Trucking Rates Utilized in the Thumb Region. . . . . . . . . . . . . . . . . The Existing Cost of Collection, Handling, and Distributing Thumb Area Corn and Wheat, for the 1976 Marketing Year. . . . . . . . . . . . . . . . . Estimated Marketing Costs for Corn, Wheat, and Oats for the 1976 Marketing Year; Existing Distribution Pattern, Elimination of Stock, and Base System. . . . . . . . . . . . . . . . . . . . . Estimated Reduction in Marketing Costs Which Have Resulted from the Introduction of Unit Train Rates and Technology . . . . . . . . . . . . . . . . The Ten and Twenty Smallest Elevators Serving the Michigan Thumb Region. . . . . . . . . . . . . . vi 49 51 51 53 54 56 59 79 133 142 148 153 5-5 5-10 5-11 Impact of Elevator Exit in the Michigan Thumb Region, 1976 Marketing Year C O I O O O O O O O O 0 Thumb Region Elevators Which are Served by the Various Branch Lines . . . . . . . . . . . . . Modification VIII: Increase in Grain Marketing Costs Imposed by the Abandonment of the Croswell- Bad Axe and Kinde-Bad Axe Lines Operated by the C620 Railroad; 1976 Marketing Year . . . . . . . . Modification IX: Increase in Grain Marketing Costs Imposed by the Abandonment of the Port Huron Saginaw Line Operated by the C 80 Railroad; 1976 Marketing Year. . . . . . . . . . . Modification x: Increase in Grain Marketing Costs Imposed by the Abandonment of the Imlay City- Caseville Line Operated by the GTW Railroad; 1976 Marketing Year. . . . . . . . . . . . . . . . Modification XI: Increase in Grain Marketing Costs Imposed by the Abandonment of the Tuscola- Saginaw Bay Railroad; 1976 Marketing Year. . . . . Summary of Abandonment Information: Elevator Characteristics, Abandonment Impacts, and Impact Reduction Resulting from 10-Car Rates and Elevator Exit. . . . . . . . . . . . . . . . . . . Cost of Monthly Rail Car Ownership . . . . . .-. . Surplus and Shortage of the U.S. Rail Car Supply for a Seventy Week Period . . . . . . . . . vii Page 156 168 169 172 174 176 179 233 239 LIST OF FIGURES The Thumb Region of Michigan . . . . . . . . Thumb Area Rail System . . . . . . . . . . . Orange-Lined Thumb Area Branch Lines . . . . Thumb Area Highway Network . . . . . . . . . Schematic Diagram of the Grain Marketing and Transportation Sector of the Mathematical Made 1 O O O O O O O C O O O O O I O O O O O 0 An Example of Suboptimal Transshipment Patterns Created by Ownership Patterns . . . Railroad and Elevator Infrastructure . . . . viii 71 81 105 139 155 CHAPTER I THE PROBLEM, SCOPE OF THE RESEARCH EFFORT, AND ANALYTICAL FRAMEWORK The Problem The grain transportation, handling, and storage system is a vital component of the agricultural production and marketing process. Its efficiency is a primary determinant of the grain prices received by farmers. Stewart estimated the costs of the logistic components for eight economic sectors, one of which was the food and food products industry.1 He found that 8.6 percent of the food industry's net sales revenue was expended for rail and truck transportation and that 23.4 percent was expended for private carriage, public and private storage, material handling, and loading costs. In total, the logistical components comprised approximately one-third of the processor's net sales. Economic theory suggests that, as part of the marketing margin, these costs are allocated between producers and consumers as a function of the slope of the supply and demand curves for the relevant commodities. "An increase in the margin means a decline in derived demand (downward shift) and derived supply (upward shift) with a consequent increase in retail price and decrease in farm 1Wendell M. Stewart, "Physical Distribution: Key to Improved Volume and Profits," Journal of Marketing, from a study by A. T. Kearney and Company, XXIX (January, 1965), pp. 65-70. l 2 price."2 If the supply curve is steeper than the demand curve or if the elasticity of supply is greater than the absolute elasticity of demand, the amount of the price change to the producer will be larger than to the consumer. For most agricultural products, including grains such as corn and wheat, the supply relationship is considered to be more price inelastic than the demand relationship, especially in the short run. Therefore increases or decreases in the cost of providing logistic services will be imposed primarily upon farmers. Changes which are limited in geographic application would likely be borne totally by producers. A localized change leading to increased (or decreased) efficiencies in the marketing process would have little impact upon equilibrium retail prices for products characterized as ubiquitous and having close substitutes. For example, the rational- ization of a logistic system serving a multi-county wheat production region could yield substantial local economies. Yet the production from this region would constitute such an insignificant portion of total production that the equilibrium retail price of wheat products would not change. In this case the net benefit or cost is allocated between the producer and the marketing agent. The allocation is based upon the degree of competition in the marketing sector and the nature of the average cost curve associated with the provision of marketing services. Thus the efficiency of the transportation, handling, and storage systems is one of the major determinants of commodity prices received by farmers. 2 William G. Tomek and Kenneth L. Robinson, Agricultural Product Prices (Ithaca, New York: Cornell University Press, 1972), p. 121. 3 However, concern regarding the agricultural logistic system is not restricted to the producer. Channel members such as supply firms, marketing firms, and carriers, whose livelihood is dependent upon grain production, share the concern regarding the efficiency of the system. The relative efficiency of a local logistics system is a major determinant of the endogenously derived demand for the market services. If a transport system is inefficient, local farmers may be placed at a comparative disadvantage, and in the long-run they will produce a different product mix which will require different marketing services. Not only is this of concern to the existing marketing firm which may be forced to exit, it is also of concern to the potential entrant. Because of the importance of logistic services to their live- lihood, farmers and channel members have displayed considerable concern over the problems encountered in marketing grain. And their concern appears to be well founded as the existing marketing channels seem to be in a constant state of crisis. Branch line abandonment petitions are threatening rail service to some communities while railroad bankruptcies are threatening rail service to entire regions. Because rail cars and trucks are not available for transportation, grain is often stored on the ground. And many rail beds have deteri- orated to the point that modern equipment cannot be used efficiently. Ports embargo grain because they are congested and cannot meet the demand for their service. Many miles of highways are concrete ribbons of chuckholes with seasonal weight restrictions limiting their use. Seasonal freezing restricts use of the St. Lawrence Seaway during the winter months, and technical obsolescence restricts 4 the size of vessels which can navigate it. The elevator industry is reorganizing, and smaller facilities are incurring increasing com- petitive pressures. Governmental units are being asked to stretch already strained budgets to provide financial assistance for various transportation and storage functions. Many solutions have been proposed to resolve these problems and to insure that the agricultural sector will be serviced by an effective and efficient grain transportation, handling, and storage system in the future. While many of the solutions advocated reflect the economic interest of the advocate, most solutions also recognize the need to transform the existing system into one which is economi- cally sound. The process of analyzing the marketing system and the demand for its services in an effort to reduce costs through reorgan- ization is called system rationalization. Rationalization has been defined by one author: to rationalize meant to wipe out the elements of chaos in competition, to strengthen the whole by putting its parts in more equitable relation, to correlate the facilities and the opera- tions to the demands upon them, and to stabilize the finances of the industry. For the purpose of the study, rationalization of the grain transportation and handling system is concerned with grain col- lection handling, and distribution of functions which are physically interlinked, the objective being to modify, if neces- sary, each of these links thus contributing to the efficiency of the system as a whole.3 One of the basic problems may be that rationalization is evolving naturally and many of the crises are simply the visible 3Robert J. Tosterud, "A Simulation Model for Rationalizing the Grain Transportation and Handling System in Western Canada: A Regional Basis," (unpublished Ph.D. dissertation, Winnipeg: Univers- ity of Manitoba, 1973). P. 4. 5 symptoms of an unorganized and uncoordinated process. In part, some of the problems, such as rail line abandonments, reflect the changing cost structure of the various modes and the resulting change in com- parative advantages. Further, technical evolution has little regard (for individuals or firms and many are not prepared to respond to technological changes. Furthermore, farmers and elevators adjust to change at different rates, and often a problem develops because of these differences. An institution may be preserved not because it is economically efficient, but because some firms are not ready to change. The rail car shortage, in part, is an example of this. Several studies have indicated that rail car utilization could be improved significantly, but the design of public policy maintains the existing level of utilization level. Thus this institutional design imposes %// costs upon early adopters of technology. The alternative design, however, also imposes costs, but upon different members of the market- ing channel. The atomistic structure, which is characteristic of the grain production and marketing subsector,compound the grain marketing prob- lems because each firm maximizes its return regardless of the impacts upon the total system. And one of the basic foundations of logistical theory is that optimizing the parts of a system rarely yields an optimal system. Thus the problem addressed in rationalizing transportation, storage, and handling systems has two focuses: efficiently organizing and coordinating the modes and links of the physical system, and effectively designing and implementing institutions and public policy to control and modify the flow of grain through the channel members. 6 Scope of the Research Effort The changes occurring within the agricultural marketing process have important economic consequences for the agricultural sector, public officials and the economy in general. Therefore the efficiency of the system which evolves deserves careful consideration. Of particular concern to Michigan officials are the marketing channels in the Thumb region. This 3,500 square mile region is a major agricultural production area for both grain and livestock. Much of the grain goes to New England or into export channels and thus requires efficient transportation handling and storage. But the system is not efficient! The highways serving the Thumb are inade- quate, the bulk of the rail system has been classified as potentially excess, and the water system is technologically obsolete. And because both Michigan and the Thumb itself are‘peninsulas, the transportation system must be self-sustaining because no bridge traffic is available to support it. Much of the elevator system within the Thumb is also obsolete as over half of the 60 elevators serving the Thumb have 200,000 bushels of storage capacity or less, and over a third have 100,000 or less. Michigan officials have expressed considerable interest in the Thumb region. Currently some of the rail lines are receiving sub- sidies and additional lines may in the future. Maintenance work is being conducted and improvements are being made in the highway system and in the port of Saginaw. Only intramodal planning is occurring, however. To solve the continuing crisis which impedes the orderly marketing of grain in the Thumb region, a coordinated multimodal rationalization approach will prove most effective in the long run. 7 Research Objective The objective of this research is to analyze current adjust- ment problems and opportunities in distribution channels as an aid to public and private policy makers and planners. To support this primary goal, several subordinate objectives were pursued including: 1) analysis and description of current practices and atti- tudes among the various members of the grain marketing channel and of the various institutional incentives which modify their behavior. 2) estimation of the impact of various changes in the grain distribution channels through the use of a systems rationalization model. The impacts which will be evaluated include: (a) abandonment of particular rail lines,(b) investment and disinvestment in infra- structure, and (c) the application of intermodel and multimodel systems. 3) preparation of an assessment of the economic consequences of alternative logistics system organizations for use in policy and planning activities of the state, local governments, and firms affected by changes in the distribution channels. Research Approach This research effort employed a mathematical model to visual- ize and rationalize the grain transportation handling and storage systems. The approach identified the costs imposed through alterna- tive combinations of resources as an optimal distribution system is approached. (However, many political and economic forces interact to restrain the adoption of an optimal system. Therefore, institutional economic theory is utilized to identify and describe the behavior of 8 channel members which constrains the implementation of the mathemat- ical results. This addendum to the mathematical results is employed to provide a more practical and useful output, which is intended to facilitate the decision process. Mathematical Solutions to Logistics Problems The use of the mathematical modeling approach to solve trans- portation, handling, and storage problems is a recent development which has evolved into the discipline of logistics. As recently as 1962, logistics was called the "economy's dark continent."4 The first textbook dealing with the subject was published in 1961.5 While the individual functions performed by the logistics channels have long been recognized, their integration into a special- ized field has occurred only since World War II. The impetus came from the development of the computer, which allowed rapid solutions for complex mathematical problems, and from the military's need to strategically equip and supply troops. The discipline of logistics has been defined by various authors. One has stated it is specifically concerned with the flow of goods through the economic system.6 Another has identified logistics as 4Peter Drucker, "The Economy's Dark Continent," Fortune, Vol. 72 (April 1962), p. 103. 5Edward W. Smykay, Donald J. Bowersox, and Frank H. Mossman, Physical Distribution Management: Logistics Problems of the Firm (New York: The Macmillan Company, 1961). 6Ronald H. Ballou, Business Logistics Management (Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1973), p. 7. 9 the process of managing all activities required to strategi- cally move raw material, parts and finished inventory from vendors, between enterprise facilities and to customers.7 A third definition is the management of all activities which facilitate product movement and the coordination of supply and demand in the creation of time and place utility in goods. Because of the recent development of managerial logistics, the functions which are included in the discipline are not universally agreed upon. Most authors, however, include facility location, trans- portation, inventory or storage, material movement or handling and communication. The applicability of the systems theory to understand logis- tic systems was discussed by Hazard: Systems theory provides a logical point of departure for understanding transportation systems. A system may be defined as a number of different elements, united by connections and functioning as a whole. There is an infinite variety of systems in nature and society. Those constructed by men are referred to as purposeful systems and the clearer the purpose, the easier it is to measure performance. Transportation, communications, and power systems are almost ideal subjects for they have clearly defined purposes and measurable performances. Generally such systems are geared to optimize certain parameters such as cost, efficiency, speed and reliability.9 And the potential contribution of the systems approach to solve agricultural logistic problems was discussed by Tosterud: Some of the more obvious potential contributions of the systems approach to the grain transportation rationalization 7Donald J. Bowersox, Logistics Management, 2nd Ed. (New York: The Macmillan Co., 1978), p. 3. 8James L. Heskett, Nicholas A. Glaskowsky, Jr. and Robert M. Ivie, Business Logistics, 2nd Ed. (New York: The Roland Press, 1973), p. 25. 9John L. Hazard, Transportation: Management, Economics, Policy (Cambridge, MD., Cornell Maritime Press, 1977), p. 66. 10 include: (1) a co-ordinated and objective treatment of the many and diverse facets of the problem, (2) the means of locating and identifying bottlenecks in the flow of grain from the farm to export and domestic markets, (3) induced or simulated changes of either a technical or policy nature which may be in one trans- portation component or sub-system and their resultant effects on other stages and the general performance of the entire system measured, and (4) the means of identifying existing policy con- flicts which may be used as an aid in formulating a general policy of grain transportation.10 Institutional Approach to Logistics Problems As the grain handling and transportation system is rational- ized, public officials will be required to make various policy deci- sions. These decisions will be necessary whether rationalization occurs through unplanned evolution or through a planning process. Economists often decry this decision process because many decisions seemingly exclude economic input. And public officials often decry the information provided by economists because it is of limited use- fulness in the policy decision process. This section develops a framework to bridge this gulf after identifying and developing the interdependency of economic actors. This section and chapter concludes with a discussion of the nature of goods and the resulting behavior performance. For a more extensive development of the analytical framework k'n utilized here, see the work of Patric who applied the same loTosterud, p. 11. 11John Michael Patrick, "An Economic Analysis of Improving the Viability of Rail Lines," Unpublished Ph.D. Dissertation, Depart- ment of Agricultural Economics, Michigan State University, East Lansing, Michigan, 1977. 11 framework to the transportation sector, and Favero,12 who studied the electric power sector. Scarcity and independence Property rights Economics assumes resource scarcity, and hence that conflict exists among people living in community. Communities normally estab- lish rules to organize and control both the use of their available resources and other types of interaction. These rules of the game or property rights "are the instrumentality by which any society controls and orders human interdependence and resolves the question of who gets what."13 These rules define, describe, and delimit the ability of individuals or groups to restrict or exclude the use of their property by others. The freedoms and prOperty rights which identify the range of choices available to a group or individual are their opportunity sets. One author has stated: An opportunity set of an individual is composed of physical and emotional capacities plus legal or customary understandings of potential options that are conditioned by the actual choices of others. Power is a function of rights and personal character- istics as well as the choices of others. Thus the opportunity set of an individual is composed of alternative lines of action that are open because of the relative structure of rights as well as the relative capacity of the person to make use of the rights.14 Opportunity sets also reflect the interdependency of human actors in that they are reciprocal in nature: "One person's freedom 12Philip Favero, "The Process of Collective Action: Small Electric Companies in Michigan," Unpublished Ph.D. Dissertation, Department of Agricultural Economics, Michigan.State University, East Lansing, Michigan, 1977. 13A. Allen Schmid, Property, Power, and Public Choice: An Inquiry into Law and Economics, Praeger Publishers, New York, NY, 1978, p. 5. 14Ibid., p. 7. 12 is another's limitation."15 This interdependency of human actors imposes either positive or negative results or externalities upon their Opportunity sets. Externalities Three types of externalities have been identified: techno- logical, pecuniary, and political. Technological externalities exist when the production or consumption of one individual, firm, or group of firms depends upon the production or consumption of others. Also included are psychic conditions of the receiver which reduce or enhance enjoyment of a resource. The utility derived by the small town businessman from the presence of rail service, even though his business could never use rail, is an example of a positive technical~ externality. And conversely, the impact of abandonment imposes a negative technical externality upon the same actor. When the exchange or market value of an asset is decreased because of someone else's actions or inaction, a pecuniary externality exists. While the prOperty value is altered, the property remains intact. The impact rail abandonment imposes upon a rail-based industry is a negative pecuniary externality. Political externalities exist when a governmental unit changes the rules of the game. When property rights are changed, "previous patterns of freedom and exposure" change for citizens and other government units.16 The extensive lobbying efforts utilized by the trucking industry to defeat deregulation would indicate they expect negative impacts from rule change or political externalities. 151bid., p. 8. 16Ibid., p. 176. 13 Likewise, the railroads' efforts towards deregulation indicate they expect positive impacts should a political externality be imposed (or granted). Since externalities restrict or enhance individual or group opportunity sets, recipients, of course, are most interested in shift- ing the direction or extent of the impacts. Property rights can be transferred in three manners: bargained transactions, administrative transactions, or status and grant transactions. In a bargained exchange the actors agree to an exchange in which both transfer some- thing of value they own to the other. While a bargained exchange is a market transaction, it does not imply that each actor's opportunity set is equal. And since each actor may have need while not having the resource in question, mutual coercion exists. Recent proposals that branch line shippers individually or collectively guarantee rail carriers a minimum volume of business to continue service illustrates a bargained transaction. Under administrative transactions either public or private authorities act to shift externalities. But while the administrative process can act to change the rules of the game, it is constrained by the public sector's rules for making new rules. One administrative transaction was the passage of the Interstate Commerce Act, which shifted property rights for both shippers and carriers. The third type of property rights transfer, the status or grant transaction, involves a one-way flow of rights dependent upon the benevolence or learned behavior of the giver. While the direc- tion of flow is a one-way movement at any particular time, the flow can be reversed over time if the property right environment changes. 14 And the flow of grant and status transfers is not necessarily from the superior to the inferior; the flow can and often does take the reverse direction. The interest-free loans some Iowa and Minnesota grain elevators have made to railroads for branchline rehabilitation illus- trate a grant transfer. Considering the extensive interdependencies which exist among shippers, among carriers, and between shippers and carriers, the logical question is whose preferences count? That is, which actors are most effective in controlling the impact of externalities? Will the recipient simply bear the impacts? Or are the political and economic rights which constitute his opportunity set such that he will attempt to shift the impacts, and if so, which vehicle will he select? The answer of course determines the distribution of scarce resources. Further, the economic efficiency of a community is rights dependent, for the valuation of resources depends upon the system of property rights. Under each alternative pattern of property rights, mathemat- ical economics yields a different "efficient solution." Thus, in addition to asking whose rights count or whose interests are internal- ized into the market system, the issue of whose efficiency counts could also be addressed. This is not to imply that more or less government is the solution, but rather to suggest that understanding the system of rights and its implications is essential in evaluating both market and nonmarket activities. The public sector: rights and externalities Economists have often differed in their perception of the proper role for the public sector. Some advocate less government, 15 while others suggest expanding the public activities. Usually this implies a normative satisfaction or dissatisfaction with the existing distribution of resources and provides little substance with which to analyze the various economic problems and conflicts present in com- munities of people. In a more useful approach, Samuels has presented a positive descriptive analysis of the public sector's role which eliminates the normative aspects of the more or less government advo- cates. He has suggested that the public sector is an arena in which various interests attempt to enhance their opportunity sets, "that the economy and the polity are worlds of power and power play" in which the "government is an economic alternative, an economic instrument available to power players," and that the government is used “as an instrument with which to gain economic advantage."17 Over time, technological, economic, legal and social environ- ments change, and some individuals or groups may become dissatisfied (or start voicing their dissatisfaction) with their Opportunity sets. As they attempt to use the public sector to enhance their rights, they are attempting to modify the arena and create a different set of rules. The role of the public sector is £9t_one of intervention versus non- intervention, for the state is ubiquitously present. Rather the choice is between actors. As Samuels states: The state had to make a choice as to which property owner was to be made not only formally secure but practically viable in his legal rights. The Court, as part of the state, had to make a judgment as to which owner would be visited with injury and which protected. The state, ultimately the Court, had to decide which 17Warren J. Samuels, The Industrial Reorganization Bill: The Burden of the Future, Unpublished paper, Department of Economics, Michigan State University, East Lansing, Michigan, n.d., p. 2. 16 party would have what capacity to coerce the other, meaning by coercion the impact upon one party of the actions of the other.18 (This legal case) therefore suggests that there is an in- electuble set of choices with which government--the state, law, the legal process-~is inextricably bound up: choices as to relative rights (whose rights are to be effectively paramount to whose?), choices as the visitation of injury (who will be allowed to injure whom, or who will be sacrificed to whom; and when is an injury, that is, to be recognized as such in law), and choices as to who will be exposed to whose coercive power. In all these matters the state must and does choose: there exists scarcity in the sense that conflicting interests and claims cannot each be secured at the same time (under existing technology), giving rise to conflict (for example, court litigation or legislative enact- ment of a change) and the necessity of choice.19 However, even a rule change does not insure the desired change in impacts. The magnitude and direction of impacts are a function of both rule design as well as rule implementation and administration, and if sufficient power is possessed by an actor, he can alter the direction of the impact and change a negative into a positive impact. Olney, the Attorney General during Cleveland's administration, recog- nized this paradox in writing to his friend, Charles F. Perkins. Perkins was the president of the Chicago Burlington and Quincy Rail- road and had recommended that Olney press for the abolition of the Interstate Commerce Commission. My impression would be that looking at the matter from a railroad point of view exclusively it would not be a wise thing to undertake. . . . The attempt would not be likely to succeed; if it did not succeed, and were made on the ground of inefficiency and uselessness of the Commission, the result would very probably be giving it the power itrunvlacks. The Commission, as its functions have now been limited by the courts, is,cn:can be made, of great use to the railroads. It satisfies the popular clamor for a government supervision of the railroads, at the same time 18Warren J. Samuels, "Interrelation Between Legal and Economic Processes," Journal of Law and Economics, 14 (October 1971), pp. 438-439. 19Ibid., p. 440. 17 that that supervision is almost entirely nominal. Further, the older such a commission gets to be, the more inclined it will be found to take the business and railroad view of things. It thus becomes a sort of barrier between the railroad corporations and the people and a sort of protection against hasty and crude legislation hostile to railroad interests. . . . The part of wisdom is not to destroy the Commission, but to utilize it.20 The institution, behavior and performance framework of analysis The discussion of scarcity, property rights, externalities and the public sector provide the basis for the second analytical framework used in this research. The institutional, behavior, and performance framework will be described next. Institutions The concept of an institution has been described by Favero. As previously demonstrated, resource scarcity implies that communities utilize property rights to govern resource control. Such rights create roles and relationships, i.e., institutional patterns among individuals and groups. John R. Commons puts the definition of institutions succinctly and with the same assumption of underlying prOperty rights when he writes about an institution as a ". . . collective action in restraint, liberation and expan- sion of private action." 50 defined, institutions are the instru- mentalities for communities to guide, direct, and condition the behavior of participants--both individuals and groups.21 Thus "institutions establish sets of reinforcement contingencies (rewards and sanctions) to elicit and guide individual and group behavior."22 And the performance of any system "is the collective outcome of individuals and groups choosing between alternative courses of action within their opportunity sets."23 20From class notes of Economics 821B taught by Dr. Walter Adams, Winter term, Michigan State University, East Lansing, Michigan, 1975. For a further clarification and treatment of this issue see Samuels, "The Industrial Reorganization Bill," p. 2. 21Favero, p. 29. 22patrick, p. 12. 23Ibid., p. 12. 18 Behavior Behavior is the response of individuals and groups to their institution. It includes the actions and choices taken within the limitations of their opportunity set. Therefore, the ability to predict and modify the behavior resulting from an alternative institu- tion is extremely important in designing institutions. Unfortunately, the behavior of individuals and groups is characterized by uncertainty and limited information. To function, decision rules are employed which allow action in spite of the uncertainty and limited informa- tion. Decision rules are maintained and discarded or modified over time as a function of their success. In general, two thresholds characterize the use and modifi- cation of (decision rules) . . .--a perceptional threshold and a reaction threshold. Because individuals and groups are limited in time, energy and ability to analyze and interpret new situa- tions, (decision rules) . . . will continue in use, even though they may no longer be appropriate (i.e., (they) . . . are no longer the most efficient means for achieving a specified set of objectives, or they may produce undesirable outcomes). Eventually, however, a perceptional threshold is reached when the appropriateness of (the decision rules) . . . are questioned. Modification and change do not occur, however, until a reaction threshold is reached. The period of time separating the two thresholds is a function of the perceptions of costs and benefits associated with change. Not until the perceived benefits adopt- ing (decision rules) . . . are greater than the perceived costs of staying with the prevailing techniques (SOPs and coordinating mechanisms) will individuals and groups move from perceptional thresholds to reaction thresholds and change becomes possible.24 The reaction threshold, which can be approximated by the cross elasticity of demand between rail and truck service, varies between shippers, resulting in externalities. As more discriminating shippers exit rail service, the financial viability of a branch line deteri- orates, threatenting service to the remaining users. 24Ibid., pp. 14, 15. 19 Performance The distributional impacts resulting from the institutions and behavior are termed performance. It can be evaluated in many ways: who gets what from the economic system, how "efficient" is the economy, upon whom and to what extent are externalities imposed, and what combination of products and services are produced? These three interrelated conceptual elements--institutions, behavior, and performance--comprise the foundation of the general institutional framework for examining economic relationships which is utilized in this research effort. And, to restate, institutions are the incentives which guide and determine the behavior of come munity participants; behavior is the response of the actors to the institutions; and performance is the collective results or conse- quences. The characteristics of ggods and services Some goods and services, identified as public goods, have unique technical and physical characteristics which compound inter- dependency, encouraging strategic behavior, and possibly resulting in a performance level undesired by all. In many ways transportation is an example of a public good, and an understanding of the alterna- tive institutional arrangements assists in predicting outcomes. High exclusive costs Many goods and services once produced can be used by everyone regardless of their contribution to the production. This type of good encourages strategic behavior by participants. An actor 20 may withhold his contribution, hoping others will provide the good and he can be a "free rider." Of course, if enough actors follow the same approach, the good may not be produced. Usually exclusion is not possible, but rather it is difficult and costly; that is, high exclusion costs exist. If goods and services possessing high exclusion costs are produced, it is normally through one of four alternatives: (1) the public sector collects taxes and provides the good, as is done with highways, roads, and bridges; (2) one individual or group receives a return sufficient to make the investment individually; for example, some short line railroads have been formed by one large shipper even though other shippers were located on the line; (3) a sense of com- munity precludes free rider status, as is often reflected in shipper cooperation during abandonment hearings; or (4) where a group is willing to provide a good but is unable to organize its efforts because of high costs, the government can provide the initial organ- izing vehicle, as was done with the public council provided during the Penn Central's reorganization. Lumpy and indivisible cost structure The provision of some goods and services, such as rail service, requires a substantial investment before the initial unit is produced. Subsequent units incur declining costs; therefore increased usage reduces the average cost per unit, and individual costs depend upon the collective consumption of all purchasers.25 25The fixed investment can include either capital investment, maintenance or scheduled operations. On many rail lines maintenance 21 Recognizing this, carriers use strategic pricing to attract addi- tional traffic, and shippers attempt to enhance their opportunity set by modifying the price environment. In the long-run, however, the system performance may prove unsatisfactory to all participants. As the rate structure was once a factor which eroded rail traffic to trucks, so now the truck tariff is eroding common carrier traffic to private carriage. Improved performance may require an institution designed to more effectively articulate individual demand. Option Demand Occasionally customers want the option of consuming a good in the future if they need it. Many firms using truck today want rail service available should energy prices increase relative truck rates. Yet the railroad cannot make investment based upon demand which may or may not materialize. Certainly the availability of a service or good in the future is of value to potential users. The problem is that contingent claim markets often fail to materialize. This is especially true for goods with high exclusion costs. Land banking of abandoned rail lines illustrates one alternative, where future options have not been provided for in the private sector. Occasionally the public sector may deem the future availability important enough to provide for rail line banking. does not vary significantly with traffic volume and the cost of adding another revenue car to a train is extremely small. 22 Institutional design and economic behavior and performance Two authors, Albert Hirschman26 and Mancur Olson27 have recently identified unique institutional arrangements which explain behavior and the resulting economic performance. Their theories are particularly relevant to the logistics sector in general and the railroad subsector in particular. Exit, voice, and loyalty Occasionally a firm will experience a deterioration in performance as the quality of their product or service decays. Hirschman suggests that the performance level can recover as manage- ment responds to exit or voice. Exit occurs when customers stop patronizing a firm, creating a decline in revenues which forces management to take corrective action. Voice is the expression of dissatisfaction by customers to management which encourages improve- ments in the firm's performance. Neither exit nor voice individually are as effective as a combination of the two, and the extent of improved performance depends upon the reaction function of management to these dual stimuli! Hirschman made two observations regarding improved perform- ance. First, "no reaction occurs for a small drop in revenue, full 26Albert 0. Hirschman, Exit, Voice and Loyalty, Harvard University Press, Cambridge, Mass., 1970. 27Mancur Olson, The Logic of Collective Action, Harvard University Press, Cambridge, Mass., 1971. 23 recovery follows upon a drop of intermediate size; and, then again, if the revenue decline exceeds a certain large percentage of normal sales volume, no recuperation ensues--."28 Management will not per- ceive a small decline in revenue or will not pursue the cause. There- fore sufficient exit must occur to surpass the managerial reaction thresholds and create a response. But if the reaction is too great, a firm will be unable to respond, a substantial drOp in revenue may bankrupt a firm, and too much protesting may harass the firm so much that it is unable to respond. And secondly, the exclusive use of exit by customers may not improve performance significantly because the firm may not be sensitive to exit or may not be aware of the factors causing the exit. On the other hand, the use of voice to protest product deterioration may create a favorable improvement in the firm's performance. Therefore, the vehicle--exit, voice, or a combination-~is just as critical to achieving improved performance as the intensity with which it is employed.29 The choice between voice and exit depends upon the pros- pects for the success of voice, cost, and the ease of utilization. The success that voice has in influencing management decisions depends upon the power of the provider and customer of the good. The more important a customer is the greater the likelihood that a provider will hear and respond to the voice option. To achieve power, patrons may use collective action. However the use of voice individually 28Hirschman, pp. 23, 24. 29A description and explanation of the continued poor per- formance of the Nigerian Railways in response to competition from trucks is provided by Hirschman, pp. 44, 45. 24 involves transaction costs while collective action compounds costs by introducing organizational expenses. Once voice is recognized as a vehicle to improve economic performance, institutions can be modified to reduce the costs. Hirschman suggests that the availability Of exit discourages the development of the voice Option, while exit enhances the effec- tiveness of voice. If an alternative product is readily available, a customer is not likely to exert effort which would improve perform- ance. On the other hand, a supplier would likely be receptive to voice suggestions when exit is readily available to patrons. He concluded that "the presence of the exit Option can sharply reduce the probability that the voice Option will be taken up widely and effectively."30 He introduces a third concept, however--loyalty-- which "holds exit at bay and activates voice."31 Loyalty is an attachment to a product or organization which encourages a continued relationship and the use of voice even though exit would be easier. Without loyalty, exit is "essentially costless," and members or users have a low estimate of their ability to influence the organization. By increasing costs and self-perception, loyalty serves a socially useful function by preventing mass exit. This unique relationship to an organization gives a firm time to respond which might not be present without loyalty. The logic of collective action In many situations an individual or firm can achieve objec- tives through individual pursuit. In other circumstances, however, 30Ibid., p. 76. 311bid., p. 78. 25 objectives cannot be achieved individually but can be achieved through the collective action of firms with similar interests. Yet collective action Often fails to materialize. Olson suggests that ". . . it does not follow, because all the individuals in the group would gain if they achieved their group Objective, that they would act to achieve that Objective even if they were all rational and self inter- Various factors interact to create this phenomenon. If exclusion costs are high, the common interest of a group in providing a good will likely be overcome by individuals adopting a free-rider strategy; each individual knows that his marginal contribution will have little impact in determining whether or not the good will be produced, but if it is produced, he can partake with or without contribution. So it is likely that few will contribute and that the good will not be or will be produced in insufficient quantities. If a few individuals stand to benefit, however, they may provide the good and absorb the entire cost, thereby eliminating the need for collective action. As group size increases, the cost of organizing, providing information, communication, and decision making increases. These initial costs make the first unit of a collective good much more expensive than subsequent units, increasing the probability that the good will not be forthcoming. Olson suggests that Only a separate and "selective" incentive will stimulate a rational individual in a latent group to act in a group-oriented way. In such circumstances group action can be Obtained only through an incentive that Operates, not indiscriminately, like the collective good, upon the group as a whole, but rather 32Olson, p. 2. 26 selectively toward the individuals in the group. The incentive must be "selective" so that those who do not join the organiza- tion working for the group's interest, or in other ways contribute to the attainment of the group's interest, can be treated differently from those who do. These "selective incen- tives" can be either negative or positive, in that they can either coerce by punishing those who fail to bear an allocated share of the costs Of the group action, or they can be positive inducements offered to those who act in the group interest.33 Summary Economic intercourse may yield a performance which is less than adequate to group members because the institutional design encourages subOptimal behavior. The works of Hirschman and Olson suggest that the design Of institutions is critical in achieving the desired economic performance. Existing institutions may need to be modified or new institutions created so that behavior is directed towards Obtaining an improved performance. 33Ibid., p. 51. CHAPTER II LITERATURE REVIEW Introduction Transportation systems and distribution channels have evolved in response to changes in technology and institutions. For the past 60 years this evolution has generally included a contraction of the rail system while the systems of the other modes were expand- ing. This contracting rail system has been the focus of many studies which can be classified in three general areas. First, several studies have discussed railroad abandonment as administered by the Interstate Commerce Commission. These studies provided insight into the institutional incentives which alter the behavior of logistic channel members and users. A second approach has examined the community impact resulting from branch line abandonment. An understanding of expected and actual impacts is mandatory in designing or implementing public policy. And the third focus involved computer modeling of alternative logistic systems. These studies described what had been done elsewhere and helped in selecting a model and parameters for this study. Administrative Procedures Literature Transcripts of the abandonment hearing held by the Inter- state Commerce Commission between 1921 and 1940 were reviewed by 27 28 Cherrington.1 He analyzed the application of "the present and future public convenience and necessity" clause contained within the Interstate Commerce Act. While Cherrington did not use institutional and public choice terminology, many Of the principles were identified as part of the Commission's decision process. He found that the various carriers and shippers have inter- dependent production functions and that, therefore, externalities are created which either enhance or restrict the individual firm's opportunity set. The Commission's role is to determine property rights and to determine whose externalities will be internalized into the market. But in making these decisions the Commission actually shapes the future course of events because each decision generally limits the alternatives available to participants. As the Commission shapes the course Of events, it must discern the public interest, but Cherrington identified the futility of their efforts as he identifies the boundaries issue: "it [the Commission] could construe public to mean the nation or local interest." And his conclusion that the law has been "interpreted to mean local public" reflects the difference in transactions cost resulting from the local consolidation of benefits versus the national dispersion Of costs.2 Cherrington also determined that the Commission is inclined to measure rail service needs in terms of actual traffic rather than 1Charles R. Cherrington, Regulation Of Railroad Abandon- ments (Cambridge: Harvard University Press, 1948). 21bid., p. 120. 29 "roseate dreams" or "hopes," thus giving Option demands little weight. In a 1964 update Of Cherrington's efforts, Conant discussed the interdependence Of rail users when he stated that compelling continual Operations on unprofitable branch lines forced higher rates upon other divisions, while abandonment might render local investment valueless.3 Again, the cost and externalities which resulted from the interdependency of production functions were identified. Abandonment Impact Literature Several recent research efforts have focused on the impacts of rationalization by examining the results of branch line abandon- ment on the local communities. After studying two Saskatchewan regions, Fast concluded that social economic changes occur before changes in grain handling and transportation systems.4 This suggests that the demise Of a community occurs in spite Of the continued presence Of rail service rather than the commonly accepted View that community deterioration follows the elimination of rail service. This seems to be confirmed by 51055, Humphrey, and Krutten when they compared nine counties which had lost rail service with 3Michael Conant, Railroad Mergers and Abandonments (Berkeley: University of California, 1964). 4H. R. Fast, "Changing Conditions in Rural Saskatchewan," Canadian Farm Economics, VII (June 1972). 30 nine control counties retaining service.5 They compared pre- abandonment and post-abandonment changes in total bank deposits, value added to farm products, value added by manufacturer, number of employees in manufacturing, new capital expenditure, retail trade sales, and merchant wholesale sales. And they determined that the growth rate in the test and control counties were not significantly different. A study by Alley could discern no difference between small communities which had lost rail service and control communities which retained service.6 The proxies used to measure abandonment impacts included utility usage and property value for northeastern South Dakota towns with a population range between 100 and 250 people. Differences in bank demand and time deposit patterns were also evaluated for test and control communities which included some larger towns. Allen also found little impact of rail abandonment upon the ten communities he studied.7 In the short run, only two Of the ten communities suffered significant adverse employment effects. He also found that in the long term the income effect was not 5J. Sloss, T. J. Humphrey, and F. N. Krutter, An Analysis and Evaluation of Past Experience in Rationalizing Railroad Net- works, M.I.T. Report R74-54, Department of Civil Engineering (Cambridge: Massachusetts Institute Of Technology: 1975). 6J. Michael Alley, "The Magnitude and Timing of Rail Aban- donment Impacts on Selected Economic Variables for Rural South Dakota Communities" (Unpublished Master of Science Thesis, Brookings: South Dakota State University, 1979). 7Benjamin J. Allen, "The Economic Effects of Rail Line Abandonment on Commodities: A Case Study," Transportation Journal, XV, 1 (Fall, 1975). 31 significant in any community, and while the substitution effect seemed to be present, it could not be verified by testing sales tax data. However, the attractiveness of these communities as a location for rail-based industries was, of course, eliminated; but again, the long-term impact could not be verified. However, Allen did find that the largest traffic items were feed and fertilizer, for which no substitutes were available, and thus they continued to move, but by higher cost modes. Therefore, farmers incurred higher costs as the result of rail abandonment. A 1973 study by Simat, Helliesen, and Eichner compared the results predicted during abandonment hearings with estimated results of the actual abandonment.8 Several types Of economic bases in several eastern communities were involved. While most non- agricultural business firms continued to prosper, a few firms were forced out of business and new industry could not be attracted into some communities. However agri-business firms selling feed and fertilizer as well as lumber and coal dealers incurred increased transportation costs. 1 Similar results were realized by Theodore and Doody, who analyzed the effects Of the abandonment Of the Rutland Railroad in New England.9 They found shippers of low-value, bulky commodities 8Simat, Helliesen, and Eichner, Inc., "Retrospective Rail Line Abandonment Study," Final report, revised, report submitted to U.S. Department Of Transportation, Office Of the Secretary (Boston: Simat, Helliesen, and Eichner, Inc., 1973, mimeographed). 9C. A. Theodore, and F. S. Doody, The Economic Impact of the Discontinuance of the Rutland Railway (Boston: Boston Univers- ity Bureau of Business Research, 1966, mimeographed). 32 (characteristics of agricultural commodities) were affected the most, but they were generally able to pass increased costs on to the consumers or, for agricultural inputs, to farmers. The Council of State Governments examined an agricultural- based rail line in Iowa and forecast that abandonment impacts on the branch line communities could be significant.10 Shippers interviewed determined that abandonment would cause grain elevators, farm implement dealers, and fertilizer and feed suppliers to reduce employment. Therefore, income and taxes to the state and communities on the branch would also be reduced. Agricultural Impacts and Adjustments Several authors have found that the costs imposed upon the agricultural sector result in adjustments. Zasada compared the results Of abandonment on two rail lines in the Saskatchewan and Manitoba wheat-producing areas with two lines retaining service.11 Every elevator on the abandoned lines closed, but the capacity was replaced by expansion of firms on the nearby line retaining service. Facilities built on adjacent lines with a high risk Of abandonment were in the form of annex space and were spread over many points. Where risk of abandonment was not significant, the new capacity was concentrated in larger centers, and new firms entered the market. Zasada concluded that the replacement of lost 10Council Of State Governments, The States and Rural Rail Preservation: Alternative Strategies (Lexington, Kentucky: Council of State Governments, 1975). 11D. Zasada, "The Probable Effects Of the Application for Railway Branch Line Abandonment on the Grain Elevator Industry," Canadian Farm Economics, Vol. III (April 1968). 33 capacity does not permit elevators to Obtain the greater economies (turnover) inherent in abandonment situations. Bunker also found adjustments occurred on a l4-mile long Iowa line abandoned in 1969.12 From 1968 to 1973 the abandonment resulted in a shift towards livestock production and a decrease in elevator viability. These results, however, are subject to criti- cism for several weaknesses. First, livestock production is a multi-year process requiring substantial acquisition costs, making it unlikely that the price variation resulting from abandonment of a short rail segment would be detected by farmers and incorporated into their decision process in four years. Furthermore, most transportation economists feel rail line abandonment is a lengthy process with line and traffic deterioration occurring for a number of years, climaxed by the abandonment. Here rail shipments of grain were reduced nearly 50 percent between 1966 and 1967. Yet this change was outside the Observation period. On other rail lines, abandonment does not appear to have had significant negative impacts. After studying another rail line in Iowa, Bunker found that from 1970 to 1973 there was no impact from the 1971 abandonment upon elevators, no statistically significant impact upon livestock and grain production, but that fertilizer dealers experienced a significant increase in transpor- tation costs.13 These results, however, cannot be generalized 12Arvin R. Bunker, "Impact of Rail Line Abandonment on Agricultural Production and Associated Grain Marketing and Fertilizer Supply Firms" (Unpublished Ph.D. dissertation, Urbana: University of Illinois, 1976). 13Ibid., p. 147. 34 since the author identified that little grain had moved by rail before the abandonment because Of access to river loading points. In a 1974 study, John Due analyzed the long-term impact Of rail abandonment on the agriculture of Sherman County, Oregon.14 He also found the net effect on wheat production to be "negligible and in a way beneficial" ten years after abandonment. The author, though, cautions that these results may be unique because of several factors, including the availability of inexpensive water transpor- tation and the cheapness Of truck-to-barge grain transfer. Four rail lines in Nevada and Oregon which had been aban- doned from 25 to 30 years were also studies by Due.15 He found that the agricultural impact for the four regions was negligible for several reasons. Some commodities, such as cattle and hay, could move by truck, while in other cases, markets and suppliers were located within 250 miles and accessible by truck or the water transportation which was available. The impact on the general community also seemed to be limited as pOpulations generally grew and light industry developed. Rail-based warehousing and wholesale distribution, however, could not develop in the communities without rail service, so they located in nearby communities which retained rail service. This resulted in little regional impact but certainly 14John F. Due, "A Case Study of the Effects of the Abandon- ment Of a Railway Line--Sherman and Wasco Counties, Oregon" (Working Paper NO. 205, Urbana: University Of Illinois, College of Commerce and Business Administration, 1974). 15 , "Long Term Effects of Abandonment of Railway Lines" (Working Paper No. 247, Urbana: University of Illinois, College of Commerce and Business Administration, 1975). 35 altered the Opportunity sets of the local communities. Further negative impacts included increased mining costs and some sub- optimal sawmill locations. It should be noted that of the three Nevada lines, the one with the least potential at the time of aban- donment is the line which Due maintains, in retrospect, should have been retained. Baumel, Miller, and Drinka used benefit cost analysis to evaluate the potential of upgrading branch lines in Iowa.16 The cost was based on bringing the line up to FRA Class II standards, a maximum speed of 25 miles per hour, and 263,000 pound carrying capacity, annualized over a 35 year period. Ten of the 71 rail lines studied produced a benefit-cost ratio greater than 1.00, but only four of the lines achieved a benefit-cost ratio greater than 1.00 based upon grain transportation savings. Five did so on the basis of industrial traffic, and one because it required only a small upgrading investment. The benefit-cost ratio for upgrading 63 branch lines was .217. Rationalization Literature Several authors have taken the next step, attempting to stimulate alternative logistic systems to determine the performance and costs under various assumptions. Baumel, Drinka, Lifferth, and Miller at Iowa State University determined the Optimal organization Of distribution facilities for a 6% county region in north central 16C. Phillip Baumel, John J. Miller, and Thomas P. Drinka, A Summary of an Economic Analysis of Upgrading Branch Rail Lines: A Study of 71 Lines in Iowa, Report NO. FRA-OPPD-76-3 prepared for the Federal Railroad Administration (Springfield, Va., 1976). 36 Iowa by maximizing the net joint revenue to the region.17 By sub- stituting six subterminal elevators and 115 car unit trains for the traditional single car movement, Baumel found that the net joint revenue would be increased 8.7 percent. They also found that while only six subterminals and 27 percent Of the present rail network were utilized in the optimal rationalized system, all existing elevators would remain in business although those Of abandoned lines would modify their Operations. And the rationalized system only required 32 percent of the rail cars required by the traditional system. However, the Iowa model assumed that major shifts in des- tinations could occur with no impact on price at the various markets. Using static prices, the authors found that utilizing 115 car unit trains resulted in all grain moving to Gulf ports while the utiliza- tion Of single car rates resulted in 9 percent of the grain moving to Gulf ports. This ceteris paribus assumption eliminates the impacts of the marketing decisions Of other regions. The authors also compared the variable cost of rail with the cost of truck and barge. This approach eliminates the need to allocate fixed rail costs and has been justified by both the I.C.C. and economists as the minimum level for rates. But this study was examining resource allocation and economic investment, not rate levels. While the allocation of railroad fixed costs has posed l7c. Phillip Baumel, Thomas F. Drinka, Dennis R. Lifferth, and John J. Miller, An Economic Analysis of Alternative Grain Transportation Systems: A Case Study, Report NO. FRA-OE-73-4 pre- pared for the Federal Railroad Administration (Springfield, Va.: National Technical Information Service, 1973). 37 problems for decades, ignoring them seems, to this writer, to be an inappropriate procedure. This study also contained parameters which required grain to be shipped during the same months it had moved in one historical year. However, in addition to seasonality, grain sales are a function Of farming technology, price, and equipment supply. And therefore it seems likely that the historical base period will not remain representative over time. Anderson, Gaibler, and Berglund applied the "Iowa Model" to a six-county Nebraska grain production region, achieving similar results.18 Abandonment of 25 percent of existing trackage and multi-car shipments over the remaining upgraded tracks provided the highest net return to the study area. Berglund and Anderson ex- panded the Nebraska study to include inbound fertilizer shipment.19 Again abandonment of some track and upgrading the remainder resulted in the least-cost logistic system. Salomone, Moser, and Headley, also using the "Iowa Model," reached similar conclusions for a Missouri region.20 18Dale G. Anderson, Floyd D. Gaibler, and Mary Berglund, Economic Impact of Railroad Branch Line Abandonments: Results of a Southcentral Nebraska Case Study, Agricultural Experiment Station Bulletin SB 541 (Lincoln: University of Nebraska, 1976). 19Mary Berglund, and Dale G. Anderson, "Impact of Branch- Line Rail Abandonment on Costs of Fertilizer Distribution" (Unpublished manuscript, Lincoln: University of Nebraska, Depart- ment Of Agricultural Economics, 1977). 20David Salomone, David E. Moser, and Joseph C. Headley, "Economic Impact of Alternative Grain Transportation Systems: A Northwest Missouri Case Study" (Unpublished manuscript, Columbia: University Of Missouri, Department Of Agricultural Economics, 1977). 38 For a west central Ohio region, Solomon estimated that the abandonment of seven branch lines reduced net revenue to the pro- ducers 18 percent.21 He also found that the existing elevators and subterminals provided sufficient storage and handling capacity. As economic theory suggests, Solomon found that country elevators were more efficient in serving local truck markets while subterminals served primarily rail-based markets. A Canadian study by Tosterud at the University of Manitoba identified the dichotomy between charges and costs and concluded that a rationalized system could reduce collection, handling, and distribution costs for grain by about 12 percent for the Boissevain Region of Manitoba.22 He found that rail rationalization, assuming a minimum distance between the farm and the elevator delivery point, would reduce costs in terms of resource use from 33.73¢ to 29.55¢ per bushel. The charges incurred by farmers, however, would increase from 17.98¢ to l9.54¢ per bushel. 'He also found that rationalization which utilized preferred delivery points reduced the costs of resources used by 4.03¢--from 33.95¢ to 29.92¢ per bushel. Preferred delivery points are the collection patterns actually displayed by farmers rather than the optimal collection point. Again, the farmer incurred an increase in charges as their 18.29¢ cost increased to 19.63¢ per bushel. 21Seyoum Solomon, "An Economic Analysis of Alternative Grain Distribution Systems in Western Ohio," Unpublished Ph.D. disserta- tion, Columbus: The Ohio State University, 1978). 22Tosterud, passim. 39 These resource savings reflect the fact that in addition to the regulation of rail rates, elevator rates are negotiated by the wheat board in Canada. By identifying the recipient of the costs and benefits result- ing from rationalization, Tosterud has verified that the participants in abandonment proceedings are economically rational. But the results also indicated that sufficient savings may be present to allow Pareto better trades which would leave farmers, elvators, and railroads better off. Of course, an administered rationalization could also be utilized. A study conducted by Bunker at the University Of Illinois examined a grain shipping area, Logan County, Illinois, that utilized water transportation for 85 to 90 percent of its movement.23 As one would expect, he found that rail abandonment would have little impact upon grain marketing cost. Utilizing 1973 destinations and model split, the author concluded that the abandonment of a Penn Central line under abandonment petition would increase marketing costs .1 percent. And the abandonment of all the D.O.T. orange- 1ined lines (those classified as potentially excess), about 66 percent of the total trackage, would increase marketing costs 1.8 percent, or about $170,000. However, when waterway user charges were imposed into the model, marketing costs increased rapidly as shipments shifted to truck. Imposing a user charge of one mill per net ton mile shifts nearly 30 percent Of the water movement from the basic solution to trucks while increasing marketing and 23Bunker, passim. 40 transportation costs 4.5 percent. Similarly, a two mill user charge eliminated 94 percent of the water traffic while increasing costs 6.4 percent over the basic solution. Under both of these user charge assumptions, the eliminated water movement shifted primarily to 50 or 100 car unit trains. The author also similated the impact of abandonment upon the system with a two mill water user charge and found charges increased another 1.8 percent as trucks increased their market shares substantially. The author noted, though, that there was a substantial shortage Of cars in the test year which might have altered destinations. The basic solutions from which all simulated changes were made may thus not have reflected a typical marketing year. Lamberton and Rudel found that truck and rail distribution services were close substitutes for transporting South Dakota grain to all destinations.24 Small changes in relative rates resulted in a relatively large substitution between modes. They also found substantial excess capacity. Eliminating 60 percent Of the eleva- tors would result in savings of approximately $5 million. ‘These savings occur primarily in the intensive production areas rather than the extensive areas where farm trucking distance becomes limit- ing. Construction of subterminals would also provide savings of $1.3 million, and multi-car rates would increase the savings. 24Charles E. Lamberton, and Richard K. Rudel, A Pilot Study to Investigate Efficient Grain Transportation and Marketing Systems for South Dakota, Report No. DOT-OS-50229 prepared for the Depart- ment of Transportation (Washington, D.C., June 1976). 41 Rausch, Schrader, and Doering examined the impact of rail line abandonment for a grain producing area in Benton County, Indiana.25 They found that abandonment would have a significant impact upon the farming community served by the branch line. Farm income would be decreased, and land values would decline (or increase less) because of lower grain prices. But the economic viability of the area would not be destroyed since business would continue operation with decreased profits. Because this region had access to multi-car rates, the results are of special interest. Most research has been done in regions with single-car rates. During the study period 1,477,092 bushels moved by lO-car units, 1,390,000 bushels moved by lOO-car unit trains, and only 252,868 bushels moved by the traditional, higher cost single-car rate. KOO and Cox examined the impacts of rationalization upon wheat and barley marketing costs in Montana.26 They found that expenditures for the infrastructure necessary to load unit trains were justified by the freight saving. Fifty-car unit trains and appropriate elevator capacity reduced marketing costs five percent. Ten and 25-car systems reduced costs three and two percent respec- tively. They found that subterminal locations and the size of the marketing regions were sensitive to shipping, assembly and invest- ment costs. 25David Rausch, Lee F. Schrader, and Otto C. Doering, III, Evaluating Rail Services to an Agricultural Community--A Case Study in Benton County, Indiana, Agricultural Experiment Station Bulletin NO. 71 (W. Lafayette, Indiana: Purdue University, 1975). 26Won W. Koo, and Linda Cox, Optimal Rail Based Grain Distribution System, Staff Papers in Economics 78-8 (Bozeman: Montana State University, 1978). 42 Hilger, McCarl, and Uhrig examined the impact of alternative subterminal numbers and locations upon average marketing costs.27 Utilizing an assumption of high exports from their northern Indiana region, they found that as subterminals were added the average marketing cost per bushel rapidly fell and then leveled out. Con- struction of the first unit reduced marketing costs $0.0125 per bushel, the second unit reduced costs $0.003, and the third unit reduced costs $0.0011 per bushel. Nine subterminals reduced the cost of marketing by $0.019 to $0.14859. They also found that as the optimal number of elevators is approached, location becomes more critical. Assuming a low level of exports, marketing costs were minimized with three subterminals which reduced marketing costs by $3 million over zero subterminals and $400,000 over nine subtermi- nals. The authors concluded that: (1) subterminal savings are dependent upon export markets and rail rate structures, and (2) underbuilding results in a greater cost than overbuilding. Tyrchniewicz, Framingham, MacMillan, and Craven examined the impacts of two major factors in the Canadian grain marketing process, "the overbuilt prairie rail branch line system and the u 28 unremunerative statutory freight rates on grain. They found that extensive abandonment of branch lines resulted in increased trucking 27Donald A. Hilger, Bruce A. McCarl, and J. William Uhrig, "Facility Locations: The Case of Grain Subterminal," American Journal of Agricultural Economics, VOl. 59, No. 4 (November 1977), pp. 674-682. 28E. W. Tyrchniewicz, C.E¥ Framingham, J. A. MacMillan, and J. W. Craven, "The Abandonment Of Uneconomic Branch Lines and Unremunerative Grain Rates: Effects on Agriculture and Regional Deve10pment," The Logistics and Transportation Review, Vol. 14, No. 4 (1978). PP. 411-432. 43 costs of $248,511 but reduced elevator costs $1,063,000 for Manitoba in 1973-74. Increasing rail rates by 258 percent, the amount neces- sary to cover rail costs, would have cost Manitoba farmers over $17 million in 1973-74. The total cost of both changes came to 13.2¢ per bushel and averaged $579 per farmer. QHKEauthors concluded that the existing absolute and relative prices of grain and livestock definitely affect the changes in farm income and the distribution Of production resulting from abandonment or rate change and that the adjustments which occur within a district or between farm sizes are cancelled as boundaries increase to provincial levels. While rationalization studies have all indicated that unit trains and subterminals reduce costs, Kulshreshtha questions these results. He felt that rationalization studies underestimated the cost imposed upon farmers.29 Most studies use marginal cost to reflect the additional cost of trucking grain a greater distance to market. As marketing distance increases, however, the fixed cost Of owning a farm truck increases. He found that in a short-haul region where grain was trucked an average distance Of 6.4 miles, 35 percent of the farm trucks‘were 25 tons or larger. In a long- haul region where grain was trucked an average of 37.7 miles, 51 percent Of the trucks were 2% tons or larger. Similarly he found that in the short-haul region 16 percent of the trucks were seven years Old or newer, compared to 45 percent in the long-haul region. 29Surendra N. Kulshreshtha, "Implications Of Cost of Hauling Grain on Planning of a Rationalized System with Producer's View- point," Economic Planning, IX, 5 (September-October 1973). 44 In another article Kulshreshtha questions the assumption that deadhaul labor remains constant after rationalization.3O "Wait- ing time Of farmers at the elevator must be affected" as rationaliza- tion eliminates elevators. He concluded that the waiting labor input has not been researched adequately. It should be stressed that Kulshreshtha did not conclude whether farmers' waiting time would be increased or decreased through rationalization. \ 30 "Grain Handling and Transportation System on the Prairie: Some Neglected Issues," Economic Planning, X, 5 (September-October 1974). CHAPTER III CHANNEL MEMBER BEHAVIOR Introduction The individuals and groups which comprise the Thumb region, as in any community, consist Of a massive, complex network Of interdependent institutions: legal, political, technological, social, economic, religious, and cultural among others. This chapter describes some Of the institutions which shape and modify the per— formance Of the transportation, handling, and storage system for the Thumb's grain. A description of the general region will be followed by a description Of the agricultural characteristics. Then the various links and nodes which comprise the grain handling infra- structure will be described as well as the institutions which con- strain or enhance their utilization. The chapter concludes with a description of the state's role in agricultural transportation. Geographic and Demographic Characteristics The region The geographic region examined in this project is the east central portion of Michigan's lower peninsula, commonly referred to as the Thumb (see Figure 3-1). The specific 3,500 square mile area studied includes Huron, Tuscola, and Sanilac counties. Also in- cluded, because Of the natural boundaries formed by the transportation system, are those portions of Lapeer, St. Clair, and Genesee counties 45 46 rusOOI-A ‘5: A hl l L. 8* c Saginaw to Breckenridge 40 miles I 'G‘ N- L. A P E a: n 1 ' E S'IE E I 51' c L A l R I Flint --_“‘ to Toledo area Port Huron 110 miles Figure 3-1. The Thumb Region of Michigan 47 north Of Highway 21 and east of Flint. The boundary of the Thumb is the transportation system which links four large industrial cities: Bay City, Saginaw, Flint and Port Huron. These cities are automobile manufacturing centers which require both intensive rail and truck transportation systems. Regardless of what happens to the transporta- tion system within the Thumb, the traffic generated by the automobile plants insures the long-term viability of the rail line and highways which form the boundary Of the Thumb. Population and Employment in the Thumb In 1975, the total population of Huron, Sanilac, and Tuscola countiesl was estimated tO be 127,800, an increase of 8.7 percent over 1970 (see Table 3-1). This continues the trend in which popula- tion has been growing at an increasing rate. People in the Thumb live primarily in rural areas and small villages. In 1970, Caro was the largest community with a pOpulation of 3,701. While the Thumb is Michigan's most productive agricultural region, one-third of the labor force is employed in manufacturing, either in small industries in the Thumb or commuting to the auto- mobile plants at Saginaw or Flint. A quarter Of the labor force is employed in service industries, and 17 percent are employed in wholesale and retail trade. Agriculture accounts for only 12 percent of the labor force (see Table 3-2). 1Because census data for Lapeer, Genesee, and St. Clair counties are not completely representative of the portion of the counties included in the test region, they are excluded from various descriptive sections Of this chapter. 48 .m com 5 woeumm .mm .m .cowumHomom ucouuso .mhma can vema .H mash ”mmoud cmuwaomouumz can mmflucooo mo coflumasmom may mo moumEfiumm .mOchO mop mo smwuom .OOHoEEOO mo ucoEuHmmmc .m.D com ccmHQOHE om .um .cofipmaomom one mo moanmfiuouomumco .H .HO> .chma com coma "coflumaomom mo mochO moumum copes: .msmcou or» no amouom .oOHoEEOO mo ucmEuHmmmc .m.c "mouoomm .coflnom Hoom ca c How mum mmmomnoca umcpo can mafls3 cofluom new» m>fim c muomammu mhma How mmmouocfl mo mums one; «we.m mmm.oH oom.ema ooe.mm oom.mm ooo.mm mama wm.> cmm.h mbm.haa mcc.mv mmm.¢m mmc.vm chma wN.> Hmm.n mmc.mca mom.mv vam.nm ccc.vm coma wm.m mmm.m evm.~ca mmm.mm hmm.cm moa.mm cmma mmm.mm www.mm «Ha.cm vmm.~m coma mucouocH momcou m50fl>oum Houoa Madonna omawcmm conom now» we mumm Scum ommmuocH mucsoo mwflucsoo maoomoa can .owawcmm .connm mo cowumaomom .Him canoe M 49 .anmenoflz .vm .om .uuocou Hmcwm .moaumflumuomumno oasocoom can Homoom Hmuococ .H .HO> .chma "cowumaomom on» no mamcmu .momcou on» no smouom .moumEEOO mo HCOEUHMQOQ .m.D ”OOHSOmm mhm.mm mmm.mH mmc.HH Hmm.ca Hmuoe v.0 oev.~ mvo.a coo Hoe ancOAumoscm m.m Ohm.m HHM.H mhv cmv guano: m.oa eao.e mmm.a om~.H mmm.a mpm>eum m.m mmc.H Hmv Hmm Ham owanom c.mm mvm.m com.v OHB.N nmn.m mooa>nom m.v mvn.a mmh mom omv mooe>uom mumuflcmm w mmflueawuc .cowumowcoEEOU .cOHumuuommcmuB v.5H cmc.c mmm.m mmb.a mma.m momma Hflmumm w Odomoaocz m.vm Nmm.ma mmm.c mmm.m hOH.m mcwuouoomocmz m.m Hmm.~ vow man «om scene: a conuosnuncoo e.aa Hev.¢ Hmm mom.H H¢>.H nmeumnmem a auummuom Hmuauasoeumm Hopes mo Hmuoa caoomoa omawcmm cows: ucoouom ow>OHQEm Honfioz momma .mowucsou maoomoa can .OmHficmm .counm cw ucoahonEm mo :ofluonauumfln .Nlm OHQMB 50 Agricultural Production in the Thumb: The Derived Demand for Transportation Services The foundation of the agriculture in the Thumb region is a level to gently rolling soil with high production capabilities. The test region consists of 2.23 million acres of which approximately 94 percent is tillable. The region normally receives about 30 inches of rainfall per year, but more importantly for agricultural production, it receives three inches or more during each of the four growing months Of May through August. While year to year variations occur, this amount Of rainfall is usually adequate for the growing crOps (see Table 3-3). Similarly, the temperatures during the growing season are also very favorable for small grains and beans. The grow- ing season for corn, however, is somewhat restrictive, and therefore shorter maturity hybrids are normally planted. In 1974, Huron, Sanilac, and Tuscola counties were comprised of 6,186 farms which contained an average of 189 acres (see Table 3-4). This reflected a 14 percent increase in farm size and an 18 percent decrease in farm numbers from 1969. But the trend is not unifonm among the various sizes of farms. The number Of larger farms, those containing 260 acres or more, increased eight percent between 1969 and 1974 to comprise 22.5 percent of the total number of farms. Simultaneously, medium-sized farms, the 57.6 percent which contain 70 to 259 acres, decreased 27 percent. But the number of small farms, those units containing less than 70 acres, decreased only 8.66 per- cent. The fact that the number of small farms is decreasing slowly suggests that they have an interest in the design of grain handling channels and that their interest will continue into the future. 51 Table 3-3. Normal Precipitation and Temperature for Flint, Michigan, 1941-1970a Normal Average Month Rainfall Temperature (Inches) (Degrees Fahrenheit) April 2.87 46 May 3.15 56 June 3.43 66 July 2.99 70 August 3.27 68 September 2.52 61 October 2.24 51 Annual 29.76 47 aSource: U.S. Department of Commerce, National Oceanic and Atmos- pheric Administration, Climatological Data, vol. 27, National Summary, 1976. Table 3-4. Farm Size: Number and Trends, 1974a Percent Change Acres Number Of Farms Percent Of Total from 1969 1-69 1,234 19.9 - 8.66 70-259 3,562 57.6 -26.83 260 & larger 1,390 22.5 + 8.34 aSource: U.S. Department of Commerce, Bureau of the Census, 1974 Census Of Agriculture, vol. 1, State and County Data, pt. 22, Michigan. 52 Wheat, corn for grain, and drybeans accounted for over 75 percent Of the 1975 planted acres. In addition, oats, corn silage, sugar beets, barley, and soybeans are grown. The mix of crops pro- duced varies as prices and weather conditions change, but several long-term trends are apparent. First, corn acreage is expanding and replacing oats, and secondly, soybeans are becoming an important cash crop (see Table 3-5). These three counties produce a significant portion of the state's total production of the various crops, and the individual counties rank among the tOp Michigan counties for many crops (see Table 3-6). Part of this grain is marketed through livestock as the Thumb is also a major production area for poultry, beef, and dairy cows. The remainder of the grain produced is exported into domestic or export channels through the use of the elevators and terminals serving the Thumb. Elevators in the Thumb Region In the summer of 1977 the Thumb region was served by 60 grain elevators, which were located at 47 delivery points located in or near the Thumb. The economic performance Of each elevator differs depending upon several charaateristics which include: (1) ownership of the elevators, (2) storage capacity of the facility, (3) railroad servicing the facility, (4) competitive structure of the industry, and (5) institutional restrictions. The capacity and ownership Of the elevators in the Thumb is discussed next followed by a descrip- tion Of the competitive structure. Rail service and institutional restrictions are discussed later in this chapter. 53 Table 3-5. Acres Of Planted Crops for 1959 and 1975, Huron, Sanilac and Tuscola Countiesa Crop as Percent of Total 1959 Acres 1975 Acres 1975 Acres Corn for Grain 99,200 228,800 29.4 Drybeans 223,300 202,500 26.0 Wheat 173,200 158,490 20.4 Oats 121,600 72,320 9.3 Corn Silage 38,700 53,500 6.9 Sugar Beets 36,440 39,860 5.1 Soybeans 500 15,500 2.0 Barley 8,670 7,260 .9 778,320 100.0 aSource: Michigan Department Of Agriculture, Michigan Crop Reporting Service, Michigan Agricultural Statistics, June 1976, Lansing, Michigan and Michigan Department of Agriculture, Michigan Crop Reporting Service, Michigan County Statistics, Field Crops 1959-1972, Lansing, Michigan. 54 .cmmHSOHz .mCHmGOH .chmH ocoo .mOHumHumum HonouHooemmm cmmH£OHz .OOH>Mmm mcHuuomom mono :mmHBOHz .OuouHOOHumm mo ucoEuummoc :mmHnOHZ “monsomm VH mH mH mo cv Hm Hm mH NH VH Hmuoa oumum mo accouwm m we :oHuooconm mucoou m H H m c m m H 0H m OMHHcmm v H m H o v m MHoomoe N m H v H v m m N H cons: msoo m3OO muuHsom muoom mcmom hmHumm upon: mumo GHMHO omoHHm muHma moon Homom mun choc cuou mmhmH .Hmuoa manning: mo ommucoouom 8 mm cOHuoocoum mucooo can muoocoum HMHODHOOHHmc couoonm mo cOHuooooum How xcmm mucooo .cum pome 55 Ownership and Capacity of Thumb Elevators The 60 elevators were owned by two large chains, four small chains, nine independent firms, and 14 cooperatives. Blount Agricul- ture, a division of J. P. Burroughs and Son, Incorporated, owned 14 elevators in 1977 with a total storage capacity of 3.5 million bushels (see Table 3-7).2 The other major chain in the Thumb, Wickes Agri- culture, a division of the Wickes Corporation, owned 12 elevators with storage capacity of 2.2 million bushels. Both Blount and Wickes owned unit train loading facilities and had unit train rates pub- lished. Kingston Farm Services and Thumb Farm Service, Incorporated each Operated three elevators, with total storage capacity Of 73,000 and 542,000 bushels respectively. Two elevators containing 495,000 bushels of storage capacity were Operated by Wruble Elevator, Incorporated. Star of the West Milling Company Operated a flour mill and two elevators, one of which was capable of loading unit trains although rates were not published. Star of the West's storage capacity was 1,600,000 bushels. A combined storage capacity of 1.2 million bushels was divided among nine independently owned elevators. Fourteen elevators with a combined storage capacity of eight million bushels were owned and operated as farmer cooperatives, one Of which was a unit train loading point with published rates. The combined capacity Of these 60 elevators was over 17.5 million bushels in 1977, with an average capacity of 292,000 bushels. But the variation in storage capacity was substantial. Twenty—two 2In 1980 the Blount Elevators were sold to three employees. 56 Table 3-7. Characteristics of the Elevators in the Thumb Region of Michigan Delivery Ownership Capacity Point Of Elevatora of Elevator Railroad Servicing Akron Blount 84,000 C & 0 Main line " Co-Op 120,000 C & 0 Main line Applegate Blount 60,000 C & 0 Branch line Avoca IND 70,000 C & 0 Main line Bad Ax Blount 200,000 C & 0 Main line Birch Run Wickes 313,000 C & 0 Main line Bradleyville Blount 50,000 None Brown City Wickes 64,300 C & 0 Main line Capac IND 126,000 GTW Main line Caro Wickes 32,500 Conrail Carsonville Blount 330,000 C & 0 Branch line Cass City KFS 43,000 GTW Branch line " Co-op 530,000 GTW Branch line " Wickes 469,000 GTW Branch line Clifford KFS 10,000 C & 0 Main line & GTW Branch line Colling Blount 315,700 Conrail Croswell Wickes 187,000 C & 0 Branch line Davidson " 53,300 GTW Main line Decker IND 48,000 None Deckersville IND 250,000 None " Wickes 63,000 C & 0 Branch line Elkton Co-Op 700,000 C & 0 Main line " " 1,200,000 C & 0 Main line " Blount 98,000 C & 0 Main line Emmett Wickes 108,000 GTW Main line Fairgrove Blount 313,000 C & 0 Main line " Wickes 360,000 C & 0 Main line Frankenmuth S of W 180,000 None Gagetown Blount 418,000 GTW Branch line Gera S Of W 1,000,000 C & 0 Main line Gilford Blount 900,000 C & 0 Main line Harbor Beach Wruble 160,000 C & 0 Branch line Imlay City Co-Op 56,000 GTW Main line Kinde Blount 160,000 C & 0 Branch line " Co-op 525,000 C & 0 Branch line Kingston KFS 20,000 GTW Branch line Lapeer IND 10,000 GTW Main line " Co-op 100,000 GTW Main line Marlette Co-op 560,000 C & 0 Main line Mayville IND 100,000 C & 0 Main line Millington IND 340,000 Conrail 57 Table 3-7 (Continued) Delivery Ownership Capacity Point Of Elevator of Elevator Railroad Servicing Minden City IND 50,000 C & 0 Branch line North Branch Blount 290,000 GTW Branch line Owendale Wickes 73,300 GTW Branch line Pigeon Co-Op 2,000,000 GTW Branch line " IND 250,000 None Port Hope TFS 175,000 None Reese Co-op 900,000 Conrail Richville S of W 420,000 Conrail Ruth TFS 32,000 C & 0 Branch line " Co-op 558,000 C & 0 Branch line Sandusky Wickes 186,900 C & 0 Branch line Sebewaing Co-op 450,000 C & 0 Main line " Blount 120,000 C & 0 Main line Snover Co-Op 300,000 None Ubly TFS 90,000 C & 0 Branch line " Wruble 335,000 C & 0 Branch line Unionville Blount 210,000 C & 0 Main line Vassar Wickes 299,000 Conrail Yale Co-Op 43,000 C & 0 Branch line aElevator company abbreviations: Blount Blount Agriculture Wickes Wickes Agriculture KFC Kingston Farm Service TFC Thumb Farm Service S of W Star of the West Milling Company Wruble Wruble Elevator, Inc. IND Independent elevators Co-Op Cooperative farmer owned elevators 58 elevators had storage capacity of 100,000 bushels or less while seven had in excess Of 500,000 bushels (see Table 3-8). Capacity also varied substantially among ownership groups. The elevators owned by Blount, Wickes, the independents, Kingston Farm Service, Thumb Farm Service, and Wruble all had less average capacity than the region's average. On the other hand, the average capacity Of the elevators owned by Star Of the West and the coopera- tives was far greater than the region's average. Star of the West used their facilities to store wheat to insure adequate supply for milling purposes. Explanations for large average capacity of the cooperatives include: (1) the fact that management Objectives and philosophy differ between private and cooperative firms, (2) the fact that cooperatives, as a vertical extension of the farming enterprise, may undertake a building project which benefits the patron owners rather than the elevator, and (3) the fact that there is a difference in long-term philosophy regarding the future role of the elevator in the Thumb. The Evolution Of Elevator Competition A major concern to the farmer selling grain is the competi- tiveness of the elevator industry. One elevator manager stated, "Farmers will support small elevators even if their bid price is lower because they do not want a monopoly." This is true in the short-run, but in the dynamic long-run, technology is redefining what small elevators are and what competition is. Economic theory suggests that if (1) sellers are assumed to be evenly scattered and to have similar supply schedules, (2) the 59 c.ccH 0mm.HmN ccm.mcm.bH c.ccH cc Hmuoe qulel a 08 .08 . m mqwll ml 86 pan 80.08 . H «.mm mmH.mch ccc.mnc.m m.mH m ccc.ccc.H I Hcc.ccm m.mm vch.mmm 00>.Nmm.v m.mm 0H 000.com I H00.0mm m.vH mHm.mcH cch.mmm.m mm mH ccc.cmm I Hcc.ccH O.v mcm.mb ccm.HHm m.mH HH ccc.ccH I Hcc.cm m.H omm.mm oom.mmm n.6H 0H ooo.om I o Hmuoa mo muHommmo moOHO mo Hmuoe mo ONHm an unwouom m md ommuo>m muHommmu unmouom m we muoum>mHm muHommmo Hmuoe Honfioz mo monsoz cmmHSOHz cw conom Deuce onu mcH>Hom muoum>OHm chuO mo coHuanHumHo muHommmo .mIm OHQMB 60 market is imperfectly competitive because firms are geographically dispersed, and (3) the grain is purchased on a f.o.b. elevator basis, then the market boundaries Of an elevator will be determined by its cost function and the cost of transportation. Historically when an elevator purchased grain, it was serving as a facility to transfer grain from the high cost mode-~the horse drawn wagon--to the low cost mode, the railroad. The extreme dif- ference in cost between these modes created demand for delivery points close to the farm; thus isolated delivery points developed which served relatively small geographic areas. The elevators built at the various delivery points varied little in capacity, and thus they had similar cost functions which tended to create uniform sized market areas. Because Of the high gathering costs, each delivery point was, in effect, a spatial monopoly. The boundaries of each market area were magnified by the high transactions cost associated with getting bids from different delivery points. Thus the only effective way competition could exist was for two elevators to locate at the same delivery point. Over time, however, the competitiveness of the elevator industry has increased substantially in response to technological and institutional developments. The horse and wagon was replaced by trucks, which are ever increasing in size and speed, thereby sub- stantially reducing gathering costs. Today a farmer can load 400 bushels Of grain in his truck, drive 100 miles to market, unload, and return home in less time than it took his grandfather to load 52 bushels in a horse drawn wagon, drive five miles to town, unload 61 and return home. This reduction in trucking costs allows farmers to shop between elevators, and a one cent difference in a bid price cOuld entice farmers up to 10 additional miles. While the average cost per bushel of trucking grain was decreasing, rail rates were increasing. And as truck gathering costs approached rail rates, the value of a transfer point located near the farm was reduced, and thus the value Of a spatial monOpoly was also reduced substantially. During the past 30 years, government grain storage programs have had a tremendous influence upon elevator cost functions. Prior to 1950 technology existed to construct large facilities, but few were built. The elevator was still considered a transfer facility. But the early 1950's saw the agricultural production needed to win the war turn into surplus production. In response, the federal government established an agricultural policy which provided for long-term storage. This institution provided the incentive for the 100,000 to 500,000 bushel or larger capacity elevators. Owners no longer had to worry about a short crop year since storage payments would cover interest and principle. And with the large volume came substantial economies of scale. To realize the economies, however, grain from larger and larger geographic areas needed to be pro- cessed, which encouraged elevators to narrow their margins to attract grain. The most recent technological and institutional changes have been unit trains and subterminals. To achieve the economies Of unit trains, substantial volumes of grain must be processed by a subterminal. And while this again results in spatial monopolies, 62 their market power is much less than that displayed 60 to 80 years ago. Because of low cost farm trucking, a wide boundary exists between markets. For example, if the Elkton terminal raises its bid price three cents, it can increase its market area by a third, assume ing Toledo does not react. Simultaneous with the transportation and elevator changes have been improvements in information and communication systems. These have enabled farmers to receive worldwide crop news rapidly and to secure price quotations from various sources. And university research and the cooperative extension service have shown farmers the value of this information and how to use it. Was the manager correct when he stated, "Farmers will support small elevator . . . ?" NO! He was making a static analysis Of a dynamic process. Farmers adjust to institutional and technological changes at different rates. The small elevator which is techno- logically obsolete is not supported by all farmers, but rather by some farmers who have not responded at all and others who have —....».._4 .. ,1 partially responded to a continually changing environment. While fewer firms are involved, the elevator subsector will remain competitive. But instead of elevators competing ten miles apart, as they have over the last 20 years, subterminals will compete 20, 50, or even 170 miles apart, and the smaller facilities will exist within their shadows serving unique needs. Spatial competition in the Thumb The 60 elevators in the Thumb are located at 47 delivery points. Nine communities were served by two elevators, and two were 63 served by three elevators. Forty percent of the elevators were located at competitive delivery points, towns with two or more ele- vators, but they had 51 percent of the region's total storage capacity. About one-third of the elevators operated by Blount, Wickes, the independents, and the small chains were located at competitive delivery points. However, 57 percent of the cooperative elevators were located at competitive delivery points. One explanation for the difference in competition between private and cooperative elevators is the difference in incentive. A private firm would attempt to create a spatial monOpOly by locating at a distance from other firms. COOPeratives, on the other hand, were Often the result of farmers using the exit Option combined with collective action when they felt the performance of the local elevator was unsatisfactory. As stated previously, the primary reason many cooperatives were started was to provide competition to a spatial monopolist who, farmers felt, was earning excess profits. The Structure Of the Elevator Subsector in the Thumb During the 1970's the structure Of the elevator subsector in the Thumb region has changed substantially. Small facilities have been allowed tO depreciate while new investments have primarily been concentrated in large volume facilities, many of which are capable Of loading unit trains. Some of the recent construction includes expansions at Gera, Pigeon, Ubly, Carsonville, Kinde, Fairgrove, and Breckenridge, and new terminals at Cass City and Elkton. Unfortunately, much of the new investment has been made with little foresight or regard to future performance. The two largest 64 elevators in the 3,500 square mile Thumb region are located seven miles apart in Elkton and Pigeon. The rail siding of the new N.F.O. terminal located in Cass City will hold 10 cars, and because the siding butts against a major highway, the future use Of unit trains is restricted. Many elevator managers feel that new construction has resulted in excess capacity which will dictate the elevator conduct in the future. Large elevators and unit train rates provide substantial economies, if grain is available. However excess capacity results in a situation in which there is insufficient grain available for all firms to achieve the desired economies. Much Of the new capacity was just coming on line in 1977, and therefore the elevator managers were just starting to Observe the conduct resulting from the new structure. But the implications had not been lost on them and many anticipate destructive competition. Historically, according to one manager, "there were big margins in the Thumb because it was isolated." These margins had allowed some farmers to haul grain direct to Toledo or Maumee. Then B & W expanded and started shipping unit trains, "and their aggressive bidding reduced the margin to where farmers can't afford to haul it to Maumee." Into this environment the Elkton terminal was built, and other facilities were expanded. The awesome capacity and potential competition is Obvious to the managers Of the smaller facilities. As one said, "I feared the day B & W would come." Another has prophesied that, "In the north, World War III is going to start one of these days." And another has predicted the result 65 to the small elevator, "We will go broke if Pigeon and Elkton have a price war." Perhaps the general feeling was best described by the manager who stated, "They're castrating us!" But most managers, including the terminal managers, feel that the terminals will also incur problems. One manager stated that "half of the subterminals will be for sale in three years; there's too much capacity," but "maybe the government storage program will salvage them." Manager after manager discussed the impact of equity and depreciation. One stated, "If an elevator has a large equity in its facility, it can milk income from it for a long time." In discussing the new facility at Cass City, another said, "NFO is all 1976 dollars, most of ours are older dollars." Within this competitive environment, what lies in store for the 34 elevators with less than 250,000 bushels storage capacity? Most Of these high-cost firms are planning for the future. Some are expanding and pursuing aggressive management strategies to remain competitive. As one manager stated, "I am scared about the future. I have to expand my marketing area." Others are living off depre- ciation with no intention of existing for more than five more years. And some are changing business by becoming suburban elevators, bean elevators, feed mills or by pursuing other alternatives. However most of these firms also face physical restrictions which limit their potential. Many are located in the middle of a town which restricts unit train potential because of limited rail siding and processing potential because Of environmental factors. Nature and the market can also alter the elevators' Oppor- tunity set. A good crop or high prices result in a larger farm 66 income, which enables farmers to purchase new equipment. The purchase of a larger and faster truck enables the farmer to bypass local elevators and haul to terminals. This impact is compounded by current income tax laws. Elevators are also dependent upon other businesses in the community. The pricing policies of Roysters and other local ferti- lizer dealers will determine whether farmers go to Toledo to purchase fertilizer. And the answer is extremely important to the elevator subsector because grain will be hauled to Toledo. Elevator competition from outside the Thumb In addition to intraregional competition, subterminals located outside the Thumb alter the institutions, behavior, and performance of elevators in the test region. Three subterminals are located in nearby Saginaw, one each in Marysville and Breckenridge, and the Toledo area contains several terminals. The importance of these facilities was projected by one manager who said, "Our competition will be trucks in five years." Three terminals are located in Saginaw and provide a market for grain produced in the Thumb. Michigan Elevator Exchange, the grain marketing branch of the Michigan Farm Bureau, has a two million bushel facility, and Wickes has a 1.2 million bushel facility; both terminals have unit train and Great Lake loading capabilities. . Frutchey Bean Company also has a 1.25 million bushel terminal in Saginaw, but it cannot load either unit trains or ships. Farmers are restricted in their access to the Michigan Elevator and Wickes 67 facilities as they will only purchase grain from "local" farmers; local has been defined as a 10-20 mile radius. Grain from a further distance must be brokered by another elevator. Michigan Elevator Exchange also owns a terminal at Marysville. This facility serves as a market for Thumb region elevators, and it will also accept grain delivered direct by farmers which has been brokered through another elevator. Marysville also restricts direct sales to "local" farmers. The largest elevator in Michigan is the 5.2 million bushel terminal located at Breckenridge and operated by the B & W Co-op, Inc. Because it is located 40 miles from the Thumb and Saginaw is in between, very little grain moves to Breckenridge from the Thumb. However B & W has extremely narrow margins, and therefore it has established the competitive conditions both in its market and in the Thumb. In fact, elevator managers located 90 miles away from Breckenridge indicated that B & W's price is a primary consideration in posting their prices. Although the Port of Toledo is located 110 miles south of the Thumb, it still is an important determinant of Thumb region conduct. Most of the grain exported from the Thumb flows east over highways or rail lines which pass through Toledo. This strategic location permits elevators and farmers with large trucks to haul grain to the unit train and water-loading facilities located at the Toledo terminals and haul fertilizer back. And again the elevators in the Thumb region are very aware of the prices and policies estab- lished by their competitors in Toledo. 68 The brokerage institution explored The institutional arrangement maintained by Michigan Elevator Exchange which restricts farmers' access to the terminals warrants further evaluation. Under this arrangement the local elevator assumes two roles: first, it purchases grain from farmers in the typical capacity of an elevator, and secondly, it assumes a broker role which involves serving as an intermediary between farmers and the terminal while never physically handling the grain. The Objective of this policy was to provide a market for local elevators without providing the competition that would force them out of business. The local cooperative owns Michigan Elevator, and thus, for the elevator, this was a logical and rational policy decision which preserved the local COOperative's market. However, the owners of the local cooperative and, indirectly, the owner of the terminal is the farmer, and it is the farmer owner who incurs the policy impacts. For the farmer who uses the brokerage services, the local elevator adds no economic value or utility tO the product, yet it imposes user fees. But for the farmer who delivers to the elevator, an economic service is provided through form utility (dryer capacity), temporal utility (storage capacity), and spatial utility (closeness for those without large trucks). Furthermore, the brokerage income probably allows an elevator tO continue in Operation beyond the time justified by the physical grain volume. SO Michigan Elevator Exchange serves as the designer and administrator of a program which alters Opportunity sets. Restrictions are placed upon the choices faced by larger farmers while the smaller farmers' set of choices is enhanced. 69 The Transportation Network The Rail System The Thumb is not served by a rail system, but rather by a group of individual lines operated by three carriers, the Grand Trunk Western, the Tuscola and Saginaw Bay, and the Chesapeake and Ohio (see Figure 3-2). Bordering the Thumb on the south and west are mainlines which serve Port Huron, Flint, and Saginaw. (Within the Thumb are primarily branch lines, most of which were orange lined by the DOT study3(see Figure 3-3). The lines of the various railroads The Grand Trunk Western Lines Three rail lines serving the Thumb are Operated by the GTW. The first is its Port Huron-Chicago mainline, which comprise the region's southern boundary. Its second line extends east from Saginaw to Denmark Junction. This line, which was acquired from the Penn Central during its reorganization, serves the subterminal at Gera and provides interline service for the Tuscola and Saginaw Bay Railroad. Both of these lines appear tO be part of the long term system of the GTW. The GTW also Operates a 66 mile branch line between Imlay City and Caseville, which runs north and south through the middle of the Thumb. An abandonment petition was filed on this line on October 15, 1974, and denied by the I.C.C. on July 6, 1977. Because 3On February 1, 1974, the U.S. Department of Transportation issued a report, Rail Service in the Midwest and Northeast Region, in which "Rail lines either not necessary to serve those points recom- mended for service or which are duplicate feeder line," were colored orange. I. I l‘ Elkton .I. I \\ \\. . Ruth I \- I ‘ \ \. I quling \ Cass City \‘ I . ‘Y \. I 3 l \ . . .’ 3 ' l '911f0r$/ o ‘ .\ Saginaw ..0 /’ , 0' E f, .’ ‘ \. V" "' " . ' ' ' I ' ‘. 00+... ;o:o:..:o ' \ “Richville '- .‘°‘°~.~o-.-; \ \ O. — —o\ '\ . ' '\ Croseell '\ Millington I, -\ \. \ - --~. \ \ \ ' \ '\ \. \ .\. \ \ \ \ '\ _“"-~-_--+-_‘~‘ \e / ‘ Flint Imlay City " “ " ~ - -'é. Port Huron . . . . . . . Tuscola-Saginaw Bay ‘ ._ . .. . ._ Chesapeake 8 Ohio .. ... _. _. Grand Trunk Western Figure 3-2. Thumb Area Rail System 71 I _/ I. / \ I. .\ I \. \i \, \- I ‘ ‘- I \ l i y ‘ I ‘ A. . / \. ‘IIIIIIII-L ' I \ “‘ _ _ I I . r s .. 1 ~ _ .... I \a I \. 'I l \. I \. \ ‘\ \. \. \. \. \, \ \. \ .__._._.. Lines identified by the Department of TransportatiOn to retain rail service _____ Lines identified by the Department Of Transportation as either not necessary to serve those points recommended for service or which are duplicate feeder lines Figure 3-3. Orange Lined Thumb Area Branch Lines 72 of the abandonment hearing a great deal Of information, much Of it conflicting, is available on this branch line. First, this line needs extensive rehabilitation. In fact, many of its 19 bridges are so weak that spacer cars-~empty cars placed between loaded cars--are used to insure that only one truck under load is on a bridge at a time. Some knowledgeable rail author- ities, however, question the necessity for this practice since the GTW plows snow with several locomotives without using spacers. At the hearing, the GTW's chief engineer estimated that a major rail and tie rehabilitation program would cost $2,961,347. But under cross examination the witness added, "I cannot say that we have to do it. . . . it's desirable but not necessary."4 After discrediting the GTW's figures, the State sent its rehabilitation expert home without testifying. The State's attorney also instructed the State's expert witness to destroy his notes containing the estimated cost Of rehabilitation. And the only person in the State who had walked the track and knew the cost of rehabilitation could not recall his figures, even after the attorney general's staff gave clearance to disclose them! The profitability Of the line was also disputed. The GTW estimated losses of $229,250 for the year ending June 30, 1976, while the State's expert witness estimated earnings of $48,719! But because of I.C.C. accounting rules, neither figure is probably representative. 4Applicant's Chief Engineer, Initial Decision No. AB—31 (Sub‘No. 3). Grand Trunk Western Railroad Company Abandonment Between Imlay City & Caseville, Michigan, Interstate Commerce Commis- sion, Washington, July 1977, p. 19. 73 Normally, when an abandonment petition is denied, the railroad allows the line and traffic to deteriorate further and then files a new petition. However many Observers felt the GTW never intended to abandon this line but rather it was attempting to secure public assistance to rehabilitate the line. And apparently the State feels there is a need for assistance on the Imlay City-Caseville line as a rehabilitation program, funded by a $1.5 million State grant, is expected to be initiated sometime during 1980. The Chesapeake and Ohio lines The C & 0 also Operates three lines which serve the Thumb. The Chessie entered the Thumb in 1951 when the Pere Marquette was absorbed into the C & 0 system. Most rail historians concur that the C & O's primary interest in the merger was to Obtain the PM mainlines. And most rail authorities today question its long term commitment to branch lines throughout its system, including those in the Thumb. The C & O's first line is a mainline between Saginaw and Detroit, which is in good condition, receives good service, and appears to be part Of a long term Chessie system. Its branch lines, however, seem destined to another fate. The C & O's second line is a branch line which the PM once Operated between Port Huron and Saginaw. This line followed the coast Of Lake Huron around the east, north and northwest sides Of the Thumb. At the time of the merger, it appears the C & O planned to abandon most of this line, retaining only the Saginaw-Elkton portion. First, through service was eliminated by abandoning a short segment 74 between Croswell and Port Huron. Secondly, service deteriorated to the expendable portion of the line, that part between Elkton and Croswell (see Figure 3-2). As a result of deteriorated traffic, the line was orange-lined by the DOT study and was classified Class 1 in the first C & 0 system plan.5 The most recent C & 0 system plan, however, reclassified this line into Class 5. But most likely this reclassification did not result from a change Of heart on the part of the C & 0. On two other lines in Michigan, the Elma-Greenville and the Hartford-Paw Paw lines, the C & O withdrew abandonment peti— tions beforetflxehearing because of insufficient cases. The primary reason is the State has become a much stronger Opponent as it actively protests abandonment. It appears the C & O strategy is tO reclassify the Elkton-Croswell segment in order to further dis- investiJIfacilities and continue to provide poor service and then file for abandonment when they are more certain of victory, probably before 1985. However the change in the C & O's plan conveys a wealth of information. The line is still viable! And proper action now could maintain viability. It is also possible, but unlikely, that the C & 0 may attempt to secure public funding as other carriers in the Thumb have done. Whatever their strategy, their commitment to this line is marginal. This line apparently is also in need of rehabilitation. While it is Class 2 track, a minimum speed of 25 miles per hour, the restriction or exception miles outnumber the Class 2 miles. 5Class 1 are those lines on which an abandonment petition will be filed within three years. Class 5 lines are all other lines or "safe lines." 75 The third C & 0 line connects Port Huron directly to Saginaw. This segment was also orange-lined by the DOT report. While it is designated Class 5 in the Chessie system plan, its future is un— certain. Some rail authorities feel this line is an important part of the C & O's system and will be retained while others question the C & O's commitment to any branch line including this one. The Tuscola and Saginaw Bay lines The third railroad serving the Thumb is a newly formed shortline, the Tuscola and Saginaw Bay. Several lines located in the Thumb were formally Operated by the Penn Central. Conrail took over these lines for 18 months after its creation, but they were physically separated from the rest of Conrail's Operations, which created operating problems. SO in October, 1977, Operation Of these lines was transferred to the Tuscola and Saginaw Bay railroad. The 45 miles of track Operated by the TSBY are in extremely poor condi- tion. Some have had no upgrading since 1948, "other than putting out fires," and need new drainage, ballast, ties, and rails. In fact, the only thing Of value is the right Of way. SO far the State has provided three grants totaling more than $5.6 million in an attempt to bring the track to Class 2. In addition the TSBY is receiving Operating subsidies. During this initial period of Operation, the TSBY has been successful in increasing traffic volume; for example, the elevator at Millington has increased its rail shipment from no cars in 1976 to 150 cars in 1978. 76 Rail Service The railroad which serves an elevator is an important determi- nant Of the firm's Opportunity set. Railroads are Often criticizedv/ by shippers for inadequate service, insufficient cars, poor attitudes and many other factors. The shippers in the Thumb region also criticized the various railraods, but throughout the interviewing process a pattern of service seemed to emerge. The six elevators located on the Old Penn Central line had found rail service so unsatisfactory they were shipping primarily or exclusively by truck. Thirty-three elevators were served by the C & 0 Railroad. Nineteen were located on the main lines between Saginaw and Port Huron or Saginaw and Elkton, and 14 were located on the branch line between Elkton and Croswell. Those shippers located on the C & O mainline expressed a general dissatisfaction with the policies and attitudes Of the C & 0 management. And while they were somewhat dissatisfied with the car supply and service, they indicated that they felt their service was superior to branch line or Conrail service. The shippers located on C & O branch lines expressed complete dissatisfaction with service, car supply, and general attitude. In fact, most felt the C & O was discriminating against the branch line, and they were convinced that an abandonment petition would be filed in the near future. Conversely, the shippers served by the Grand Trunk Western expressed a general satisfaction with the service and car supply and were very pleased with the attitude of the carrier. Little differ- ence was discerned between the nine shippers located on the Imlay City-Caseville branch line and the six located on the Port Huron- 77 Chicago main line. Perhaps the role Of the State in the abandonment hearing on the Imlay City-Caseville line, which will be discussed later, contributed to the goodwill between the GTW and its shippers, but most interviewees seemed to indicate a high level of cooperation had existed for some time. Seven elevators were not served by any railroad in 1977. Two of these were relatively new facilities which had been designed and built tO ship exclusively by truck. In fact, one was located directly on a rail line, but it was not built with a rail loading spout. Five elevators had lost rail service because Of abandonment, two as far back as 1952. All five had been without rail service for at least five years. The fact that these elevators have continued in business and even expanded indicates they are Optimistic about their future. The general attitude among the managers Of these facilities was that they were Operating satisfactorily without rail service, once they had survived the initial adjustment period, which usually occurred prior to abandonment. This is not to imply they did not want good rail service; rather, they stated that no rail service was not significantly different from the poor service they had experienced before abandonment. Exempt Trucking Subsector Complementing and competing with rail service is the agri- cultural trucking subsector which is exempt from I.C.C. rate and route regulations. The characteristics of a competitive industry are displayed by the exempt trucking subsector: barriers to entry are low, capital requirements are minimal, resources are highly 78 mobile, and there is little product differentiation. In theory, a competitive industry should yield zero economic rent in a long run equilibrium position. In practice, however, there appears to be an excessive amount of exit and entry. An owner operator experiences financial difficulty and sells his tractor and trailer to another individual, who also experiences financial dif- ficulty. And the cycle goes on and on. This implies there is a negative profit equilibrium position for the exempt trucking sub- sector. Apparently the production function of the exempt owner Operator has a utility component which is rewarded by the romance and mystique of driving a truck and the independence of being one's own boss. This utility results in the trucker "living off depre- ciation," or accepting a rate of return which is lower than the theoretical equilibrium point. The competitive exempt trucking subsector sell their services to what is apparently an organized OligOpsony. The OligOpsony is organized around Michigan Elevator Exchange, which publishes a rate sheet or guide (see Table 3-9). The appearance of the organized OligOpsony results because not only were these rates used by ele- vators affiliated with Michigan Elevator, they were also used by all other elevators in the Thumb. In establishing their rates, Michigan Elevator determines costs from individual truckers and then analyzes supply, demand, and competitive characteristics. The most recent rate sheet was published in 1978. And in spite of increases in fuel and equipment prices, the previous increase was issued in 1974. 79 Table 3-9. Truck Tariff, Exempt Trucking Rates Utilized in the Thumb Region hon Cad. 5|? Totem 4.5-43” Mick?!» (lamb: {war “wwwm vLIlfl-III-unII-dh- he 6W snumaemxs... ’ I . fl. 0. 5...:28 - 1...». flint,“ 48902 SEPTEMBER 2, 1974 TRUCK RAFES FOR GRAIN USING MILEAGE GUIDE MILES RAT: PER BUSHEL MILES RATE PER BUSHEL o to 10 35¢ 106 to 110 13 t 11 to 20 '4 t 111 to 115 14 £ 21 to 25 ‘5 t 116 to 120 14 f 26 to 30 sit 121 to 125 145i 31 to 35 6 t 126 to 130 1651 36 to 40 65¢ 131 to 135 15 t 41 to as 7 t 136 to 140 15 t 46 to so 8 d 141 to 145 15ft 51 to 55 Bit 146 to 150 15§£ 56 to 60 9 t 151 to 155 16 d 61 to 65 9&6 156 to 160 17 t 66 to 70 [0 t 161 to 165 17 l 71 to 75 Io'é 166 to 170 17 t 76 to 80 L1 6 171 to 175 . 1796 81 to 85 Ilfé 176 to 180 18 t 86 to 90 I2 6 181 to 185 18 t 91 to 95 I2 186 to 190 1856 96 to 100 12}¢ 191 to 195 1856 101 to 105- Izit 196 to 200 19 d 201 - This will not be a common rate for us and we will have to truck it by finding trucks and rates on hand. These rates will appiv for wheat, soybeans, corn, rye, and edible beans in bulk. For trucking oats, barley, and any other grains, cheek with Dispatcher. 80 There are several theoretical requirements for an organized OligOpsony: First a market leader must exist. Usually they have a significant portion of the market, at least 25 percent. In the Thumb, 25 percent of the elevators are affiliated with Michigan Elevator Exchange. And secondly, the leader must be able to communicate pricing decisions. In practice, U.S. anti-trust law prohibits com- munication of price or other decisions between members of an oligop- sonist industry. In the Thumb, communication is achieved within legal limits as the exempt truckers themselves serve as the communi- cation vehicle! As truckers go from elevator to elevator, they quote the Michigan Elevator rates. And thus the oligopsonist elevators capitalize on the non-monetary utility component of the competitive trucker's return. Roads, highways and bridges The exempt trucker and the fammer are served by a 5,500 mile network of roads, highways, and bridges in the three county Thumb region (Figure 3-4). This network consists of three classes of roads: state highways which comprise 440 miles, or eight percent of the total; primary highways, which comprise 1,020 miles or 18.5 percent; and local rural roads, which comprise 4,050 miles or 73.5 percent. This extensive grid of roads is, however, inadequate for the grain marketing needs. The farm to elevator movement is re- stricted because only 35 percent of the roads are paved, and only 12 percent are all weather. Grain flows between elevators and markets are also impeded because one-third of the Thumb's elevators, with 25 percent of the capacity, are served only by roads with seasonal restrictions. 81 —— Roads and Highways with Seasonal Restrictions _. . _ All Season Roads and Highways Figure 3-4. Thumb Area Highway Network 82 The grain flow is further restricted by the physical and technological obsolescence of the system. A recent evaluation by county engineers indicated that 21 percent of the primary roads, 42 percent of the local roads, and 48 percent of the bridges are inadequate by federal and state engineering standards. Part of the inadequacy results from the age of the road. A recent study reported that about 70 percent of the nation's rural bridges in use today were built before 1935.6 By 1950, about 50 percent of the structure of the local rural roads were in place. Thus the widths, grades, bases, surface designs, and capacities of many rural roads in use today were designed to meet the traffic needs of the 1930's and 1940's. Since 1950, however, farm size has increased substantially, and the larger farm is operated with larger equipment. Today many rural roads and bridges are not wide enough to handle much of the current to carry large capacity farm trucks and thus are technologically obsolete. The problem is compounded by increased yields per acre, which have increased the volume of grain moving over the roads. The distance 13x2 grain travels has also increased because the lower average costs associated with large farm truck and large elevators encourage farmers to bypass local elevators and haul direct to a subterminal. In fact, many small elevators move a significant portion of their grain to local subterminals by truck, increasing road usage. 6C. Phillip Baumel , The Local Rural Road and Bridge Problem and Alternative Solutions, National Extension Transportation Task Force, U.S. Department of Agriculture, Washington, D.C., N.D., p. l. 83 The Water Transport System Even though it is bordered by the Great Lakes-St. Lawrence navigation system, there are no ports located in the Thumb. Two reasons for this are engineering limitations and spatial competition. From an engineering explanation, many miles of the Lake Huron and Saginaw Bay shoreline are marshy and not suited for port construction without extensive and continuing dredging. Some shore- line would not even support elevator footings. From a spatial competition explanation, the freight savings associated with vessel loading apparently do not offset the advantage of a location in the center of a grain production region. Or at least in the mind of the terminal owners it does not. During the interviewing process the terminal managers discussed both reasons but seemed to stress the spatial competition aspects. And as oligopoly theory suggests, they were very concerned about the loca- tion decisions of other firms constructing terminals. The Thumb does, however, have access to water transportation since it is served by terminals located at the nearby ports of Saginaw, located on the Saginaw River, and Toledo, located on Lake Erie. While many salties, or ocean vessels, navigate the Great Lakes-St. Lawrence system, its ports are at a comparitive disadvantage with Atlantic ports. Fresh water provides less buoyancy than salt water, which reduces the weight a salty can take on. Their loads are further restricted by the 27 foot depth of the St. Lawrence which limits ships to a draft of 255 to 26 feet. With these restric- tions many salties are limited to half of the normal load and must 84 top off at some point beyond the seaway, usually Montreal. The loss of one inch at the water line can reduce the cargo-carrying capacity of a major vessel by 80-120 tons. The Great Lakes-St. Lawrence system is further restricted by the freezing of the fresh water. In spite of the technical capabilities for 12 month navigation, the Great Lakes-St. Lawrence system is onlqugfi;open eight to nine months per year.7 The port of Saginaw has an additional impediment. With a maximum depth of 22 feet, the Saginaw River forces salties loading at the Saginaw terminal to top off before leaving Lake Huron. In addition, the Saginaw River requires continuing dredging to maintain its 22 foot channel. But deeper dredging is prohibited because bridges have been engineered based upon a 22 foot river depth. Therefore the port of Saginaw is best suited to shipping lakers, ships with a sampan design constructed specifically for lake commerce. Because of these limitations there is little incentive for empty vessels to enter the Great Lakes-St. Lawrence system to load grain, Therefore, the supply of ocean vessels within the system is dependent not upon the demand for outbound service, but rather upon the volume of inbound commerce. A primary source of inbound traffic is steel destined to the automobile manufacturers, and thus the supply of ocean vessels to load grain is, in part, a function of the U.S. trade policies governing steel. 7John L. Hazard, Winter Commerce on the Baltic: Some Impli- cations on Opening the Great Lakes, Land Economics, Vol. XLVII, Number 3: August 1971, pp. 256-266. 85 Water rates The level of water rates is affected by both short run and long run factors. Since water rates are unregulated, they vary over time in response to changes in either the short run supply or derived demand for transportation services. It is these short term rate fluctuations which determine the level of investment in vessel capacity. The available technology is the major factor in establish- ing the long term rate level. And for the Great Lakes ports, the vessel carrying capacity of the Great Lakes and St. Lawrence Seaway is the determining technology. For example, modernization of the St. Lawrence Seaway, completed in 1959, gave larger ships access to the lake ports and generally reduced rates. It is also the long term technologically based vessel charges which the railroads respond to. The completion of the St. Lawrence Seaway created a new competi- tive environment, and the railroads responded by publishing lower export rates. The elevator survey revealed that 17 percent of the total grain marketed through Thumb region elevators was transshipped through the ports of Saginaw and Toledo. Forty-two percent of the Thumb region's grain destined for export markets was transshipped through the ports, with the remainder shipped by unit train from the subterminals within the Thumb. However not all grain shipped to Toledo and Saginaw is reshipped via water. Each of the vessel loading facilities at Saginaw also has unit train capabilities, and some terminals at Toledo are not even located on water, while the remainder have both train and vessel loading capabilities. The seasonal loading restriction imposed by the freezing of the lakes 86 and seaway necessitates dual loading facilities. The amount of grain transported direct to the lake ports by Thumb region farmers is also thought to be an insignificant portion of the total grain volume. Because port elevators chose not to reveal the origins of their grain, this assumption is based upon several other factors. Various elevator managers were asked to indicate the volume of grain they thought was delivered direct by farmers to the ports. Secondly, the institutions which restrict farmer delivery to the terminals limit the amount of grain which can bypass Thumb area elevators. Further the extensive utilization of unit trains by port elevators suggests that ocean and rail rates are competitive. And thus the subterminals located along the western border of the Thumb which also have train rates would intercept grain before it reached Saginaw. Economics of vessel ownership Vessel owners have suffered from excess capacity until very recently.8 From 1974 through 1978, ocean rates were at extremely depressed levels, which made vessel operation uneconomical. Exces- sive ship orders during the last shipping boom and slow trade growth created excess capacity. And governmental subsidies designed to protect jobs resulted in additional tonnage which was not needed and which prolonged the slump. During 1979 the rates from U.S. gulf ports to Amsterdam have more than doubled. Owners still are not fully covering fixed costs 8N. Leonard Anderson, "Ocean Freight Exerts Influence on Export Trade," Cargill CrOp Bulletin, June 1979, Minneapolis, MN, p. l. 87 on newer vessels, but older tonnage and tonnage purchased at depressed prices is operating profitably. Thus during the period of this study, in addition to rail and truck rates, ocean rates also failed to compensate the carrier for the services rendered. The Public Sector A Word on Theory The final participant in the grain marketing process is the public sector which performs various functions including planning, regulation, funding, and taxation. In these capacities the government modifies the opportunity sets of all channel participants by estab- lishing and altering rights, privileges, exposures, and responsibil- ities and thereby changing the costs borne by a firm or sector. As identified in Chapter I, the public sector serves as the arena of interaction in which the various private participants attempt to alter or control the imposition and extent of market impacts and externalities. Each private individual and firm knows the game and the rules, and thus all decisions made are conditioned and motivated by these rules. And each public agency also knows the rules of the game, and through its administrative process builds a clientele which provides justification for continuing the agency. Public provision of transportation Throughout history the public sector has assumed various roles in the provision of transportation services and way. Generally roads, highways, and bridges, and waterways have been primarily provided by the government. Rail lines, on the other hand, have 88 normally been provided through the private sector. "The Great Fiasco" was an exception in which the State of Michigan responded to citizens' demands for improved transportation services by building railroads.9 The results of this 1837 venture were so financially devastating that a constitutional provision was implemented prohibiting State involvement in transportation. The constitution has since been changed, again allowing State involvement in rail lines. Therefore today the various levels of government are financially involved in all modes of transportation except pipeline. The public continued ‘U3construct.and maintain highways, waterways, air terminals and airways, and recently has to a limited extent become involved in rail line maintenance. Operating subsidies are provided to some rail companies and airlines. Policy Impacts and Opportunity Sets This section describes areas in which the public sector serves as the arena of interaction in which rights are altered, resulting in enhanced or restricted opportunity sets. Changes in technology After New York City became the commerce center on the Atlantic coast, because of the Erie Canal, other states quickly followed suit and constructed canals. However, these investments were rendered worthless by the commercial success of the iron horse. To protect their investment and to assist in repaying construction bonds, New 9Willis F. Dunbar, All Aboard! A History of Railroads in Michigan (Grand Rapids, Michigan: William B. Eerdmans Publishing Company, 1969), p. 121. 89 York, Pennsylvania, and Ohio all taxed the railroad on tonnage moved and restricted the commerce which could move by rail. A century later, as trucks started eroding rail traffic, similar protection was not forthcoming. Road construction Congestion resulting from automobile and truck traffic may justify construction of a multi-lane limited access highway. And while the community may view trucks as marginal vehicles, the road will be designed to facilitate their use. In addition to providing a faster flow of automobile traffic, the new road will also reduce the cost of operating trucks. Thus the trucking industry can capitalize upon the change, and the net result will be a shift of traffic from the railroads to the motor carrier. And a public expenditure primarily designed to facilitate automobile traffic enhances the opportunity set of the trucking firms at the expense of the railroad. In fact, while the needs of the automobile owner may justify the new highway, the most intensive lobbying efforts will not come from them but rather from trucking and construction in- terests. Highway engineers recognize this, and thus highways are designed and built to carry trucks. Prohibiting or rerouting truck traffic is a viable long term solution, but it is seldom even dis- cussed, let alone used. Rather, new highways are built, and the client-agency relationship insures the continuing proliferation of concrete solutions to the traffic congestion problems. 90 Rail abandonment The rail abandonment hearing is the classic example of behavior modification resulting from a specific set of rules adminis- tered by a public agency. Normally when a business is unprofitable, a market decision would indicate that the operation cease. But the impacts of abandonment are considered to be so great that the public sector has collectively decided that a market solution is not apprOpriate and that a specific legal procedure must be followed. This institution not only alters performance but modifies all the behavior of all community members extensively. Crossings and fences Historically, when a road was built across the private pr0perty of the railroad, its rail line, the railroad was responsible for maintaining the crossing, which came to be used by its competi- tion. In some states the railroad is responsible for fences which keep cattle off the rail lines while the farmer is responsible for fences which keep cattle off highways. And since highways are public property, they are not taxed while rail right of ways are taxed. These differences in property rights and institutions have altered the Opportunity sets of both modes. The Performance of One Agency Many agencies serve as arenas of interaction for the various transportation users and suppliers in the Thumb. The performance of some, such as the I.C.C. and BOT, have been reviewed extensively by others and thus will not be discussed. This focus will be upon those agencies which are unique to Michigan and the Thumb. 91 Simular to most other states, Michigan did not have a Department of Transportaion before the mid-1970's. Rather it had a Department of Highways and a Public Service Commission which participated in railroad abandonment hearings. But the collapse of the Penn Central, the DOT Preliminary System Plan, and the RRR Act provided the need for a comprehensive planning agency. The result was the creation of a Rail Planning Section within the Department of Highways. The word transportation was also added to the department name, resulting in the Department of Highways and Transportation. One of the first public actions regarding the Thumb taken by the newly created Section was to drop a bomb at Caro, Michigan. This bomb reverberated throughout the Thumb and eventually came back to shake the Department. It was on August 12, 1975, a hot, sultry evening, that Congressman Traxler was holding a public meeting to discuss the future of the Grand Trunk Western line between Imlay City and Caseville (an abandomment petition had been filed on the line October 15, 1974). After the president of the GTW, John Burdekin, had explained the financial dilemma of the line and the State Department of Agriculture, through Porter Barnet, had dis- cussed the need for the line, Tom Trimbach of the Michigan Rail Planning Section discussed the future of the line by stating: I kind of get the job in state government to figure this all out. I'm in charge of the Rail Planning Section. . . . We are at the present time planning to subsidize the solvent carrier from Imlay City to Caseville, and we've asked for a proposal and this letter is about to go out to all of the 92 solvent carriers. This is one line we are planning to keep open and we will subsidize it.10 The audience sat in stunned silence and then slowly broke into applause, as many faces broke into smiles of victory. The rail line had been saved! However a few audience members had looks of shocked concern on their faces as they turned to others and ques- tioned Trimbach's authority to make the statement and the state's financial ability to carry it out. Congressman Traxler then stated: You know, if we had gotten that letter we wouldn't have had a meeting. I think what you are telling us is that as far as the State Railway Plan, it is your intention to provide sub- sidies for the non-profitable, non-bankrupt lines that you think are meritorious and deserving of that kind of subsidy, and you're telling us that the state perceives that this Imlay City to Caseville line is one of them, is that correct?11 Trimbach then added: Very simply, we had a hell of a crisis until we had the tripple R Act of 1973. There is sufficient dollars available from both the Federal government and currently being made by the State government in line with the whole set of plans here that we're working on in the state government to first sub- sidize the state in the problem areas and to determine how much money is necessary to keep it in operation. . . . I guess I'm kind of put on the spot to tell you what I think of your Imlay City to Caseville. Well, so I am. We've studied this thing. We've analyzed it. We've put out various plans and analysis so far. We consider it extremely important. I know of no reason why it would not fall into a marginal category and could not be subsidized. Our plan here would be running it through a private enterprise which is the current carrier and unless we get a complete hangup on negotiations, we would plan to sit down and negotiate with the solvent carrier in keeping that 10Caro, Michigan, Public Response of the Citizens of Michigan's 8th Congressional District to a Grand Trunk Abandonment Proposal, Imlay City to Caseville, Michigan, and the Conrail Proposal. Congressman Bob Traxler, U.S. House of Representa- tives, Washington, D.C., August 1974, p. 20. llIbid., p. 20. 93 line open for a reasonable amount of money. And that's what the whole game is all about.12 Eighteen months later, during February, 1977, the abandon- ment hearing was held on this line that the State had promised to "keep Open" and "subsidize." The State was represented at the hearing by a staff attorney from the Attorney General's Office assigned to the Highway and Transportation Department. Because of the conflict which arose, the specific role of the State in I.C.C. abandonment cases should be clarified. That role is to represent the interest of all Michigan shippers and peOple and not necessarily the interests of shippers located on a particular rail line. Usually, however, if the State intervened, it was on the behalf of the shippers located on the contested line in order to preserve service. The State intervened in the Imlay City to Caseville hearing, apparently to work with shippers to pre- serve service. But after the hearing the State's staff attorney felt that the shippers were not supportive of the State's effort. In fact, by the end of the hearing he felt the shippers were working with the GTW. And many shippers interviewed agreed with him. The primary reason may have been that the new director of the Rail Planning Section had testified: As a result of the Department's analysis of the situation, it has been determined for various reasons to be developed during this hearing that the Grand Trunk Western received adequate financial compensation for owning and operating the line in question, and therefore the department has obviously become an active protestant in the case with the expressed goal of having the Interstate Commerce Commission rule that the Grand Trunk Western be required to continue to own and provide 121bid., p. 21. 94 service on the trackage in question without compensation or sub- sidy by an independent party such as the State of Michigan.13 The shippers felt the abandonment petition was simply part of a much larger problem which "saving" the line could not solve. They felt that the deteriorated condition of the line prevented adequate service and that freight revenues would not allow the GTW to rehabilitate the line. After the State reversed its position, the shippers felt they had been abandoned and that the State didn't comprehend the real issues. Shortly after the decision had been reported by the I.C.C., the State's assistant attorney for the case questioned the need for this study by exclaiming, "Oh, you don't have to worry about this line anymore!" Perhaps the shippers'feelings were valid! 13Cass City, Michigan, Hearing before the Interstate Commerce Commission on the Grand Trunk Western Railroad Company's Abandonment between Imlay City and Caseville, Michigan, February 1977, p. 410. CHAPTER IV THE MATHEMATICAL MODEL The use of logistics theory to solve macro distribution problems is a recent development, occurring simultaneously with improvements in computer technology and capability. Not until the 1960's did a significant volume of work appear which addressed distribution questions such as: where should plants be located, how many should be built, which sources should supply each plant, and which plant should service each customer? In this chapter, a review of the more prominent theoretical efforts will precede the develOpment of the mathematical model used in this study. The chapter will conclude by describing the informa- tion in the model. Development of the Theory Location Theory The systems analysis techniques utilized 1J1 rationalizing logistic systems have developed from the location theory literature. A German economist, von Thunen, is generally considered the founder of location theory.1 His work was followed by another German, 1J. H. von Thunen, Der esolierte Statt in Beziehung auf Landevertschaft and Nationalokonomie, Hamberg, 1826. 95 96 Weber.2 While their work involved many abstract assumptions and utilized approaches which later proved to provide inadequate theory, Weber and von Thunen provided the impetus for others to deve10p and refine location theory. The result has been the development of a discipline which has provided the economic framework for solving logistical location problems. In recent years many economists have applied location theory to solve agricultural marketing problems. Some of the more signifi- cant efforts are discussed below. The Early Models The plant location models developed during the early 1960's treated space as continuous and assumed that supply or demand was uniform throughout the region. These models determined the optimum sized plant and the corresponding market area dimensions. Included in this grouping are four studies. In 1959, Fred Olson developed a model which determined how far apart dairy processing plants should be located based upon transportation and processing costs.3 Williamson develOped a theoretical model in 1957, which illustrated "how the equilibrium size of marketing plants located in a spatial market depends upon marketing density.4 In 1960, Henry and 2A. Weber, Uber den Standort der Industrien, Tubingen, 1909 (translated, Afred Weber's Theory of Location of Industries, by C. J. Freidrich, Chicago: University of Chicago Press), 1928. 3Fred L. Olson, "Location Theory as Applied to Milk Process- ing Plants," Journal of Farm Economics, Vol. XLI No. 5 (December 1959). PP. 1546-l556. 4J. G. Williamson, "The Equilibrium Size of Marketing Plants in a Spatial Market," Journal of Farm Economics, Vol. 44, No. 4 (November 1962), pp. 953-967. 97 Seagraves applied this model to the broiler industry and determined the lowest total unit cost for processing and assembly.5 French enlarged upon the theoretical framework of previous studies by exploring the special case involving a square grid system, the system present in much of the Central United States.6 He also estimated long run assembly cost functions and identified efficient assembly techniques. The Stollsteimer Model Building upon the above works, John F. Stollsteimer developed a model which determined the least cost number, size, and location of plants.7 In his words: The problem is one of determining the number, size and location of facilities that will minimize the combined cost of assembling and processing the total quantity of raw material ' produced in the region, given I raw material sites, each of which produce a quantity (xi) of a material to be assembled and processed at one of L possible locations. The procedure required to minimize [these costs] with respect to plant number and location varies with the presence or absence of economies of scale in plant Operations and the way in which plant costs are influenced by plant location.8 To solve empirical problems the model requires four categories of data which include: 5William R. Henry and James A. Seagraves, "Economic Aspects of Broiler Production Density," Journal of Farm Economics. Vol. XLIII, No. 1 (February 1960), pp. l-l7. 6B. C. French, "Some Considerations in Estimating Assembly Cost Functions for Agricultural Processing Operations," Journal of Farm Economics, V01. XLII, No. 4 (November 1960), pp. 767-778. 7John F. Stollsteimer, "A Working Model for Plant Numbers and Locations," Journal of Farm Economics, V01. 45, No. 36 (August 1963): pp. 631-645. 81bid., pp. 632-633. 98 (1) Estimated or actual amount of raw material to be assembled from each point of origin (in distribution problems the amount of product demanded at each destination). (2) A transportation-cost matrix which specifies the cost of transporting a unit of material between each point of origin (destination) and each potential plant site. (3) A plant-cost function (or functions) which permits the determination of the cost of processing any fixed total quantity of material in a varying number of plants. (4) Specification of potential plant locations.9 Although the Stollsteimer Model has become a classic in plant location theory, it contained several restrictions which limited its usefulness. Other economists have suggested modifica- tions which incorporate additional realism, increase the size of the problem which can be handled, and explore the sensitivity of the solution. Modifications to the Stollsteimer Model Polopolus extended the model to include multiple raw products and multiple finished goods.10 This multiple product model differs from Stollsteimer's Model in that "aggregate assembly costs are affected by varying locational patterns as the product dimension is increased and that total processing cost varies both with the number of plants and the combination of products handled at each optimum plant location."11 Chern and Polopolus discussed the shortcomings of the con- tinuous and linear plant cost function used by Stollsteimer: 91bid., p. 639. 10L. Polopolus, "Optimum Plant Numbers and Location for Multiple Product Processing," Journal of Farm Economics, Vol. 47,, No. 2 (May 1965): PP. 287-295. 111bid., p. 287. 99 First, continuous plant cost functions are often unrealistic when applied to agricultural handling and processing operations. Second, under the implicit assumption in the Stollsteimer model that an identical TPC function exists for each plant, the nature of a linear function limits the impact of the size of individual plants in determining an industry's total plant cost. Third, theoretically the long-run total plant cost goes through the origin. It is reasonable to expect a very small, if any, inter- cept value if the TPC function is continuous and all factors of production are completely divisible and are therefore treated as variables in the long-run. Hence, the assumption of cone tinuity and linearity is not a realistic assumption and there- fore represents a weakness of the original model.12 Thus they made the following modifications to the Stollsteimer Model: (1) The number of locations are treated independently of the number of plants due to the constraint on maximum plant capacity, and "multiplant" locations therefore may appear in the results; (2) the effects of plant size on the magnitude of total plant costs are explicitly shown by adopting a discontinuous plant cost function; (3) excess capacity is introduced in determining the Optimum solution.13 Warrack and Fletcher suggest an algorithm that operational- izes the Stollsteimer MOdel for problems where many plants can enter the solution.14 The problem they identified was the following: Operational constraints of the Stollsteimer long-run spatial model have been severe. The data input requirements are large. More serious, for all but small problems the optimization tends to be computationally demanding to the point of infeas- ibility.15 12W. Chern and L. Polopolus, "Discontinuous Plant Cost Function and a Modification of the Stollsteimer Model," American Journal of Agricultural Economics, V01. 52, No. 4 (November 1970), p. 581. 13Ibid., p. 584. 14A. A. Warrack and L. B. Fletcher, "Plant-Location Model Suboptimization for Large Problems," American Journal of Agricultural Economics, Vol. 52, No. 4 (November 1970), pp. 587-590. 151bid., p. 587. 100 Fuller, Randolph, and Klingman used a network analysis approach to determine the impact of decreasing regional raw product outputs and changes in storage technology.16 The basic Stollsteimer Model was expanded to consider the outbound flow of product by King and Logan.17 They developed a transshipment model which simultaneously considered the cost of shipping raw material, processing, and shipping final product. By providing for shipment through intermediate supply or demand points, this model expanded the economic activities which could be examined. The King and Logan model has subsequently been modified to include more realism by Hurt and Tramel18 and Leath and Martin.19 Other modifications to the King and Logan transshipment model include a sensitivity test developed by Taft, Cassidy, and McCarthy,20 which determined the stability of solution, separate 16Stephen W. Fuller, Paul Randolph and Darwin Klingman, "Optimizing Subindustry Marketing Organizations: A Network Analysis Approach," American Journal of Agricultural Economics, Vol. 58, NO. 3 (August 1976). pp. 425-436. 17Gordon A. King and Samuel H. Logan, "Optimum Location, Number and Size of Processing Plants with Raw Product and Final Product Shipments," Journal of Farm Economics, Vol. 46, No. 1 (February 1964): pp. 94-108. 18Verner G. Hurt and Thomas E. Tramel, "Alternative Formula- tions of the Transshipment Problem," Journal of Farm Economics, Vol. 47, No. 1 (August 1965), pp. 763-773. 19Mack N. Leath and James E. Martin, "The Transshipment Problem with Inequality Restraints," Journal of Farm Economics, Vol. 48, No. 4, Part I (November 1966), pp. 894-908. 20H. I. Taft, P. A. Cassidy and W. O. McCarthy, "Sensitivity Testing and the Plant Location Problem," American Journal of Agricultural Economics, Vol. 52, No. 3 (August 1970): PP. 403-410. lOl programming by Kloth and Blakely,21 and concave programming by Chandler, Snyder, and Faught.22 As with much of economic theory, the Stollsteimer Model assumes that there are no institutional or structural restraints which constrain the least-cost optimal location of plants. However, public policy and efficient plant location may be in direct conflict because the efficient number and size of plants usually involves economies of scale or a spatial monopoly. Public policy decries monopolistic industrial structures and through various courses of action has attempted to preserve competition. Thus within an applied framework Optimal solutions can only be reached when insti- tutional restrictions are included. Bobst and Waananen examined the results of public policy upon the spatial organization of the dairy industry.23 Restricted and unrestricted solutions for an example problem and for the fluid ’ milk processing industry in the State of Washington are compared. The restraints are shown to alter spatial organizations in such a 21Donald W. Kloth and Leo O. Blakely, "Optimum Dairy Plant Location with Economies of Size and Market Share Restrictions," American Journal of Agricultural Economics, V01. 53, No. 3 (August 1971): PP. 461-466. 22Wilfred Chandler, James C. Snyder and William Faught, "Concave Programming Applied to Rice Mill Location," American Journal of Agricultural Economics, Vol. 54, No. 1 (February 1970), pp. 126-130. 23B. W. Bobst and M. V. Waananen, "Cost and Price Effects Of Concentration Restrictions in the Plant Location Problem," American Journal of Agricultural Economics, Vol. 50, No. 3 (August 1968): pp. 676-686. 102 way as to increase industry costs, but they also reduce the latitude for spatial price discrimination which may-exist in unrestricted organizations. During the 1970's several plant location models have been designed to specifically analyze the grain subsector. The first of these was developed at Iowa State and applied in Iowa, Nebraska, and Missouri.24 Other models have been developed in Canada, Illinois, South Dakota, Indiana, Ohio, and Montana.25 These models are conceptually similar and have similar objective functions. They differ, however, in two general aspects. First, each test region has unique characteristics which modified the models. And secondly, each study placed different emphasis upon the various functions that facilitate the physical grain flow. Thus, each model has unique subroutines. These dif- ferences will be identified later in this chapter. The Mathematical Model The method of analysis utilized in this study is based upon a mathematical Optimization model. The particular model used is a two stage, single-period transshipment plant-location model which was developed at South Dakota State University. The solution is based upon a combination algorhythm which searches and compares alternative grain distribution systems and selects the optimal configuration based upon the criteria of minimizing net marketing 24Baumel, et al., Economic Analysis of Alternative Systems; Anderson, Gaibler and Berglund; Salomone, Moser and Headley. 25Tosterud; Bunker; Lamberton and Rudel; Hilger, McCarl, and Uhrig; Solomon; Koo and Cox. 103 costs for producers (because of the small geographic area, pro- ducers incur changes in efficiencies). Components of the distribu- tion systems which potentially would be modified include collection, handling and processing, or distribution activities involved in marketing specific volumes of grain from farm origins through elevators and transshipment point to final destination under the constraint of partial equilibrium in the grain industry. The optimizing procedure required the following data base: A specific volume of grain available at each origin xij in time t. Markets or destination requiring a specific volume of grain xjk during time t. A handling or processing cost function H for each node in the elevator and subterminal grain handling system. And collection A and distribution D costs for each potential link including farm truck, commercial truck, vessel, or the rail alter- natives; single car, three car, 10 car and unit trains. The handling and transportation cost functions are interdependent and display substantial economies of scale. To achieve economies of scale in distribution, an elevator must have a large facility which also yields economies of scale in handling and processing. Since elevator size varies substantially in the Thumb, the cost of processing and transporting grain varies substantially among firms. The specific cost of each node and link is develOped later in this chapter. The demands for grain that the model satisfies represents the actual destinations of grain shipped by Thumb region elevators in the 1976 marketing year, and the supply represents the actual reported marketings. 104 Mathematically the model is expressed as follows: Given LP'C Minimize TC = u NIH 3’ X + 1ft” u :1: N + where TC = total assembly, handling and distribution costs Aij = cost per bushel of transporting grain from supply area (i) to elevator (j); x.. = bushels of grain transported from the supply area (i) to the elevator (j); LP = a predetermined or existing location pattern for j elevators amont the (3) possible combinations for J elevators given L potential locations, J :_L; C = institutional constraints; H- = cost per bushel of handling grain at elevator j given plant sizes, LCj; Xj = bushels of grain handled at elevator (j); Djk = cost per bushel of transporting grain by rail or truck from elevator (j) to terminal (k); and Xjk = bushels of grain transported from elevator (j) to terminal (k). Figure 4-1 schematically describes the movement of grain as represented in the mathematical model. The grain marketings of each farm are transported by farm truck to one of three alternative destinations: a local elevator, a subterminal located in or near 105 Home: HOOflunEonunz onu mo wouomm coHumuuommcmua can mcfiuwxumz samuw can no Edumm«o oaumamnom .Huv whomam Hana J Hmcfifiouasm anamoz nouns 9685. - mug—Mme. - \_. - uuomxm n a Hmcaefiounom uoum>oao (v xoonu m cwumxu E - Hmm AIL acumen 8.8 xoaeT random ll Emu Shoo )\ HQUQH ‘ F mumxume Hmcowmom *6st I —! umxnos occamam 382 Hand m 106 the Thumb, or a destination located in or near the Thumb. Receipts at local elevators are shipped back to farms via farm truck, to either subterminals or markets located in or near the Thumb via commercial truck, or to Eastern feed destinations by railroad. Grain received at Thumb area subterminals is shipped via unit train to export destinations or by truck to nearby ports. And either unit trains or water is used by subterminals located near the Thumb to reach export markets. Assumptions To represent most realistically the actual logistics system, the simulation model should have as few simplifying assumptions as possible. Some assumptions, however, are required to simulate a system which is as complex as the agricultural grain marketing system. The assumptions which underlie this study are listed below: (1) All data must be in single standard units of measure- ment. (2) All data and problem information must be expressed numerically. (3) Quantities of grain supplied and demanded are pre- determined. (4) Assembly costs vary only with distance and quantity. (5) Farmers who are diverted to other elevators as a result of rationalization minimize their delivery costs by hauling to their nearest remaining delivery point. 107 (6) All grain delivered to the elevator is shipped out; thus an elevator's beginning inventory is equal to its ending inventory. Data Required for Model Questionnaire Much of the data used in this study was secured through a questionnaire administered during a personal interview which asked about physical characteristics and grain volumes for each elevator (see Appendix A). The physical characteristics requested included storage capacity as of July 1, 1977, receiving capacity, load out capacity, the presence or absence of dryer facilities, and length of rail siding available. Also, each elevator was asked the types of commodity handled, bushels of each handled during the 1976 marketing year, and destination and mode of outbound shipments by commodity. This questionnaire was completed during the summer of 1977 by the elevator manager and the interviewer. Most other grain rationalization studies used mailed surveys to secure their information. The personal interview strategy employed in this study contributed a wealth of additional informa- tion and insight beyond that which could be secured from a mailed questionnaire. Much of this information dealt with the institu- tional behavior and performance aspects of the elevator and trans- portation subsector in the Thumb. In conversations most elevator managers provided a great deal of information dealing with normative issues including the quality of rail service, the changing 108 competitive environment in the Thumb, changes in the structure of the region's elevators subsector, and the impact of technological changes. Elevators in the Thumb The list of the grain elevators serving the Thumb was com- piled from the Official Directory of Michigan Grain and Agri Dealers Association. This list was compared to a list of licensed elevators secured from the State of Michigan. After carefully evaluating the business of each firm, it was determined that 60 elevators purchased grain in the Thumb. Of these, 48, or 80 percent, pro- vided data regarding their grain volume, shipments, and destinations. Wickes Agricultural, which owned and Operated 12 elevators serving the Thumb, chose not to provide information for this study. Receipts and shipments for the Wickes facilities were projected by multiplying their licensed storage capacity by the turnover rates corresponding to similar elevators. Location, ownership, capacity, and rail service are identified for each elevator in Table 3-7. Grain Requiring Logistical Services The amount of grain which requires handling and transporta- tion services is dependent upon various factors and assumptions which are discussed in this section. Assumptions which differ between this and other grain system rationalization studies will also be identified and discussed. 109 Grain production requiring logistic services Grain produced within the Thumb is either consumed locally or shipped beyond the Thumb to final markets. Grain shipped out of the region requires both elevator and transportation services and in this study is defined as commercial grain. The Thumb is also a major livestock production area, and feed grains are marketed through livestock. Neither elevator nor transportation services are required for grain fed on the farm on which it is produced. Thus this grain does not enter the model. However, some grain fed in the Thumb passes through elevators and because it requires elevator services, this grain enters the model. It uses elevator capacity but does not incur distribution costs nor does rationaliza- tion alter its assembly costs. This assumption is based upon Baumel's conclusion that the results of this research under the assumptions stated, suggest that none of the alternative grain distribution systems evaluated would force country elevators out of business if their railroad line would be abandoned.26 Thus the country elevator would continue in business and purchase feed grains for resale to area farmers. Interregional grain flows Its geographic location, the elevator locational pattern, and institutional restraints served to isolate the Thumb from inter- regional grain flows. While some grain was imported and exported, the amount was not substantial. Thus no import or export assembly vectors were included in the rationalization model. The capacities 26Baumel, et al., Economic Analysis of Alternative Systems, p. 75. 110 of border elevators were modified, however, to reflect inter- regional grain flow. Monthly grain marketing Many rationalization studies determined grain flows on a monthly basis or some other division of the marketing year.27 But this study used annual flow for two reasons. First, many regions such as Iowa or Illinois produced corn and soybeans which are harvested simultaneously over a short period of time. This places stress upon the capacities of marketing facilities. In the Thumb, corn, beans, and wheat are major crops by volume, and wheat harvest starts in July, while corn harvest extends into December. Thus the stress is much less. And secondly, monthly grain marketing patterns vary over time in response to prices, price expectation, and tech- nological change. For example, the Iowa State study found that In a twelve county district. . . . the amount of grain moving off the farm in the fall as a prOportion of total grain movement increased from 29 percent in 1964 to 59 percent in 1969. The increase in the amount of corn moving from the farm to the elevator in the fall reflect to a large extent the increasing use of corn field shelling. Field shelled corn requires the use of aeration and drying equipment, which is often more accessible at elevators during harvest than on farms.28 ' In spite of the tremendous changes in marketing patterns over the five year period, 1964 to 1969, the Iowa study used 27For example, all studies using the Iowa State model and Bunker's study at Illinois. 28Baumel, et al., Economic Analysis of Alternative Systems, p. 13. 111 the monthly flow of grains from elevators, as reported by elevator managers for the 1970 cr0p year, . . . to estimate the monthly flow of grain in 1980. . Adoption of the picker sheller may have been simply the first step in adopting a technological package. Since 1970, many farmers have purchased dryers, and the volume of grain sold during harvest has declined. And any model which is built upon only part of a technological change will not be representative in the long run. Iowa State's projection of the monthly marketing pattern for 1980 was also based upon projected supply and demand conditions in 1980, because of increased foreign and domestic demand for corn and soybeans, it was assumed that government storage and reseal programs would not exist in 1980 or that the net flow of grain into and out of these programs would be zero.30 Forecasting grain carryover on a year to year basis is difficult; over a long period of time it becomes impossible. Annual carryover has increased significantly over the past few years, and it is extremely unlikely that 1980 will see a net change of zero in carryover stocks. In summary, monthly shipments add very little substance to a mathematical grain marketing model. While the results may more closely simulate the historical base year, any changes in the market pattern reduce the validity Of the results. Thus this study will use annual grain flows. 291bid., p. 15. 3OIbid., p. 15. 112 Volume of grain Seven major crops are grown in the Thumb region: corn, wheat, oats, barley, dry beans, soybeans, and sugarbeets. The volume of each crop moving into commercial channels was determined during the personal interview processes when each elevator manager identi- fied the volume of each type of grain processed for the 1976 crOp year. Marketing patterns Each cr0p produced in the Thumb has a different marketing pattern, so the destination of each is analyzed individually. The destinations represent the marketing patterns for the 1976 crop year. Corn, oats, and wheat were included in the mathematical model. For the reasons identified below, the other crops were excluded from the model. Corn The corn entering marketing channels accounts for nearly half of the total crop volume marketed in the Thumb. About five percent of the grain marketed is fed in the Thumb. Of the remainder, about 55 percent was sold for feed in Eastern markets from New York through New England while 40 percent is exported through Eastern ports. The export grain primarily moves through subterminals and unit trains. The New England market is reached through single and three car shipments. Boston was selected as the representative destination for the New England feed markets. 113 Oats Feed grains include both corn and oats, and for purposes of this study they are combined. Some of the oats were used for local feed while the remainder flowed by single rail car and truck into the near East markets, which extend from Kentucky and Ohio east to Virginia and New York. Wheat Nearly 60 percent of the wheat produced entered export channels through unit trains to the east coast markets, while about nine percent moves to New England. A third of the wheat is milled in Michigan and enters the private distribution system of the miller. Drybeans There are certain crops for which rationalization is neither practical nor possible, and drybeans are one. They are a specialty crop, and Michigan produces over 25 percent of the U.S. total production. Thus Michigan production goes over the U.S. from Maine to California and from Maryland to Texas to Oregon, which constrains any mathematical model. Furthermore, as the beans leave the Thumb, they have already been sold to canners. The canner, therefore, will internally rationalize supply and consumption patterns with his plant locations, and rationalizing the Michigan production would provide no useful information. 114 Soybeans Soybeans are a minor crop in the Thumb, and most move by truck to Toledo. There they are combined with the production from other regions and shipped out by unit train or vessel. Unless soybean production increases drastically, the marketing process is already as efficient as possible. Shipping by rail would increase total costs, and unit trains from the Thumb are not feasible. Therefore soybeans are excluded from the mathematical model. Barley Barley is also excluded from the model because of small production and a single destination. The barley grown in the Thumb is either fed or shipped to Detroit for malting in transit. Neither the destination nor transportation costs will be altered signifi- cantly by rationalization. Sugarbeets Michigan is a high-cost sugarbeet grower, and thus it can effectively compete only in local markets where it is isolated from competition by transportation rates. Furthermore, the beets are processed in the Thumb, and again the distribution activity is rationalized by the private sector. Thus sugarbeets are excluded from the study. Assembly Costs The cost per bushel of assembling the grain from farms to elevators was derived from a single assembly vector, the volume of oats was adjusted to reflect the difference in test weights between 115 it and the other commodities. The base system utilized the existing locational pattern of the Thumb's elevators. Thus for the assembly activity, each assembly origin was identified as the marketing receipts area of each existing elevator. Each assembly destination was identified as each existing elevator location. Since alternative logistics systems were analyzed by the mathematical model, any changes in the volume of grain handled by an elevator modified the size of its origin area. Therefore regardless of changes in elevator numbers or sizes of originating areas, an elevator assembled grain from its own origin area. Grain assembly costs are dependent upon the total grain processed at an elevator, the marketing density of the originating area, and the cost of providing transportation services. The volume of grain received by each elevator was determined from the question- naire. Grain marketing density (D) for the region was determined by dividing the total volume of grain marketed by the number of square miles in the region. "Mu Rhc l i D‘ (D H (D D II marketing density for the region; Rho = the bushels of commodity (c) received at elevator (h); A1 = the size of the region. The regional density (D) was adjusted to represent variations in productivity between townships. The adjustments were based upon 116 county average yield information provided by county extension agents from the Thumb and by the regional farm management extension specialist. Dh = (D) (LIh) where: Dh is a marketing density for the ch elevator LIh is a township marketing factor based upon adjusted county average yield. The cost of moving grain between the farm and elevator is dependent upon the fixed cost of vehicle ownership and the variable cost of vehicle Operation. For this study these figures were determined by updating the results of a farm truck cost study which estimated the cost of operating a 300 bushel vehicle (see Appendix 8).31 The total fixed cost incurred annually for farm truck ownership was $1,911.17, of which half was allocated to grain marketing activities (see Appendix B). The total variable costs per mile are $.231 + §l飧, where d is the one way distance between the farm and elevator, and the element in the hth row of the h assembly cost vector is AACh = 30.0319 + $0.0022dg. A word of caution The major component of the farm to elevator cost function is depreciation and opportunity cost. While most people are 31Kenneth Keehn, "Cost of Assembling Grain in South Dakota," unpublished Masters Thesis, Economics Department, South Dakota State University, 1975, passim. 117 concerned about the impact of increased gas prices, depreciation per mile costs eight times as much as gas. In fact, total variable costs are approximately half of depreciation charges. Obviously the treatment of depreciation is critical to the collection cost function. Investment credit, additional first year depreciation, and accelerated depreciation schedules change the useful life of a farm truck. Rather than a physical life, it becomes an institutional life based upon income tax incentives. This is especially true during years of bumper crops or high farm income. And during periods of rapid inflation farm trucks, rather than depreciating in value, may actually appreciate or increase in value. A second problem in determining the depreciation charge is the age-old question of allocation of fixed costs. Farm trucks and tractors are used for various operations, including marketing of grain. One study charged all the fixed cost to grain marketing because a truck would not be owned if it were not for marketing.32 Another study assumed that the tractor had been purchased for field work and only variable costs are charged to the grain hauling function.33 The result is significantly different cost functions. The impact of varying assumptions regarding depreciation is reflected in the range of depreciation charges between various studies. The low was a 1975 study which reported a depreciation 321bid., p. 13. 33Baumel, et al., An Economic Analysis of Alternative Sys- tems, p. 205. 118 charge of $420 annually while the high was a $1,697 charge in 1977. This represents a difference of $0.50 per mile. This study has used a single collection cost function representing a 300-bushel farm truck. Other studies have develOped much more sophisticated collection functions which include several sizes of farm trucks or a farm tractor and varying sizes of trailers. However, considering the depreciation problem, refining the model to reflect the few cents per mile difference between various truck sizes may be working on the wrong side of the decimal point.34 One study identified the specific capacity and age of farm trucks used by each farmer.35 In addition, existing farm configura- tion and size was included in the collection function. These specifications simulate the historical base very accurately, but the purchase of a new truck by any farmer or a land transfer modifies the parameters. Again, perhaps the model is more sophisticated than is justified by the data. Grain Processing Costs Country elevators and subterminals perform a variety of grain marketing functions including receiving, drying, merchandising, cleaning, storage, and loading out grain. The cost of performing these services is dependent upon two primary factors: the size of the facility and the intensity of use. For a given elevator size, 34Don Parlberg, "How My Mind Has Changed Regarding the Role of the Agricultural Economist in Public Affairs," (Paper presented at the Consultation on Ways of Knowing iJ1 Economics and Ethics, Purdue University, August 14, 1964), p. 3. 35Tosterud, p. 88. 119 in the short run, the major cost components are the fixed costs. Therefore as the volume of grain processed increases, up to plant capacity, the average cost per bushel declines rapidly. Exceeding plant capacity, however, for example storing grain on the ground, increases costs resulting in an increasing short run average cost curve for volumes beyond the elevator's handling capacity. Thus higher turnover rate or more intensive use results in lower costs up to a point beyond which costs increase. Most studies have reported "that the elevator industry exhibits extensive economies of scale." Or in the long run the average cost of handling grain decreases as elevator size increases. Several explanations for the economies in the elevator subsector can be suggested. First, larger elevators require less investment per bushel of handling capacity, which results in less depreciation per unit. One study reported that the average depreciation for a 138,000 bushel facility was 4.l¢ per bushel while it was l.07¢ for a 990,000 bushel elevator. Secondly, as elevator size increases, Opportunities for labor specialization increases, and as size increases, labor is utilized more intensively. The economies of labor utilization resulted in a cost reduction from 7.3¢ to l.2¢ per bushel as average elevator size increased from 138,000 to 990,000 bushels. And lastly, as elevator size increases, the management cost is spread over more units of volume. For elevators with an average licensed capacity of 138,000 bushels, management 120 cost 4.l¢ per bushel, but for 990,000 bushel facilities, management cost only 0.4¢ per bushel.36 Several studies have questioned the applicability of a long run average cost curve based only upon elevator capacity.37 These studies examined receiving, drying, and loadout capacity to deter- mine the limiting factors in the handling process and determined elevator costs accordingly. Based upon their precedent, ten Thumb region elevator managers were asked to identify their receiving, drying, and loadout capacity during the pretest of the personal interview process. All provided the information, and all also, with some disgust, indicated that an elevator's throughput could be determined by storage capacity. One manager stated, "the dryer and receiving capacity is designed to fit storage facilities." Elevators which expand storage capacity would seem to contradict this, but most storage expansion also expands handling capabilities. Furthermore, each handling function is performed separately and with separate equipment. Thus any impediment in the handling pro- cess can be overcome by extending the working day, as is done with dryers. A normal dryer complement is based upon a 24-hour day as the elevator minimizes its capital investment and spreads it over more units. Therefore, the processing costs developed and used in this study reflect only the elevators' storage capacity. 36Frederick Lorenz, "South Dakota Grain Location and Cost Analysis," (Unpublished Master of Science Thesis, Brookings: South Dakota State University, 1972), p. 62. 37See Bunker or Baumel, et al., "An Economic Analysis of Alternative Systems." 121 Economic constraints The elevator cost data presented has been based upon "engineering" averages. Two economics factors, age of capital and equity capital, also have a major impact upon the average operating costs for grain elevators. Elevator construction costs have in- creased faster than inflation over the past decade. For example, in 1976 one Thumb area elevator postponed construction of additional storage space for one year during which time costs increased from $1.50 to $1.75 per bushel. Simultaneously, the cost of long term borrowed capital has increased significantly. The result is that old facilities enjoy lower fixed costs. Equity capital has a tremendous impact upon the operating cost of the smaller, older elevators. Many of these facilities are paid for, and engineering and economic studies may overstate their cost because the owner is living off depreciation. In the long run these firms will not survive, but in the short run they can compete effectively in spite of their higher variable costs. Thus the comparative advantage of the newer and larger facilities is mitigated in part because of their increased fixed cost and because the older facilities have little or no depreciation or long term interest costs. Specific elevator cost function Numerous studies have examined the factors which affect the cost of operating grain elevators and estimated cost functions.38 38A few of the numerous grain elevator studies include: S. W. Fuller and M. L. Manuel, "Factors that Affect Country Grain Elevator Efficiency," Bul. 550, Agricultural Experiment 122 This project has utilized the estimating equation developed by Lorenz which estimated elevator costs based upon capacity.39 Lorenz estimated average elevator handling costs (AHC) with a general function that approached zero asymtotically: (AHC)-1 = a + bV This mathematical equation eliminates the problems associated with linear cost functions, achieving zero average costs at some positive volume of grain processed. However, Lamberton and Rudel identify two economic difficulties which remain: Station, Kansas State University, Manhattan, Kansas, February 1972. Allen G. Schienbein, "Cost of Storing and Handling Grain in Commercial Elevators, Projections for 1974/75," Dept. of Agri- cultural Research, Report No. FdS-252, Washington, D.C., February 1974. U.S. Department of Agriculture, Economic Research Service. "Cost of Storing and Handling Grain and Controlling Dust in Commer- cial Elevators, 1971-72, and Projections for 1973-74." U.S. Dept. of Agr. Res. Rep. No. 513, Washington, D.C. 1973. U.S. Department of Agriculture, Economic Research Service. "Estimated Cost of Storing and Handling Grain in Commercial Elevators, 1971-72," Econ. Res. Ser. No. 475, Washington, D.C. 1971. S. L. Van Ausdle and D. L. Oldenstadt, "Costs and Efficien- cies of Grain Elevators in the Pacific Northwest," Bul. 713, Washington Agricultural Experiment Station, Washington State University, November 1969. M. Van Oppen and L. D. Hill, "Grain Elevators in Illinois: Factors Affecting Their Number and Location," Dept. of Agricultural Economics, Agricultural Experiment Station, University of Illinois, Urbana-Champaign, Illinois, November 1970. D. J. Waltz, "Optimum Size and Location of Elevators," (Un- published Master's Thesis, North Dakota State University, 1970) , p. 25. Terry Yu-Hsien Yu, "Analysis of Factors Affecting the Optimum Size and Number of Country Elevators in Indiana," Ph.D. Dissertation, Purdue University, 1967. Don Zasada and O. P. Tangri, "An Analysis of Factors Affect- ing the Cost of Handling and Storing Grain in Manitoba Country Elevators," Research Report No. 13, Department of Agricultural Economics and Farm Management, University of Manitoba, Winnipeg, July 1967. 39Lorenz, p. 88. 123 First the function approaches zero rather than some positive average cost as the volume of grain handled increases. Second, while it is plausible that the long-run cost curve is not observed to have a positive slope since firms would not construct plants larger than optimal, it is not plausible that the short- run average cost curve should not have a positive slope at some output level. When the elevator Operates at its maximum rate for the maximum hours in the relevant time period, the short-run average costs should increase rapidly and marginal costs approach infinity. There are two possible explanations of why elevators' short-run average costs have not been observed to increase with volume of grain handled. The curve may not be smooth but have a corner at the maximum attainable handling level. This implies an infinite marginal cost at that point and consequently no firm would operate beyond the corner. A second explanation is that all firms have completed any long-run plant adjustments when the data is obtained. This implies that all elevators, of whatever storage capacity, are operating as optimally sized plants for their level of grain handling. Thus, each elevator would reflect non-increasing average costs. The specific function used 1970 accounting cost data from South Dakota elevators. Using both the T-test and F-test, the function was found to predict average handling costs which were significant at the 0.01 level and the coefficient cxf determination (r2) was 0.74. This model's predictions were very close to those of other studies conducted in other states. The specific formulation for average handling cost derived by Lorenz was: (AHC)-1 = .0377 + .00000019(LC) where LC is elevator licensed storage capacity. Within the math- ematical model this function can be applied to either individual elevators or to some grouping. Since the licensed capacity of each elevator in the Thumb was known, the handling cost was calculated for each facility. The equation was modified to reflect the 4OLamberton and Rudel, p. 61. 124 increases in the price index, and the element in the h-th row of the processing or handling vector, as reestimated, became AHCh = 1 .02124 + .00000017LCh Distribution Costs While problems exist in estimating assembly and handling cost functions, the major problem is in estimating distribution costs. Grain is distributed from the Thumb via rail, truck, or vessel. Vessel rates are negotiated for each load and are normally based upon many factors including supply and demand for vessel service. Often the grain movement is a backhaul and is carried on a "contri- butions to fixed cost" rate. In addition, vessel rates are normally very secretive, and thus exact rates are often unknown. Truck rates, as discussed earlier, are administered at a level which appears to be below total costs. Seemingly rail rates have no relationship with costs although many railroads claim that rates are below costs. And the I.C.C. and railroad accounting systems preclude any effective evaluation of rates and costs. Even if the heroic task of estimating transportation cost were undertaken, an issue still remains: should fully allocated costs, variable cost, or resource use be used to represent trans- portation costs? This is also a presumptuous task. Baumel explained and justified the Iowa State procedure, The estimated variable costs, rather than the fully allocated costs, were used in the analysis in this study. Economists generally agree that, since fully allocated costs are computed with an arbitrary allocation of fixed costs to units of traffic, it is meaningless as a basis for the pricing of rail service and 125 must be rejected as the test for a particular rail rate. Vari- able cost, although not to be employed for the determination of a rail rate--specifies the lower boundary for a pricing decision. The railroad must determine a certain level over variable cost at which the established rate generates a maximum contribution toward fixed cost and the railroad's net income. . . . In this study, the variable rail costs are compared with truck and barge costs.41 A rationalization study, however, is not a rate-setting procedure, but rather suggests a resource allocation mix that will affect society for many decades. On the other hand, Tosterud employed resource use as his criteria for transportation costs: Therefore any transportation cost minimization model which relies on rates rather than true costs is, in fact, a misnomer. What is usually being minimized in such a model is shipper's transportation costs, not the costs of supplying the transporta- tion service to the shipper. A model must be defined in terms of whether rates, resource costs, or a combination of both are being assumed in the model. It is mandatory that the implica- tions of the selection be fully explained as well.42 This approach fails to recognize the decision-making process in either the private or public sector. An economic decision making unit determines its course of action by the cost it perceives rather than upon "society's costs." The situation is further compounded by the public expendi- tures which are not included in either the cost or rates of the carrier and are often not considered in resource use. Seaway and highways are constructed and maintained by the public sector, and neither the vessel nor the trucker pays user fees which completely compensates the public for the provision of the way. 41Baumel, et al., An Economic Analysis of Alternative Systems. p. 44. 42Tosterud, pp. 72, 73. 126 Transportation vector elements In summary, then, the transportation vector can include rates which are not representative of resource use or costs which are not representative of resource use. Neither alternative is desirable, but one must be selected. For purposes of this study the published rates of each mode will be used to represent the cost of transportation. The use of rates does not maximize society's benefit, but it does recognize the workings of the public and private decision processes. Both elevators and farmers base their decisions upon the costs they perceive, which are the transportation rates they pay, rather than upon some optimum resource allocation. Michigan public officials also use perceived costs or rates as they make long-term planning decisions. Perhaps the idealist would argue that the public sector should maximize the return to resource use. But the pragmatist recognizes that Michigan officials do not make the rules; for example, rail rates which are determined in a much larger arena. Rather, they simply try to serve a clientele group given an institutional framework. Most public decisions result in marginal changes, and recognizing this, this research attempts to provide information which can be used within the existing institutional framework. Truck rates The (h,d)-th element in the truck portion of the distribution- matrix represents the truck rates per bushel between the h-th eleva- tor and the d-th destination. They were determined by measuring the distance between each elevator and each destination and applying 127 the approPriate rate from the tariff. The tariff used was the rate sheet published by Michigan Elevator Exchange (see Table 3-4). To determine the rates for distances in excess of two hundred miles, an estimating equation was derived. Rail rates The (h,d)-th element of the rail portion of the distribution matrix represents the rail rates between the h-th elevator and the d-th destination. The rates were secured from various C & O railroad tariffs through the cooperation of C & O personnel. Since rail rates are published in hundred weights, conversion to bushels was necessary. Rail rates varied substantially between wheat and corn, and thus a separate matrix was constructed for each. There were single car, three car, ten car rates, and 65 car unit train rates43 in effect during the study period. In the initial matrix, the rate assigned to the (h,d)-th element was the rate used according to the manager of the h-th elevator. If two rates were used, the rate which was used the most was entered into the matrix. Water rates Water rates are not published; vessel sales are made through brokers on a pick up basis; and no one in the Thumb seemed to know what the rates were. Brokers did not want to release the rates they were paying, and carriers did not want to disclose the rates they 43Both 65 and 100 car unit train rates were in effect during the test period, but most grain was moved under six consecutive 65 car train rates, as 100 car rates were not cheaper. 128 were charging. After many phone calls, however, sufficient informa- tion was collected to construct a water transportation matrix for the ports serving the Thumb. CHAPTER V RESULTS OF THE SIMULATION AND POLICY IMPLICATIONS Introduction As described in Chapter III, the grain marketing system which serves the Thumb region is a fermenting, unfolding, evolving system. This process of change imposes both positive and negative impacts upon members and users of the marketing system. Most users and members of the marketing channels are aware of these changes and are devising long term adjustment strategies to cope. While they recognize that these changes are inevitable,nnst channel members are concerned about the extent and direction of the positive and negative impact imposed by the changes, and each participant strategically attempts to manipulate the process to create a more favorable combination of impacts. This chapter addresses these concerns by reporting the results of the mathematical model which was used to estimate the impacts resulting from alternative arrange- ments of the logistic system serving Michigan's Thumb region. This research effort concentrates on estimating the extent and direction of impacts which will result from changes in the logistics system rather than focusing on determining an optimal solution. This approach is utilized because optimal solutions have two limitations which restrict their implementation by policy makers. First, they are a static solution, and any change in resource prices \// 129 130 or technology invalidates the results; and secondly, they are unattainable through the political decision process. Multiple solutions which reveal the probable economic consequences of alter- native courses of action facilitate the needs of those interested in the impacts: local and state elected officials, local and state employees, transportation firms, investors, grain elevators, farmers, grain buyers, and others. This chapter opens with a brief review of the mathematical model. Then the various simulations are presented including the base model, a group modeling institutional modification, a group simulating change in elevator number, and a group exploring changes in the transportation system, including rail abandonment and water- way expansion. Model Highlights The commodities simulated in the mathematical model included the corn, oats, and wheat produced in the Thumb region during the 1976 calendar year and marketed during the crOp year. Because of similar marketing patterns, corn and oat production was combined and throughout this chapter corn refers to both commodities. Destination patterns and transportation rates varied extensively between corn and wheat. For example, a significant volume of the domestic corn was shipped into the New England feed market while domestic wheat was destined to Michigan and regional markets. Furthermore, commodity rates were available for corn which were substantially lower than the equalized wheat rates. The model could have been modified to handle the different 131 destinations, but the discrepancies in transportation rates could not be built into the model economically. Therefore, individual simulations were made for each commodity. The activities accommodated in the model include collection, handling and distribution. Collection, or assembly, involves the movement of grain from the farm to the elevator and was assumed to occur by farm truck. Handling and processing includes the movement of grain through the elevator and was represented by a single cost function which encompasses all elevator activities. And distribu- tion incorporates the transportation of grain from the elevator to the final destination and the handling costs involved in any trans- shipment activity. The distribution cost functions were based upon the tariff rates of the various carriers or were estimated when unavailable. The Thumb area varies substantially from other regions which have been the focus of rationalization studies. First, it is adjacent to a water transportation system. And more importantly, unit train movements were used extensively prior to and during the test period. Thus the substantial saving which other studies have projected have already been realized to some extent by the Thumb area grain producers. Model Results The Existing Distribution System The initial solution attempted to duplicate the shipment patterns for corn, wheat, and oats that existed within the Thumb region during the 1976 marketing year. This solution estimated that 132 the total cost for marketing the 16,862,100 bushels of corn, 2,484,810 bushels of oats and 9,497,960 bushels of wheat in 1976 was $19,177,105 or $.665 per bushel (see Table 5-1). The total cost incurred in marketing wheat was $6,379,733, and the cost per bushel was $.67. Marketing activities for corn and oats cost a total of $12,797,372 or $.66 per bushel. Although the marketing pattern for wheat included a higher percentage of shipment to nearby markets, the reduced commodity rail rates available for corn resulted in the slightly lower marketing cost per bushel for corn. The total cost of assembling this grain was $1,185,948. Assembly costs were based upon the assumption that each elevator collected grain from its originating area. The cost of processing and handling grain through the Thumb region elevators totaled $5,112,370. And railroad and truck distribution costs amounted to $12,878,787. Distribution costs were based upon the rate levels in existence during the test period, and distribution patterns duplicated the grain shipment patterns reported by Thumb area ele- vator managers. System Slack As with any economic system, the existing distribution costs incurred by Thumb area grain producers include costs resulting from organizational inefficiencies or slack. In a market economy com- prised of numerous independent firms, such as the United States' economic system, individual and collective actions impose costs upon the economy. Agricultural marketing channels are no exceptions, and the grain marketing system serving the Thumb region displayed various 133 Table 5-1. The Existing Cost of Collection, Handling, and Distribu- ting Thumb Area Corn and Wheat for the 1976 Marketing Year Collection Handling Distribution Total Wheat Total Cost $ 364,864 $1,727,302 5 4,287,567 $ 6,379,733 Cost per Bushel 0.038 .182 .451 .672 Corn* Total Cost 821,084 3,385,068 8,591,220 12,797,372 Cost per Bushel .042 .175 .444 .661 Grand Total Cost 1,185,948 5,112,370 12,878,787 19,177,105 Total Cost per Bushel .041 .177 .446 .665 *Oats and Corn are equalized on a hundred weight basis. 134 types of substandard performance or economic slack. Following is a series of modifications which explore some of the costs imposed by this slack. The first estimate explores slack in the collection process, and then distribution activities are analyzed. The final objective of these modifications is to estimate a slackless starting point with which to compare alternative channel organizations. Collection slack While marketing their grain, many farmers bypass the local elevator and haul to a more distant facility creating economic inefficiency or collection slack. These subOptimal collection patterns emerge for various reasons: (1) very likely individual farmers lack perfect information regarding either prices or collec- tion costs; (2) loyalty resulting from friendships, social relation- ships, or financial investment, such as in a cooperative elevator, may alter collection patterns; (3) some elevators and farmers have specialized in a single commodity, which may create unique marketing channels; (4) discrimination by railroads among elevators may result in one elevator being plugged and unable to accept grain while another is still receiving grain, (forcing farmers to bypass the plugged facility); and of course, (5) the ability to adjust and adapt to these types of restrictions varies with the managerial capabilities of each individual elevator manager. Differences in bids can induce farmers to haul grain farther. However this does not generate slack but rather defines the bound- aries for each elevator's Optimal collection area. 135 Determining collection slack would have involved interviewing each Thumb area farmer to ascertain individual grain flows, which was not done in this study. The mathematical model utilized an Optimal collection pattern and therefore underestimates collection costs if slack is present in the study area. However collection inefficiencies can be approximated indirectly by utilizing the work of Tosterud. He used two assumptions to estimate the cost of collecting grain for a similar sized region with about the same number of elevators. One was an optimizing solution similar to this study while the other utilized the revealed preference of each farmer. He found that the collection cost incurred through the revealed preference solution total $242,521, which was 12 percent more than the optimal solution.1 If collection patterns in the two regions are similar, the cost of collection slack in the Thumb can be estimated to total about $140,000. The existence of collection slack implies that existing information institutions and transportation policy may generate inefficiencies as farmers market their grain. Distribution slack The estimates reported for the existing distribution pattern duplicated the flow of grain between elevators, transshipment points, and destinations as reported by the individual elevator managers for the base year, 1976. However, these distributional patterns are less than optimal because of four economic organizational factors lTosterud, pp. 132-137. 136 which impose costs upon the marketing process. The first of these, the cost of the slack resulting from the free market system, is estimated in Modification I. The second, the cost of slack imposed by the existing ownership pattern, is estimated in Modification II. Thirdly, the costs imposed through suboptimal transshipment activi- ties are identified in Modification III. Modification IV estimates the cost incurred through modal selections which do not minimize costs. Slack was estimated by a simulation which forced the dis- tribution patterns reported by elevator managers. This was compared to an optimal solution which contained no restrictions. Modification I: free market slack In the Thumb region most grain shipments were destined to points at which the elevator has a comparative advantage. However, some suboptimal shipment patterns exist in which elevators were serving points at which they had a competitive disadvantage. This free market slack exists for a variety of reasons including: (1) firms always lack perfect information, and the amount and accuracy of information possessed varies between elevator managers. Thus each firm may have a different opinion regarding the "best" market on any particular day resulting in a sub0ptimal grain flow. (2) Often the marketing pattern of a firm involves established relation- ships such as friendships or contacts which allow one firm access to a particular market which is not available to other firms. In fact, during the interview process one elevator manager refused to identify specific markets because he wanted to maintain monopolistic 137 access to these markets. (3) Further, the length Of time needed to respond to market changes varies among firms, again creating inef- ficiencies. And lastly, (4) some firms simply display ineffective managerial decisions, again imposing costs upon the marketing system. The net result is that trucks meet on the highway hauling grain in opposite directions as elevators ship past each other and impose costs upon channel users. Modification I measured the potential savings which would result from optimal distribution patterns. It assumed that all elevators would ship the same quantity of grain as previously, each transshipment point would handle the same volume as previously, and each destination would receive an identical amount as previously. This modification allowed the mathematical model to optimize dis- tribution patterns by modifying transshipment and direct shipment activities. The cost savings were derived totally from distribution activities as collection and handling costs remained constant. The potential savings that the Thumb region could experience by eliminating free market slack from the marketing system totaled $399,113 for the test period (see Table 5-2). This amounts to just over two percent of the total marketing cost under the existing distribution pattern. Modification II: ownership slack In either a purely competitive system in which all elevators are individually owned or in a monopolistic system with all elevators under single ownership, free market slack exists because of sub- Optimal transshipment patterns. However, the ownership pattern of 138 the Thumb area elevators seems to increase free market slack. The Thumb's competitive structure includes three firms comprised of a series of line elevators which provide grain for a subterminal. These line elevators were located throughout the Thumb, and as each firm attempted to maximize individual profits, it displayed slack resulting from suboptimal transshipment activities. For example, the Thumb Farm Terminal is owned and supplied by three of the largest elevators in the region. In the mathematical model it was nearly impossible to completely duplicate the shipment pattern into the terminal. In spite of the artificial restraint employed, the model tended to secure grain from small local elevators rather than from the terminal owners. The terminal owners had a comparative advantage into the eastern rail based feed grain market, and yet they were trucking to Elkton. Other elevators had the comparative advantage into Elkton but were shipping either to Gilford or East. Wickes and Blount, the other firms with terminals and line elevators, displayed similar transshipment patterns which institutionalized "ownership" slack. A specific example of the distribution pattern resulting from the ownership patterns can be seen in Figure 5-1. The terminal at Elkton is served by Sebewaing, which is more favor- ably located to Gilford while the Blount terminal at Gilford is served in part by three elevators located near, and one elevator located in, Elkton. The grain trucked from Sebewaing to Elkton passes by the Sebewaing elevator as it is shipped east by Elkton. It should be stressed that while the ownership slack within the macro distribution system increased because of line elevators, the administered distribution system of each firm was minimizing Cl ——-) ----5 Figure 5-1. 139 Elevators Subterminals Transshipment Flow of Grain to Subterminals by Truck Market Flow of Grain From Subterminals by Rail An Example of Suboptimal Transshipment Patterns Created By Ownership Patterns 140 private costs. Each terminal requires substantial and regular flows of grain to operate efficiently. Line elevators provide one means to secure these grain flows. And using a terminal to reduce inventory cost at line elevators could easily offset the added trucking costs. Further line elevators can provide access to larger collection markets and thereby provide a price buffer when grain is needed to fill out a unit train. Thus, managerial actions which optimize profits for the individual firm impose costs upon the total marketing system. In part, ownership slack is a short run phenomena. If the number of elevators in Michigan continues to decline, many of the line elevators will close and the farmers will market direct to the subterminals, reducing present patterns of slack. Modification II attempted to estimate the slack resulting from the existing ownership patterns for Thumb region elevators. It is a further progression of Modification]g.and all destinations received the same amount of grain as previously, all elevators handled the same amount of grain as previously, and all transship- ment points served the same grain volume as previously. The differ- ence is that transshipment activities were linked to ownership. For the 1976 marketing year, the ownership pattern present in the Michigan Thumb is estimated to have increased the distribution and marketing cost by $230,836 (see Table 5-2). This represented 68 percent of the total slack identified in Modification I. Yet only 55 percent of the elevators are involved in the ownership patterns identified, and these handled only 54 percent of the grain flow. 141 Modification III: transshipment slack Extensive transshipment activities existed in the test region during the 1976 marketing year. Over 31 percent of the grain handled by Thumb elevators was transshipped through subterminals into export channels. While transshipment is a vital managerial strategy in implementing unit train movements, suboptimal trans- shipment patterns were displayed by the Thumb area elevators. This can be explained in part by discriminatory allocation of rail cars and service between main line and branch line elevators. The unavailability of storage space during the harvest season at smaller elevators also encourages transshipment into local subterminals, creating temporial utility. This modification attempted to optimize transshipment activities by maintaining elevator origin patterns and ultimate destination patterns but eliminated forced transshipment activities through the subterminals. Thus the model determined whether an elevator should ship directly to an ultimate destination or through an intermediate transshipment destination. The mathematical model estimated that Thumb region marketing costs would be reduced by $154,724 through a reorganization of transshipment activities (see Table 5-2). But while costs were reduced, transshipment volume actually increased five percent from 8,730,816 bushels to 9,180,650 bushels. Reorganization of trans- shipment activity, however, did not generate pareto better results for each subterminal. The Thumb Farm terminal at Elkton was the major benefactor as its transshipment receipts increased from two 142 .Hmuou on» Ca omooaocw uoc mw pa xomam umxumfi comm ca omooaoca mw xomam mflcmumc3o mmsmowm4 moo.mmm.ma omm.nmm.ma Ohm.NHH.m mom.mma.a unwom oocouommm mwmm «hmo. Hmm coauunomm xomam Hmuoa 0mm.mmo.mH mmm.hm Nmm.Hmm.NH onm.mHH.m mom.mm~.a xomam Home: >H COMHMOMMMOQZ mum.mmm.ma mmh.vma mmo.vmh.ma Ohm.mHH.m www.mma.a xomHm acmemwsmmcmua HHH :OwHMOAMAOOZ mom.mvm.ma 0mm.0mm Hmm.hvm.ma osm.maa.m www.mma.a xomHm mflnmuoczo HH cowumowmwooz Nmm.hhh.ma mHH.mmm onw.m>v.~a Ohm.NHH.m www.mma.a xomam umxwmamowm H cowum0flmwooz moa.hha.mam www.mhm.mam Ohm.maa.mw mom.mma.am cwouumm newuonfiuumwo mcfluwwxm umou Hmuoa cowuoooom coauonwuumfio onwaocmm COAuOOHHOU xomHm Eoumwm owmm one .xooum mo coflumcwswam .cwouumm coauonfiuumwo msflumflxm “wmmw mcwuoxumz whoa on» MOM mumo pom .umoss .cwou How mumoo mcwuoxumz omumawumm .mum magma 143 to five million bushels. Also receiving positive impacts were the Saginaw facilities, which enjoyed a 19 percent increase to 3.7 million bushels in transshipment activity from Thumb area elevators. Facilities receiving negative impacts were the subterminals at Toledo and Marysville, which were eliminated from the solution, and the Gilford subterminal, which lost 70 percent of its 1.5 million bushel volume. In addition to identifying slack, these results provide insight into the competitive environment among subterminals and indicate future trends. The elevator survey was conducted during the first 18 months of operation for the Elkton subterminal, and thus its total competitive impact had not been integrated into the marketing practices. These results suggest that Elkton, and also Pigeon, since it has received unit train rates, will become major export facilities serving all Huron County elevators. Unit train rates from Saginaw were about 1.2 cents per bushel less than from Gilford and the difference is great enough to attract Tuscola County grain past Gilford into the port elevators. Over time, Gilford will not lose 70 percent of its volume as it effectively competes by accepting lower margins. Increasing energy prices, which increase collection cost, will improve Gilford's competitive position over time. Unless unit train rates are equalized, any additional subterminals in Tuscola or Eastern Saginaw Counties will face similar competitive problems. Of course, should these points be equalized, then Elkton and Pigeon will be placed at a competitive disadvantage. Because Toledo is so far from the Thumb 144 and Marysville does not have unit train rates,2 Sanilac, Lapeer and St. Clair Counties are at a competitive disadvantage in serving export markets. Modification IV: modal slack Transportation rates are published and readily available to all shippers. In fact, the rate institution has been implemented in such a manner that a lack of information or uncertainty regarding rates is nearly impossible. However, elevator managers ship via higher cost modes regularly, displaying economic inefficiency or "modal slack." Often equipment shortages or service failures con- tribute to modal slack by forcing shippers to use a higher cost mode. In other cases a consignee may request a specific mode to satisfy operational or institutional restrictions such as the transit privilege. Occasionally elevator managers may ship via a higher cost mode for convenience. And often modal patterns have developed historically and have become institutionalized thereby lagging changes in rate pattern and other economic incentives. Modification IV is an attempt to measure the costs resulting from suboptimal modal selection or modal slack in the Thumb region. This estimate is derived by analyzing existing shipment patterns and determining the optimal selected mode. For the 1976 marketing year slack is estimated to total $27,255 for the Thumb region (see Table 5-2). 2Short line and short haul carriers usually can not afford to publish unit train rates because of problems with car allocation and rate division. 145 Summary: distribution slack The estimated slack present in the distribution system totals $581,097, or 4.5 percent of the total distribution cost, and three percent of the total marketing cost (see Table 5-2). These savings suggest three extremely important thoughts: first, vertical co- ordination merits further investigation; secondly, communication of information is important; and thirdly, the cost of slack must be identified in rationalization studies. Certainly over half a million dollars provides incentive to undertake some form of vertical coordination. One technique would be for the Thumb area elevators to form a shipper association and hire an administrator who would schedule and arrange distribution activities. Other potential arrangements are also possible. Among the four types of distribution slack, the cost imposed by modal selection is by far the least important. It is also the area in which the institutional format provides the best and most usable information flow to channel members. This suggests that perhaps the design of information channels is extremely important and that substantial savings could be generated through better channels which provide both accurate and functional information. This also suggests the need for vertical coordination which extends beyond the immediate study region. Some type of national informa- tion system may prove most beneficial. Transportation rates are of course a national system. Since this study was not designed to include in-depth analysis of the slack identified in the marketing channel, caution 146 must be used in interpreting these results. However, the presence of $580,000 of economic inefficiency suggests an area for further research activity. There is danger of double counting in estimating economic inefficiencies. While every effort was taken to insure that slack was not overestimated, it is possible that some double accounting did occur and is included in the total. However, the issue is the direction and relative costs imposed by slack rather than the specific cost. The presence of economic slack also suggests that any rationalization study which adequately duplicates existing distribu- tion patterns includes slack and using it as the base point may overstate the potential savings which would result from an optimally organized system, for, if implemented, even an optimal distribution system would likely contain slack. Therefore, the progression from an existing system with slack to an optimal system without slack overestimates potential savings. To overcome this limitation, free market,3 transshipment, and modal slack are eliminated from the total marketing cost estimated for the existing distribution pattern. The result is the base reference point from which slack has been eliminated and can therefore be compared to subsequent slackless system organization. These costs are estimated to total $18,596,008 (see Table 5-2). 3Ownership slack is part of free market slack and thus is included indirectly. 147 Marketing Costs Before Unit Train Rates The economic foundation of most rationalization studies is the estimation of the potential savings which will result with implementation of unit train technology and institution. During the 1976 market year, however, both multi-car and unit train rates were utilized extensively by Thumb region elevators. In addition to the standard single car rates, three and ten car domestic rates were published on corn into the New England feed markets, and export rates were published for ten car and 65 car unit train shipments.4 The extensive investment made by the region's elevators in train loading facilities implies that the savings estimated in other studies have already been partially realized in the Thumb. Modifi- cation V attempted to measure the impact unit train rates had upon the marketing costs within the test region. This modification eliminated all multi-car rates for either domestic or international movement except three car rates. Each elevator continued to handle the same volume of grain, and thus collection and handling costs remained constant. Of course, the elimination of unit train rates also remOved the incentive to transship grain through train loading points, and therefore transshipment activities did not appear in this solution. Modification V: unit train savings The estimated benefit received by the grain marketing system in the Thumb from the adoption of unit train technology is $3,216,992 4Shippers in the Thumb used eight consecutive 65-car unit train rates. Other unit train rates were published but were not widely used. 148 for the 1976 marketing year (see Table 5-3). Thus marketing costs have been reduced 15 percent annually through this technological and institutional innovation. However, change is a dynamic process, and all of the potential benefits have not yet been captured. Further savings will be realized over time and will be identified in other modifications. Table 5-3. Estimated Reduction in Marketing Costs Which Have Resulted from the Introduction of Unit Train Rates and Technology Base Reference Marketing Cost Without Unit Train Point* Unit Train Rates Savings Collection $ 1,185,948 $ 1,185,948 Handling 5,112,370 5,112,370 Distribution 12,297,690 15,514,682 Total Cost 18,596,008 21,813,000 $3,216,992 *The base reference point is based upon current practices, including three car, 10 car, and 65 car unit train rates. This figure has had the cost of slack removed. The estimated savings generated by the implementation of unit trains were determined by using a static framework based upon the intrastructure in place during the 1976 marketing year. However, the technical and institutional environment is a dynamic one in which constant change occurs. The infrastructure in place during 1976 was a response to an economic stimuli, unit train rates. Subterminals would not have been built if the incentive provided by unit train rates had not existed, and thus more grain probably would have flowed through the smaller elevator. Possibly some elevators would 149 not have exited, which would have meant lower collection costs and higher average handling costs. And the interregional comparative advantage would differ and different markets would be served. Foreign destinations would be reached through the ports at Saginaw and Toledo rather than Baltimore. Thus, rather than estimating the cost of distribution had unit trains not been introduced, this modification projects the cost of eliminating unit train rates from an infrastructure designed around them. Elevator Exit "We cannot even afford to lose one elevator," one Lansing public employee has stated with heartfelt emotion, yet each year elevators continue to cease operation, perpetuating the trend which has existed for several decades. The public places much of the blame for this decline in elevator numbers upon poor rail service and railroad abandonment. As a result, there is extensive public sentiment to maintain rail service as a means of preserving elevator service. This raises questions regarding the economic activities which surround elevator exit: are railroads primarily responsible for the decline in elevator numbers? Does the elimination of an elevator impose economic costs or benefits upon the grain marketing system? Who are the impact recipients? And should public policy be designed to preserve the country elevators? Railroad impact upon elevator exit The first question, whether railroads are responsible for the exit of the country elevator, can be addressed by economic 150 theory. It suggests that in a modified market economy such as that which characterizes the American economy, the country elevator numbers serving a region is determined primarily by the workings of Adam Smith's "invisible hand." Over time, the elevator industry approaches an economically Optimal structure as resources are allocated by purchasers revealing their preferences through voting with their expenditures. The interjection of technology which often creates substantial scale economies, can disrupt this short- run equilibrium. The adoption process for this technology can proceed in various ways, but it suffices here to assume that some firms will adopt it while others do not. As adopting firms lower their production costs, part of the savings must be passed to farmers to attract the larger volumes of grain necessary to achieve the lower costs. Now the farmers determine the fate of the non- adopting elevators! If the value of a local elevator is greater than a higher price at a distant elevator, the local farmers will continue supporting the local elevator by voting with continued patronage. On the other hand, if local service is valued less than price increases, the farmers effectively vote the demise of the non- adopting firms through exiting with their patronage. Farmers also adapt to technological change at varying rates. Some farmers immediately respond to the new technology, thereby rewarding adopters and encouraging further adoption. For a time, other farmers continue to support non-adopting elevators and thereby provide some economic stability during the process of change. Their loyalty provides the Opportunity for a gradual disinvestment in elevator facilities. 151 Loyalty depends upon several factors including the economic and social valuation placed upon local service, personal relationships, and most importantly the size of truck owned by the farmer. This does not imply that rail service has no impact on the evolutionary structure of the elevator industry. Rail service and the other determinants of an elevator opportunity set such as managerial ability, access to capital, existing physical structure, and location are the major factors in determining which elevators continue and which cease Operations. Thus rail service is an important influence in determining which elevators adopt technology and which exit, but cost-reducing technology and not rail service decrees that some firms must exit.5 For example, an elevator located on a branch line may have a completely different future than its competitors located on the main line. It may choose not to pursue an expansion program because of the uncertainty of the environment. Or perhaps it is not uncertainty which restricts investment, but rather absolute certainty! As reported in Chapter III, most elevator managers recognize and are adjusting to the changes occurring in the technological environment. But they will also, if possible, use the political arena to postpone or reduce impacts including those resulting from technological change, and this accounts for the effort to preserve rail service to save elevators. 5In certain situations changes in rail service such as unit train rates may be the technological impetitus generating the new structure but technological changes and rail service must be dif- ferentiated. 152 As identified in Chapter II, Baumel has reported findings,6 which verify these conclusions. He found that extensive abandonment would not eliminate any elevator but rather would change their method of Operation. Economic impact of elevator exit The second question, whether the elimination of an elevator imposes economic costs or benefits upon the grain marketing system, is answered by model modifications which identify the net economic cost imposed by elevator exit. As elevator attrition occurs, the average distance grain is hauled increases, increasing collection costs. As high cost elevators are eliminated and grain is processed through lower cost facilities, handling costs are reduced. Distri- bution costs are reduced as elevators exit primarily because of geographic location of the smaller elevator and achieving distribu- tion economies such as three car rates. In the next modifications, the parameter which forced grain to the smaller elevator was modified, allowing farm collection to bypass them. The first variation, Modification VI, involved the elimination of all elevators with 50,000 bushels of storage capacity or less. This included the first ten elevators identified in Table 5-4. A second variation, Modification VII, involved the elimina- tion of all elevators with less than 100,000 bushels of storage capacity. This included ten additional elevators or a total of 20, 6Baumel, et al., Economic Analysis of Alternative Systems, p. 75. 153 Table 5-4. The Ten and Twenty Smallest Elevators Serving the Michigan Thumb Region Location Owner* Storage Capacity The ten smallest elevators in Michigan's Thumb region: Lapeer Ind 10,000 Clifford KFS 10,000 Kingston KFS 20,000 Ruth TFS 32,000 Caro Wickes 32,500 Cass City KFS 43,000 Yale Coop 43,000 Decker Ind 48,000 Bradleyville Blount 50,000 Minden City Ind 50,000 The eleven-twentieth smallest elevators in Michigan's Thumb region: Davidson Wickes 53,300 Imlay City Coop 56,000 Applegate Blount 60,000 Deckerville Wickes 63,000 Brown City Wickes 64,300 Avoco Ind 70,000 Owendale Wickes 73,300 Akron Blount 84,000 Ubly TFS 90,000 Elkton Blount 98,000 *Ind. indicates an independent elevator, KFS indicates elevators owned by Kingston Farm Services, and TFS indicates elevators owned by Thumb Farm Services. 154 one-third of those presently serving the Thumb (see Table 5-4). The elimination of the ten smallest elevators reduced the regional storage capacity by 338,500 bushels while the elimination of the 20 smallest elevators reduces it 1,050,400 bushels. The twenty smallest elevators, comprising one-third of the 60 elevators serving the Thumb, are geographically dispersed through- out the region rather than being concentrated in a particular area (see Figure 5-2 for the specific location of the small elevators). This ratio also extends to rail service, as one-third of the ele- vators without service and one-third of those located on either main or branch lines have less than 100,000 bushels of storage capacity. Thus the 20 smallest facilities e£e_pgp concentrated on branch lines. In general, the small elevators do not have a monopolistic service area. Seven are located at competitive delivery points, another seven are located within five miles of a larger elevator, and six are located between six and ten miles from another delivery point. Therefore any impacts imposed by elevator exit are likely to be distributed rather evenly throughout the Thumb region. Modifications VI and VII: elevator exit Through eliminating the ten smallest elevators, the net cost of marketing grain was reduced $270,952 for Michigan's Thumb region during the 1976 marketing year (see Table 5-5). Eliminating the second ten elevators reduced marketing costs an additional $164,276, and the total reduction for 20 elevators was estimated to be $435,228 (see Table 5-5). The cost of collection activities increased $84,863 as the 20 smallest elevators ceased operation 155 0". O 1 ‘. I I. “'7 1‘ O 0 q / ' \. 07;: \ 0 9‘ x3 .’ t \ .\. o/ o\ x, 10 9 \ \o \'I\ ' '10 . D 'X 1 \ o | 'o O . U I X! ° :0 U 0 .""\.O Q . 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HOumaoao mo uomoam .mln waan 157 while handling and processing costs decreased $457,521 and distribu- tion costs were reduced $63,570. Any policy based upon these impacts must include a recognition of the time horizons over which these costs and benefits are incurred and perceived. This is especially important since impacts vary significantly between the various marketing functions. In a static analysis, farmers incur an immediate and obvious increase in collection costs as elevator exit eliminates their market. However, the savings generated through reductions in hand- ling and processing are spread over a longer time frame and therefore are often concealed and not perceived by recipients. This occurs because the income stream of the small elevator exceeds its oppor- tunity cost, which warrants continued operations but the income stream does not warrant rehabilitation. Thus in spite of its higher operating costs, the smaller elevator has survived by offering competitive bids and living off depreciation and the exit of an elevator will not create an immediate increase in grain prices be- cause most of the cost reduction has been passed on as elevators have disinvested in facilities. Therefore, the impacts which are perceived to result from elevator exit differ significantly from the actual impacts. And since the benefits are not as Obvious as costs, channel members and users may be working against their long term interests. Impact recipients Elevator exit is not a pareto optimal transaction in spite of the cost reduction. Some community members benefit while others 158 incur costs. Following is a partial description of the impacts and impact direction which result from the changing elevator structure. Farmers Farmers whose elevators adapt to the changing competitive environment by purchasing technology actually benefit as their price is enhanced while they don't incur additional transportation expense. On the other hand, farmers losing local elevator service will incur additional transportation expense. This impact can be especially burdensome for the smaller farmer who was located near the elevator and delivered grain with a farm tractor and trailer. He may be forced to invest in a truck. Kulshreshtha further suggests that other farmers may need to increase their truck investment.‘7 In the short run the purchase of commercial transportation services may be substituted for investment in farm trucking capabilities. This does not mitagate the impact but rather simply changes the form of the impact. The increase in transportation costs imposed upon farmers through closing one-third of the Thumb region elevators, the smallest 20, totals $84,863. Those farmers who currently serve the seven elevators located at competitive delivery points will incur no additional costs. The bulk of the increase will be borne by the farmers serving the delivery points which are six to ten miles from other elevators. Farmers will share with elevators the nearly half a million dollars saved as elevators' handling and processing are 7Kulshreshtha, "Cost of Hauling Grain," passim. 159 reduced. The amount received by each depends upon the elasticity of demand for marketing service, the investment required to achieve economies in grain processing, and changes in marketing margins. It seems plausible that the farmers share would exceed the increased transportation costs they bear. Thus, in total, the farmer may be- a net gainer. But the impacts are not allocated among farmers equally as some farmers gain substantially while others are net losers. Transportation companies Railroads are characterized by extensive scale economies which can be realized more effectively through serving fewer and larger elevators. Therefore as elevator exit occurs, railroad operating costs will generally be reduced, especially if multi-car units are substituted for single car shipments. However substantial reduction in railroad costs probably will result through rail abandonment rather than elevator exit. The benefits captured by the railroad as elevator exit occurs were not included in the mathematical model because they are virtually impossible to measure accurately. Because of the increased collection distances the commercial trucking industry will likely benefit as a result of an increased demand for their service in collecting grain. These costs were included in the model through the increase in collection cost. The smaller elevators also use a disproportionately larger share of truck shipment in their total modal mix. 160 Elevators Both remaining and exiting elevators experience economic impacts and modifications in their opportunity sets as some facilities cease operations. Those firms adOpting technology, expanding facil- ities, and remaining in business enjoy an increased volume of grain and increased accounting profits. Of course, an increased investment is undertaken with expectations of an increased return. And some economic profit is necessary to induce the capital investment re- quired to achieve the economies of scale possible in grain handling and processing. Extensive economic rent is unlikely, however, be- cause 40 firms would remain and a substantial number have invested or potentially could invest.in the most efficient technology. Exit- ing elevators incur a reduction in capital investment and the elimination of their income stream. Usually exit occurs over time as a disinvestment process. When the combined salvage value of capital and the opportunity cost of management exceed the income generated the elevator will cease operations. Thus the impacts received by elevators are largely modifications in opportunity sets, and again there are both gainers and losers. Communities The presence or absence of an elevator is deemed by many to be an essential component of the community's opportunity set. The expansion of an elevator is thought to increase retail trade while the demise of the local elevator is often viewed as a death sentence to a community. This indirect impact upon the community's 161 Opportunity sets was not included in the model because over the region the negative and positive impacts may balance out. Future trends and policy implications The results of the mathematical model suggests that the historical trends of elevator structure and concentration will con- tinue over the next several years. That is, some elevators will increase handling capacity while others disinvest over time and eventually exit. The impetus for this trend are the economies of scale generated by the adoption of technology“ While economic efficiencies will increase as the elevator structure continues its evolution, the benefits enjoyed will not be enjoyed by all channel members or users. And when an inequitable allocation occurs, or is perceived to occur, those injured may try to modify the impact. The inherent danger is that they will address the wrong issue. Technology, which generates inequitable impacts, is not the problem. Rather the institutions which allocate the impact are failing. And policy must be directed at the problem. Therefore, public policy and efforts should not be directed towards preserving the existing elevator structure. Instead, if the distri- bution of impact is considered socially unacceptable, effort should be directed toward designing institutions and infrastructure which allocate impacts in a socially acceptable manner. Perhaps the most beneficial role the public sector can assume is to become actively involved in providing better information and in long range, 20 to 30 year, planning. Elevator planning occurring separately from 162 railroad and highway planning must result in a less than optimal product. Long range highway and railroad planning could assist both farmers and elevator operators. Rail Line Abandonment Rail abandonment is a critical concern to both members and users of the agricultural marketing channel. One witness testified at the GTW's abandonment hearing for the Imlay City-Caseville branch that the loss of rail service "could result in as much as $1.00 less per bushel that farmers would receive."8 The various railroad companies, on the other hand, insist that serving branch lines which produce losses will erode the profits and threaten the financial viability of the entire rail system. The GTW claimed that the Imlay City-Caseville line was operated at a deficit of $229,250 for the year ending June 30, 1976.9 Because of the anticipated impacts, local citizens and state and local public officials are faced with difficult questions. What abandonment strategy should be employed, which rail lines are essential, should public monies be utilized to maintain rail service, and if so, under what criteria and how should the transportation system be organized to best serve the region in the long run? One elevator manager has suggested that these questions will be answered in a political manner, because "rail line abandonment is a political 8National Farmers Organization, Exhibit before the Interstate Commerce Commission Abandonment Docket No. AB 31 (Sub No. 3), Grand Trunk Western Railroad Company Abandonment Between Imlay City and Caseville, Michigan. 9Initial Decision No. AB-31 (Sub No. 3), Grand Trunk Western Railroad Company Abandonment Between Imlay City and Caseville, Mich- igan, Interstate Commerce Commission, Washington, D.C., July 19T7,p. l7. 163 issue not an economic one." Perhaps the less cynical might suggest that the availability of valid economic information will improve the decision-making process, thereby resulting in a more Optimal com— bination of resources over time. Estimation of abandonment impacts This series of modifications is designed toprovide economic information which can facilitate the decision-making process involved in designing an intermodal transportation network and elevator hand- ling system which will employ resources effectively in the long-run. This is achieved by estimating the direction and extent of impacts that are imposed through branch line abandonment. Each modification will report the impact imposed through the abandonment of one of the four branch lines in the Thumb. The assumptions which form the foundations for these modifications are critical because a model can only Optimize within the parameters established. The assumption built into these modifications regarding their response will have a significant impact upon the extent of the estimated impacts. For example, transportation rates to export or to Eastern feed grain markets are increased through abandonment. But there is little agreement regarding the extent of the rate increase. In the earlier estimated cost increase of $1.00 per bushel made by the NFO at Cass City, the underlying assumption was that distribution patterns would remain the same and only the transportation mode would vary. They assumed that truck shipments to the same destination would replace rail movement. However, this is unlikely because the New England market can be reached through transshipment cheaper than by 164 truck. And a market solution would force each firm to adopt the least cost Operating procedure. Thus one distribution assumption is that all grain flow patterns will remain the same and trans- shipment will be used by elevators losing rail service. Another assumption is that the region maintains existing destination tonnage while shipment patterns shift between those elevators retaining and losing service. This allows an optimal reorganization of dis- tribution patterns. And a third alternative involves modifying the destination served by the marketing system. This would involve shifting grain flow from the Eastern rail markets to regional truck markets for all elevators losing rail service. Unfortunately, each of these assumptions contains limitations and departs from reality. The first assumption does not recognize shifts in comparative advantage created by abandonment. While the second is extremely easy to model, it is a completely unrealistic assumption because existing practices and information flow restrict optimal shifts, especially in the short run. The third assumption violates the ceteris paribus assumption because changes in destination will alter price patterns, especially in local truck markets, and this assumption becomes more limiting as branch line abandonment becomes more extensive. Similar limitations exist in both the collection and hand- ling processes. Either a change in the volume of grain transshipped or a change in volume handled by each elevator will shift elevators along their short run average cost curve, increasing some and decreasing other processing costs. The optimal collection pattern 165 will also vary in response to abandonment as it is dependent upon handling and distribution costs. Rail abandonment occurs in an interdependent dynamic economic environment, which further compounds the difficulty of estimating impacts. Elevator exit, changes in farm trucking capability, multi- car rates, and the highway system are among the many factors which affect and simultaneously are affected by rail line abandonment. Attempts to estimate impacts without including other changes restrict the scope of the results. Because of these constraints, and to provide a more useful type of information, several forms of abandon- ment impacts will be reported. First, an upper bound will be estimated. It assumes that all grain formerly destined to the Eastern feed grain market from elevators on the line under study will be transshipped through nearby elevators retaining rail service. Then a lower bound will be estimated which assumes that elevators losing rail service will alter destinations from the Eastern rail market to local truck markets. These represent the extremes of the probable outcomes. More extreme scenarios, while possible, are not probable and thus are excluded. A third alternative is also included. It assumes that the probable outcome is a combination of transshipment and serving local truck markets and therefore the final increase in distribution costs will fall somewhere between the other two alternatives. This third alternative is designed to represent the most probable outcome. Impacts resulting from the change in the collection process as abandonment occurred were estimated. These modifications assumed 166 that as distribution costs increased, farmers located near the boundary of an elevator's collection area would exit to a firm retain- ing rail service. Modifications in handling costs resulting from abandonment were also estimated and included in each scenario. Other impacts were also aggregated with the economic impacts imposed through rail abandonment to give a broader view of the total impacts and possible policy alternatives. The first variation involved combining elevator exit and abandonment. As elevators exit, they erode the traffic on branch lines, leading to the demise of the line. Similarly, abandonment alters the Opportunity set of each elevator, and the small elevator may be forced to exit grain merchandising operations and assume other roles. This interdepend- ence was addressed through estimating the joint impact of all the elevators on the subject line with less than 100,000 bushels of storage capactiy exited. The second modification involved the introduction of ten car rates at elevators on the rail lines adjoining the line under study. Thus if one elevator lost rail service, it could transship grain to nearby elevators with ten car rates. Currently ten car rates are published, but they provide no incentive for shippers or receivers to invest in the infrastructure necessary for their use. A com- petitive level of ten car rates was determined by using an estimating equation based upon single car, three car, and unit train rates. Both of these variations reduce marketing costs, and when integrated with abandonment impacts, they reduce the costs inflicted upon the farmers losing rail service. However they are not intended 167 as a slight of hand manipulation to eliminate abandonment impacts. Rather they are included to suggest that institutions can be designed using market transactions to reduce the negative impacts resulting from abandonment. Modification VIII: abandonment impacts of the C & O's Bad Axe to Croswell line upon the grain industry The longest branchline serving the Thumb region and the one serving the most elevators is the C & 0 line between Bad Axe and Croswell and Bad Axe and Kinde. This line parallels the east coast of the Thumb serving 14 elevators, nearly 25 percent of the elevators in the Thumb. The particular elevators served by this branch line are identified in Table 5-6 and are displayed in Figure 5-2 as C & 0 line one. These elevators have an average capacity of 213,400 bushels, which is substantially less than the regional average of 291,000. Totally they handle 1.87 million bushels of wheat and 3.1 million bushels of corn. This branch was orange-lined in the DOT study and also was the subject of an abandonment petition which was recently withdrawn. The costs imposed by the abandonment of this line are displayed in Table 5-7. In most abandonment hearings the main emphasis is upon the increased distribution costs which will result from the loss of rail service. The loss of this line will result in a probable increased distributional cost of about $237,078 for grain. However, farmer exit will interact to reduce this increased cost. As abandonment alters the pricing environment, farmers located near the elevator's competitive boundaries will shift their patronage to elevators Table 5-6. Thumb Region Elevators Which Are Served by the Various 168 Branch Lines Railroad Branch Line Location Owner Storage Capacity Modification VIII Kinde Blount 160,000 C & 0 Line 1 Kinde Coop 525,000 Croswell to Bad Axe Ubly Wruble 335,000 Bad Axe to Kinde Ubly TFS 90,000 Harbor Beach Wruble 160,000 Ruth Coop 558,000 Ruth TFS 32,000 Minden City Ind 50,000 Deckerville Wickes 63,000 Deckerville Ind 250,000 Sandusky Wickes 186,900 Carsonville Blount 330,000 Applegate Blount 60,000 Croswell Wickes 187,800 Modification IX Avoca Ind 70,000 C & 0 Line 2 Yale Coop 43,000 Port Huron to Brown City Wickes 64,300 Saginaw Marlette COOp 560,000 Mayville Ind 100,000 Modification X North Branch Blount 290,000 GTW Kingston KFS 20,000 Imlay City to Cass City Coop 530,000 Caseville Cass City Wickes 469,000 Owendale Wickes 73,300 Gagetown Blount 418,000 Modification XI Colling Blount 315,700 TU & SB Richville S of W 420,000 Entire System Caro Wickes 32,500 Millington Ind 340,000 Reese Coop 900,000 Vassar Wickes 299,000 169 th4mm I NmH.mOHI m0m.ma I www.mmdl mmm.mha+w Ohm.HmH+ th.om 1» mno.smm+ omo.®m + mmm45mm+m mow>uom mew mcficwmumu muoum>oao Somme: um moonwaomumm mono» Hmo cos mom.ma + ooufiamcoflumu monouumm c0wuonflwumwo use noduuoaaoo uflxm woum>oam one.m +m omnwachAHMH mcumuumm cowuonwwumwo pom cOwuomHHoo aflxo wmsumm Am>wumcwmuam uomme manmnoumv muoxwma ucofimflnmmcmuu mom xoouu HMOOH mo cowumcwnsoo ucmumcoo cwmoumm cofluooaaou Ao>wumcumuam mucosa umozoav umxums xoouu HmooH ow menu usmumcoo cumuumm cowuomaaoo Ao>flumchouam uomme ummnmflnv occamcm zoz ou mwnmmcmuu ucmumcoo cwouumm cowuooaaoo mumoo Hmuoa mumou cofluonfiuumfio mumoo mcwaocmx dd ommwuocH cw ommouocH cw ommouocH mumoo cofluooaaoo cfi mmmouocH scaumoamaooz smuumm know mcwuoxumz puma «omouawmm o a O on» ho ooumuomo wooed oxm ommnmocflx ocm oxm ommladosmouo on» no ucoscoocmod on» ma ommomEH mumou mcfiuoxumz cwmww ca ommouocH "HHH> coflum0fimaooz .hum magma 170 retaining rail service. This will increase collection costs but handling costs will decrease because elevators with lower handling costs will enjoy the increased patronage, and a portion of the increased distribution costs will be offset. The total cost imposed by abandonment after farmers have shifted marketing patterns totals $179,500. The establishment of lO-car rates on nearby rail lines would reduce abandonment impact by $85,278.10 This means that the increase in marketing costs of $179,500 imposed by abandonment could be reduced by nearly 50 percent if the railroads implemented lO-car rates on nearby lines. Thus the railroads have the opportunity to utilize a limited market transaction by pacifying shippers losing rail service with an economic incentive that reduces their costs. Of course the savings would be even greater if lO-car rates were published and rail service retained! However, this does provide shippers and carriers with a potential market transaction. Abandonment also disrupts the competitive environment among grain elevators. Small facilities will likely modify operations, and some will discontinue grain merchandising operations. Because smaller elevators have higher operating costs, their exit reduces regional marketing costs. The exit of all elevators with less than 100,000 bushels of storage capacity located on this rail line will reduce abandonment impact $105,162. 10This amount includes only the savings which would occur for the grain currently marketed through elevators located on this branch line. Obviously substantial savings will also occur for grain currently marketed through elevators located on nearby lines. 171 Modification IX: abandonment impacts of the C & O's Port Huron-Saginaw line upon the grain industry The C & 0 also Operates a second branchline in the Thumb region which runs between Port Huron and Saginaw. This branch, which was also orange-lined by the DOT study, serves five elevators (see Table 5-6) with an average storage capacity of 167,400 bushels, which is less than 60 percent of the region's capacity (see Figure 5-2, C & 0 Line 2). Three of these elevators have less than 100,000 bushels of storage capacity. Collectively these five elevators handled 1,988,450 bushels Of wheat and corn during 1976. The abandonment of this line will result in a probable increase in distribution costs of $89,748 (see Table 5-8). The costs imposed after the long term modifications in collection pat- terns resulting from farmer exit have occurred will total $66,070. The introduction of 10 car rates on adjacent lines would reduce these impacts by $30,203. Thus the railroads could again reduce the $66,000 impact of abandonment by nearly 50 percent by introducing 10 car rates. Three of the five elevators located on this line have less than 100,000 bushels of storage capacity and exit of these three elevators integrated with abandonment for this line would reduce abandonment impacts $36,148. Modification X: abandonment impacts of the GTW's Imlay City-Caseville line upon the grain industry The Grand Trunk Western Railroad Operates a branch between Imlay City and Caseville. An abandonment petition was denied July 6, 1977 for this trackage, which was also orange-lined by the 172 mom.om I ouw>umm Hwew mcwcweuou muoue>mam >nuemc ue moonwaneumo woven ueo cos mva.omu vnm.na+ mmq.m>n moe.mm+ emuaaecoaueu mcumuueo cOAuoanumflo one cOAUOOHHOO ufixe uoue>oam ono.eo+w mmm.mh + hmo.m 1% vm~.m +m emufiaecoaueu ucumuueo componfiuumflo one cowuomaaoo ufixo Hosuem \.mvh.mm + Am>fiuecneuae poemfiw manenoumv , muoxuee uceemwnmmceuu one xoouu Heooa mo cowueCflnEoo uceumcoo cumuuem cofiuomaaou Hmv.mm + Aw>fluecuouae poems“ umozoav umxuefi xosuu Heooa Op meow uceumcoo cumuuem cofiuoeaaou ovm.>ma+m Ao>wuecwouae uoemafl ummnmflmv oceamcm 3oz Ou mwnmmceuu pneumcoo snouuem cowuomHHOU mumou Heuoa mumoo cowuonfiuumflo mumou mcwaocem mumoo cowuooaaou cofiueOAMAOOS Emummm ca owemuocH ca mmemuocH ca mmeouocH cfl wwemuocH new» mcwuexnez puma «onHHflem o a U ecu an ooueummo mafia sesamem couom uuom ecu mo ucwscooceoe on» >9 oomomEH mumoo mcfluexwez caeuo ca omemuocH "xH nodueowmaooz .mam manea 173 DOT study. In addition to other industrial and agricultural users,. service is provided to six grain elevators with an average storage capacity of 300,000 bushels and a total combined volume of 3.4 million bushels of grain handled. Two other elevators located on this line, the Pigeon and Clifford facilities, are also served by the C s 0 Railroad. Because they have alternative rail service available, they are not included in the analysis of this line. The abandonment of this line will increase distribution costs $87,354. The long term impact after farmers have rationalized their collection patterns will be a net increase in marketing costs of $58,567 (see Table 5-9 and Figure 5-2). The availability of 10 car rates on nearby lines retaining service reduces the impact by over $52,900. Thus for this rail line the introduction of 10 car rates by the C & O on its nearby lines will offset $52,900 of the $58,567 cost imposed by a GTW abandonment. For this particular line a market transaction designed to alleviate some of the costs imposed through abandonment would be very possible if institutions existed which would not only allow a market solution but would encourage and facilitate it. The exit of elevators with less than 100,000 bushel storage capactiy will increase collection costs $16,437 while reducing handling costs nearly $150,000. The resulting net impact is a marketing cost reduction from elevator exit of $133,000. Modification XI: impact of the abandonment of the entire Tuscola and Saginaw Bay Railroad upon the grain industry The last branchline serving the Thumb is operated by the Tuscola and Saginaw Bay Railroad, a short line road which serves six 174 ovm.oh 1 ouw>kom amen mnflnfleuou muoue>oao anueon ue omnmfianeumm woven Heo nos vmq.mman o Hom.mvan hmv.oa+ oouwaenowueu mnuopuem nOHunnfluumflo one noauooaaoo uwxo uoue>oam OHH.mm +m men.vm + mnm.ma um mH>.m +m omunnmconueu mcumuueo nofiunnfluumwo one nowuomdaoo uwxm Hofiuem mov.moa+ 16>numcumuam bemoan unnmnounc muoxuefi unoemfinmmneuu one xonuu HeooH mo nowuenflnaoo pneumnoo nuouuem coauomaaou moo.am + Am>wuenuouae uoemEfl umo3oav umxuefi xonhu HeooH on menu pneumnoo nuouuem nowuooaaou mmv.oha+w Ao>auenuouae uoeoEfl amonmwnv oneaonm 3oz on mfinmmneuu pneumnoo nuouuem coauooaaoo mumOU HeUOB mumoo nofiunnwuumflo mumOU manonem mumou nOfluomHHOU nowueowmmooz Eoumam cw mmeouonH cw omeouonH nw omeouonH n“ mmeouonH new» manumxumz puma “emouanmm ago on» an ewumnmmo mung madn>mmeo:>uno erEH on» no unofinoonenn on» an oomOQEH mumoo mnwuoxuez nfieuu nfi omeononH ”x nowueowwwooz .mnm wanes 175 elevators. The particular elevators served are identified in Table 5-6 and are displayed in Figure 5-2. The average storage capacity of the six elevators is 384,500 bushels, which is much larger than the regional average of 291,000, and collectively they processed 900,000 bushels of wheat and 2.2 million bushels of corn. For all practical purposes, this line, which was orange-lined by the DOT, had been abandoned by the Penn Central and Conrail. How- ever since rejuvenated by short line management and public funding, grain shipments have increased dramatically. Unfortunately, this line faces competition from the nearby C & 0 lines, and most of the elevators are located within a few miles of elevators served by the C & 0. Distribution costs will increase $43,686 if the line is abandoned (see Table 5-10). This figure is relatively small because of the subterminals located nearby, which reduce the cost of trans- shipment. Modifications in collection patterns as farmers exit will result in a long term marketing cost increase of $21,000. The introduction of lO-car rates at elevators retaining rail service will reduce the impact $27,028, completely offsetting the $21,015 increase in costs imposed by the abandonment of this line. This again reflects the need for an analysis of the institution which motivates the behavior of railroads and their customers. Recipients of abandonment impacts / In total, rail abandonment imposes a net cost upon the grain marketing channel. However, as with elevator exit, the impacts are not allocated equally among members or users, and some enjoy net 176 mmo.h~ I oow>uom Hweu unfinweuou muoue>oao anueon ue oonmwaneumo woven Heo nee www.ma n o emm.am : Hoe.~+ emanaeconumn mcumuumn noflunnmuumwo one nofiuooaaoo afixo woue>oam mno.Hm +w mmm.mm + mmn.~a 1w vow +8 emanaeconumu coauomaaoo Unnxm MOSHMh www.mv + Ao>wuennouae poems“ oaoenoumv mumxuea unosmwnmmneuu one xonuu Heooa mo nowuenflnfioo uneumnoo nuouuem coauomaaoo 0mm.mH + Ao>wuenuouae poemfiw awesoav noxuee gosh» HeooH ow mach pneumnoo nuouuem nowuooaaoo omm.oo +w Ae>wuenuouae poemaw amonmflnv oneamnm 3oz Ou mwnmmneuu uneumnoo nuouuem nofiuoeaaou mumoo Heuoa mumoo conusnnuumno mumoo manaecmm mumoo conuomaaoo conumonuauoz suumsm nw omeouonH nfi emeouonH n“ omemnonH nu mmeouonH new» manumxumz puma “emouanmm see smunmmm leaoomoa man we unmsnoonenn on» an ommomEH mumou mnfiumxuez nflewo nw omeouonH "Hx nowueOflmwooz .OHIm mHQeB 177 benefits while others receive net costs. Furthermore, some impacts are immediately apparent while others occur in small increments over time. In this section the recipients of abandonment impacts are described. Railroads A major benefactor of branch line abandonment is the rail- road. Not only are they able to eliminate an alleged source Of financial drain but collectively they are likely to retain the bulk of the agricultural traffic flow while simultaneously achieving economies of scale. This occurs because, after abandonment, trucks gather the grain from farmers or smaller elevators to the larger elevators or subterminals which are capable of shipping multi-car or unit trains. As a result, the high cost collection function is reduced for the railroads, andtflmadistribution function is performed more economically. The Thumb area railroads will capture the benefits generated by abandonment in two ways. First, abandonment will eliminate the loss or potential loss which occurs from operations, and secondly, abandonment will eliminate the capital improvements which are neces- sary on each of these lines. Unfortunately, neither of these figures can be accurately determined. As reported in Chapter III, the earnings on the Imlay City-Caseville line ranged from a railroad estimate of a $229,250 loss to a shipper expert estimate of a $48,719 profit. Disagreement also existed regarding rehabilitation expenses for this line although the need was not questioned at the 178 abandonment hearing. Perhaps in the future accurate data will become available from the experience the public sector gains in subsidizing the various short lines through Michigan. In spite of the disagreement about the specific profit level, most shippers and carriers would probably agree that under existing operating procedures none of the four subject lines generates a level of profit which adequately compensatestfluarailroad when com- pared to other industrial sectors. Because of the low return, rail service can only be maintained on these lines in one of two ways: coercion, or a public or private subsidy. Coercion is currently being employed but is not effective in the long-run. The reason is developed in Appendix C. The problems of collective action among shippers in initiating a market transaction is explored in Chapter I. Organizational and transaction costs and the free rider strategy all interact to restrict organizational efforts. In addition, the profitability of a venture also reveals the incentive for collective action. The estimated costs imposed through abandonment can be capitalized or discounted using the established estimated life and discount rate to determine the feasibility of rehabilitation, pro- viding an operating subsidy, or both. For these particular lines, a market transaction offered through collective action to retain rail service does not appear to be forthcoming because of the limited costs abandonment imposes upon the collective community of channel members (see Table 5-11). Rail service was continued on the Tuscola and Saginaw Bay Railroad through collective action, but a major share of the financial 1I79 .uuxo huuoeneo oweuOuu mo oaonunn ooo.ooa nenu need now: quue>0Ho HHe oanocu mavens“ nu nowuunoox««a .uunaa anueon no oonmwabeuuo one money neuuou mu muoenaw na nowuunoomuu .unuoo uneanoonene oanonm wnwuoxuen nweum nu omeononw oaoeboume mmo.wH wmo.- nmo.H~ mmm.~n m~5.NH1 com ooo.ooa.m oom.cwm o neumzu ouuune rmma Hx nowueuawnooz «No.mma ocm.on oaa.mw mon.cm w~m.na1 oH~.m ooo.oow.m ooo.oom o oaaw>omeu Ou huwo meHaH 390 x noaueowuuoo: Shem 898 08.3 REE a8; 1 is; 84.35; co}: n 323% 3 noun: uuom O a o xu nowueoauuoo: Noa.noam wn~.mwm wNn.o~Hm o-.~mam ~n¢.¢~1w om~.ww ooo.o~m.c coo.m- «a ex< oem 0» Hauaoonu o w o HHH> noqueoawwooz oo>umm uuauaxe «uuaueu «ooeouona enoue>oao an uuoue>oao uOue>eHo mo neonoa mo no newneno newneno newneco oeaonen mo oo>nou noauonoom nowuunoem uuenaw ueoo uooo umoo nqeuw zuaoeneo euoue>oao uoenaH uoenau Heuoa nonunnuuueao mnuaonem nouuooaaou uo onnflo> omeuo>< mo neoanz nowuoo uwxm uoauem .uune uOue>OHe one oeueu ueonca scum wnuuanoeu noduunoou uoeoaa one .muoena« unmanoonebe .mowumwueuoeuenu uOue>on "nouueBLOwnH uneanoonebe wo hueaanm .Halm waneh 180 support was publicly provided. It is doubtful that the shippers could have collectively achieved the same results. The State support reduced the costs, and therefore the benefits which were captured by a few shippers were sufficient for them to proceed. Motor carriers The volume of grain requiring commercial transportation by motor carriers will increase as transshipment activities increase, and thus truck operators are also a major recipient of the positive abandonment impacts. Highways.--Both collection and distribution activities will require additional truck traffic after abandonment, increasing highway wear and maintenance costs. Because of the multiple funding sources at each level of government, the recipient of these increased costs is difficult to identify. As far as gasoline taxes extend in providing maintenance, the increase is borne by the user, and the cost is included in the increased collection and distribution costs reported in this study. If gas taxes fail to completely finance maintenance, the excess is not included in the estimated costs. This study was not designed to pursue this specific issue, but a Minnesota study examined the impact abandonment had upon high- 11 way cost. And a study by Tucker and Thompson explored the 11Richard Hoffbeck and Jerry Fruin, "The Impact of Railroad Abandonments on Highway Costs," Department of Agricultural and Applied Economics, University of Minnesota, May 1979, p. 2. 181 economic effect that rural road development had upon grain assembly costs.12 Farmers Individual farmers are a major recipient of the costs “I imposed by rail abandonment although some will actually benefit. Farmers located near elevators retaining rail service will enjoy higher prices as their elevators expand and achieve lower operating costs. Farmers near the competitive boundaries will incur additional trucking costs as their marketing patterns change. The increased collection costs for each line are displayed in Table 5-11. The reduction in handling costs will also be incurred, in part by these farmers offsetting their increased collection costs. In total, farmers located near the competitive boundary will probably be net gainers. The group receiving the bulk of costs imposed by abandon- ment are the farmers located near the elevators which lose rail service. The loss of rail-based markets will force their elevators to reduce their bid price in response to increased distribution costs. Nearby farmers, however, will not incur the total increase in distritution costs because elevators will be forced to absorb some of the increase to maintain an adequate grain.volume (see Table 5-11). The exact allocation is impossible to project, but it 12J. Dean Tucker, and Stanley R. Thompson, "Economic Effect of Rural Road Development on Grain Assembly Costs: The Case of Lenawee County, Michigan," Department of Agricultural Economics, Michigan State University, East Lansing, Michigan, December 1979. 182 is dependent upon the distance between elevators, the cost curves of competing elevators, and the elasticity of demand for marketing service. Elevators Increased distribution costs and restricted opportunity sets will be imposed upon elevators losing rail service. To remain competitive and retain as many of their patrons as possible, they will absorb a portion of the increased distribution costs displayed in Table 5-11. These elevators also lose the opportunity to expand, but most branch line elevators anticipated the potential abandonment long ago and have devised their strategies accordingly. As railroads reduced service and maintenance levels, these elevators employed a similar strategy and disinvested or restricted new investment. The results can be observed by comparing the regional average elevator capacity of 291,000 bushels to the average capacity of the elevators located on each branch line (see Table 5-11). Various studies have revealed that the loss of rail service does not force viable and efficient elevators out of business.13 It does, however, determine which elevators can adOpt technology that will reduce operating costs and which cannot. Thus smaller elevators with higher operat- ing costs losing rail service will need to evaluate their predestined future and some will be encouraged to cease Operations sooner than they normally would have while others may pursue alternative Oppor- tunities such as feed milling or serving suburban clients. 13See Chapter II for additional details. 183 Abandonment does not impose costs upon all elevators, however, for those retaining rail service actually benefit. Their operating cost, including distribution, will be reduced relative to competitors losing service allowing them to attract additional grain. Their opportunity to expand is also enhanced by the elimination of rail service to their competitors. In the long run, technological innovation dictates that some elevators must exit to provide operating economies for adopters. Railroad abandonment is a major factor in determining which invest and which will exit. Other rail users This study has examined the abandonment impacts imposed upon grain channel members only. Each of these rail lines also serves other shippers such as fertilizer and lumber dealers, and their impacts have not been measured in this study. Of course, the in- terest of all transportation users must be included when designing long term railroad and highway systems. Summary of abandonment impacts The abandonment of any of the four Thumb area branch lines will impose an immediate increase in the cost of distributing grain as truck collection is substituted for rail. The largest cost increase will be imposed if the grain is transshipped through nearby elevators retaining rail service while the smallest cost will be imposed if the grain is delivered to nearby truck markets. The probable cost impact will fall somewhere between these two extremes as elevators employ both alternatives. This increase in distribution 184 costs will force elevators losing rail service to reduce their grain bids, and farmers located near the competitive boundaries will be encouraged to patronize nearby elevators retaining rail service. Exit by these farmers tends to mitigate a portion of the increased distribution costs. While their collection costs increase, elevators handling costs decrease as the grain is processed through lower cost facilities, and the increase in distribution cost is reduced as farmers patronize elevators retaining rail service eliminating trans- shipment activities. Because abandonment imposes costs, private interests have solicited the active participation of the public sector. In the Thumb region the State has participated in several ways: in the GTW hearing it intervened to assist shippers in maintaining service, rehabilitation and operating funds have been provided to continue service on the Tuscola and Saginaw Bay Railroad, and financial assistance appears imminent on other lines. This series of events raises several questions. Should the State insure continued service on all branch lines in the Thumb? Should it allow all to be aban- doned? Or should it selectively preserve some? And if the latter option is pursued, which lines should be retained? Many scenarios are possible. It is not the purpose of this research to recommend a particular course, but rather to provide information useful to policy makers in designing a long-term intermodal transportation network. In designing this network, the cost imposed by the abandon- ment of each line can be capitalized or discounted over a period 185 of time. This figure can be compared to the rail operating income (or_1oss) to determine the viability of the line and the extent of public funding necessary to maintain service. If a purely financial analysis is employed, none of these four lines appears to justify retention. It is unlikely that the total cost which will be imposed upon channel members through abandonment is greater than the costs imposed upon the railroads through continuing service, based only upon grain traffic. However the decision must be extended to include all commodities and other economic, social, and political factors. Two of these other factors, boundaries and time horizons, will be pursued further. The extent of the costs imposed by abandonment is dependent upon the regional boundaries. As the study region in- creases in size, benefits received by nearby elevators retaining rail service mitigates a portion of the costs imposed upon farmers and elevators losing rail service. Establishing very narrow boundaries may result in crisis situations while extending the boundaries reduces the crisis to a smaller problem as the intensity of partici- pants is diluted. A second boundary issue deals with multiple abandonments. In the Thumb, the costs imposed by abandonment are not cumulative but rather increase at an increasing rate as multiple lines are evaluated.14 Because of the number of potential combinations, 14This may not be generally true depending upon the geo- graphic location of main and branch lines but in the Thumb region, abandonment of multiple lines result in abandoning the nearby lines. For example, abandonment of the Imlay City-Caseville line eliminates the nearby transshipment points for the Croswell-Bad Axe line. 186 evaluation of multiple abandonments was impractical. Furthermore, private and public decisions are directed toward individual lines, rather than towards interrelationship of costs is an important element in long term evaluation of rail lines. The definition of boundaries is a critical component of effective long term planning. ... The time horizon necessary for the introduction of technology is also a critical concern when evaluating rail abandonment. If rail abandonment is the result of a dynamic interaction of market’ forces responding to changing economic production functions, then any action designed to preserve the status quo in order to minimize externalities will result in the imposition of other externalities by either preserving a high cost technology which will maintain general channel inefficiencies or creating dual channels in which inefficiencies prevent the general channel from achieving potential cost reductions. Three of the largest elevators in the Thumb region abandoned the railroad at their facility and built a subterminal to market their grain. Two of these were not in danger of losing rail service, but they recognized the economic savings which are generated by unit train shipments. Simultaneously, their competitors are attempting to maintain single or three car shipments. Farmers and elevators adopt technology at different rates, and efforts to preserve the status quo are simply a revelation of this fact. Policy designed to preserve the status quo will protect, in the short run, those not wanting to change, while imposing cost upon those attempting to achieve economies of scale. These impacts, resulting from the time horizon, were displayed in two modifications to rail abandonment, the introduction of ten car rates and elevator 187 exit. Both reveal the impacts of institutional and technological evolution over time. And both revealed that over time rates and exit interact to reduce marketing cost and that given sufficient incentives to adopt new institutions and technology, the impacts of abandonment will be completely mitigated and in total, marketing activities will cost less. Of course, there will still be losers and gainers. This implies not that innovations should be abandoned, but that efforts to maintain the existing infrastructure may be abandoned in lieu of efforts to devise a more equitable or desirable allocation of impacts. Thus abandonment imposes costs as distribution activities consume additional resources. Through market incentive, farmers will alter patronage patterns, reducing some of the additional costs. However, alternative institutional and technological environments could be designed which would reduce or eliminate the costs of abandonment. A primary factor in achieving these environments is an effective institutional design which will motivate individual behavior towards the desired economic performance. Changes in Vessel Rates Access to the fourth coast of the United States, the Great Lakes-St. Lawrence Seaway navigation systems, is provided to Thumb region shippers through the nearby ports of Saginaw and Toledo. Elevators can utilize this alternative marketing channel by trans- shipping via motor carriers, and farmers can deliver direct to ports, by-passing local elevators. However, the Lakes system is only used moderately by Thumb shippers. The elevator survey 188 revealed that 17 percent of the grain handled by the Thumb region elevators was transshipped through the port facilities. The amount of grain delivered direct by farmers is difficult to determine, but most elevator managers thought it was an insignificant volume. But even delivery to the ports does not insure the grain will be transported out by water! Both Toledo and Saginaw utilize unit trains extensively to reach the Atlantic ports, and the terminal managers at Saginaw seemed to feel their future was linked to rail rather than water. During the test period significantly less than half and probably less than 25 percent of the grain handled by the saginaw facilities was shipped out by water carriers. While the Michigan Elevator facility is about ten miles up river from Saginaw Bay, creating access problems for vessels, management felt the location gave access to more grain, and because of unit train rates, the competitive locational advantage outweighed any vessel problems. Therefore, rather than being a major marketing channel for moving the Thumb region's grain, the water system's primary contri- bution seems to have been the creation of a competitive environment, which has been a major factor in establishing the level of railroad rates, especially multi-car and unit train export rates. This raises several questions. Under what rate levels would transshipment and water movement expand from Thumb region origins? What volume of grain could potentially be available for water move- ment? And what will be the railroad's reaction to modification in ocean rate levels? These questions will be explored in this section 189 as the impacts imposed through alternative levels of water rates from the ports of Toledo and Saginaw are evaluated. Water rates: variability and levels Over time, water rates fluctuate extensively. For example, between Atlantic ports and Rotterdam typical rates varied from $6.88 per long ton in 1972/73 to $14.23 in 1973/74 and $7.58 in 1974/75. Lake port rates to Rotterdam also vary substantially. However, the critical competitive factor is the rate differential between the Lakes and Atlantic ports. It is this differential which shippers compare to unit train rates as they select a mode. And it is this differential that shippers in the Thumb did not seem to know! How- ever by using various sources of data, the differential for a "typical year" was estimated to be about a $0.028 per bushel ad- vantage for water carriers. It should be stressed that the rate differential also fluctuates as rates vary both between seasons and on a daily basis. Thus the advantage of water rates also fluctuates, both increasing and disappearing over time. This rate advantage indicates that water transportation via the Great Lakes-St. Lawrence system should be the dominant modes. It isn't! Apparently the water system is an inferior mode for various reasons including vessel shortages, limited shipping season, rate uncertainty, limited system capacity, and the institutional unit train rate structure. Various levels of unit train rates are published from Saginaw to Baltimore which are based upon the number of consecutive train loads. Rates for eight consecutive train loads of 65 cars are about two cents 190 less than the rates for five consecutive trains. Since over 225,000 bushels of grain are necessary to fill one train, shipping by irregular water carriage could jeOpardize securing the grain neces- sary to utilize eight train rates. Modivication XII: variation in water rates This modification evaluates the interaction of unit trains and water rates as the latter vary. However because water rates are unregulated, their level is uncertain, and most importantly, the competitive environment generates reactions to each action. This modification evaluates competitive boundaries and reactions among elevators rather than the estimated savings generated. Identifying specific dollar values implies greater confidence than is warranted in the benefits generated by fluctuating rates and fails to recog- nize competitive realities. And the interest of policy makers lies in the direction of impacts and the reaction of participants as incentives are modified rather than in the specific level of the incentives. To evaluate the impact of the alternative levels of water rates, these rates were substituted for the unit train rates which had been employed for Saginaw and Toledo in previous modifications. The base for this modification was Modification III, which allowed flexible transshipment volumes and patterns while maintaining origin and destination volumes. Three subterminal locations entered the solution in Modification III. 191 It estimated that through an Optimal organization of market- ing activities, 3,711,000 bushels of grain would be transshipped through Saginaw, 5,015,270 through Elkton, and 454,600 through Gilford. In addition, Elkton would process 1,479,000 bushels of grain delivered direct by farmers and Gilford 1,422,200. Modification XII suggests that in theory, successive reduc- tions in water rates of 1.7 cents per bushel will increase the volume of grain transshipped through Saginaw while reducing the volume transshipped through Gilford and Elkton. The first reduction elimi- nates Gilford as a transshipment point and reduced the volume at Elkton by 477,000 bushels. A second round of water reductions reduces the volume through Elkton by an additional 2,224,000, while the third round eliminated Elkton as a transshipment point. Should additional rate reduction occur, first Gilford and then Elkton will find it more profitable to deliver the grain they received from farmers to Saginaw rather than ship it via unit train to Baltimore. The benefactor of water rate reductions was Saginaw, as its terminals received increased volumes at each successive level of rate reduction. But regardless of the level of water rates, Toledo did not enter any solution. By enlarging the rate differential, all export grain could be forced through the ports, but only Saginaw entered the solution. An inspection of shadow prices and grain volumes indicates that the only way Toledo would enter any solution would be to increase the percentage of grain exported to include most of the grain that was destined to New England. While this Option was not pursued, it appears that elevators located in the 192 southern portion of the region would transship through Toledo under these conditions. While these results contradict the existing flow of grain to Toledo, they provide a great deal of insight. They imply that the smaller elevators serving the southern portion of the Thumb face limited and high cost marketing alternatives which sug- gests that continued rail service is critical to these elevators. Further, the availability of backhauls is exclusive to Toledo, which encourages patronage by reducing trucking costs when a backhaul is available. Should the unlikely event of significant reduction in water rates actually occur, the simulated outcome is unlikely to material- ize. The self-interest of Blount's and the Thumb Farm terminal will dictate that they take competitive counter action to survive. In addition to the subterminal at Gilford, Blount owns and operates 13 other elevators in the Thumb region. Each of these points is a captive source of grain and will continue to transship to Gilford as Blount operates its entire Operation to maximize profit. The fixed cost of their terminal provides a buffer against short term rate reductions. However, the simulation verified an observation made during the interview process: Gilford's location places it at a comparative disadvantage in attracting non-captive grain. Elevator managers had reported little grain being transshipped through Gilford. This occurs because Saginaw has a two cent advantage in rail rates and thus can attract corn traffic from elevators that potentially could transship to Gilford. And even though the flour mill owned by Star of the West, located at Frankenmuth, does not 193 have rail service, it effectively attracts the wheat traffic from the Gilford area. By milling the wheat and marketing the flour regionally, the mill is able to bid aggressively and attract a significant volume of grain. The owners of the Thumb Farm terminal at Elkton--the coopera- tives at Sebwaing, Ruth, and Elkton--are also captive shippers because of their financial investment, and thus Elkton will also maintain its transshipment volume should a water rate reduction place it at a competitive disadvantage. Further, Elkton is somewhat geographic- ally segregated from the other subterminals which provides a limited isolation from the impacts of small water rate reductions. Should a rate reduction occur, Elkton will receive smaller negative impacts than Gilford and will absorb them by narrowing margins. The recent introduction of unit train rates at Pigeon, which is only seven miles from Elkton, will have a far greater competitive impact than water rate reductions. This implies that as Adam Smith's invisible hand guides each participant interacting in the competitive market, the reaction will be to narrow margins rather than to reduce volume significantly. The widest margins will be enjoyed by those facili- ties with the most favorable locations, in this case the elevators located at Saginaw. Not only would they benefit should water rates become favorable, but they also enjoy lower rail rates. Rate fluctuations imply a two way movement, and thus far this section has focused on decreases only. This is because increases are basically irrelevant because each port also has unit trains available which, except during periods of equipment shortages, creates an upper bound on water rates. Port elevators will respond 194 to increases simply by expanding their usage of rail service. During periods of equipment shortage each terminal is restricted in the volume of grain it can ship. However, port elevators have the water alternative even if it is more expensive. The additional cost will be borne by farmers as elevators widen margins to allocate the limited supply of cars. Therefore, the competitive advantage of Saginaw is enhanced even when water rates are greater than unit train rates! Because of technological restrictions on the Great Lakes-St. Lawrence navigation system, its competitive disadvantage is likely to continue and increase over time. This makes a prolonged or significant rate reduction unlikely. Modification XII suggests that the primary future role of the fourth sea coast will be, as it had been in the past, to define the upper boundary for rail rates. The volume of Thumb region grain moving through the system will likely continue to be small. Summapy of Simulation Results For the 1976 grain marketing year, the cost of marketing corn, oats, and wheat produced in Michigan's Thumb region totaled $19,177,105, or $0.665 per bushel. This estimate includes several inefficiencies or slack. The first of these, collection slack, involved suboptimal delivery patterns by farmers, and was estimated indirectly by transposing data from another region. Four elements of slack were also identified in the distribution process which were estimated to total $581,000 or three percent of the total marketing costs. 195 If 65-car unit trains had not been utilized to distribute the Thumb's grain during the test period, marketing costs would have been over $3.2 million greater. It was further estimated that the exit of the ten smallest elevators serving the region would reduce marketing cost $270,952 while the exit of the 20 smallest would . result in a $435,228 reduction. The costs imposed by railroad {$5gfptiif . U . abandonment after farmers respond to competitive modifications were ,-fi’"“ II estimated for each of the four branch lines serving the Thumb region 91' for the 1976 marketing year: C & O's Croswell to Bad Axe Line $179,528 C & O's Port Huron to Saginaw Line 66,070 GTW's Imlay City to Caseville Line 58,567 Entire Tuscola & Saginaw Bay Railroad 21,015 The Great Lakes-St. Lawrence Seaway navigation system has significantly altered the rate level for all modes serving the Thumb even though only a small percentage Of the region's grain moves out by water. The present level of unit train rates was established to directly compete with the vessel rates. Should water rate reduc- tion occur, however, the subterminals at Gilford, Elkton, and Pigeon would be eliminated as transshipment points, and if the reduction is substantial enough, these points will also truck their grain purchased from farmers to the local ports rather than ship via unit train to Baltimore. Limitation to simulation results Two factors limit these results: first, only grain market- ing impacts were evaluated; and secondly, the model used did not rationalize the system because only existing locations were evaluated. . 4 I ~. 196 Throughout this chapter, the interrelationship between an effective grain logistics system and effective institutional design has manifested itself. Two additional institutions affect long- term planning: rail car supply and the abandonment hearing. These are discussed in Appendix C. CHAPTER VI SUMMARY, CONCLUSIONS, AND RECOMMENDATIONS Summagy Problems and Objectives Upon picking up a loaf of bread in the supermarket, shoppers often exclaim in disbelief at the high prices. Many attribute a significant share of the prices paid for bread and other food items to the farm sector. However, the various logistical activities which create temporal and spatial utility actually comprise a larger share of the consumer's marketbasket than does the value added by the farmer! And this is a major concern to farmers. Eco- nomic theory suggests that the cost of providing the various market- ing services will be allocated between farmers and consumers as a function, in absolute value, of the price elasticity of demand or supply. The latter, generally, is considered less elastic; hence, farmers incur greater impacts. Thus, a significant portion of efficiencies or economies achieved within the marketing channels occur to farmers. And conversely inefficiencies or diseconomies are also incurred largely by the producer. Since farmers only contribute about 25 percent of the value of the consumer's marketbasket, any changes in the costs of other components tend to have a significant impact upon farm.prices. 197 198 Farmers and other channel members recognize their dependency upon the logistic system and have long been concerned about its efficiency. Each of the nodes and links which comprise the system seem to justify their concern. This research effort examined the logistic system serving a major agricultural production area which consists of the 3,500 square mile Thumb region in Michigan. Like Michigan, the Thumb itself is a peninsula which limits transportation alternatives. The major markets served by the Thumb include the New England feed industries and the export markets which require an effective and efficient logistic system. The research objective was to analyze current adjustment problems and opportunities in distribution channels as an aid to public and private policy makers and planners. To achieve this: The current practices and attitudes among the various members of the grain marketing channel and the various institutional incentives which modify their behavior were analyzed and described; The impact of various changes in the grain distribution channels were estimated through the use of a systems rationalization model; and an assess- ment of the economic consequences of alternative organizations of the logistic system was pursued for use in policy and planning activities. Theoretical Framework The early location theory literature provided the foundation for the development of rationalization models while the computer provided the capabilities. During the last 20 years, significant 199 progress has been made in the development of mathematical programs capable of Optimizing agricultural logistic systems and grain sub- systems. The model used in this study minimized the total cost of distributing grain. The components which cOmprised the distribution system included the collection function or the transportation of grain from the farm to the first elevator, the handling activity at each elevator, and the distribution factor or the transportation of grain from the elevator either directly or through a transship- ment point to a destination. The data requirement included destina- tions or ultimate markets, and potential subterminals or trans- shipment points, elevator locations, production points and volumes, and alternative transportation modes. Further the costs of the service provided by each link or node was required. The study analyzed the flow of three commodities produced in the Thumb: wheat, corn, and oats. Three actual and potential modes of transportation were evaluated and compared including water, truck, and various rail alternatives such as single car, multi-car and unit train shipments. While many potential elevator and subterminal sites exist, only existing sites were explored. Given a specific pricing structure, mathematical results reveal the optimal combination of resources. However, mathematical models do not include externalities or institutional incentives which restricts their applicability by either public or private planners. This study attempted to overcome this by analyzing selected incentives which play an important role in private planning decisions. To achieve this end an institutional, behavior and performance framework of analysis was employed which explored 200 human interdependence and actions which modify the potential outcome Of various public actions designed to alleviate transportation problems. The Current System One-third of the sixty elevators serving the Thumb region have a storage capacity of less than 100,000 bushels and some of these will probably exit in the future. Seven elevators have sub- stantial storage capacity and have achieved significant economies of scale by making additional capital investments. These elevators are served by three railroad companies, the C & O, GTW, and T&SBY whose Thumb area operations are comprised primarily of branch lines. The exempt trucking subsector also serve Thumb region elevators by providing collection and distribution activities. There is an apparent negative average economic return to exempt trucking. The reason is that the trucking subsector reflect purely competitive characteristics while the elevator subsector displays oligopsonist behavior in the purchase of motor carrier services. Apparently owning a truck and being one's own boss yields psychic returns and therefore trucks remain in adequate supply despite the negative returns. These truckers use highways which, engineering studies report, are rapidly deteriorating. The final modal link serving the Thumb region is the Great Lakes-St. Lawrence Seaway navigation system and the nearby ports of Saginaw and Toledo. But various restrictions prevent the system from dominating export traffic. Rather its role seems to have been to force the establishment of unit train rates for export traffic. 201 Conclusions The cost of marketing the corn, oats and wheat produced in Michigan's Thumb region totaled $19,177,105, or $0.665 per bushel, for the 1976 grain marketing year. This estimate includes several inefficiencies or slack which exist in the distribution process: 'free market slack estimated the cost of subOptimal distribution patterns displayed by elevators; ownership slack estimated the cost Of suboptimal distributional patterns generated through owner- ship patterns, transshipment slack estimated the costs imposed by supoptimal transshipment patterns; and modal slack estimated the cost of suboptimal modal selection. These slacks were estimated to total $581,000 or three percent of the total marketing costs. This cost was hypothesized to exist because informational channels and vertical coordination mechanisms are less than perfect, perhaps significantly lessd The utilization of 65-car unit trains to distribute the Thumb's grain during the test period has reduced marketing costs by over $3.2 million. Should the ten smallest elevators serving the region exit, marketing cost would be reduced by $270,952 while the exit of the 20 smallest would result in a $435,228 reduction. The sentiment to retain elevators in light of these projected savings occurs because of impact timing. Elevator exit creates an immediate and obvious increase in collection costs for those still loyal to the small firm while the significant reduction in handling costs are received in increments over time as elevators disinvest in their 202 facilities. Thus the actual costs and benefits are not perceived in total creating incentives which are counter productive to the long run efficiencies of the total channel. Of course, within the channel, different members have different interests and a high cost elevator can still be cheaper than purchasing a truck for those farms delivering by farm tractor and trailer. The public can assume a critical role by securing and providing better information to channel members, and it can assume an active role in long-term planning. The impacts imposed by railroad abandonment after farmers have responded to competitive modifications were estimated for each of the four branch lines serving the Thumb region for the 1976 marketing year: C & O's Croswell to Bad Axe Line $179,528 C & O's Port Huron to Saginaw Line 66,070 GTW's Imlay City to Caseville Line 58,567 Entire Tuscola & Saginaw Bay Railroad 21,015 While the abandonment impacts cannot be summed, their range relative to the amount of channel slack present reveals a great deal about the role of each in achieving greater grain marketing efficiencies. In conjunction with abandonment, institutional and tech- nological changes were evaluated. The introduction of ten car rates on nearby lines retaining rail service could be used by the rail- roads to reduce the negative impacts imposed by abandonment on all lines and on two, the costs could be virtually eliminated. Thus institutional modifications which encourage market transactions and cooperation could prove effective h1reducing the costs borne by those incurring the largest negative impact. Branch lines are also ‘3 C, 1‘ I\ 203 ‘7 L) ., generally served by smaller high cost elevators and over time market forces will interact leading to their exit which will reduce marketing costs by a greater amount than abandonment will increase them. Thus 4 the invisible hand of the market is working to reduce channel costs as elevators exit creating economies of scale in handling and rail- \ V roads exit creating economies of scale in collection and distribution. “aflif? '< Should the unlikely event of substantial or prolongedArate reductions occur, the subterminals at Gilford, Elkton, and Pigeon would be eliminated as transshipment points and if the reduction is substantial enough, these points will also truck the grain they purchased from farmers to the local ports rather than ship via unit train to Baltimore. The most intensive impacts are received by the Blount subterminal at Gilford. The Thumb Farm terminal, located at Elkton, is somewhat isolated from the ports and thus receives less extensive impacts. The major benefactors of any reduction in water rates are the subterminals located at the port of Saginaw. In spite of its apparent favorable location, the port of Toledo entered no solution regardless of the extent of rate reduction. The last member, and a critical component, of the logistic system serving the Thumb region is the public sector. Historically the private sector has often sought relief from perceived inequities or injustices through the public sector. The result has often been a problem-specific and action oriented effort designed to identify and implement a "solution" immediately. Private interests insist that something be done: Do anything but just do something! The outcome has been to identify problems narrowly and in a limited time 204 frame rather than as part of a long term broad policy issue. And often symptoms rather than causes have been addressed. A major impetus for governmental involvement has been the different rate at which individuals and firms adjust to technological innovation. The introduction of technology imposes externalities upon those unable or unwilling to adjust as rapidly as a market solution dictates and results in cries for the preservation of the status quo logistic channel. Conversely, preserving the existing system imposes externalities and costs upon earlier adopters. Recommendations This research suggests that the role assumed by the public sector is critical in determining the long term effectiveness of a logistics system and the institutional design is the most important single factor. Either behavior yielding the desired performances is generated or destructive behavior results which precludes the preferred performance. This section first recommends a general public role, then several specific issues are addressed and the chapter concludes with recommendations for further research. General Policy Recommendations To achieve a logistic system which will effectively serve shipper's future needs, a total integrated approach involving inter- modal planning must be implemented immediately. Specific elements included the following: (1) a unified integrated approach which covers all of a logistics system's broad component; (2) a long term planning horizon; and (3) institutions which rely upon market 205 transaction by facilitating collective action and reducing trans- action and information costs. Each of these will be explored briefly. Broadgplanning Agricultural logistic systems are broad and complex economic organizations comprised of a large number of interacting and inter- dependent nodes and links. Recognizing this both State and national governmental units have made significant progress during the 1970's towards unified integrated transportation planning and these efforts deserve the applause and support of the various economic interest groups. Each transport mode and elevator location has inherent advantages which can be incorporated into an intermodal system that will serve the Thumb's future needs. But to achieve the desired performance from the logistic channels a renewed and intensified dedication must be made to a policy of effectively integrating and unifying the various modes and the supporting facilities such as elevators and subterminals. Only a broad definition of logistic problems will facilitate this end. Long term planning The various State and federal agencies involved in funding, planning, and administrating logistic channels have increasingly recognized the need for long term planning. Unfortunately in day-to-day Operations, clientele pressures usually force public agencies to focus on short term crises which take presidence over long term needs assessment, designing or planning activities and thus the public planning horizon is relatively short, often just a 206 few years. On the other hand, transport companies and occasionally shippers use a longer planning horizon. This discrepancy means that public agencies are often reacting rather than providing leader- ship and planning. It is important that public agencies directing and planning logistic functions be formally charged with analyzing needs and alternatives. Further, they must be adequately staffed and funded to perform this responsibility. Causal versus symptomatic problem identification A critical component of long term planning is to differenti- ate problematic symptoms from causal factors. In the short run, policy may be designed to relieve symptoms but a continuing series of policies directed at symptoms precludes addressing or resolving the basic cause of the problem. Credible policy The success a public agency achieves in designing and implementing broad long term logistic policies is dependent upon its credibility and support from channel participants and client groups. Unfortunately, credibility is easy to lose and difficult to earn. Very critical are long term plans which lack credibility because they reflect extensive pressures from specific client interest groups. For example, long term rail plans must be reason- able. While shippers prefer the inclusion of most or all branch lines in State plans, they are unlikely to have confidence in the State's ability to implement such a plan. Carriers will also question the State's ability to implement such a plan because the 207 abandonment strategy allows them to veto State efforts. On the other hand, plans which are credible and realistic may not please specific client groups but are much more likely to achieve broad based support and to prove successful. Credible planning becomes a self fulfilling prophecy. Implementation of plans and policies is difficult under the best conditions but without the support of shippers and carriers the task is virtually impossible. And support is earned through credible programs. Collective action agency Perhaps the single most effective strategy that Michigan could pursue to resolve the long term logistic issues facing the Thumb region would be to concentrate on designing and implementing effective institutions which would generate behavior leading to the desired performance. Many of the failures in the present logistic system have resulted from policy implemented to resolve past failures. When market solutions generate undesirable outcomes, often the reaction was to replace it with administered procedures rather than attempt to improve the performance of the market through institu- tional modification. The most common reoccurring thread woven 1* throughout this research effort was the fact that the existing / institutional design discourages or precludes the use of market transaction to resolve logistic problems. Rather institutions encourage reliance upon administered procedures and public agencies. The need is for institutions which encourage and facilitate collec- V/ tive action in all areas of logistic service. A State agency should be established which encourages shippers, carriers and shippers 208 and carriers to work together in an arena of self-sufficiency. Specific areas of responsibility would include the reduction of both transaction and information costs. Collective action has solved many logistic problems within a market framework. Specific Policy Recommendations Channel members and users will adjust to changes in the logistic system, regardless of any action or inaction by the public sector. Efforts directed at minimizing the costs imposed by adjust- ment will probably prove much more effective than efforts which attempt to preserve some institution or infrastructure component. Rail cars The State prOposed purchase of rail cars will prove ineffec- tive in the long run and should be revoked in favor of alternative strategies. Two suggestions include: (1) State institutions to facilitate information gathering and collective action among shippers; and (2) collective action among the State agencies to modify the rules and regulations which discourage investment in rolling stock. Rail line abandonment Among shippers and receivers, rail line abandonment is a critical issue and it receives a significant share of public sector efforts. But perhaps many of the current issues could be more effectively addressed through a non-marginal change in institutional design which would encourage each participant to reveal preferences 209 and participate in market transactions. The first requirement is a long term, broad and credible transportation plan. The second component is to modify the current administrative abandonment process. And the third is to create a new institution which facilitates collective action and will allow shippers to detenmine their own destiny within a market environment by a reduction in transaction and information costs. Elevator preservation Elevator owners, farmers and railroads long ago recognized that the adoption of technological innovation required investment by some firms and disinvestment by others. The die has already been cast and many firms are living off depreciation. Efforts to preserve these facilities will not reduce externalities but rather will alter the recipient and in the long run impose greater market- ing cost. If the reduction of externalities is a public goal, transportation or relocation assistance would provide a more effec- tive long term allocation of resources than preserving the status quo infrastructure. Suggested Areas of Additional Research Over the past 20 years, agricultural economists have suc- cessfully developed and refined rationalization models until the state of the art is sophisticated and precise. Future modeling efforts need to focus on the data base which is utilized in these models because the quality of the technique used to analyze the data is far superior to the quality of the data. Specifically 210 accurate costs are needed for each transportation mode. The estimated fixed cost of Operating a farm truck has ranged from $500 to $1,500 in various rationalization studies. Since fixed costs are the major component of total costs, this is an unaccept- able range. But at least the fixed costs of trucking can be estimated. Estimating and allocating any costs, either fixed or variable, for the railroad is currently impossible but critical to effectively rationalize an agricultural logistic system. Similar problems exist with other transportation functions and the use of rates as a proxy for costs will not yield long term solutions which are Optimal or satisfactory. The effective utilization of rationalization studies is also constrained by a second limitation; public acceptance and implementation. Again the quality of mathematical modeling has far surpassed the institutional research necessary to effectively utilize the results in implementing long term public planning. Future pay-offs now lie with the exploration of alternative insti- tutional arrangements and the resulting behavior and performance and research efforts should be directed toward this end. APPENDICIES APPENDIX A QUESTIONNAIRE Elevator Name Elevator Address Elevator Location 1. 10. Which grains does your firm handle? Corn Oats Soybeans Wheat Barley Drybeans What is your storage capacity as of July 1, 1977? bushels What is your receiving capacity? bushels per hour Do you have dryer facilities? Yes _____ No If yes, what is the rated capacity at 10% moisture removal? bushels per hour What is your main restriction of receiving grain? Leg Pit Dryers Scales Other How many bushels can you load out in an 8 hour day? HOpper Cars vehicles per 8-hour day Trucks vehicles per 8-hour day How many hOpper cars does your rail siding hold? Can the line serving your elevator carry fully loaded hOpper cars? Yes No If yes, explain any qualifications Do seasonal road restrictions affect your marketing procedures? Yes No If yes, explain How many bushels of grain did your facility handle during the marketing year? 211 212 What was the destination, mode and volume of your shipments for the marketing year indicated? Commodity Year Market Bushels by truck Bushels by rail Commodity Year Market Bushels by truck Bushels by rail Commodity Year Market Bushels by truck Bushels by rail Commodity Year Market Bushels by truck Bushels by rail Commodity Year Market Bushels by truck Bushels by rail 213 Commodity Year Market Bushels by truck Bushels by rail Commodity Year Market ‘ Bushels by truck Bushels by rail APPENDIX B COLLECTION COSTS Introduction Appendix B displays the development of the Operation cost for farm trucks and the assembly cost vector. The procedure used throughout this section follows that used by Lamberton and Rudel.1 Farm Truck Costs The basic assumptions of the analysis include: 1. Each truck will travel 2,400 miles per year. 2. The average truck has a 300 bushel capacity. 3. Each truck is used to market 30,000 bushels of grain annually. 4. Each truck is used in various activities on the farm and the fixed cost will be allocated on the mileage incurred in each use. Fixed Costs 1. Insurance fees Based upon $100 deductible standard coverage--$320 per year. 2. License fees Based upon a net vehicle weight of 8,000 pounds and a farm plate--$59 per year. 1Lamberton and Rudel, passim. 214 215 Opportunity cost and depreciation Assumptions: a. Opportunity cost of capital 6% (i). b. Life expectancy of 15 years. c. Acquisition cost $15,000 (AC). d. Salvage value $3,000 (Sv). e. The average truck is 50% depreciated. f. Truck purchases are spread evenly over time. Opportunity cost and depreciation = 1 (1 + 1)“ i AC - su (1 + 1)N - 1 (1 + i)N - 1 .06 (1 + .06)15 .06 = 15,000 - 3,000 (1 + .0615 -1 (1 + .06)15 - 1 $1,415.55 per year. Shelter costs Assumptions: a. 300 square feet of space is required. b. Life expectancy is 20 years. c. Maintenance is 1% of original cost per year (Mc)' d. Acquisition cost is $4 per square foot (Ac). e. Salvage value is $0.00 (Sv). f. Opportunity cost of capital is 6%. 216 i (1 + i)” A + ACMC (1 + 1)N - 1 Shelter Costs .06 (1 + .06)20 ($1,200) . + ($1,200)(.01) (1 + .06)15 - 1 $116.62 per year. Total annual fixed costs a. Insurance $ 320.00 b. License 59.00 c. Opportunity cost depreciation 1,415.55 d. Shelter 116.62 $1,911.17 The annual fixed costs are allocated between alternative truck uses based upon the mileage for each alternative use. The typical farm truck is driven about 2,400 miles per year assuming an average annual farm marketing per truck of 30,000 bushels each year, the average truck makes 100 annual elevator trips. The average farm-to-elevator distance (d) for each originating area is calcu- lated on the assumptions: i) grain marketing is spread homogeneously over the area; ii) farmers deliver grain to the nearest elevator; and iii) the rural road system is a grid.2 Therefore, 28. c. French, pp. 767-778. 217 where: Rh is the volume of grain received by an elevator; Di is the marketed density of the i-th township. The calculated average farm-to-elevator distance for the Thumb region in 1977 was approximately six miles. For 100 trips annually, this resulted in a total grain marketing mileage of 1,200 miles or approximately one-half of the total truck mileage. There- fore half of the annual fixed costs are allocated to grain marketing activities. Variable Costs 1. Tire Cost Per Mile Assumptions: a. Replacement tires cost $100. b. Expected life is 40,000 miles. (Unit tire price) (tires per truck) Tire cost per mile life expectancy ($100) (6) = -———————- = $0.015 40,000 2. Driver Labor Costs Assumptions: a. Wage rate of 2.50 per hour. b. Average speed of 40 miles per hour. 218 wage per hour Driver wages per mile speed per hour $2.50 = $0.0625 40 Fuel Cost Assumptions: a. Truck uses regular gasoline. b. Truck averages seven miles per gallon. c. Gasoline price is $0.63 per gallon. price per gallon $0.63 Gas cost per mile = = = $0.09. miles per gallon 7 Oil and Lubrication Assumptions: a. Truck requires service every 800 miles. b. Servicing costs equal $8.75 and include oil, filter, lubrication and labor. cost of service $8.75 = $0.011. Service cost per mile = miles per service 800 Maintenance Costs Vehicle age determines maintenance costs with a new vehicle incurring little maintenance costs while older vehicles incur higher costs. For this project an average cost of $125 per year was estimated. average maintenance cost per year Maintenance cost miles per year $125. 2,400 219 6. Unloading Time Labor Cost Assumptions: a. Wage rate Of $2.50 per hour. b. Loading, unloading, and waiting time is 30 minutes per trip. Unloading time labor per mile = (unloading wages) (hours of unloading time) (2) (distance to elevator) ($2.50) ( .5) - $ .62 Zd d 7. Total Variable Cost Per Mile a. Tire cost $0.015 b. Driver labor 0.063 c. Fuel cost 0.090 d. Oil and lubrication 0.011 e. Maintenance cost 0.052 f. Unloading time labor 0.833 d Total Variable Cost Per Mile = .231 + $ .62 d For the average one way farm to elevator distance determined in the Thumb of six miles, this represents a variable cost per mile of $0.335. Total variable costs are the product of $0.335 and the total annual mileage the equipment is driven. For any farmer the total annual mileage (M) is: 220 where P is bushels of grain marketed and AL is the average bushels per truck-load. For the two ton truck carrying an average of 300 bushels the average one way distance of six miles: M = .0400 P Therefore, total annual variable costs are: TVC $0.335 M TVC $0.0134 Total costs, the sum of fixed and variable costs are: TC = $995.59 + $0.0134 P and assembly cost per bushel is AAC = $995.59 P + $0.0134 + .0319 + .0134 = .0453 if there are 30,000 bushels hauled per truck. To determine the cost of assembling grain at each elevator it is assumed that each farm operates one grain truck. The fixed cost per bushel per truck of $0.0319 is therefore assumed to apply to each bushel received at the elevator and the h-th elevator's fixed costs of assembly are $0.01604 x Rh’ The variable costs of assembling grain at the elevator are based on the variable truck costs per mile of $0.335. Total miles driven hauling grain to the h-th elevator from the h-th Originating Area are: 221 M: = Eb . 28% AL where R: = grain from Originating Area h received at elevator h; AL = 300 average bushels per trip; and, 2d§ = mean round trip distance driven assembling each truck- load. Thus, total variable assembly costs of assembling grain at elevator h from its own Originating Area are: Tvcg = $0.335 x Hg x .00668fi (where .0066 = 2 - 300) and variable assembly costs per bushel are: Avch = $0.335 x .00668h h h = $0.002218fi Therefore, the element in the h-th row Of the Assembly Cost Vector is: h h AAcfl 50.0319 + $0.0022d and represents the cost per bushel of assembling grain from the h-th Originating Area at the h-th Assembly Destination. APPENDIX C INSTITUTIONAL FACTORS Institutional Limitations "There Ought To Be A Law" This research reported estimates of the extent and direction of economic impacts resulting from alternative modifications to the logistic system serving Michigan's Thumb. However, efforts to utilize the available data and improve the economic efficiency of grain channels are likely to meet with limited success. Because of the established institutional parameters, this research addresses two, the branch line abandonment procedure administered by the ICC and the investment in rail cars and their allocation, also subject to ICC regulation. This does not imply that the ICC is either the only or the most limiting institutional restriction. Rather, it is one of many. But transportation is a vital component of grain marketing channels and a highly regulated sector, and therefore the ICC assumes a prominent role in planning and implementing logistic systems. Following the Civil War, the frontier moved rapidly westward as settlers immigrated from Europe. The vast North American con- tinent was quickly spanned by rail lines which moved people to the prairies and transported the fruits of their labor back to the Eastern population centers. However the prairies were not easy to 222 223 tame. Drought, hail, insect infestation, and other elements of nature created extreme hardships for the early arrivals. These afflictions were present in an economic environment in which rail- road building was plagued with graft and corruption, and monopolistic railroad Operations employed discriminating practices of all types and natures.1 Usually when people observe discriminating behavior, they feel "there ought to be a law." This is especially true if they are the recipients of negative impacts or externalities. And so the farmers responded to this seeming alliance between nature and the railroads which impoverished them by employing collective action, and used the National Grange as a vehicle, resulting in the passage of the Interstate Commerce Act. Among the many responsibilities delegated to the ICC is the responsibility to determine the public need and necessity for railroad branch lines. It is also responsible for monitoring the allocation of rail cars between shippers and among the various carriers. The following two sections examine the role the State of Michigan can assume to more effectively plan a logistic system within the institutional framework which is called the ICC. In this situation the State has volitional choice and not voluntary choice. 1Railroad builders were often able to extract grants from the communities they served. In fact, the construction of some rail lines seem to have been undertaken with the primary goal of defraud- ing stock and bond holders. Once built many railroads took full advantage of the monopolistic environment by discriminating against individuals, locations, and commodities. For additional detail, Locklin more completely describes these events in the Credit Mobilizer, p. 139, Railroad Financing, pp. 125-140, and Discrimina- tion, pp. 147-169. D. Phillip Locklin, Economics of Transportation, 7th Ed., Homewood, Illinois, Richard D. Irwin, Inc., 1972. 224 That is, the State is free to act within a limited environment. It does not have the opportunity to reconstruct a more favorable decision environment. Public Provision of Transportation Equipment: Some Long Term Economic Impacts Continuing shortages of rail equipment for the movement of grain have imposed marketing problems and costs upon the grain industry. For example, one study estimated the total cost due to the lack of transportation equipment was 2.36 million dollars for Iowa elevators in 1969.2 In spite of efforts to resolve the equip- ment problem through the private sector, these costs have persisted and led to attempts to seek relief through government intervention. One such effort in Michigan has been a proposal by the Highway and Transportation Department that the State purchase covered hopper grain cars to supplement the railroad fleet. Similar proposals have been advanced in other states by private interest or public officials. In his State of the State message, the governor of South Dakota suggested purchasing 1,000 rail cars; North Dakota has recently concluded a preliminary feasibility study which evaluated State ownership; and during October 1979, the province of Saskat- chewan ordered 1,000 cars. In this section a brief description of the historical car supply will be followed by a discussion of some of the factors creating the problem. Then the economics and problems of public car 2W. H. Thompson and C. P. Baumel, Impact of Transportation Equipment Shortages on Iowa Country Elevators, Transportation Journal, Fall 1972, volume 12, #1, p. 51. 225 ownership will be discussed. The section will conclude with a discussion of the long-term impacts that State provision of rail cars would have upon the supply of equipment available to move grain. This will be achieved by analyzing the economic incentives which motivate railroad and shipper investment in rolling stock. The long-term involves a period long enough for the railroads and shippers to make major changes in investment and disinvestment policies. History and causes of the rail car shortages While the "investigation of the reasons for seasonal railcar shortages" is often included in current lists of critical trans- portation issues to be addressed, the problem is not of recent origin. The very first case heard before the ICC "involved a complaint by the North Dakota Board of Railroad Commissioners against the Northern Pacific Railway for failing to provide adequate car service to North Dakota shippers."3 And this problem received the attention of the ICC and the Congress. "As early as 1907 the Commission held extensive hearings on freight car shortages, re- ceiving testimony from shippers of grain, coal, and lumber on their inability to obtain freight cars in sufficient numbers at the time requested."4 In the fall of 1921, the Joint Commission of Agricul- tural Inquiry, created by a Senate Resolution, found that "the 3Frank N. Wilner, Preliminary Report on Feasibilitygof State of North Dakota Acquiring a Covered Hopper Rail Fleet, North Dakota Public Service Commission, November 1974, Bismarck, North Dakota,p.43. 4John Richard Felton, The Utilization and Adequacy of the Freight Car Fleet, Land Economics, Vol. XLVII, #3, August 1971, p. 267. 226 supply of box cars, coal cars, stock cars, and refrigerator cars is inadequate to meet the demand during normal periods of activity and should be rapidly augmented."5 And in 1953, William Hudson found that "the lack of any substantial increase in the supply of boxcars means that a tight box car situation with periodic shortages, particularly of the better class of equipment required for grain and grain products, will probably continue over the next several years."6 In spite of this attention, the problem continues. No single factor can be identified as the primary contributor to this continuing shortage of railcars. Rather, it has resulted fromtfluainteraction of numerous economic and non-economic incentives over time. Following are seven factors which have and continue to contribute to the shortage. First, the railroads have failed to share in general periods of economic prosperity. They have earned an average of less than two percent return on investment between 1964 and 1978, and during 7 the last four years the return has averaged .7 percent. This problem is compounded in the eastern district,8 which contains 5Transportation, Report of the Joint Commission of Agricul- tural Inquiry, House of Representatives,67th Congress, First Session, Report 408, Part 3, October 15, 1921, as reported in Robert Tosterud and David C. Nelson, A Study of the Box and Hopper Car Supply Prob- lems in the United States, Upper Great Plains Transportation Institute, Paper #10, September 1969, Fargo, North Dakota, p. 4. 6William J. Hudson, A Study of Conditions Affecting the Transportation of Grain by Railroad, U.S. Department of Agriculture, June 1953, p. iii, as reported in Tosterud and Nelson, p. 4. 7Association of American Railroads: Yearbook of Railroad Rants, 1979, AAR, Washington, D.C., p. 20. 8The eastern district includes Indiana, Ohio, Pennsylvania, Virginia, and the states north of these. 227 Michigan, as eastern railroads have incurred deficits in six of the last nine years! The low return is a double edged sword. Railroad earnings are not sufficient to serve all their capital requirements, and the rate of return discourages investing what little earnings are generated back into the railroad. A second factor contributing to the rail car shortage is the seasonal production pattern of grain combined with year-to-year variation in foreign demand which created temporary equipment deficiencies. The result is that "carriers may invest in capacity that is under-utilized during off-peak periods or use existing capacity so intensively that costs increase in greater proportion than output."9 These temporal demand fluctuations can be compounded by agricultural production practices. For example, the technological development and adaptation of the picker sheller and corn dryer increased from 29 to 59 percent the amount of corn moving directly to the Iowa elevator during harvest10 and the increases in farm storage capacity also provided farmers with the ability to alter historical marketing patterns and create surges in grain movements as prices change. A third factor contributing to the equipment shortage is the 11 decrease in car utilization over time. Shippers are constantly 9Erharot O. Rupprecht, Demand for Freight Cars in the Move- ments of Grains, Paper presented at the annual AAEA meeting, August 15, 1976, p. l 10Baumel, et al., An Economic Analysis of Alternative Sys- tems, p. 13. 11Roger Jones, Another Nail in the Railroad Coffin, Tgapeppp: tation Research, Pergamon Press, Elmsford, N.Y., Volume 7, #4, December 1973, passim. 228 striving to reduce labor requirements while providing greater pro- tection for cargo. The result has been the demise of the plain, 40 foot, narrow door box car. It has been replaced by cars specifically designed and equipped to meet the requirements of individual com- modities. However, this has resulted in an inflexible car fleet which cannot serve multiple uses as demand changes. Therefore the percent of loaded miles has decreased from 67 percent of total miles in 1946 to 55.5 percent in 1976. Fourth, rail rates remain stable throughout the year, failing to reflect the seasonality of grain production or to allocate demand over time. While the Railroad Revitalization and Regulatory Reform Act of 1976 (RRRR Act) addressed this issue by instructing the Interstate Commerce Commission "to provide sufficient incentive to shippers to reduce peak-period shipments,"12 seasonal rates have not yet been widely adopted. The "Economics of Forced Compensation" is the fifth factor contributing to the shortage of rail cars. The Economics of Forced Compensation is the title Tosterud and Nelson13 have applied to the incentive provided by existing per diem rates. Per diem rates are the fees paid by one railroad to another for using rail cars. They are established by the American Association of Railroad and the ICC and historically have been maintained at a level which is not compensatory for the railroad which owns the car. The non-compensatory 12Public Law 94-210, Railroad Revitalization and Regulatory Reform Act of 1976, 94th Congress, 82718, February 5, 1976. 13Robert Tosterud and David C. Nelson, p. 62. 229 per diem level continues primarily through the efforts of deficit carriers or those railroads whose total car usage is greater than their ownership. Usually car deficit carriers are located within territories which terminate more interregional carloads than are originated. Historically, this has been the eastern carriers. The western roads are forced to interline carloads of traffic with eastern carriers, and rather than invest in cars to meet their needs, the deficit carriers simply retain and use the interlined cars as long as they are needed. During periods of car surpluses, cars are returned to the owning carrier empty while westbound loads are loaded in the cars owned by the deficit carriers. In addition to an increase in empty miles which use additional resources, this practice also places a disproportionate share of the cost of the car surplus upon railroads having an adequate car supply. Grunfield summarized the impact of the per diem incentive,14 (a) a per diem rate which was less than prospective daily ownership costs of a new freight car would lead to an over-all deficiency in freight car ownership; (b) a single per diem rate would discourage the purchase of the more expensive freight cars with their greater annual depreciation expense15 and (c) a seasonally inflexible per diem rate would fail to equate freight car demand with opportunity costs during peak and Off-peak periods. The sixth factor is that the existing demurrage charges make rail cars economical storage alternatives during periods of storage 14Yehunda Grunfield, "The Effect of the Per Diem Rate on the Efficiency and Size of the American Railroad Freight Car Fleet," Journal of Business, January 1959, pp. 56-57. 15The Association of American Railroads instituted a multi- level per diem rate on January 1, 1964. 230 stress. Demmurage is the fee shippers and receivers pay for holding a rail car beyond the normal time necessary for loading or unload- ing. While the daily demmurage rate increases with time, elevators which are filled because of heavy grain movement still find rail cars an economical storage alternative. Unfortunately, this inef- ficient use of grain cars normally occurs during periods of the greatest car shortages. And the seventh factor is that the ICC is charged with the responsibility for the public interest and must decide between the interests of large and small shippers. An Iowa study indicated that the utilization of 110 car unit trains could reduce the demand for rail cars by 72 percent.16 But unit trains can only be used by a minority of shippers, those with large facilities. Thus the ICC is charged with choosing between efficiency and equity. It must choose between interests as it determines whose interests are to be legitimized. The ICC's existing policy has limited the percentage Of cars used in unit trains, protecting the interests of the smaller and branch line elevators. These seven factors have interacted with others not identi- fied to create an environment which has discouraged the railroads from purchasing grain cars. In fact, between 1960 and 1979 the railroads have actually disinvested in plain box and covered hopper cars! The total carrying capacity has declined from 36.4 to 29.2 16Baumel, et al., An Economic Analysis of Alternative Systems, p. 100. 231 million tons.17 These figures can be misleading because the total grain volume moved depends upon how effectively the capacity is used. Efficiency depends upon the trips per car and the percentage of the total fleet which are in serviceable condition. The problem is compounded in the eastern district where a more rapid disinvestment has occurred. Between 1957 and 1967 the percent of the total boxcar supply which was owned by eastern railroads decreased from 39.3 to 31.2 percent while covered hopper ownership decreased from 41.9 to 27.8 percent. The economics of public car ownership The various factors contributing to the rail car shortage have created a situation which is often intolerable. One response has been the suggestion that the State acquire rail cars with the objective of increasing the total number available to transport Michigan's grain. However, the success of this proposal depends upon the profitability of rail car ownership. Profitability can be addressed generally by utilizing economic theory. If owning rail cars were profitable, railroads would be shifting the supply curve to the right by investing, rather than disinvesting as they have in the past. During the last ten years, for example, class one rail- roads reduced their car ownership by 14,760 cars per year.18 The 17Association of American Railroads, p. 50. It should be noted that this represents a reduction in total capacity, not in rail car numbers. 181bid., p. 49. 232 argument can also be extended to shippers who would gladly purchase cars if they were a good investment, but shippers have also been reluctant investors. While shipper owned or leased cars increased by 4,159 units per year between 1968 and 197819 they were not purchased as an investment but rather as a necessary cost of doing business. They were acquired to gain access to profitable markets that could not be reached without cars. The elevator loses money owning the rail cars, but it makes enough on the higher grain prices to Offset the loss and their total income is increased. The specific profitability of the State owning rail cars is developed in Table C-l. The major variables are turned around time, car cost, and mileage credits. Turnaround is the number of trips a car makes each month and is usually higher if the car is in a unit train. Car costs can either be estimated through a lease or purchase price. Since both methods are used extensively by shippers and an active lease market exists, theory suggests that either lease prices or purchase prices would provide adequate estimates for car costs. Mileage credits are the fees paid by railroads to shippers when shippers use their own car. The current rate is 24 cents per loaded mile for covered hopper cars. Table C-l reveals that car lease payments exceed mileage earnings for all reasonable assumptions. Rail cars do not pay for themselves. The figures in Table C-l all represent actual turnaround experiences of private shippers. TO minimize its loss, the State would need to match the efficiency of private shippers. Serving nearby markets such as Chicago with a reasonable two trips 191bid., p. 49. 233 Table C-l. Cost of Monthly Rail Car Ownership Assume: l) A 15 year lease signed during the first quarter of 1980. A likely lease rate would include a monthly payment $570 and an annual charge of $0.02 for each mile over 30,000. This rate is subject to increases as maintenance costs increase. 2) Railroads pay $0.24 per loaded mile for privately leased or owned covered hoppers. Monthly Profit or (Loss) Cost of Lease Number of Loads Mileage Credit Per Car Per Month Per Month Earned Per Month 300 Mile One Way Trip--Chicago $570 1 $ 72 $(498) 570 2* 144 (426) 570 3 216 (354) 700 Mile One Way Trip--Ba1timore 570 1* 168 (402) 576 2** 336 (240) 604 3 504 (100) 1500 Mile One Way Trip--Gulf Points 580 1 360 (220) 640 l.66*** 600 ( 40) 640 2**** 525***** (115) *Probable turnaround for single car movement--Current turnaround for Burlington Northern (BN) **Probable turnaround for unit train ***Turnaround achieved by unit train shippers in Nebraska using Burlington Northern ****Turnaround achieved by unit train shippers in Nebraska using Union Pacific *****The Union Pacific has a lower rate rather than a mileage credit which works out to about $0.175 per loaded mile 234 per month for a single car movement results in a net cost of $426. or $0.061 per bushel of grain transported. Achieving two trips per month to Baltimore is the goal of many unit train owners in Michigan. With current lease costs this results in a cost of 3.4 cents per bushel transported or $240 per month. Trips approaching 1,500 miles one way are unlikely to occur by unit train from Michigan because of its location and comparative advantage. However, 1,500 mile trips could occur by single car movement, but even one turn- around per month for a single car is unlikely. Thus single car shipment of 1,500 miles will result in a net cost of at least $0.063 per bushel and probably more. Public good theory Under any reasonable assumption regarding turnaround, State ownership of rail cars will impose costs upon the public treasury. However, profitability is not a prerequisite for public investment. In the United States, public provision has often resulted when an insufficient quantity of a good has been provided by the private sector, and an insufficient quantity of rail cars allegedly exists. Publicly provided goods usually have features in common including high exclusion cost, indivisible output, joint supply, or external- ities. Exclusion costs are non-existent for grain cars. The use of a single car involves one way movement of 3,500 bushels of grain between one origin and destination by an individual shipper, and while the shipment is in route, no other shipper can derive direct benefits from the car. The output of the rail car is easily devis- able in that 3,500 bushels is a very small movement. In fact, the 235 volume is so small that quantity discounts--multi-car rates--are given when several cars are used together. Joint supply is also not characteristic of rail cars in that the only product produced is the movement of grain. Externalities are ubiquitous and the situation with rail cars is no exception. The presence or absence of cars directly affects the elevator shippers by providing or restricting access to various markets. The prices farmers receive also vary as elevator access to markets is modified. And the change in farm income reverberates throughout the local and State community, indirectly affecting most economic sectors. Elevators have the opportunity to modify their impacts by purchasing or leasing rail cars for their private use. However, theory suggests that second round and indirect impact recipients, receive externalities while being powerless to act. This is not true for farmers needing access to rail cars. A significant number of elevators throughout the State are farmer cooperatives, which are a vertical extension of the farming operation. Through ownership in the local co-op elevator, farmers have the opportunity to invest in rail cars and modify the extent of the impacts. In general, rail cars possess the character- istics of goods which are normally produced by the private sector rather than by the government. They are less of a public good than many items presently produced by the public sector. This does not preclude the public from providing rail cars, however, because the citizenry can collectively undertake any objective it chooses. 236 Problems of public car ownership Should the State purchase rail cars, it will experience the problems of efficiency and equity which have plagued the railroads in the past. Efficienty and equity Throughout their history, railroads have been charged with discrimination against some shippers in the allocation of cars. Through the purchase of rail equipment the State could attempt to alleviate this. The State will find, however, as the railroads have, that efficiency and equity are often mutually exclusive goals. The elevators which are experiencing the greatest shortage are also the most expensive to serve, i.e., the small or branch line elevators. Through serving these elevators, the State will reduce turnaround and increase the net cost per bushel. Thus the State would have to choose between efficiency and equity, between moving the greater volume of grain for each dollar invested and serving all the eleva- tors in Michigan. And this would be an extremely difficult decision for any public employee. The State could assign cars permanently to individual shippers, but this would result in a fleet which would be inflexible and unresponsive to changes in demand. And further, a permanent assignment is difficult to justify based upon shipper needs. If a shipper would benefit enough to merit a State assigned car, he should invest in a private fleet. The State could also assign the cars to the railroad's fleet, but this would mean the carriers would allo- cate the cars. And if the cars ever returned to Michigan, the same 237 allocation problems created by the railroads in the past would con- tinue. Empty cars could be assigned after each trip but this requires extra handling by the railroads and takes extra time, which increases costs. Limitations to efficient car utilization The elevators which have used their fleets the most ef- ficiently have hired full time traffic managers. This would be a requirement for the State. A fleet of 1,000 cars would take a minimum staff of three people and a high speed computer hooked to the railroad's computers. The first problem they would need to address is car assignment and efficient utilization within the existing car-handling policies of the railroads. For example, rail- roads can not effectively divert and reconsign rail cars. While there are institutional arrangements which could increase car utilization for the State, implementation would be a problem because of the institutional rigidity of the railroads, who are unaccustomed to this type of fleet. And the problem is compounded because the railroad would resist changing its Operations for a limited number of cars. The seasonality of grain marketing creates fluctuations in the derived demand for transportation services. Some firms have achieved a higher level of utilization by co-leasing with shippers with different seasonal demand patterns. For example, grain dealers and fertilizer dealers occasionally co-lease equipment, and each shipper uses the cars during their period of greatest need. 238 Occasionally, a shipper will find the seasonal patterns have fluctuated, creating the need for the cars when they are assigned to the co—leasee. A private business recognized that to maximize long term profits, an occasional short term loss may be incurred. But considering the political problems that could result if State owned rail cars were moving fertilizer during a grain car shortage, it is unlikely any public official could advocate a co-lease. 20 railroads need not Under existing tariff regulations accept private (State owned) cars during periods of car surpluses. And the significant variation in the volume of grain marketed within and between crop years can turn car shortages into surpluses. For example, weekly shortages of 8,000 covered hoppers during October 1976 evaporated into surpluses of nearly 5,000 cars per week by the end of 1976. Surpluses also existed during most of May through September 1977 (see Table C-2). In addition, cars not in use incur a storage charge if they are stored on a railroad-owned siding, and many elevators in Michigan do not own their sidings. During time of surplus equipment, the State would encounter the same dilemma as the other non-rail owners. That is, how do they capital- ize on an investment which is continuing to incur costs but which cannot be used? The problem of surplus equipment could be resolved in the short run by requiring that publicly owned rail cars be utilized before carrier or shipper-supplied equipment. This would minimize the net public cost, but as the railroads and elevators became the residual car supplier, utilization of their equipment 20Association of American Railroads Agreement OT-5. 239 Table C-2. Surplus and Shortage of the U.S. Rail Car Supply for a Seventy Week Period.a 40-Foot Covered 40-Foot Covered Week Narrow Door Hopper Week Narrow Door Hopper Box Cars Box Cars 9/ 4/76 9311 (3621) 5/ 7/77 3946 (996) 9/11/76 9220 (2623) 5/14/77 5284 627 9/18/76 9733 (3178) 5/21/77 5940 1955 9/25/76 9185 (3980) 5/28/77 7811 2577 10/ 2/76 8242 (4017) 6/ 4/77 8448 4002 10/ 9/76 7346 (3919) 6/11/77 8238 2020 10/16/76 3673 (8130) 6/18/77 8595 386 10/23/76 3072 (9142) 6/25/77 8302 705 10/30/76 3209 (8056) 7/ 2/77 7912 1486 11/ 6/76 2740 (7261) 7/ 9/77 6318 (32) ll/13/76 6329 (5671) 7/16/77 5140 (62) 11/20/76 7509 (3848) 7/23/77 3773 (1415) 11/27/76 9500 (1104) 7/30/77 3024 (1035) 12/ 4/76 10923 1463 8/ 6/77 2656 (1050) 12/11/76 11129 2800 8/13/77 2251 (543) 12/18/76 11805 4844 8/20/77 3121 41 12/25/76 12996 5216 8/27/77 3129 1098 1/ 1/77 12734 5279 9/ 3/77 3706 1935 1/ 8/77 11695 2641 9/10/77 3542 949 1/15/77 10700 (835) 9/17/77 3030 (897) 1/22/77 7980 (3624) 9/24/77 2202 (2052) 1/29/77 3714 (7291) 10/ 1/77 1246 (4111) 2/ 5/77 1433 (9666) 10/ 8/77 462 (4647) 2/12/77 (1053) (12140) 10/15/77 175 (3753) 2/19/77 (1722) (11957) 10/22/77 (269) (6836) 2/26/77 (2213) (10050) 10/29/77 (837) (8145) 3/ 5/77 (2924) (11433) 11/ 5/77 (1157) (9796) 3/12/77 (2479) (11381) 11/12/77 (1226) (9100) 3/19/77 (1550) (10839) ll/19/77 (1255) (9215) 3/26/77 (1042) (9246) 11/26/77 (1202) (7464) 4/ 2/77 (1028) (8321) 12/ 3/77 (1851) (7186) 4/ 9/77 (817) (7396) 12/10/77 (1655) (6947) 4/16/77 (301) (6994) 12/17/77 (1512) (7068) 4/23/77 (1018) (5921) 12/24/77 (1353) (7182) 4/30/77 1445 (4378) 12/31/77 (1273) (6865) Key surplus or (shortage) aSource: North Dakota Public Service Commission, "Preliminary Report on Feasibility of State of North Dakota Acquiring a Covered Hopper Rail Fleet," Bismarck, North Dakota, November 1978. 240 would decrease, making ownership more expensive and encouraging an even faster disinvestment for railroads and the reduction of shipper investment. Therefore, this would be counter-productive to the long run objective that State provision of rail cars was designed to achieve. Impact of public provision upon car supply In spite of potential management difficulties or operating costs, these are not the critical issue in determining if the State should purchase rail cars. Rather the key issue is the long-run impact. Will public provision increase the total supply of rail cars available for Michigan grain shippers, or could the supply actually be decreased over time? The answer is dependent upon the expected behavior or response of existing car owners including railroads and elevators. If one assumes that public investment will have no impact upon either private investment or car allocation, the additional investor would increase the total car supply and relieve a portion of the cost imposed by shortages. Unfortunately, this is an unlikely outcome. Limited capacity exists for building rail cars, and delivery usually varies from between one and two years. Therefore, the total number of cars which can be manufac- tured will not increase with State purchase, and an investment would simply delay delivery to private purchasers. This scenario is also unlikely because it does not consider the economic incen- tives for either the railroad or elevators which lease cars. 241 If, on the other hand, one assumes that the railroads and shippers will adopt strategic behavior in response to the newly created economic institution and incentives, the effective increase in the total supply of rail cars will be far less than the State's total purchase. In fact, it is possible that if the State of Michigan purchases rail cars, the long term impact will be to reduce the number of cars available to move grain. This scenario, which assumes a strategic response by current car owners to the perceived economic and political incentive, is the probable outcome. Railroads have existed in a highly regulated environment for many years and have learned to make calculated decisions based upon the response they expect from the public sector. In fact, rail- roads are often accused of strategic manipulation in other decision making processes such as branch line abandonment cases.21 These allegations, however, are simply charges that the railroads are attempting to maximize profits within the existing institutional parameter, and there is little reason to expect them to alter their profit-maximizing behavior when planning car investment. The con- tinuing low rate of return to car ownership provides no incentive for the railroads to purchase additional cars or even to maintain the existing fleet. Presently the opportunity cost of capital dictates that railroads disinvest in rail cars and utilize the capital for other purposes, very likely non-rail investment. 21It would indeed be unfortunate for those who consider themselves victims of present railroad manipulative behavior to design new institutions which would encourage further behavior of a similar nature! 242 Furthermore, carriers have revealed their strategy with their unabated disinvestment policy of the past many decades. And unless incentives change, the carriers have no intention of altering the direction of their negative investment pattern but may increase the rate of dis- investment. The other major source of grain cars is the elevators, which have become unwilling investors in response to the railroad's disin- vestment. Access to rail cars is profitable for grain-elevators because greater net returns can be secured in rail-based markets. But because of rail disinvestment, carrier—supplied cars are not readily available, and many elevators have responded by purchasing or leasing cars. However, mileage credits do not offset lease costs, and consequently the rail cars themselves result in a net cost. Thus while access to rail cars is profitable for elevators, access to someone else's car is more profitable than a private fleet, and elevators prefer to eliminate their investment. This situation provides elevators with the incentive to also adopt strategic behav- ior and attempt to induce someone else to purchase rail equipment, in this situation, the State. The net result is that because of the ownership costs, both railroads and shippers want additional invest- ment in rail cars but by someone else. If the railroads believe that the State will purchase rail cars, their strategy will likely be to disinvest faster and to reassign cars to other States, which would create additional need and possibly additional investment. The strategy adopted by eleva- tors is slightly more difficult to project. They have more to lose 243 if rail cars are unavailable, but they also have better access to the decision-making process, which encourages strategic behavior. It is likely that as long as shippers believe that a potential public investment might be forthcoming, private investment will be discouraged and delayed. Shippers will also actively encourage public investment through lobbying and news releases. This neces- sitates a prompt and forceful decision because as long as the deci- sion remains unresolved or private investors perceive an irresolute decision, they will delay additional rail car purchases. Because public investment discourages private investment once the State has initiated a fleet, continuing pressures will exist to expand the public fleet as private owners disinvest. Of course, one can argue that the State can purchase perhaps 1,000 cars and announce that it is a one-time transaction, never to be repeated. But this is simply round two of game theory. And in round three, most shippers probably would believe further public pressure could force another round of State investment and then another. The proverbial camel's nose is in the tent. The exact outcome is impossible to quantify, but there is no doubt that should Michigan purchase 1,000 rail cars, there will not be an additional 1,000 cars available to State shippers twelve months after delivery. Some railroad-owned cars would be shifted to other States, and some shippers would cancel purchase plans. In the short-run public investment would likely increase the total supply of cars, but by a lesser amount than planned. But in the long-run, after shippers and carriers have had adequate time to alter 244 investment,tflmamarket would absorb public purchase by reducing private investment, and the net increase in car supply would be minimal. The extent of private disinvestment will depend upon private expectations. Should private investors believe that additional public purchases are possible, the long—term impact could actually be a reduction in cars available as private interests attempt to "force" additional public investment. If private investors believe that no additional public cars are forthcoming, the long-term impact will be an increase in total car supply, but the increase will be substantially less than the number of cars provided by the public. Another alternative would be for the State to become the only supplier of grain cars, in which case it could specifically determine what the total supply of available equipment would be. A viable alternative to increase railcar availability The reason that State ownership of railcars would prove ineffective in altering the supply is that this plan addresses only the symptoms and does not treat the causes. The most effective long-term solution entails addressing the cause of the problem by modifying the institutional incentives affecting supply and demand. Supply side modifications Returns which compare favorably to alternative investments are the most successful vehicle to induce potential investors to purchase railcars. This suggests that the rental rate for railcars should be determined through market transactions rather than through administrative procedures. And it further suggests that administrative 245 action designed to correct a misallocation of resources created by previous administrative actions usually proves ineffective in allevi- ating the problem, while generating additional misallocations. The recent short-line car owners are a classic example. A second vehicle which has proven effective in increasing the supply of rail cars is collective action between various eleva- tors. In some instances the purchase of rail cars was included in an overall cooperative effort such as building a subterminal. In other cases the only collective action effort has been to acquire and manage a cooperative fleet of rail cars. But in spite of its success, collective action has not become a widely adOpted strategy in Michigan because of information limitations and organizatiOn costs. Thus a vehicle which would encourage and facilitate the various cooperative, private, and line elevators in collectively purchasing and managing a rail car fleet could reduce the equipment shortage problem. One alternative would be to establish a rail car expert within the State DOT. This individual would have the needed information regarding all aspects of car leases including cost and risk and could function as the vehicle through which organizational efforts could proceed. This institutional arrangement would, of course, reinforce the railroads' current disinvestment strategy. Demand side modifications When grain prices are high, or during harvest season, car shortages exist, while at other times, rail cars stand idle. Thus the temporal allocation of demand is critical to effective utiliza- tion. Felton has suggested a rail car market in which potential 246 users could bid for railroad equipment.22 In addition to encourag- ing additional investment on the supply side, this would allocate equipment more effectively and partially eliminate the problems of seasonal demand variation, non-compensatory per diem and demurrage rates, allocation among shippers, and the decrease in utilization. Other institutions which would prove effective in allocating demand temporally include flexible rail rates and seasonal rates. Should variable rates be implemented, risk will increase for elevators because as they contract grain for future delivery they can not lock in a transportation rate. Therefore, elevator margin will widen unless a futures market in transportation service is developed to protect elevators against transportation risk. Wider margins would be borne by the farmer. However, the volume of grain requiring transportation is too volatile to suggest that these marginal changes would be completely effective in allocating demand over time. While domestic demand for grain is relatively stable over time, export demand fluctuates greatly in response to various factors such as weather-generated shortfalls of grain in other countries, embargoes, and other foreign policy, and policies of other nations, among other factors. Each time export, and thus domestic, prices decline, farmers react by reducing the volume they are willing to sell and increasing the amount they store. As part of its food policy, the public sector responds by making on-farm storage easier. Both construction and carrying charges are subsidized. But when prices improve, an even larger volume of grain requires transportation, which compounds 22Felton, p. 272. 247 car shortages and creates even larger transportation bottlenecks. And again, a public policy designed to assist a segment of the citizenry generates behavior which yields a suboptimal performance and perhaps even a destructive performance. It should be noted that on-farm storage which allocates grain over the marketing year contributes to the orderly utilization of rail cars. On-farm storage which enables farmers to store production from more than one crop year compounds the cyclical nature of grain marketing and compounts car allocation problems. To prevent this build-up of grain reserves at the point of production and therefore stabilize the demand for transportation services, an institutional technological modification is necessary which allows the deployment of grain to potential markets while the farmer retains control and ownership. Direct farmer ownership of storage facilities at ports would achieve this objective. Individual farmers, acting collectively, would build storage facilities near a port with some type of transfer to the export houses. Their grain would be shipped via the normal mode, mixed with grain of others, to this storage facility during periods of low prices. When an individual was ready to sell, he would issue instructions to the facility manager to deliver the grain to an export house. Obviously this suggestion is plagued with numerous problems, including: (1) potential managerial difficulties, (2) liability claims for transit or storage damage, (3) unwillingness of local elevators to load farmer owned grain, (4) lack of physical control by farmers, (5) the higher construction, land, and tax costs at an urban facility. 248 Finally, on-farm storage costs are perceived to be much less than they actually are, which perceptually makes off-farm storage come paratively less favorable. Yes, this institutional arrangement-- direct farmer ownership of storage facilities--is plagued with problems, but the potential benefits justify further exploration. The public sector would play a critical role in facilitating collec- tive action and providing information. Existing agricultural and food programs and tax laws would also need to be modified before off-farm storage could materialize. The exact impact that direct farmer ownership of storage facilities at ports would have upon the agricultural production and marketing sectors and the effective utilization of limited resources is unclear and needs further analy- sis. Existing agricultural policy and tax laws which encourage investment in farm storage facilities beyond one year's crop are probably going to compound the rail car shortage over time. Summary and conclusion The State is correct that public intervention is necessary to modify the supply and demand for rail cars. Rather than addi- tional restrictions upon the market, however, the key is a solution based upon a minimum of administrative proceedings and a maximum of institutional incentives designed to induce investment. Because of the various economic incentives, State provision of rail cars will induce strategic behavior by railroads and shippers. Their response will be a reduced investment in rail cars, counteracting the State funding. The exact impact upon the total or the marginal supply is indeterminant, but the increase in supply will be significantly 249 less than the total number of cars acquired by the State. State action which would encourage collective action among the various elevators and increase the available information would likely have a more permanent effect. To resolve the problem, it is necessary to modify the institutions which have created the existing situation. Only then will an adequate fleet of cars be available to transport grain produced in Michigan. The Rail Abandonment Hearing: An Institutionalized Adversary Proceeding The second half of the 19th century was the golden era of railroading. The emphasis was upon new construction, and abandonment was an infrequent and minor concern. This changed over time, however. By 1915 the motor carriers had started to become a competitive factor in supplying transportation services. Their position was enhanced by the First World War, which created a tremendous increase in the derived demand for transportation service. The result was that the war effort allowed the comparative advantage of each mode to exert its influence in the market. Therefore the competition from motor carriers for short hauls and the continually increasing volume of traffic forced the railroads to rationalize their systems by abandoning branchlines and focusing on mainlines. As a result, the emphasis switched from railroad expansion to contraction. Rail- road mileage peaked in 1916 and has been declining since. The public control which was deemed necessary over branch line abandonment, as with most types of railroad regulation, origin- ated with the states. In spite of differences in the extent and 250 method of control between states, "there grew up a well recognized body of legal principles limiting the right of abandonment."23 The courts, under common law, held that the railroads "entrance into business was accompanied by a special or general Charter which gave the company certain privileges, such as eminent domain, in exchange for which the company incurred obligations to the State and to the public."24 A duty to continue service, once instituted, was in- cluded as one of these responsibilities. In addition to returning the railroads to private owner- ship25 and thoroughly revising the Interstate Commerce Act of 1887, the Transportation Act of 1920 expanded the ICC's function to include control of rail line construction and abandonment, subjugating the State's role. In an interesting twist of events, the House of Representatives' debate over this law focused on the extension of federal power over new construction rather than abandonment. Sub- sequent events have certainly altered the emphasis. During the debate, Representative Sears of Wisconsin identified a major factor in the decision process. The gentleman from.Wisconsin (Mr. Esch) has just eloquently said that this is a national question and rises above a state question. Does not the gentleman fear that next November the question may be a Congressional-District question when the peOple begin to realize that we are giving up their rights?26 23Cherrington, p. 17. 24Ibid., p. 18. 25The railroads had been nationalized as part of the war effort. 26Congressional Record, 66th Congress, lst Session, Volume 58, p. 8536, November 14, 1919. 251 And Cherrington most effectively summarized the long term impacts of decision. All of the speakers against the extension of federal control over construction and, incidently, over abandonment, seem to have assumed that local constituents seeking a new railroad or opposing the abandonment of an old one would receive more favorable treatment from their own state commissions than from a centralized authority in Washington. In the light of sub- sequent Opposition by state officials in many abandonment cases this assumption appears to have been more-or-less correct. 27 For 60 years the ICC has been interpreting and administering the Transportation Act of 1920 and subsequent amendments. As with any economic sector the performance of the Transportation sector can be expected to be as efficient and as responsive as the institu- tional environment in which it functions. A brief analysis of the existing abandonment institutions reveals that they provide an incentive, the abandonment proceeding, which may not lead to an optimal performance. Long-term collective planning has been destroyed, and an adversary situation is created. The long-term allocation of resources such as industrial location, transportation infrastructure, and human capital location is cur- rently determined, to some extent, not by market transaction or public planning but by railroad management responding to the abandon- ment institution. This section describes the behavior and performance generated by the ICC's administrative proceedings. The abandonment procedure The institution which has evolved from the Interstate Commerce Commission's regulations requires that railroads desiring to dis- continue service file an abandonment petition. A public hearing is 252 then held at which the public convenience and necessity is determined. Railroads must justify abandonment by proving that the loss which will be incurred by continued operation outweighs the benefit to the public. This provides the railroads with the incentive to insure that a rail line is in fact defunct before an abandonment petition is filed. As a result, the railroads take a long-term abandonment strategy in which they allow service to deteriorate and defer maintenance of ways. Their action effectively destroys demand, destroys the track, and destroys potential collective action. This railroad strategy may take many years of continuing effort. A branch line in this research project, the C & O's line between Bad Axe and Croswell, is a classical abandonment effort. The C & O was forced to acquire this line when it purchased the Pere & Marquette in 1951.28 The P & M mainline provided access into a new market for the Chessie, but apparently it immediately started an abandonment strategy on the branch lines. Originally this line served Port Huron also, but the Croswell to Port Huron 28One other phenomena of the American enterprise system also contributes in an adverse manner. In America, big is good, bigger is better, and biggest is best. Over time, this attitude has per- meated the railroads, resulting in mergers or purchases of one railroad by another. Very often these mergers have simply been a means to gain access to select markets with no concern for the branch lines being served by the acquired carrier. This blatant lack of concern for their customer, the public, would be less sig- nificant if substantial operating economies resulting from these mergers but the evidence of economies is far from conclusive. The Penn Central is the classic example of a merger which failed and the Chicago, Milwaukee, St. Paul and Pacific is also an alleged victim of a railroad merger. This suggests that macro-economic incentives which motivate railroad management also interact to create a performance which is less than desirable. 253 segment had no shippers and therefore was abandoned, which also turned a through line into a branch line. Recently the C a O filed for abandonment on this line, but apparently because of a strong and effective State protest, the petition was withdrawn. However, it is unlikely the C a 0 will alter their strategy after 29 years; this would appear to be only a temporary setback. When the abandonment case is heard, it is a legal proceeding with plaintiffs and interveners. It is an adversary proceeding. One observer at the hearing for the Imlay City-Caseville line was asked by another, "Who's side are you on? You'd better be careful because we take care of ourselves."29 And while the statement may have been a poor attempt at humor, it certainly reflects the attitude of the shipper participants. Shippers also are encouraged to adopt strategic decision making because<1fthe institutional framework. They may conceal preferences for rail service, modal selection may vary because of the different incentives, and they will attempt to use the public sector to enforce their interests rather than addressing them in the market. Destroying collective action The railroad abandonment strategy has a fascinating result which contributes significantly to the railroad's success in 29This statement also reveals a great deal about the per- ception of shippers. Asking the public sector to force continued operation of a deficit Operation is an interesting definition of taking care of oneself! 254 abandonment cases Inn: is devastating to shipper effort. Deteriorat- ing service over an extended period destroys collective action among shippers. Shippers of different commodities possess different cross elasticity of demand for transportation services and thus have different reaction thresholds. Abandonment could never have occurred on the C & O branch line 30 years ago because there were too many users and they all would have reached their reaction threshold simultaneously when the abandonment petition was filed. However, as service deteriorates the shippers are divided and conquered. Those with a higher demand for service leave and shift to truck, leaving fewer and fewer shippers, and finally when only a handful of bulk shippers remain, the railroad proceeds with abandonment. By this point only a few loyalists, for whom exit is an expensive alternative, remain to protest the abandonment. The ultimate suc- cess of this adversary process is to file a petition to which there are no shipper protestants. Collective action may have even been attempted over time as the shippers who were more service sensitive complained to the railroad at the time of the initial service deterioration. They also solicited assistance from other shippers whose reaction thresholds were lower. While the other firms recog- nize the deterioration in rail service, the impact was still small and they were not ready to take collective action and invest money or time to improve rail service. At this point the cost of either a financial or time investment is greater than any cost imposed by deterioration of service. Thus the early reactors are faced with the choice of protesting alone or exiting. And after employing 255 the voice option, perhaps extensively, and getting no reaction from the railroad, they use the exit option, while people with the lower reaction thresholds continue loyal. The early use of voice and exit suggests that the railroad has adequate time to improve service if it intended to maintain the branch line. But that is not their goal, and voice and exit simply reinforce their devious behavior. As service deteriorates, the reaction threshold of different commodities are approached and passed. And each successive group utilizes voice and fails. They then exit as the same cycle is repeated over and over. Eventually the only shippers left are the bulk commodities such as grain and fertilizer dealers. At this point collective action may occur because the filing of abandonment petition serves as a rallying cause, but even at this stage col- lective action is not a certainty. The shippers may believe that their numbers are too few and the volume of shipment too small to justify retention of rail service, and they switch rather than fight. The effectiveness of the rail strategy even extends to efficiency measures. For example, when the railroad goes from daily service to thrice a week service, shippers who are extremely service- sensitive will use the voice Option to protest. Shippers who are less sensitive, such as grain elevators, see this as a way to reduce railroad costs and therefore may not oppose this economy move. Regardless of the railroad's intentions, the result is the same. When the voice option fails and collective action fails to material- ize, service-sensitive shippers employ the exit Option, leaving the 256 less sensitive loyalists behind. And again, shippers are divided and conquered. The behavior of the railroads is even encouraged by the ICC's administrative rules which govern the testimony which can enter the judge's decision process. Testimony by a shipper that the railroad failed to provide service and forced a modal shift is not utilized by an examiner as evidence that potential traffic exists which could improve a line's financial viability; rather, it is interpreted as revealing that rail service is unnecessary because an alternative is available! This rule reinforces railroad aban- donment strategies but leaves shippers in a quandary. Shipper exit plays into the hands of the railroad while shipper loyalty or voice generally proves ineffective in the long run. The policy paradox The abandonment institution has created a situation in which both private shippers and state and local public officials must make decisions and plans within a very constrained decision environ- ment or Opportunity set. Two alternatives exist for these interests: they can protest an abandonment petition, which usually is an ineffective and futile effort, or they can allow the abandonment effort to proceed without intervention, which insures that the rail service will be terminated. Regardless of the option selected, the probable outcome is the same, the loss of rail service. The need of both the public sector and railroad shippers is for modifications in the institutional parameters to eliminate the adversary nature of service modification and create a climate in 257 which all of the interested parties can effectively participate in the long-term planning process. Several recent legislative efforts have attempted to modify the institutional incentives. For example, one recent law requires the railroad to classify all lines and identify those which are potentially subject to abandonment. This law provides two years' advance warning. Unfortunately, this law falls into the class of rule changes described as marginal. Often when society is dissatis- fied with the performance of an institution, small or marginal rule changes are made which do not modify the behavioral incentives. These changes usually do not significantly improve performance but rather entice the public into believing that performance will be improved. 'The law described above is most definitely a marginal rule change. It does not alter the institutional incentive but simply forces the railroad to disclose its hole card marginally sooner or to delay abandonment two years. Thus similar abandonment strate- gies will continue with only a slight variation in timing. If a better source of information is desired, a complete annual report of railroad maintenance by mile post should be required of the railroad as well as a record Of shipper car orders and cars supplied by rail line. This would reveal maintenance and service policies for each branch line as they are made rather than when the results become apparent. But even this suggestion does not alter the incentives. If instead of an adversary environment, institutions were designed to encourage cooperation, performance could be 258 improved significantly. As a suggestion, the elimination of the abandonment institution and a reliance upon market transactions would create a better performance. Immediately upon determining that it was no longer interested in serving a particular line, a railroad could approach shippers and say that it had reservations regarding continued service. The issue would not be the condition of the track or traffic volume but rather that the long term plans of the carrier did not include the particular line. Therefore rather than destroying a branch line, a railroad would offer it for sale or negotiate some other market solution: a new tariff rate could be negotiated between the carriers and shippers which would entice further service. A short-line railroad could purchase and operate the branch line. Another railroad could buy the line. And, of course, the possibility exists that a market transaction would also lead to abandonment. Whichever option is selected by shippers, they would be given a real choice between viable alterna- tives rather than the hopeless situation imposed upon them by the abandonment institution. The key to implementing a successful market solution is to create institutional incentives which not only make collective action among shippers possible, but very probable. A viable market can only exist when shippers can collec- tively evaluate alternatives and initiate action. Reverting to a market transaction without institutionalizing collective action would create a performance which would be completely unacceptable. A market environment would allow the various carriers to provide those services for which they have a comparative advantage. 259 For example, the C & O is alleged to be a very efficient main line carrier for hauling goods long distances. Forcing them to Operate in production functions in which they are inefficient seems to be a questionable allocation of resources. Had market transactions been possible in the past, the Thumb's rail system would have a different structure today. Thirty years ago the C & O railroad could have explicitly stated to the shippers that they had no interest in Operating the Bad Axe to Croswell line even though it was profitable at the time. The shippers then could have employed market transactions when it was still viable, when it could still attract industry, and when it was still used by all shippers. But by the time the abandonment petition was filed, the line was virtually destroyed. This is not a proposal to eliminate railroad abandonment. Abandonment will continue to occur. This proposal is an attempt to improve the performance of an economic subsector which is currently Operating at a level substantially less than Optimal. Under this proposal, users are given the Opportunity to place a value upon a going concern, rather than a defunct line. If the bid materializing from collective action is greater than the salvage value to the railroad, service will continue. If the bid is less than the salvage value, the resource will revert to a higher use! Summary: the abandonment institution The quantitative results presented earlier suggest certain directions for the investment and disinvestment of resources. The abandonment institution, however, restricts the effective designing 260 and implementation of long-term railroad plans by the state and shippers. The railroad planning horizon is much longer, and rail- roads control the environment. Thus only state plans which are consistent with railroad's plan will be successful in the long-run. This suggests that a non-marginal change which would modify the railroad investment/disinvestment incentives would facilitate the use of this and other quantitative information by the public sector. Unfortunately, the rules of the game are determined in a national arena and the state is simply one of many actors. In summary, the abandonment proceeding was designed to protect shippers, but its results have been to do them a disservice. Hopefully, recent rule changes designed to modify the institution may overcome many of the problems identified in this section. Implication and Institutional Limitation Engineering and economic costs and benefits are the basic factors in designing a marketing channel to serve the long-term needs of the Michigan grain subsector. However, an understanding of the institution which motivates channel members is critical in implementing any system. The state can plan a long-term grain marketing system and identify essential rail lines and highways. Implementation of this system, though, is dependent upon channel member COOperation, and unless the state plan concurs with long term railroad interests, carrier cooperation is unlikely under existing institutional arrangements. In fact, the state will find that many actions are effectively mitigated by carrier counter actions. Designation of a rail line as essential is a futile effort 261 if the carriers are implementing a long-term abandonment strategy on the same line. Existing institutions would encourage an increase in strategic manipulative behavior by the railroad in response to an essential classification for a branchline, as service and main- tenance are modified to reflect the carrier's long term interests. Even providing cars to counteract railroad's branchline strategies will prove rather ineffective as the shippers themselves will adopt self-destructive practices. The only marketing channel which will prove effective in alleviating long term problems is one whose design includes a primary consideration of the many institutional incentives which motivate and modify members' behavior. Channels which are designed to enlist member support and participation through positive reinforcement will prove more effective in achieving desired channel goals. Channels whose design discourages support or contains counter-production or self-destructive incentives will not resolve channel problems. 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