13

PRICE, PRODUCTIVITY AND FINANCIAL PERFORMANCE IN THE TRANSPORTATION SECTOR

Improvements in transportation productivity and logistics are vitally important to economic growth. In 2000, the spike in fuel prices led to transport price increases growing faster than the inflation in the economy, rail freight transportation being an exception. In 2001, most indicators point to a contraction of output and prices, and a deterioration of financial returns, particularly in the airline industry.

This chapter examines the economic and financial performanceNote 1 of transport industries in Canada over the last four years, highlighting the most recent years for which data is available. Tables 13-3 to 13-6 at the end of this chapter show price and output indicators, cost structures, productivity and unit costsNote 2 indicators, and financial indicators, respectively.

After a period of robust annual productivity growth in the first half of the 1990s, productivity increases in selected transport industriesNote 3 slowed during the second half of the decade to 1.6 per cent a year. Productivity growth in 2000 reached 2.4 per cent.

Table 13-1 shows performance indicators for selected transport industries and the economy.

In the mid-1990s, the prices of transport services fell in real terms by 2.3 per cent a year. From 1996 to 2000, they increased by 0.6 per cent. Most of the increases were recorded in 2000. More than 50 per cent of the nominal increases in transport prices in 2000 were related to higher fuel prices. In 2001, transport prices returned to a pattern of price increases that were below the inflation rate.

With lower transport prices in the first half of the 1990s and the increasing trade orientation of the Canadian economy, the annual output gains of large transport firms doubled the growth of the economy in the early 1990s. From 1996 to 2000, transport output grew slightly more than in the economy. In the first half of 2001, the business sector grew by 1.8 per cent in the selected transport industries. In the second half of the year, the economy grew marginally by 0.4 per cent. This flattening in economic activities, and the aftermath of the September 11 terrorist attacks in the United States, resulted in marginal growth of the transport sector in the year 2001.

Rail Freight Industry

A strong productivity growth and intense cost reduction efforts allowed Canadian National (CN) and Canadian Pacific Railways (CPR) to enjoy good financial performance in recent years. Despite higher fuel prices in 2000, rail freight rates continued to decline, and both carriers reported further improvement in operating ratios. In 2001, the operating revenues and income of the Canadian operations of CN and CPR declined slightly.

Price and Output Indicators

From 1996 to 2000, the output of CN and CPR operations in Canada grew, on average, by 3.2 per cent a year. Rail freight prices declined by 0.6 per cent a year. In 2000, despite a 40 per cent spike in fuel prices, rail freight rates continued to decline. In terms of commodity groupings, grain ratesNote 4 increased by five per cent between 1996 and 1998, but declined in the next two years by 6.2 per cent. Over the 1996 - 2000 period, freight rates of bulk commodities declined 5.3 per cent a year, with a revenue yield around 25 per cent lower than that of all non-bulk commodities. Intermodal services represented the most significant source of rail traffic growth (44 per cent), while total rail traffic grew by 16 per cent. Still, the average yield of intermodal services is significantly higher than that of other traffic. In the first half of 2001, revenues for prices and traffic were basically unchanged from the previous year.

Cost and Productivity Indicators

Rail freight is the most capital-intensive transportation activity, with 30 per cent of its total costs related to capital-related expenditures. In 2000, the labour cost share continued its decline and accounted for 35 per cent of total costs, a drop of 3.6 per cent. Fuel costs, as a result of higher diesel prices, accounted for ten per cent of total costs, up from seven per cent in 1999. The two major freight railways in Canada have showed impressive productivity growth since 1996, with an average productivity growth rate of 4.4 per cent a year. In 2000, railways surpassed the trends observed in other modes, showing a productivity gain of 9.6 per cent. These gains allowed railways to reduce their unit cost annually by almost 3.1 per cent over the 1996 - 2000 period. In 2000, unit costs fell by 5.8 per cent, despite a major increase (3.3 per cent) in factor prices.Note 5

Financial Performance

Since 1996, productivity gains have allowed the carriers to lower freight costs and improve financial results at the same time. Operating income in 2000 increased by $250 million and the operating ratio declined for the fifth consecutive year since 1995, reaching 79.3 per cent. In 2001, the combined operating income from the Canadian operations of CN and CPR declined slightly. Regional railways accounted for 11 per cent of total operating revenues of freight railways in Canada, and they had an average operating ratio of 91 per cent in 2000.

VIA Rail

VIA Railís traffic continued to grow in 2000 and 2001 despite hefty price increases. The combination of higher prices and cost reductions brought VIA Railís cost recovery close to 50 per cent.

Price and Output Indicators

In 2000, VIA Railís revenues grew by 7.3 per cent, the result of prices rising by 6.1 per cent and output growing by 1.1 per cent. From 1996 to 2000, the prices of VIA Railís passenger services increased by 4.1 per cent a year on average, exceeding the inflation rate. Yet output rose by 2.6 per cent annually. As a result, VIA Rail was able to increase its operating revenues by 30.2 per cent over this period. The willingness of consumers to pay more for VIA Railís services was illustrated by a traffic gain of 1.5 per cent in 2001, despite a 10.7 per cent price increase.

Productivity and Unit Cost Indicators

In 2000, the share of fuel costs in total costs increased at VIA Rail as it did in rail freight transportation in general. However, VIA Railís hedging strategiesNote 6 limited fuel price increases to 16 per cent. Still, fuel accounts for less than five per cent of VIA Railís costs. In 1999 and 2000, VIA Railís productivity gains were close to six per cent per year, following a period of stagnation between 1996 and 1998. Total unit costs in 2000 fell slightly, yet they were 13 per cent lower than in 1996. In the first half of the 1990s, unit costs had already dropped by 19 per cent.

Financial Performance

VIA Rail has increased the proportion of total costs it recovers every year since 1991. Two thirds of this improvement was achieved from cost reductions and one third from price increases. When all costs are included, however, VIA Railís cost recoveryNote 7 is still below 50 per cent.

Trucking Industry

In 2000, the effect of higher fuel prices on trucking freight rates was partially offset by increased efficiency. Output continued to be strong. Operating ratios edged below 95 per cent. In 2001, weak trucking prices and output contributed to rising operating ratios.

Price and Output Indicators

In 2000, industry revenues rose by 9.8 per cent and prices by 3.3 per cent. Fuel price increases of 28 per cent were a major factor in price increases. Output continued to grow at a robust rate of 6.3 per cent, a rate still lower, however, than the average ten per cent in previous years. In real terms, overall trucking prices have declined by 0.5 per cent since 1996. Whereas domestic trucking prices fell by 3.2 per cent, the prices of transborder services increased by 4.3 per cent. Preliminary figures indicate that output peaked in the first quarter of 2001 and declined in every other quarter of the year. Prices have also been soft due to reduced fuel prices and the slowdown in the North American economy.

Productivity and Cost Indicators

Until 1999, the trucking industry exhibited a stable cost structure. In 2000, the fuel cost share increased by 2.1 percentage points. Total factor productivity in the trucking industry increased by 2.7 per cent in 2000. The industry reacted to the spike in diesel prices by improving its fuel management practices; fuel efficiency gains reached 6.5 per cent. In 2000, trucking unit costs rose by 2.7 per cent. Without the effect of higher fuel prices, total unit cost would have been stable.

Between 1996 and 2000, total factor productivity growth reached 1.6 per cent. Over the same period, unit costs increased by 0.8 per cent, half the rate of inflation in the economy.

Financial Performance

In 2000, as prices increased more rapidly than unit costs, operating ratios edged below 95 per cent, a performance in line with previous yearsí trends. The trucking industry can be viable with an operating margin of about five per cent of operating revenues. Large trucking carriers maintained their profitability in the first two quarters of 2001. The operating ratio of the larger carriers remained the same in spite of softer freight rates prevailing in the trucking industry.

Intercity Bus Industry

Declining productivity and factor price increases led to a unit cost increase of nine per cent in 2000. Price increases and strong output growth allowed the bus industry to achieve an operating ratio of 89 per cent, enough to cover the cost of its capital.

Price and Output Indicators

Revenues for the intercity bus industry grew by 15 per cent in 2000. Prices rose by 3.5 per cent, whereas output increased by 11 per cent. The relative importance of the different sources of industry revenues remained the same: 84 per cent from passenger services, 12 per cent from parcel services, and four per cent from various other activities.

The share of scheduled bus services was stable, at 40 per cent of total intercity bus passenger service revenues. The revenue share of charter and tour services reached 46 per cent in 2000, leaving specialized intercity bus services, such as limousine and sightseeing services, with a smaller share of total industry revenues than in previous years.

The changes in demand for each type of intercity bus service were asymetrical to price changes. Demand for scheduled intercity bus services was flat between 1996 and 2000, a period over which nominal prices for those services went up by 14 per cent. Conversely, activity levels for other bus services increased by 35 per cent, while their prices fell by seven per cent. Over the 1996 - 2000 period, the output of the intercity bus industry increased by 4.1 per cent a year while its prices rose by 0.5 per cent a year.

Cost and Productivity Indicators

Before 1999, the cost structure of the bus industry remained relatively stable. The labour cost share dropped by 3.8 per cent in 2000. Fuel, other variable and capital costs gained one, two, and half a percentage points, respectively.

While total factor productivity declined in 2000, it has increased overall by 0.9 per cent a year since 1996. However, labour productivity and fuel efficiency increased by 4.7 and 4.2 per cent, respectively. Fuel efficiency significantly improved in 2000, growing by 4.9 per cent, which mitigated the impact of a 29 per cent fuel price increase. Capital productivity declined by 5.7 per cent a year between 1996 and 2000, reflecting an increase in capital intensityNote 8 in the industry. Low productivity gains were not enough to offset factor price changes. As a result, overall unit cost increased by 1.3 per cent a year between 1996 and 2000. Much of the increase occurred in 2000, when unit costs rose by 8.9 per cent, due to productivity declining by 3.6 per cent and factor price increasing by 4.9 per cent.

Financial Performance

Before 2000, operating ratios in the bus industry averaged 85 per cent. Productivity gains made by the industry were responsible for the improvement in the profitability of the intercity bus industry. In 2000, through price increases, the industry achieved an operating ratio of 89 per cent, enough to cover its cost of capital.

Urban Transit Systems

In 2000, the revenues (excluding subsidies) for urban transit and urban service operators rose by 7.8 per cent, a result of both higher prices and increased ridership. In spite of flat productivity growth, cost recovery continued to climb steadily.

Price and Output Indicators

After two years of marginal price increases (1997 to 1999), transit system prices grew by 4.3 per cent in 2000, a pace similar to that of the early 1990s. Still, the output of transit systems increased by 3.4 per cent. In the past, such price increases led to declining ridership. Between 1996 and 2000, prices increased by 2.1 per cent a year while output grew by 3.2 per cent a year.

Productivity and Cost Indicators

Transit systems are among the most labour- and capital-intensive of all transport industries, with a respective share of 51 and 27.9 per cent of total costs. The labour cost share in 2000 was 1.8 per cent lower than in 1999, and the cost of fuel and other materials and services slightly increased its share of total costs.

Total factor productivity of transit systems in 2000 was basically the same as in 1999, 4.1 per cent higher than in 1996, but still below the peak level of 1995. In spite of a 15 per centNote 9 increase in fuel prices, fuel efficiency declined by 4.4 per cent in 2000. This confirmed the previous yearsí trend of deteriorating fuel efficiency. Both labour and capital productivity increased in 2000. Since 1996, labour productivity rose annually by 2.5 per cent a year. The decline of capital productivity, 1.3 per cent a year, corresponds to increasing capital intensity.

Transit costs per unit of output rose by 3.9 per cent in 2000, but were marginally higher than in 1996. Since 1996, capital costs have exhibited the largest increases, 3.8 per cent a year, followed by fuel costs at 2.2 per cent a year. The reduction of unit labour costs averaged 1.6 per cent a year.

Financial Performance

The total cost of transit systems was estimated at $4.3 billion in 2000. Cost recovery has been increasing steadily since 1996, reaching 48 per cent in 2000. Annual operating subsidies have been relatively stable, at $1.5 billion, while capital subsides declined 30 per cent in 2000 from their 1999 peak.

Transit System in Selected Provinces

This section examines key performance indicators of transport systems for British Columbia, Alberta, Ontario and Quebec, as shown in Table 13-2.

Ontario stands out as having a productivity and unit cost performance well below the national average. However, it did achieve the highest cost recovery, but only because it charged the highest fares (per kilometre) in the country. Alberta had the lowest unit costs, which nonetheless recorded the lowest cost recovery, as its fares were also the lowest in the country. Quebec had the smallest revenue shortfall, at $1.36 per passenger. British Columbia had the greatest revenue shortfall, at more than $2 per passenger, because of low prices relative to unit costs, and the fact that transit riders were travelling over longer average distances than in other provinces.

Air Transport Industry

In 2000, the group of air carriers included in this analysis generated total revenues of $13 billion, 11.7 per cent more than in 1999. The economic slowdown in 2001 and the events of September 11 crystallized the fragility of the industry.

Price and Output Indicators

The 1996 - 2000 period was one of strong growth for the air transport industry, with total revenues growing by 11 per cent a year, transport output by 5.8 per cent, and airfares by 4.8 per cent. Since inflation in the economy was limited to 1.5 per cent a year, this suggests that airfares were increasing in real terms by 3.3 per cent a year over this period. The changes in airfare prices, measured at the carriersí level, were affected by navigation fees, which replaced the Air Transportation Tax. When this is factored in, air prices increased in real terms by 1.1 per cent.

Figure 13-1 shows price trends in the airline industry with and without the Air Transportation Tax, from 1996 to 2000.

In 2000, the air transport industry enjoyed rising prices and demand. Airfares increased by 7.8 per cent, and passenger and freight services both grew by 3.9 per cent. The prices of domestic passenger services rose by 7.8 per cent, but output fell by 0.8 per cent. Price increases in transborder services were about 4.7 per cent (a rate much lower than in recent years) and transborder demand grew 15 per cent. In international markets, fares had been stable, with minimal increases in recent years. Because fares in international markets are more sensitive to fuel price increases, they grew by 9.9 per cent in 2000. Demand for foreign travel to markets outside the United States continued to be strong, a 6.8 per cent increase, which is in line with previous trends. Revenues from freight activity increased on average by five per cent a year between 1996 and 2000, thanks to respective one and four per cent increases in the volume of air freight and cargo rates.

During the first nine months of 2001, passenger traffic was stable, and profits fell by seven per cent, owing to reduced fuel costs and heightened competition in the domestic market. The impact of September 11 can be illustrated by the 19 per cent reduction in Air Canada passenger traffic, followed by an 11 per cent drop in the fourth quarter. Average yields fell by 17 per cent in September, and by ten per cent in the fourth quarter. Other carriers did better. WestJetís traffic increased by 50 per cent in the fourth quarter.

Productivity and Unit Cost Indicators

The cost structure of the airline industry was affected by a 54.7 per cent increase in fuel prices in 2000, which raised the fuel cost share from 12 to 16.4 per cent. The capital cost share declined to less than 15.5 per cent of total cost. Leasing and interest expenses, which represent fixed obligations that have to be met from the operationsí revenues, represent almost 73 per cent of the capital costs of Canadian airlines. In comparison, they are estimated to account for 25 per cent of the capital costs of US airlines. This highlights the financial vulnerability of Canadian carriers to internal (e.g. economic slowdown) and external (e.g. September 11 events) shocks.

In 2000, total factor productivity of the airline industry dropped by 1.6 per cent and was marginally higher than in 1996. While fuel efficiency improved by two per cent in 2000, labour productivity dropped by 3.8 per cent, the first drop since 1991. Capital productivity increased by 3.6 per cent, reflecting the disinvestment strategies of some carriers. The robust output growth situation -- more than six per cent a year since 1996 in air transportation -- should have been conducive to productivity improvement. Over that period of strong demand, however, the industry faced significant structural changes, a mix of consolidation of some carriers and very significant expansion of others. This made it difficult for the industry to match resource utilization and demand, which in turn translated into poor productivity performance.

Since 1996, the air industryís unit costs have increased annually by 4.5 per cent, due to marginal productivity gains and factor prices rising by 4.7 per cent a year. These factors, together, added almost $1.8 billionNote 10 to the cost base of the airlines. Over the same period, revenues increased by one quarter of this amount. In 2000, the situation worsened, with negative productivity gains and factor prices increasing by 8.9 per cent. As a result, unit costs rose by 10.8 per cent.

Financial Performance

In 2000, the airline industry posted an operating income of $26 million. The consolidated income of Air Canada and Canadian Airlines International Limited (CAIL) showed a loss of $101 million, compared to an operating profit of $127 million for the other carriers covered in this analysis. In 2001, Air Canadaís profitability was adversely affected by increased domestic competition, the economic slowdown and the impact of September 11. Air Canada reported an operating loss of $731 million. Total loss before income tax reached $991 million. Of the publicly traded independent carriers, only WestJet was profitable. Canada 3000 went under and Air Transat, as a result of large unusual charges, faced some financial losses in 2001.

NOTES

1. Different database definitions, assumptions, coverage, reference years and calculation procedures may produce different results and affect observed trends in productivity and prices. Changes in data availability lead to methodological modifications that affect the results. This explains differences between the series shown in this annual report and those presented in previous annual reports.

2. Unit costs are costs per unit of production.

3. Larger firms in rail freight, air and trucking, or 93 per cent of the revenues of all the firms reviewed in this chapter.

4. Some of the increases result from adjustments to correct rate anomalies following the abolition of the Western Grain Transportation Act (WGTA).

5. Factor prices refer to the average price paid by the transport carriers to purchase the factors of production they use.

6. A hedging strategy is one where a company negotiates a fixed price for fuel purchases over a period of time with suppliers.

7. The measures of cost recovery here are different from those published by VIA Rail. This report takes into account overhead costs, depreciation and the opportunity cost of capital of net fixed assets. Extraordinary items, however, are excluded.

8. Capital intensity is the ratio of fixed assets over revenues in constant prices.

9. The increase was in the order of 33 per cent in provinces where transit systems do not use fuel as motive power.

10. This estimated cost increase assumes the same level of output as in 1997.