APPENDIX A Objective: Analysis Of The High Speed Rail Authority s Planned Pricing William H. Warren July 2, 2010 Management Summary To analyze the pricing used in the HSR Authority s Ridership Forecasts and in the 2009 Business Plan. Conclusions: My overall conclusion is that the planned HSR ticket prices that were used in the High Speed Rail Authority s (HSRA s) Ridership Forecasts and the Business Plan are unrealistically high, and are not sustainable in a competitive marketplace. I base this conclusion on a review of actual, existing air fares in the Northern California Southern California marketplace, and a review of how the Auto Costs were determined in the shorter distance automotive marketplaces. HSRA s planned prices will need to be reduced at least 25% to reflect the competitive market s actual pricing and costs. These findings are shown on the HSR Plan Table B and HSR Plan Table C Worksheets of the attached Excel Workbook Average Fares. Summary of Findings: 1. The average net prices that the HSR Authority should use for revenue forecasts (as shown in Table C of the 2009 Business Plan) must be adjusted down from the gross prices charged to passengers (as shown in Table B of the 2009 Business Plan), to reflect the state and local sales taxes. I do not believe this was done. 2. The long distance market segments, where the airlines are the primary competitors, are over priced relative to the prices I see in the market today. I have looked at prices on the Web, done a weighted average of these prices and I have concluded the gross prices that the HSRA should expect to achieve are between 20% and 25% lower than the prices shown on the 2009 Business Plan. 3. The medium distance market segments, where automobiles are the primary competitor, are over priced because of how the HSR prices were computed. I believe that a pricing plan that sells at a price that is attractive, compared to the cost of two passengers in an automobile, is necessary to achieve the high market penetration the HSRA wants to achieve in these segments. Based on my analysis, I believe that the gross Appendix A Page 1 of 18
prices that the HSRA should expect to achieve are between 20% and 40% lower than the gross prices shown on the 2009 Business Plan. 4. The short distance, local, market segments, where local rail and autos are the primary competitors may be over priced, relative to my knowledge of Caltrain pricing for their Baby Bullet service on the San Francisco Peninsula. I have not done any detailed analysis of these segments, but I think further work is necessary. Recommendation: An independent, non-biased, organization should be commissioned by the State of California s Legislature to study these three marketplaces and determine if my conclusions are reasonable. An international consulting organization, such as McKinsey and Company, or Bain and Company, would be good candidates. The outcome of such a study should be used in future Ridership Forecasts and Financial Plans. The Following Two Sections of This Document: The next section of this document A Detailed Analysis Of The HSRA s Planned Prices describes the methodology I used in the first two Worksheets of the attached Excel Workbook - Average Fares. This section deals extensively with the Air and Automobile market pricing. The last section of this document Recommended Changes to HSR 2009 Business Plan Tables shows the original Tables as published in the 2009 Business Plan and my recommended changes to these tables to reflect my projected pricing as well as clarifying what the various columns in the Tables represent. These Tables are the last two Worksheets of the attached Excel Workbook - Average Fares. Note to the reader If you are going to be viewing PDF versions of the Excel Workbook, please be aware that these PDF pages do not shown you what Worksheet you are in. In effect, all the pages are presented, in order, from all the Worksheets. Therefore, the first four PDF pages are from my Air Worksheet, the fifth page is from my Auto Worksheet, the sixth page is from my Table B Worksheet, and the seventh page is from my Table C Worksheet. My apologies for any inconvenience. I am sure Adobe would apologize also, if they thought about it for 5 minutes. Appendix A Page 2 of 18
A Detailed Analysis Of The HSRA s Planned Prices In the Air Fare Marketplace These market segments represent 44% of the HSR Planned Revenues, per Table C. This is shown on the bottom of my HSR Plan Table C Worksheet of the attached Average Fares Workbook. Table B of the 2009 Business Plan shows the $126 one way average ticket price from San Francisco to Los Angeles, and the $105 one way average ticket price from Anaheim to San Jose. I made the assumption that these prices were Gross Costs to the passenger, i.e. these prices include all appropriate fees and taxes. To validate these two prices I took the Southwest Airline s Web site Wanna Get Away prices over a 5 week period and calculated the average price for each week the first week is if I want to fly in the next week, the second week is if I want to fly 2 weeks from now; out to the fifth week, which is the price if I want to fly 5 weeks from now. The results are shown in the attached Excel Workbook Average Fares, in the Air Market Worksheet. San Francisco to Los Angeles For the San Francisco to Los Angeles segment, please look in cells D9 to D13 of the Worksheet Air Market. As this is a very competitive flight corridor, with 7 other carriers in addition to Southwest, you see that the price of $132, for flights in the next few days, drops off very quickly to a base price of $79, four weeks in the future. I placed comments in Column N to note how Southwest discounts their Base prices in the middle of each week, and raises their prices around a holiday (the 4 th of July in my case). I calculated the average prices for the next 3 weeks and 4 weeks as $89 and $87. However, I decided I wanted to create three cases to measure how sensitive these average prices are to passengers buying their tickets far in advance, or more at the last moment. I created a Best Case, with 40% of the passengers purchasing tickets in the week they are going to travel (therefore paying a higher price), and a Worst Case with 40% purchasing tickets over a month in advance (therefore getting lower prices). The results for the three cases are shown on cells J15 to L15, ranging from $91 to $83. Since these prices are before fees and taxes, I then ran a few complete price quotes, on the Web, to learn that the mark-up to the Gross Price to the customer is 19%. I then adjusted the price per ticket paid to Southwest in each of the 3 cases up to the Gross Price in cells J17 to L17. For the purpose of this analysis, I decided to use the Medium Case, with 40% of the tickets being purchased 3 weeks before the trip, which gave me a Gross Price to the customer of $99, and a net price to Southwest of $83. Appendix A Page 3 of 18
I then went to Orbitz on the Web to see how close the other 7 carriers matched the Southwest pricing strategy. Once I adjusted everyone to a Gross Price after fees and taxes, the competition was within 5% of the Southwest prices, starting with the high prices in the $132 range, in the first week, and quickly dropping to the $59 in the mid week prices in the 2 to 3 weeks in advance time period. In some cases the price differences were in the range of $1. Clearly this is a very price sensitive market, with a premium charged for last minute tickets and holiday tickets, and deep discounts during slack periods. Therefore, my conclusion is that the HSRA s projected Gross Air Fare price of $125, in cell K21, is not realistic, and I believe my Gross Air Fare Price of $99, in cell K17, more fairly represents this market. If this is correct, the difference of $26 is a 32% drop in the HSRA s Gross Air Fare number. Therefore, the HSRA s planned HSR Gross Price of $105, from Table B, is more than it should be. This price is also shown in cell N21, which is intended, by the HSRA, to be 83% of the $125 Air Fare number. I believe the more realistic HSR numbers are in cells N29 to Q31, where the HSR Gross Price should be $83. (See cell O29, as 83% of my projected average Air Fare Gross Price of $99, in cells K17 and Q28.) Since this Gross HSR Price contains a State tax of 9.75%, the Net Price that the HSRA will realize is $75 (please see cell O30). The Net HSR Price is the appropriate price to use in the Business Plan for the Financial Plan and in the Ridership Forecasts. I was unable to find any reference that the numbers in these documents are gross numbers that would contain tax collections that would need to be set aside for the tax authorities. If I am correct in both my competitive price reduction, and my conclusion of a Gross Price being used instead of a Net Price, then the $105 Gross Price in Table B needs to be reduced to $83, and a Net Price of $75 also needs to be shown, as the input to the Financial Plan and the Ridership Forecasts. There is, therefore, a real risk that the price the HSRA is using is $30 too high. This would indicate they need to adjust downward their revenue forecast for this segment by 28%, as shown in cells J30 to L31. Anaheim (Orange County) to San Jose I followed exactly the same procedure to collect competitive pricing from Southwest. This is a much less competitive marketplace, with only two other carriers, and with a far fewer number of competitive flights. The results of my pricing analysis are shown in cells A37 to N48. Note the prices are higher for travel within one or two weeks of purchasing the ticket, with my Medium Case average ticket price at $99, as opposed to $83 in the San Francisco to Los Angeles market. However, also note that the long term base price is also $79. Therefore my Medium Case Gross Price is up to $118 (see cell K50). This is compared to the Air Fare price shown in Table B at $105 (see cell K54). Appendix A Page 4 of 18
Table B then shows the HSRA s planned ticket price as $103 (see cell N54). This price is based on the Business Plan calculating other ticket prices on the distance of the ticket relative to the distance and price of the San Francisco to Los Angeles ticket. I believe that in a market which is well defined, such as the Anaheim to San Jose corridor, to ignore competitive pricing is a serious error. The HSRA s prorating planned pricing, based on distances, may help to insure operating costs are covered, but it gives no assurances that customers will elect to use your services. Therefore I am going to hold to the 83% pricing against Air Fares. Following this logic, the HSR Gross Price should be $98 (see cell O62), at 83% of the current Medium Case Air Fare pricing (see cells Q61 and K50). The resulting Net Price, after adjusting for taxes, is therefore $89. Therefore the correction from the price in the Business Plan (see cell N54), to the Net Price for the HSRA s Financial Plan and Ridership Forecast purposes (see cell O63), is a reduction of $14 (as shown in cell L63), which is a 13% reduction. Additionally, it is a serious error to assume that Southwest will continue to hold its higher prices in the first and second weeks, compared to the San Francisco Los Angeles market, once HSR enters the market. Since their long term base price is already $79 in both markets, it is my expectation they will reduce their first and second week prices to match the more competitive prices of the San Francisco Los Angeles market. When this happens, the average Air Fare Gross Price, for the Medium Case will drop from $118 (see cell K50), to $99 (see cell K17). The cells N66 to Q68 show that the Net Price for the HSR will then be $75, the same price as in the San Francisco to Los Angeles market (see cell O30). If I am correct in both my competitive price reductions, and my conclusion of a Gross Price being used instead of a Net Price, then the $103 Price in Table B needs to be reduced to $83, and a Net Price of $75 also needs to be shown as an input to the Financial Plan and the Ridership Forecasts. There is a real risk that the price the HSRA is using is $27 too high and they need to adjust downward their revenue forecast for this segment by 27% (as shown in cells J68 to L69). Other Air Markets I then repeated the same process for the Los Angeles to Sacramento market and the San Diego to Bay Area market. The results are at the bottom of the Air Market Worksheet. In the Automotive Marketplace These market segments represent 48% of the HSR Planned Revenues, per Table C. This is shown on the bottom of my HSR Plan Table C Worksheet of the attached Average Fares Workbook. It appears these automobile replacement markets will be the largest source of revenues, per the HSR Plan. Appendix A Page 5 of 18
This is a very complicated market place for which we need to figure out a better pricing plan. The root of the problem is that the competitive device, the automobile, can carry from 1 to 4 passengers, with the second, the third, and the fourth passengers at effectively zero marginal cost to the passengers. Alternatively, it makes no sense to give away a second, third, or fourth seat on a HSR train until almost immediately before the day and hour of the train, in the hopes that a paying passenger will show up. Current Pricing Methodology Before commenting more on the pricing plan issues, I want to deal with what I believe are problems in the calculations of the projected HSR fares in the markets currently served by auto. In the Auto Market Worksheet in the attached Average Fares Excel Workbook, on rows 8 to 14, I show what I believe should be the prices presented in the current Business Plan, based on the Plan s $126 average Gross Price air fare between San Francisco and Los Angeles. In cells G12 to G14 are the prices currently shown in the HSR Plan for these three market segments. Cells H12 to H14 show what I believe would be the net price to the HSRA, after allowing for the 9.75% sales tax. However, the Business Plan states that the pricing plan for these segments is to set to be at 83% of the $126 fare, adjusted for the difference in the distance between these two cities, as compared to the distance between San Francisco and Los Angeles. In effect, this means taking the $126 fare times 83% and dividing this by the number of miles from San Francisco to Los Angeles, which is stated to be 432 miles in the Business Plan; but is actually 381 miles, per Yahoo Maps. This yields a price per mile number. This number is then multiplied by the number of miles between each pair of cities, such as 131 miles, as stated in the Business Plan, of the Bakersfield to Burbank pair, but which is actually 103 miles per Yahoo Maps. This yields a Gross Price for HSR of $28, as shown in cell J12. This Gross Price is then adjusted down to remove the California sales tax, with the Net Price of $26 in cell K12. Compared to the Gross Price shown in Table B, of $51.25, and in cell G12, this produces an error of $26, which is a 50% error. Note however that the corrected Gross Price is now 67% of the Auto Gross Costs, which makes more sense than the $51 number which is in the Plan. The same logic applies to the two other city pairs, yielding Corrected Gross Prices which are106% and 88% of the Auto Gross Cost, as shown in cells O13 and O14. Problems With This Methodology The problem with this logic is that I do not believe the Gross air fare number of $126 for the San Francisco to Los Angeles marketplace. As discussed above in the Air Fare Marketplace section of this document, I believe the correct price is $99. Therefore, in rows 16 to 22, I duplicated the logic of rows 8 to 14, but using a price of $99 in the calculation in cells J20 to J22, as opposed to a price of $126. This leads to prices which are way too low because they are based on prices from a very competitive airline market place, and they represent Gross HSR prices which are only 53% to 69% of the Gross Auto Cost. Appendix A Page 6 of 18
My Recommended Methodology I therefore set aside the HSRA s Plan objective of pricing as a % of the San Francisco to Los Angeles air fare, and decided to set the Gross HSR prices at 83% of the Gross Auto Cost. These results are shown on row 24 to row 30, and, by definition, they are 83% of the Gross Auto Cost (as seen in cells O28 to O30). I recomputed the Gross Auto Cost, by defining the Gross Cost per mile, in cells F28 to F30, to be the 2009 IRS (Internal Revenue Service) mileage deduction of $0.55 per mile, divided by 2 passengers per mile. As I will explain below, my choice of 2 passengers per auto, as opposed to 1 passenger per auto, is to allow a set of HSR prices that will be attractive to both the 1 and 2 passengers per car market segments. With the cost per mile in cells F28 to F30, I then multiplied this rate by the corrected number of miles, from Yahoo Maps, in cells C28 to C30, to yield my new Gross Auto Costs in cells D28 to D30. My new Projected Gross HSR Price in cells J28 to J30 is 83% of the Gross Auto Costs in cells D28 to D30. But, the reduction in the Gross HSR Price and the adjustment to reflect the Net HSR Price, after taxes, leads to a 55% to 30% reduction in HSR revenues. My conclusion is this pricing off of Gross Auto Costs is a better competitive plan, as it does not risk pricing errors as air fare and HSR pricing battles break out in the longer distance markets. Therefore, in my summary analysis in the HSR Plan Table B and the HSR Plan Table C Worksheets, I am adjusting all the HSR ticket prices in the Auto market segments down by 25%. However, when I look at the Net HSR Prices shown in column O of the HSR Plan Table C Worksheet, these prices seem high, compared to the three Net HSR Prices shown on the Auto Market Worksheet in cells K28 to K30. It may be that a 30% to 35% reduction will be necessary to get the Gross HSR Prices at 83% of the Gross Auto Costs in all the Auto segments. I believe it is critical that this pricing methodology be reviewed and then the various prices that are in the Business Plan and the Ridership Forecast be adjusted, accordingly. The Four Passengers Per Auto Problem The problem with setting the Gross HSR prices, in the Auto Markets, to be at 83% of the Gross Auto Cost is that this auto cost can be for 1 to 4 passengers. Lacking any specific data to validate my opinions, I created in the Auto Market Worksheet in the attached Average Fares Excel Workbook, in rows 32 to 39, my best guess as to the distribution of the number of passengers per car in the market places where both the originating and the destination cities are not served by airlines. I created three cases in cells F32 to H39 with the best case having the largest number of single passenger cars, and the worst case having the largest number of 3 passenger cars. From this matrix I calculated the average number of passengers per car, for the three different cases, in cells J39 to L39, ranging from 1.9 to 2.6 passengers per car. From this I computed the distribution of all Appendix A Page 7 of 18
passengers in each case, with respect to which type of car the passengers are in; this is in cells N32 to P39. Looking at the Medium case in Cells O35 to O38, we see that 16% of all of the passengers are in a car by themselves, and 22% are in a car with one driver and one passenger. Additionally, 62% of the passengers are in cars with a driver and 2 to 3 additional passengers (see cells O37 to O38). Clearly the 16% of the passengers which are in a car by themselves are a target for selling a HSR Ticket. However, I found in the 2008 Business Plan, on page 13 of the 15 page document, a Table B, which shows Phase 1 with Fares at 77% of Air. It shows the intended market share penetration, by HSR, for the various market segments. (I could not locate a similar table in the 2009 Plan.) For the largest two Auto markets, the San Joaquin Valley to the LA Basin, and to the Bay Area, the penetration goal is 8% to 9%. This would mean, that of the 16% of the passengers in these markets that are in a single passenger auto, between 50% to 55% would need to be captured by HSR to provide an 8% to 9% penetration rate. It is for this reason I set my pricing to be at 83% of the Auto Cost for the auto with two, not just one, passengers; to penetrated the 2 passengers per auto market segment. Pricing Versus Market Share My opinion is that with Gross HSR pricing at 83% of Gross Auto costs, I think a 33% capture rate may be possible, but I believe a 50% to 55% is not possible. Therefore, I set the pricing at 83% of the Gross Auto Cost with 2 passengers. This market segment, I believe could be 22% of the market, as shown in cell O36. Therefore the total market that is available is 16% plus 22%, or 38% of all the auto passengers. With a penetration rate of 33% times this 38%, we get a market share of 10% to 11%, which is a little bit above the goal of 8% to 9%. I would market this pricing by creating a Companion Ticket program that would allow 2 people to travel together, in just these Auto markets. The total price for the two seats could be at 83% of the Gross Auto Cost, for 2 passengers, for that segment. I would then create a single ticket price at a premium, of (for example) 33% above the price of the Companion Ticket price. In the Bakersfield to Burbank segment, for example, the Gross Auto Cost per person is $28 (for 2 passengers), and therefore the Projected Gross HSR Price is $24 for each of the 2 Companion Tickets what would be sold together (and the two riders would need to travel together). For the rider who does not have a companion, the price of one ticket would be 33% higher, or $32. It is my opinion that the 62% of the passengers that are in 3 or 4 passenger autos will never be captured by HSR (see cells O37 and O38). In the Local Marketplace - These market segments represent 8% of the HSR Planned Revenues, per Table C. This is shown on the bottom of my HSR Plan Table C Worksheet of the attached Average Fares Workbook. Appendix A Page 8 of 18
I did no detailed analysis of the Local Los Angeles Basin and Bay Area Peninsula markets, but I believe some serious investigation is warranted. The average Net HSR Price of $19, when uplifted for taxes, becomes an average Gross HSR Price of $21. This seems very high to me, because in the Bay Area the Gross Caltrain Price for a ticket between San Francisco and San Jose is $6.60 for an 8 ride ticket, and $7.75 for a single ride ticket. The time for this segment is one hour on the Baby Bullet train. This means the HSR customer is going to be asked to pay at least 3 times as much to reduce his/her travel time from one hour to 30 minute (best case), or to 40 minutes (worse case). What I do not believe is a reasonable assumption is that the HSR annual forecast is for 4 million local passengers in 2035 in the Bay Area Peninsula, while the 2009 Caltrain boardings were approximately 11 million. This means HSR is planning to take up to 35% of the current Caltrain boardings, at a substantially higher price. It could be a smaller percentage if HSR also takes some auto traffic (at $21 per ticket). Appendix A Page 9 of 18
Recommended Changes to HSR 2009 Business Plan Tables In the HSR 2009 Business Plan, Using Table B To put my projected results in perspective, I want to present a revised Table B from the 2009 Business Plan. Therefore, I have, as the next to last Worksheet, in the Average Fares Workbook, a HSR Plan Table B Worksheet. Columns A to G are directly from Table B, on page 70 of the 2009 Business Plan. I added column H to P to show how I would modify this Table. As the prices shown on Table B are Gross Prices that the passenger pays, including all taxes and fees, I have added column I to reflect what the HSRA would receive as a Net Price, net of taxes, with the pricing shown in the current plan. In column K I noted if I am using the Gross Air fare or Auto costs as a basis for my Projected HSR Gross Price in each of the market segments. For the top two market segments, where the air fare price is driving the HSR price, I show, in column L, (highlighted in yellow) the projected price I believe Southwest will offer in these markets. My logic for these prices is discussed in the Air Fare Marketplace portion of my Detailed Analysis. For the last three market segments, where the auto cost is driving the HSR price I show, in column M, (highlighted in yellow) is the gross auto cost that I have recomputed, for two passengers per auto, for these markets. My logic for using these costs is discussed in the Automotive Marketplace portion of my Detailed Analysis. Just taking these 5 sample market segments, in Table B, I believe the average price used by the HSRA in Table C, where revenue is calculated, will drop from $79 (see column G), to $52 (see column O), about a 34% reduction. So now I would like to discuss Table C, because just viewing the average fare from Table B is not a valid conclusion. In the HSR 2009 Business Plan, Using Table C I want to collect the consequences of the analysis I have done, above, regarding the air and auto markets. Therefore I have, as the last Worksheet, in the Average Fares Workbook, a HSR Plan Table C Worksheet. Columns A to G are directly from Table C, on page 72 of the 2009 Business Plan. I added column H to show the percentage distribution of the total revenue to the various market segments. I added column I to show the average Net HSR Ticket Price (after taxes), and column K to identify what form of transportation is the primary competitor for pricing analysis. I marked the Local markets as both Auto and Local Rail, as I am not sure as to which is the primary market HSRA will attempt to replace. From all of this we see, in column H, that the Air replacement market has been projected to be about 44% of HSR revenues, the Auto replacement market is about 48% of HSR revenues, and the Local Rail and Local Auto is about 8% of HSR revenues. Appendix A Page 10 of 18
I then placed the new Net HSR Prices for the Air markets in column M, from the work I did in the Air Market Worksheet. I recalculated total revenues with just these Air prices changes, in column N, with a drop in total revenues of 16%, compared to column F. I then recalculated the Net HSR Prices for the Auto markets at a 25% reduction from column I, based on the work I did in the Auto Market Worksheet. These are shown in column O. I then recalculated total revenues with both the Air prices changes and the Auto price changes, in column P, with a drop in total revenues of 27% compared to column F. Note that it is highly possible that a reduction of about 33% to 35% may be needed to achieve the penetration of the 2 passenger per auto market place. I summarized the total % of revenues that the HSRA planned to receive from the Air, the Auto, and the Local Markets on the bottom of this Worksheet, in cells H29 to K32. I then summarized the results of my projected Revenues for these three markets in cells K29 to Q32. Because I did not change the prices, and therefore did not change the revenues for the Local Rail/Auto market, this segment grew as a percentage of the total. However the Auto market remains the most significant source of revenues in the 2035 time period. In column R I summarized the new Net HSR Prices, with the average Net ticket price now at $51 (see cell R27), as opposed to the $70 (see cell I27). This $70 average Net ticket price is used in the HSR 2009 Business Plan as part of their financial forecast. In Table E of the 2009 Business Plan, on page 73, the Revenue per year divided by Riders per year yields the $70 per Net HSR price per ticket. Based on my analysis, this number should be $51, a reduction of 27%. In Closing This concludes my Detailed Analysis and Recommended Changes to the Business Plan Tables B and C. Please see my Conclusions and Recommendation on the first page of this document. Appendix A Page 11 of 18
AIR MARKET SAN FRANCISCO TO LOS ANGELES AIRFARES Appendix A Page 12 of 18
AIR MARKET ORANGE COUNTY TO SAN JOSE Appendix A Page 13 of 18
AIR MARKET LOS ANGELES TO SACRAMENTO Appendix A Page 14 of 18
AIR MARKET SAN DIEGO TO SF BAY AREA Appendix A Page 15 of 18
AUTOMOTIVE TRANSPORTATION MARKET Appendix A Page 16 of 18
TABLE B HSR BUSINESS PLAN RIDERS & REVENUE Appendix A Page 17 of 18
TABLE C INITIAL PHASE, 2035, BOARDINGS, 83% OF AIR, IN 2009$'S Appendix A Page 18 of 18