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Ferry pricing

Open letter from James Fulford (Red Funnel CEO)

Richard Beet’s letter on ferry pricing to Ventnor Blog  on 29/7/12 has prompted me to write in an open letter format the comments and points that I have made to a reasonable number of Island residents who have written to me personally over the last few years, often with copies of both the letter and my reply to Andrew Turner MP.

Not the most expensive water in the world

Much of the content was picked up in the OFT enquiry in 2009 which can also be found here. This study also addressed the oft quoted (but sadly urban myth) of the Solent as ‘the most expensive ferry route per mile in the world’.  No one knows where this came from, but the only study of which we are aware was done by Napier (NZ) university and I have reproduced it here which shows Red Funnel as one of the cheapest commercial ferries per mile and beats many of the Scottish and other subsidised routes.  Even with their shorter routes the other Solent ferry operators are unlikely to do badly on this study either.

Similarly some say that cross Solent costs more than eg Dover-Calais.  I would argue that it is not surprising they can offer cheaper prices than us.  The Dover - Calais route carries 15 times the volume of freight that we carry, is a year round business (sourced roughly 50:50 whereas we are 80%mainlander 20%Islander) and runs at much higher occupancy/utilisation.  Freight accounts for over 70 per cent of Dover – Calais volumes whereas it accounts for less than 40 per cent of the volumes on our route.     The total volumes carried on the Dover – Calais route dwarf those on our route, and they also offset lower fares by much higher shopping spend (some £15-£20per head).  At the risk of descending into economic jargon, their route and markets allow for far greater economies of scale than the Solent and the Isle of Wight can offer.

Who should pay?

The rather predictable conclusion I will get to is: providing this amount of ferries to/from the IW for this (relatively small) amount of passengers is expensive – far more expensive than it used to be and someone has to pay!  Logic would suggest that the 3 follow-up questions are:
1. If the price were lower would the increase in volumes lead to increased/maintained revenue?
2. How many ferries should be provided? And:
3. Who should pay? (the user or someone else? – if someone else, presumably a tax payer in London or Berlin, or a shareholder/bank)

It will be quite a long letter as I hope to pick up most of the points both in Mr Beet’s original note and in the comments supplied on VB, and of course suggest an answer to these 3 questions.

Red Jets only break even

Let’s take the Red Jets first as this is a clearer cut simpler situation. The service currently makes about £8m in revenue a year.  The current timetable costs about £8m pa to deliver, meaning the service just about covers its costs including depreciation of the assets used in supplying the service.  The £8m of annual costs does not include any apportionment of the interest we are charged on the debt within the business.

We would suggest that we have some experience at running this type of service, and this, together with all the cost savings we have made over the last 2 years (taking occupancy up from 19% to 30%), mean that it is unlikely that someone else can run this timetable for materially less than us – especially a) with fuel at 55p a litre (when it was 25p 2 years ago), and b) given we need run at very high speed (37+ knots) over 11 miles.  We aren’t saying that we are the best run ferry business, we are saying that it is unlikely that someone else could provide the same service materially more efficiently.

The facts are, that the prices, as shown in the OFT report and on our website here have gone up by less than inflation.  So why is the business only breaking even?  The biggest issue is fuel – these vessels were designed for $30 barrel oil not $100 barrel.  Costs on engine maintenance, which mostly takes place in Europe, have also risen significantly particularly due to exchange rate moves. We have also invested in far more sophisticated safety and quality management standards well above the regulatory minimum.  While we have pursued crewing and landside cost savings (eg through the introduction of ticket machines), the cost economics of the Red Jets are very, very different from when they started operations in the mid 1990’s. 

So why is the price where it is?  Let’s start by assuming the number of passengers remains constant at the current level of 1.1m trips or 0.55m returns – that means the average fare we need to achieve to cover our costs (with the current timetable) is £14.50.

Can Red Jet price to all users come down?

Taking from the questions above:

1.    We could halve the fare to see if the numbers more than double (ie to make revenue go up) – we tried this by bringing our (11 nautical miles 37knots) service to £7.50 return (post 11am) – 50p more than the (3 land miles 20mph) bus from Newport to Cowes return.  We found that initially pax numbers increased (roughly by the amount the fare was cut) to leave us net the same revenue.  After a few months numbers dropped off even at this lower rate to make overall revenue slightly lower than before – so moving the price did not work.
2.    We had already changed the timetable (the old timetable at the new fuel price would have cost more than £8m) to hourly after the commuter period – interestingly this had no effect on numbers, and ended up filling the boats from 19% ‘full’ to 30% ‘full’.
3.    Who should pay if not the user? As noted above, the business is not making any contribution towards the interest we pay to our banks so, short of asking the banks to pay us a subsidy (which I suspect would be a brief conversation!) there is not a lot they can do to reduce the fares.  Moving to the shareholder, it seems unclear to me why any business owner should voluntarily run their business at a loss because its customers have asked them to – look at the current milk farmers! Obviously any business (restaurant, farm, airline, ferry) running at a loss for long will close – either just for the quiet times or totally.

Despite the success of CalMac in Scotland, it is hard to argue the taxpayers in Basingstoke, Manchester or Berlin should be paying.  There is little point in asking IWC to pay as they would have to raise the money from Islanders anyway – and yet Islanders only make up half of the traffic on the Red Jets. Therefore it seems to me that there is no one else but the user to pay.

We need to work with you users to ensure that the amount of sailings provided is only what you need or value, as clearly you shouldn’t be asked to pay for something you don’t need or value.  By careful analysis of the market, including changes made over the last 2 years, we think we are now providing the right timetable that meets this need, but we are always willing to listen and hopefully this letter will provide further insight into your needs.

Red Jet pricing between different users

The final question is: which users should pay what amount all to ensure the total adds up to the £8m that the timetable costs?  One option would be for everyone to pay £14.50.  However we think it is not fair for students (£9), children(£7), senior citizens(£9), hospital patients (some free) and even commuters (about £9 per working day for annual pass) all to pay this amount – so the average is £14.50 but we put in rules to charge more than this to some types of customer and less for others.  It makes no real difference to us, provided either: the total adds up to £8m, or: the consensus of customers tells us to provide a smaller service which would then cost less than £8m.

To fund these discounts to the groups mentioned above, the off peak payers pay about the par price of £15 and everyone else pays about £20-£25.  We also give Islanders more favourable rules, but have to be careful not to be seen to discriminate against Mainlanders and tourists (the latter would not impress IW hoteliers!).  If we chose to give a new discount to anyone else (of the current traffic), we would have to fund it (to balance the books) by asking the current £20 payers to pay more.

That is the core pricing structure which we think is about fair between different groups.

In conclusion, because the average price achieves breakeven, and recent growth attempts have been broadly neutral, the only way that we could get some groups on the Red Jet to pay less than they currently pay, is if we can ask other groups to fund it by paying more (not an easy ask!).

The saviour for the future on the Red Jet side will be renewed growth in the IW economy, and new technology or lower fuel prices – a material change in either could lead to pricing going up slower than inflation.

Vehicle ferries and Red Funnel overall

Hopefully that covers the Red Jets, let’s now move towards the car ferries, where I will make comments about Red Funnel, but I suspect they may have some relevance to other Solent ferry companies.

I will cover ‘fluid’ pricing, length-of-stay based pricing, price competition and returns made by ferry companies versus debt held, which are the main points that came up on the VB.

Debt at time of acquisition back in the boom

Taking first the point of debt and prices paid for acquisitions, I would argue the price paid for the business and whether it was funded by debt or equity (ie shareholders’ cash) is not relevant to current and future pricing of ferry tickets.  The prices paid for these types of business were driven by the strong asset price inflation at the time (just like the house market) itself driven by cheap and easy money (back in the boom).

In our particular instance, much of the business case was based on us delivering strong volume growth for the IW, which has been impacted/delayed by the economic downturn.  Many of these businesses have not performed to expectations of pre-crash, but I very much doubt whether they (and certainly not we) have been pressurised to put prices up artificially just to meet obligations to banks, nor have these businesses been forced to go bust/stop trading.  Indeed there are numerous examples where banks/shareholders have had to share in the pain of these mismatched expectations by writing down the value of their investments/putting new money in.

Going for volume not price

While every private business is tasked by its owners to maximise revenue all of the time, price is only one of the contributors to revenue.  Volume is by far and away the more important part.

In our car ferry market we are constrained from increasing price from 3 avenues:
1.    we want to attract new passenger growth, so need to keep price growth low,
2.    we are operating in a fiercely competitive market cross-Solent (as seen not least by the sharp swings in market share over the last few years).  You say that sometimes prices are similar, but any business (restaurant, market stall, garage, high street retailer, supermarket) will look at its competitors’ pricing (which are of course publically on show), and try ‘not to be beaten on price’ unless it feels it is operating a superior service – every day we use price , promotion and quality to gain a lead on our competitors, and presumably they do the same.  
3.    we take our social  responsibility seriously and try to ensure prices do not grow faster than inflation over the medium term, (unless external costs like fuel grow out of control in which case we will have to pass them on whilst looking for cost savings across the business).

Unlike the Red Jet business, the car ferry business does make a modest financial return on the capital required to buy/replace vessels and ports (again this is pre-interest return so it is unaffected by (ie before subtracting) the debt issue).  The OFT study covered this and described the return as ‘not excessive’.  As mentioned above the return is principally driven by encouraging people to take holidays on the IW (80% of the car ferry traffic are mainlanders and RF spend over £1m pa marketing to mainlanders to come on holiday here – through sites like myisleofwight.com).

So again it is down to how many sailings are required/customers willing to pay for?  Again we think we have got the balance about right, although we lose money in the first and fourth quarters of the year.  In fact if it were not for the holiday traffic, we wouldn’t be able to run anything like the current timetable - on pure economic grounds alone, outside the holiday season we would only run morning freight runs!

Car ferry pricing and pricing between different users/tickets

The starting point for overall pricing is based on 2 things – first, like the Red Jets, the cost to deliver the required timetable and second the cost to the family of getting to the IW versus competing self-drive holiday destinations like Cornwall, Scotland, Brittany etc (and also being mindful of the cost of package tours to the Med or a cruise).  Interestingly, on the car ferry side, we tend to compare well when fuel is high, as the relative cost of getting to the IW, versus the cost of driving to Cornwall, increases less fast.

Keeping freight aside, which is fiercely price competitive and about 40 per cent by volume of our business (25 per cent of our revenues), the rest of the car ferry business is, as mentioned 80% mainland orientated.  Given the difficulties of discriminating price policies between mainlanders and Islanders, our primary pricing approach is geared to this market.  If we smooth out the whole year our average price is about £60 return for a car – which works out at £15pp for a family of 4 (or even a tenner for a family of 6).  Yes we know that some cars have only 1 driver, but the majority have more, and several years ago the industry responded to this declared need by moving to per-car not per-passenger pricing.

We could have just this one price all year round, and some of these posts argue for just that.  However the effect would be that we have no day returns (£60 is a bit steep to go just for the day to/from the IW unless it is in high summer with lots going on), no business in winter weekends, no business mid-week (except freight and business) and nothing at all in the evenings/nights, yet we need to average this price (with current levels of traffic – which we would not get!) to deliver the timetable.  The visitor attractions would all have to close, and the hotels would lose all the offseason short break business they have worked so hard to build up, and at £60 return, Islanders would dramatically reduce their travel patterns except for peak summer, and eventually you would end up with a cheaper but freight-early-morning-only 365 day service  and then a summer holidays service.

Correspondingly on summer weekends and at festival there would be queues half way up to the M3 and all the way way back to Newport, meaning the price, except for those lucky enough to be able to get onto the boat, in the middle of the day on a Fri, Sat or Mon would be £infinity – i.e. the boat is sold out (which is surely the worst price of all!).  You may say why not put extra boats on? but it’s not so easy – there are no vehicle ferries available for charter for just the month of July/August (and any ferry would need to go through big mechanical modifications/MCA approvals anyway to operate in our waters and fit our berth), and you would never build a 4th car ferry (at £20-£25m) if you were only going to use if for about 50 hours (5 hours a day for about 10 days) a year.  And the landside infrastructure challenges would remain.

This problem is one the airlines have also considered and the solution has been yield management (also called fluid pricing or demand management).  What it says is that you have a whole range of prices which are higher when demand is likely to be high and low when low.  Essentially we are sending price signals to try to encourage some to move to less busy times of the day/week/year.  It is all done completely transparently and potential customers are encouraged to look at all sailings over the period with different prices – it also rewards those who are prepared to commit early.  Whilst average prices are around £60 a return crossing, for the vast majority of the year you can cross for about £30, but in peak, peak summer Saturday, middle of day, last minute it can go well over £100.  It gives the passenger a better experience as it tries to persuade them onto less busy sailings, which are far more comfortable, and makes the chance of a sell-out less likely.  The good news is that Islanders (eg at Festival, or on Friday nights) are often moving in the opposite direction, and the prices will be completely different to match the different levels of business.  It can be cheaper to stay an extra night in a hotel than travel at the same time as the rush!

Like us, in the internet age the airlines have moved away from pricing based on where you live.  It is much harder, even if you wanted to, to discriminate according to where you live when you use e-tickets and are not sending tickets by mail – especially when both ends use the same currency.

However, the one thing that the airlines have moved (partially) towards, but we ferries haven’t yet is pricing irrespective of length of stay (ie same price if you go for a half-day or for a month).  This is probably because most airlines are not trying to sell cheap non-business day returns to the leisure market, and so they don’t need to be able to discount below the overnight  (what we call short-break) fare.  We still do charge more for ‘period returns’ ie more than 5 nights, as we feel it is easier to offset the cost of the ferry over the holiday when you are away for a week or more, but this may change.  What we don’t want to do is to have to stop being able to offer cheap day returns, primarily to drum up last minute extra business.  These fares are also much used by Island business drivers.

Interestingly cheap day returns to drum up new business can have the unintended effect of hurting your peak ‘extended stay’ business, as it may well be cheaper to buy 2 cheap day returns rather than 1 extended stay.  If these two segments were completely separate, you would be able to price a cheap day return (or a single!) at less than half of a period return, but, as the IWCP letter showed, the markets are not separate and passengers may, not unreasonably, choose to buy 2 day returns a week apart with the intention of not turning up for the 2 return legs.  Unfortunately the only way to stop this is to keep the cheap day return prices high (during the extended stay summer season, particularly on weekends/changeover day), which is a shame as whilst the hoteliers may be pleased, the attraction owners and Islanders will not, as they enjoy using low cheap day returns!

Wrapping it all up - user pays, and we believe the prices between different users are fair and sensible

So in conclusion, the Red Jet business is priced to raise enough money to pay for the timetable that (we believe and have tested) Islanders want.  We try to make the different prices between different groups as fair as possible, but if one goes down another will have to go up (until there is general growth in the market).  On both parts of the business, the levels of debt have no bearing on prices (the debt levels are to do with asset prices back in 2007 and many companies have changed debt levels since then).  In both parts of the business, prices are moving broadly in line with or are lower than inflation.  Revenue growth is more likely to come from volume growth to and from the IW, not from (above inflation) price increases.

The car ferry does better than the Red Jet financially, and it uses fluid pricing to try to avoid sell-outs.  It competes strongly on price and quality, and tries to offer discounts to people prepared to travel outside busy hours, but it still needs to raise enough revenue to pay for the existing timetable.  Whilst marketing is primarily targeted at mainland families (which benefits the Island tourism industry), Islanders benefit from having far more sailings than could be justified by Island demand alone, and if they are lucky enough to have any flexibility on timing, they can pick the cheaper, quieter sailings.  They receive various volume/loyalty discounts and IW targeted offers which also help.

I hope that I have managed to shed some light on how we work and why we operate the business the way we do.  We think it is using ‘user pays’ in as fair a way as possible to pay for the timetable demanded.  As ever, I look forward to hearing your comments and observations.

Yours sincerely

James Fulford
CEO Red Funnel
First published 03-August-2012

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